MKS Instruments, Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018. Unless otherwise noted, financial amounts below are in U.S. dollars and millions. The company supplies instruments, subsystems, process-control solutions and related services to semiconductor and other advanced-manufacturing markets through its Vacuum & Analysis and Light & Motion segments.
Financial performance
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Net revenue | $554.3 | $437.2 | +26.8% |
| Gross profit / margin | $262.9 / 47.4% | $205.5 / 47.0% | Margin +0.4 points |
| Operating income / margin | $131.6 / 23.7% | $83.6 / 19.1% | +57.5% |
| Net income | $105.1 | $65.1 | +61.6% |
| Diluted EPS | $1.90 | $1.18 | +61.0% |
| Operating cash flow | $72.8 | $66.1 | +$6.7 |
| Capital expenditures | $9.4 | $4.1 | +$5.3 |
Product revenue was $496.7 million and service revenue $57.6 million. Revenue growth reflected increases in both semiconductor and other advanced markets. Vacuum & Analysis revenue rose to $348.3 million from $278.0 million; Light & Motion rose to $205.9 million from $159.2 million. Semiconductor-related customers generated approximately 57% of revenue in both periods.
Cash and cash equivalents, restricted cash and short-term investments totaled $541.5 million at quarter-end, versus $543.3 million at December 31, 2017. Current assets were $1,308.0 million and current liabilities $291.0 million. Total debt was approximately $346.7 million, comprising $341.3 million of long-term debt and $5.5 million of short-term debt; the term-loan principal balance was $348.5 million before unamortized fees and discount. The company prepaid $50 million of term-loan principal during the quarter. It reported compliance with debt covenants and no scheduled term-loan principal payments before maturity following prior prepayments.
Operating cash flow included significant working-capital investment: receivables increased $37.3 million and inventory $28.2 million, while accrued compensation declined $32.5 million, primarily as year-end bonuses were paid. Financing cash outflow was $67.1 million, including the $50.0 million debt repayment and $9.8 million of dividends. Investing cash outflow was $0.6 million. Cash and investments provide substantial liquidity relative to reported debt.
Material changes and comparability
- Revenue increased $117.1 million year over year. Semiconductor revenue rose $65.0 million, while revenue from other advanced markets rose $52.1 million, primarily reflecting industrial technologies and life and health sciences.
- Gross margin improved 0.4 percentage points overall. Light & Motion margin rose to 50.7% from 48.1%, while Vacuum & Analysis declined to 45.5% from 46.4%. Management attributed the latter decrease to unfavorable product mix and material costs, including a non-recurring material-cost credit in the 2017 period.
- Operating margin improved to 23.7% from 19.1%. Lower amortization and interest expense, and the absence of 2017 acquisition and integration costs, contributed; SG&A, R&D, restructuring and environmental expenses increased.
- The company adopted ASC 606 using the modified retrospective method on January 1, 2018, recording a $1.8 million increase to opening retained earnings. Management said the effect on Q1 revenue was immaterial. The 2017 comparison follows the prior revenue standard. Spare-parts revenue and associated costs were also reclassified from products to services in the comparative period, with no effect on total revenue or cost of revenue.
Outlook, risks and unusual items
- The filing gives no specific numerical revenue, earnings or margin guidance. Management said it expects continued significant R&D investment and noted semiconductor capital-equipment demand can shift rapidly and future demand or industry weakness is difficult to predict.
- On April 11, 2018, after quarter-end, the company repriced its term loan, reducing the LIBOR margin to 1.75% (with a 0.75% floor). The term loan’s March 31 interest rate was 3.648%. The company had also fixed the rate on a portion of the borrowing through a swap expiring in September 2020.
- Q1 included $1.0 million of environmental costs related to an EPA-designated Superfund site acquired with Newport, and $1.2 million of restructuring charges, primarily administrative-function severance. The company also recorded a $790,000 tax benefit related to provisional Tax Cuts and Jobs Act estimates; management said future tax adjustments could be material while the accounting remained incomplete.
- The effective tax rate was 17.1%, versus 15.8% a year earlier. A new IRS audit of Newport for tax year 2015 was scheduled; the IRS examination of the company’s 2015–2016 federal filings was effectively settled during the quarter without material impact.
- Two customers, LAM Research and Applied Materials, represented 12.6% and 12.2% of revenue, respectively. International sales were approximately 50% of revenue. These concentrations expose results to customer, semiconductor-cycle, geographic and foreign-exchange risks.
- A shareholder lawsuit concerning Newport’s acquisition continued against certain former Newport directors; MKS and Newport had been dismissed from the action. MKS received a third-party subpoena in April 2018. Management said ordinary-course legal matters were not expected to have a material adverse effect.
Important facts for investors to verify
- Whether semiconductor and advanced-market demand, customer concentration and the pace of growth remain sustainable.
- Whether working-capital needs, especially receivables and inventory, convert into cash as activity expands.
- The effect of the April 2018 loan repricing on subsequent interest expense and the company’s debt-repayment plans.
- Final Tax Act accounting, potential changes to the effective tax rate, and outcomes of open tax examinations and uncertain tax positions.
- Potential environmental liabilities and developments from the Newport-related litigation and subpoena.