MKS Instruments, Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018. Unaudited; dollar amounts below are in millions unless stated otherwise.
Business context
MKS supplies instruments, subsystems, process-control solutions and related services to semiconductor equipment makers and other advanced-manufacturing markets. Its reportable segments are Vacuum & Analysis and Light & Motion. Semiconductor-related customers accounted for 56% of nine-month revenue, down from 58% a year earlier.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $487.2 | $486.3 | $1,614.6 | $1,404.2 |
| Gross profit / margin | $231.9 / 47.6% | $228.0 / 46.9% | $769.6 / 47.7% | $653.1 / 46.5% |
| Operating income / margin | $117.0 / 24.1% | $110.2 / 22.6% | $400.0 / 24.9% | $286.6 / 20.4% |
| Net income | $93.3 | $76.0 | $321.3 | $261.5 |
| Diluted EPS | $1.70 | $1.38 | $5.82 | $4.75 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $278.3 | $274.4 |
- Q3 revenue was nearly flat year over year; nine-month revenue increased about 15%. Nine-month net income rose about 23%, while operating income increased about 40%.
- Q3 segment revenue: Vacuum & Analysis $286.0 million, down from $308.3 million; Light & Motion $201.1 million, up from $178.0 million. Nine-month revenue grew in both segments.
- Cash and cash equivalents, including restricted cash, were $399.9 million; short-term investments were $219.8 million. Together, these totaled $619.6 million, compared with $543.3 million at year-end 2017.
- Term-loan principal was $348.5 million at 3.8% interest; balance-sheet long-term debt, net of fees, was $343.0 million, plus $6.1 million short-term debt. The company reported compliance with loan covenants and no scheduled term-loan principal payments required before maturity.
- Current assets were $1,412.5 million and current liabilities $262.5 million. Inventory increased to $399.1 million from $339.1 million at year-end.
Changes, drivers and unusual items
- Q3 semiconductor revenue declined year over year, primarily from lower customer volumes, while advanced-market revenue increased 11%, led by industrial technologies. For the nine months, both semiconductor and advanced-market revenue increased.
- Management said semiconductor capital-equipment spending was moderating and expected the effect to continue into Q4. It gave no numerical revenue or earnings guidance.
- Q3 gross margin improved 0.7 percentage points. Product margin benefited from favorable mix; service margin fell 3.6 points, primarily due to material costs and unfavorable mix. Nine-month margin improved 1.2 points.
- Nine-month operating cash flow was broadly unchanged despite higher earnings, with a $142.1 million working-capital increase, including $80.4 million absorbed by inventory growth.
- Interest expense declined year over year following term-loan prepayments and repricing. The 2017 nine-month comparison included a $74.9 million gain on the sale of the Data Analytics Solutions business; 2018 had no such gain.
- Q3 restructuring charges were $1.4 million, mainly severance; nine-month restructuring charges were $3.4 million. The company also recorded $1.0 million of environmental costs in Q1 related to a Superfund site acquired with Newport.
- The company repurchased 818,131 shares for $75.0 million in the nine months and paid $0.58 per share in dividends. The board declared a further $0.20-per-share dividend after quarter-end.
- ASC 606 was adopted January 1, 2018 using the modified retrospective method, increasing opening retained earnings by $1.8 million; management said its Q3 revenue impact was immaterial. 2017 comparative results were prepared under the prior revenue standard.
Outlook, risks and contingencies
- On October 29, 2018, MKS agreed to acquire Electro Scientific Industries for approximately $1.0 billion cash, funded with cash on hand and up to $650 million of committed term-loan financing. Closing was expected in Q1 2019, subject to customary conditions, including regulatory and ESI shareholder approvals; the agreement has no financing condition.
- MKS also signed a commitment letter for a $100 million asset-based revolving facility to replace its existing $50 million facility.
- Management identified proposed additional U.S.-China tariffs as a potential material risk to products made in China and components sourced there. The company said it would consider alternative sourcing, operational changes and price increases if needed.
- Income-tax accounting under the Tax Cuts and Jobs Act remained provisional. Q3 included a $0.9 million tax expense adjustment; gross unrecognized tax benefits were $32.5 million. A Newport 2015 tax audit was underway, with no issues identified at the filing date.
- A shareholder class action concerning the Newport merger remained in discovery. MKS and Newport had been dismissed as defendants; management did not expect ordinary-course legal matters to materially affect results, financial condition or cash flows.
- The company cited semiconductor demand shifts, customer and product-design wins, international exposure, foreign-exchange movements, and tax-law interpretation as risks. Two customers each exceeded 10% of nine-month revenue: Applied Materials (13%) and Lam Research (11%).
Important facts for investors to verify
- Whether semiconductor spending and MKS revenue trends weakened further in Q4, and how much advanced-market growth offsets that exposure.
- Inventory levels, cash conversion and receivables as demand changes; nine-month operating cash flow was supported by earnings but constrained by working capital.
- Final ESI transaction terms, regulatory and shareholder approvals, financing, closing timing and the resulting debt and integration burden.
- Final Tax Act estimates, the outcome of tax examinations and changes in unrecognized tax benefits.
- Potential effects of additional tariffs, customer concentration and the remaining Newport shareholder litigation.