MKS Instruments, Inc. — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016. Unaudited results; amounts below are in millions of dollars unless otherwise noted.
Business context and reporting period
MKS supplies instruments, subsystems and process-control solutions for advanced manufacturing, including semiconductor, industrial, life-sciences and research markets. On April 29, 2016, MKS completed its acquisition of Newport Corporation for approximately $1.01 billion, including repayment of Newport debt. Newport’s results are included from the acquisition date and form the new Light & Motion Division, so reported year-over-year growth is substantially acquisition-driven.
Key financial metrics
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $380.7 | $209.3 | $890.2 | $641.1 |
| Gross profit | $168.4 | $94.2 | $382.2 | $290.1 |
| Gross margin | 44.2% | 45.0% | 42.9% | 45.2% |
| Operating income | $53.0 | $41.4 | $94.8 | $134.4 |
| Operating margin | 13.9% | 19.8% | 10.6% | 21.0% |
| Net income | $32.5 | $29.8 | $59.3 | $96.8 |
| Diluted EPS | $0.60 | $0.56 | $1.10 | $1.81 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $127.4 | $95.6 |
- Q3 revenue increased 81.8%; nine-month revenue increased 38.9%. The Newport acquisition contributed $151.5 of Q3 revenue and $270.0 for the post-acquisition portion of the nine-month period.
- Q3 net income rose 9.3%, while nine-month net income fell 38.7%. The nine-month comparisons reflect the acquisition, higher amortization and acquisition-related costs, and increased interest expense.
- For the nine months, operating cash flow was $127.4; investing cash flow was negative $581.4, mainly reflecting the Newport acquisition; financing cash flow was positive $601.7, largely from term-loan proceeds.
- At September 30, cash and cash equivalents were $366.9, short-term investments $53.1, and restricted cash $5.9. Cash plus short-term investments, excluding restricted cash, totaled $420.0, down from $658.2 at December 31, 2015. Current assets were $1,002.3 and current liabilities $230.4.
- Term-loan principal outstanding was $668.2; balance-sheet debt, including current maturities and net of certain financing costs, was about $650.6. The $50.0 million ABL facility was undrawn. MKS reported compliance with its debt covenants.
- Q3 and nine-month dividends were $0.17 per share per quarter and $0.51 per share cumulatively, respectively. A further $0.17 quarterly dividend was declared for payment in December 2016.
Material changes versus comparable periods
- Newport added the Light & Motion Division and broadened MKS into photonics, optics and lasers. Q3 Light & Motion revenue was $151.5; legacy Vacuum & Analysis revenue increased 9.5% to $229.2. For the nine months, Vacuum & Analysis revenue declined 3.3% to $620.2.
- Product gross margin declined 1.5 percentage points in Q3 and 2.8 points for the nine months. Newport inventory fair-value step-up charges were $5.0 in Q3 and $15.1 for the nine months. Reported Q3 gross margin was 44.2%; excluding the step-up charge, Light & Motion’s Q3 gross margin was 45.6%.
- Q3 operating income increased, but operating margin fell to 13.9% from 19.8%, with higher SG&A and intangible amortization. Nine-month operating income declined despite higher revenue.
- Interest and other expense was $10.8 in Q3 and $16.3 for the nine months, compared with income in the prior-year periods; the increase was primarily related to acquisition financing.
- Unaudited pro forma results, assuming Newport had been acquired January 1, 2015, show nine-month revenue of $1,070.5 versus $1,090.6 and net income of $65.3 versus $48.2. These figures are not a forecast and are not necessarily indicative of actual combined results.
Outlook, commentary, risks and unusual items
- No numerical revenue or earnings guidance is provided. Management said semiconductor demand shifts are difficult to predict and future demand or industry weakness is uncertain. It expects R&D investment to remain significant and said product selection for future customer equipment generations is important to results.
- Semiconductor-related customers accounted for approximately 58% of nine-month revenue, versus 70% a year earlier; management estimated this could be approximately 50% of sales in future periods following Newport. Other advanced-market revenue is exposed to project timing and weakness in legacy general industrial and solar markets.
- Acquisition-related items include $10.9 of acquisition costs for the nine months, higher amortization, inventory step-up charges and Newport executive severance-related compensation costs. Purchase accounting remained preliminary; later measurement-period adjustments could be material.
- Debt is primarily floating-rate, although an interest-rate swap fixed the rate on $335.0 of term-loan principal at 4.70% through September 2020. MKS estimated a 10% interest-rate change would alter annual interest expense by approximately $1.4.
- Two consolidated Newport shareholder lawsuits were amended into a single action in October 2016 seeking monetary damages related to the merger. MKS disputed the claims and said it would defend vigorously; it did not expect the legal matters to have a material adverse effect.
- Gross unrecognized tax benefits were approximately $30.6 at September 30, up primarily because of Newport. Contractual purchase obligations totaled $205.5; operating lease obligations totaled $70.4.
Most important facts for investors to verify
- How much reported revenue and earnings growth reflects Newport versus organic performance, especially in the legacy Vacuum & Analysis business.
- Whether Newport integration, purchase-accounting adjustments, inventory step-up charges and amortization affect margins or earnings beyond the periods disclosed.
- Debt repayment pace, interest costs, covenant compliance and the company’s capacity to sustain dividends alongside acquisition-related obligations.
- Trends in semiconductor demand, customer concentration, and the general industrial and solar markets; also monitor receivables and working-capital conversion.
- Outcome and potential financial exposure from the Newport shareholder litigation and uncertain tax positions.