MKS Instruments, Inc. — Q3 2015 Form 10-Q
Business context and reporting period. Unaudited results for the quarter and nine months ended September 30, 2015, compared with the corresponding 2014 periods. MKS supplies instruments, subsystems, process-control solutions and related services for advanced manufacturing, particularly semiconductor equipment and device markets. Semiconductor-related customers accounted for about 70% of revenue in both nine-month periods. The company changed its reportable segment structure in 2015; comparative segment figures were recast.
Financial performance
Amounts below are in millions of U.S. dollars except per-share data and percentages.
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Revenue | $209.3 | $186.8 | $641.1 | $577.8 |
| Gross profit / margin | $94.2 / 45.0% | $79.3 / 42.5% | $290.1 / 45.2% | $248.3 / 43.0% |
| Operating income / margin | $41.4 / 19.8% | $28.2 / 15.1% | $134.4 / 21.0% | $96.6 / 16.7% |
| Net income | $29.8 | $29.1 | $96.8 | $81.6 |
| Diluted EPS | $0.56 | $0.55 | $1.81 | $1.52 |
| Operating cash flow | Not separately stated for the quarter | $95.6 | $67.7 |
- Q3 revenue rose 12.1% year over year: product revenue increased 13.2% and service revenue 5.7%. Nine-month revenue rose 11.0%.
- Q3 gross margin improved 2.5 percentage points, principally from higher volumes and product mix; product margin gains included the effect of the Granville-Phillips inventory step-up amortization. Operating margin also expanded.
- Q3 net income grew only 2.2% despite higher operating income, as the tax comparison was unfavorable: Q3 2015 tax provision was $12.3 million versus a $0.6 million tax benefit in Q3 2014. Effective tax rates were 29.3% and (2.0%), respectively; 2014 benefited from discrete tax-reserve releases and other tax items.
- Nine-month capital expenditures were $8.8 million. Operating cash flow less capital expenditures was approximately $86.7 million (calculated). Investing activities used $170.3 million, largely reflecting net investment purchases, the Precisive acquisition and capital expenditures; financing activities used $35.7 million, mainly dividends and share repurchases.
Balance sheet, liquidity and capital allocation
- At September 30, 2015, cash and cash equivalents were $195.1 million and short-term investments were $196.8 million, totaling $392.0 million. This compared with $435.0 million at December 31, 2014. Long-term investments were a further $240.9 million.
- Total current assets were $719.4 million and current liabilities $107.6 million. Stockholders’ equity was $1,146.7 million.
- No borrowings were outstanding at quarter-end. A Japanese subsidiary had revolving/short-term credit arrangements with aggregate capacity equivalent to $19.2 million; these arrangements generally renew every three months.
- Nine-month dividends totaled $26.9 million; the board declared a further $0.17-per-share dividend payable in December 2015. MKS repurchased approximately 244,000 shares for $8.9 million during the nine months, with $153.9 million remaining under its authorized program at September 30.
Changes, outlook, risks and unusual items
- Management reported Q3 revenue was 7% lower sequentially than Q2, ending three quarters of sequential growth. Following recent semiconductor-equipment capital-spending reductions, it anticipated Q4 2015 revenue could be below Q3; no specific revenue guidance was provided.
- Nine-month semiconductor-related customer revenue increased 11% year over year; other advanced-market revenue increased 10%, with growth attributed particularly to solar, data storage and analysis metrology. Management noted eight consecutive quarters of growth in other advanced markets.
- Two customers each represented more than 10% of Q3 revenue: 18% and 16%. International revenue was about 43% of nine-month revenue. Semiconductor demand volatility, customer concentration, foreign-exchange movements and product-design wins are material business risks.
- Precisive was acquired March 17, 2015 for $12.1 million net of acquired cash, including a deferred $2.6 million indemnification-related payment. Its post-acquisition revenue and earnings were immaterial. Nine-month restructuring charges were $1.6 million, principally for workforce reductions and foreign manufacturing consolidation/outsourcing.
- Gross unrecognized tax benefits were approximately $19.7 million at quarter-end. The IRS began examining 2011–2013 federal tax filings in 2015; management said it had adequately provided for tax positions but acknowledged outcomes could differ. Management expected no tax-rate effect from writing off a fully reserved $20.5 million capital-loss deferred tax asset in Q4.
- Management said ordinary-course legal proceedings were not expected to have a material adverse effect. No material changes to previously disclosed risk factors or market-risk exposure were reported. Disclosure controls were assessed as effective, with no material quarterly change in internal control over financial reporting.
Most important facts for investors to verify
- Whether semiconductor capital-spending reductions translate into the anticipated Q4 revenue decline, and how subsequent orders and bookings develop.
- How much of reported growth and margin improvement is sustained by volumes and mix versus acquisition accounting, currency effects and other period-specific factors.
- Cash-flow conversion and working-capital demands, particularly inventory growth; nine-month inventory increased by $25.2 million in operating cash-flow reconciliation.
- Customer concentration, international exposure and the implications of foreign cash balances: management said $207.3 million of cash and short-term investments was held by foreign subsidiaries and substantially all would be subject to U.S. tax if repatriated.
- Tax examination developments, the resolution of unrecognized tax benefits, and the ultimate purchase-accounting and integration contribution from Precisive.