MKS Instruments, Inc. — Q3 2013 Form 10-Q
Business context and reporting period. MKS supplies instruments, subsystems, and process-control products and services for semiconductor and other advanced manufacturing markets. This unaudited filing covers the quarter and nine months ended September 30, 2013, compared with the same periods in 2012. Semiconductor-related customers accounted for approximately 66% of revenue in the first nine months of 2013.
Financial performance
Amounts below are in millions of dollars except per-share data.
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Revenue | $166.5 | $141.4 | $465.0 | $509.7 |
| Gross profit | $62.2 | $56.6 | $178.9 | $216.9 |
| Gross margin | 37.4% | 40.0% | 38.5% | 42.5% |
| Operating income | $12.3 | $6.4 | $27.4 | $67.6 |
| Net income | $2.5 | $2.6 | $15.5 | $43.9 |
| Diluted EPS | $0.05 | $0.05 | $0.29 | $0.82 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $41.8 | $113.8 |
- Q3 revenue increased 17.7% year over year, led by higher product sales; nine-month revenue declined 8.8%.
- Nine-month product revenue fell 9.1%, while service revenue declined 7.0%. Q3 product revenue rose 22.0%; service revenue was nearly flat.
- Nine-month operating income and net income fell substantially despite the Q3 revenue rebound. Q3 operating income increased from the prior year, which included a $5.3 million litigation settlement charge.
- Product gross margin declined 3.2 percentage points in Q3 and 4.1 points for the nine-month period. Management cited excess and obsolete inventory charges, product mix, and, for the year-to-date period, lower volumes. Q3 inventory charges were particularly associated with a solar-market product.
Liquidity, cash flow, and debt
- At September 30, 2013, cash and cash equivalents were $254.8 million and short-term investments were $365.9 million; combined, $620.7 million, versus $615.2 million at December 31, 2012. Long-term investments were $5.2 million.
- Nine-month operating cash flow was $41.8 million, down from $113.8 million. The filing attributes 2013 cash generation to net income and noncash charges, partly offset by working-capital investment, including increases in receivables and inventory.
- Nine-month investing cash outflow was $42.7 million, including net investment purchases, $9.2 million of capital expenditures, and $2.3 million for the Alter acquisition. Financing cash outflow was $30.7 million, principally dividends.
- No borrowings were outstanding at quarter-end. A Japanese subsidiary had available credit lines of up to approximately $23.3 million; acquired-company borrowing arrangements had been repaid and terminated.
- Current assets were $893.6 million and current liabilities were $96.2 million. Management said U.S. cash and short-term investments were adequate for expected domestic operating needs and potential dividends or repurchases.
Changes, outlook, risks, and unusual items
- Management reported semiconductor revenue improving sequentially in each of the first three quarters of 2013, with Q3 semiconductor-market product revenue up 41.7% year over year and total semiconductor revenue up 10% sequentially. It cautioned that semiconductor capital-equipment demand shifts are difficult to predict and that the timing and extent of future demand remain uncertain.
- Nine-month revenue from non-semiconductor advanced markets declined 14%; solar revenue fell sharply amid industry oversupply. Excluding solar, those markets declined 6%. The filing gives no formal earnings or revenue guidance.
- The effective tax rate was 80.4% in Q3 and 44.8% for the first nine months, versus 61.3% and 35.7% in the comparable 2012 periods. A key driver was the decision to pay tax at a substantially reduced rate on certain accumulated earnings of an Israeli subsidiary relating to 2002–2011; tax incentives partly offset the charge. Gross unrecognized tax benefits were approximately $45.4 million at quarter-end, excluding interest and penalties.
- The company began restructuring small sales and engineering facilities, with an approximately 27-person headcount reduction and $1.4 million of charges for the first nine months. Completion was expected by December 31, 2013.
- In March, MKS acquired Alter Power Systems for approximately $2.4 million net of cash acquired, expanding microwave-power capabilities and applications.
- MKS corrected a prior-period presentation error: uncertain tax positions had been presented net rather than gross on prior balance sheets. The company concluded the error was not material and did not amend prior filings. The correction increased reported other assets and other liabilities by $17.7 million at December 31, 2012; it did not affect prior-period income statements or cash flows.
- Two customers represented 16.4% and 13.5% of Q3 revenue, respectively. The company also faces exposure to semiconductor-cycle volatility, solar-market weakness, inventory valuation, foreign exchange, and uncertain tax positions. Management said ordinary-course legal matters were not expected to have a material adverse effect.
- The board declared a $0.16-per-share quarterly dividend after quarter-end, payable December 13, 2013, subject to the stated record date. Future dividends remain subject to board approval.
Important facts for investors to verify
- Whether the Q3 semiconductor recovery continued after the reporting date, and how concentrated revenue remains in the two major customers.
- Whether inventory reserves—especially for solar-related products—and product mix continue to pressure gross margins.
- How much of the elevated tax provision is unusual or nonrecurring, and the potential outcome of tax examinations and uncertain tax positions.
- Whether operating cash flow improves as receivables and inventory convert to cash, given its decline from the prior-year period.
- Completion and total cost of the restructuring, and whether the Alter acquisition delivers the expected market expansion.