MKS Instruments, Inc. — Q2 2018 Form 10-Q
Business context and reporting period. Global supplier of instruments, subsystems and process-control solutions, with Vacuum & Analysis and Light & Motion segments serving semiconductor, industrial, life-science, research and defense markets. This unaudited filing covers the quarter and six months ended June 30, 2018; comparisons are with the corresponding 2017 periods. Amounts below are in U.S. dollars; financial statement figures are presented in millions unless stated otherwise.
Financial performance and position
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Revenue | $573.1 | $480.8 | $1,127.4 | $917.9 |
| Gross profit / margin | $274.9 / 48.0% | $219.6 / 45.7% | $537.7 / 47.7% | $425.1 / 46.3% |
| Operating income / margin | $151.3 / 26.4% | $92.9 / 19.3% | $282.9 / 25.1% | $176.5 / 19.2% |
| Net income | $122.9 | $120.4 | $228.0 | $185.5 |
| Diluted EPS | $2.22 | $2.19 | $4.12 | $3.37 |
| Operating cash flow | Not separately stated | Not separately stated | $182.4 | $175.5 |
- Q2 revenue rose 19.2% year over year; first-half revenue rose 22.8%. Q2 revenue included $510.0 million of products and $63.1 million of services.
- Both segments grew: Q2 Vacuum & Analysis revenue was $368.3 million, up from $310.0 million; Light & Motion was $204.8 million, up from $170.8 million. First-half segment revenue was $716.7 million and $410.7 million, respectively.
- First-half operating cash flow increased to $182.4 million. Working capital consumed cash, notably inventory ($59.5 million) and receivables ($42.5 million); capital expenditures were $21.8 million.
- At June 30, cash and cash equivalents, including restricted cash, were $427.4 million; short-term investments were $203.7 million. Combined cash and short-term investments were $631.1 million, versus $543.3 million at year-end 2017.
- Debt included $342.1 million of long-term debt, net, and $12.5 million of short-term debt. Term-loan principal was $348.5 million; its stated interest rate was 3.7%. The company had prepaid $425.0 million of principal since the facility began and reported covenant compliance. Its $50 million asset-based revolver was undrawn.
- Q2 dividends were $0.20 per share; first-half dividends totaled $0.38 per share. The board declared another $0.20 quarterly dividend on July 30, 2018.
Material changes versus prior comparable periods
- Q2 gross margin increased 2.3 percentage points and operating margin increased 7.1 points. Management attributed gross-margin improvement mainly to higher volumes, with favorable product mix helping Light & Motion; Vacuum & Analysis had some unfavorable mix offset.
- Q2 net income increased only 2.0% despite strong operating growth, while pretax income fell to $148.5 million from $158.0 million. The prior-year quarter included a $74.9 million gain on sale of the Data Analytics Solutions business; there was no comparable gain in 2018. The 2017 sale also boosted first-half earnings comparisons.
- First-half interest expense declined to $9.4 million from $15.8 million, primarily reflecting debt prepayments and loan repricing. April 2018 repricing reduced the term-loan LIBOR margin to 1.75%.
- First-half revenue growth reflected increases in semiconductor-related sales and other advanced markets, particularly industrial technologies. Semiconductor revenue represented approximately 58% of first-half revenue in both years; two customers each contributed over 10% of Q2 revenue.
- Inventory rose to $384.9 million from $339.1 million at December 31, 2017; receivables rose to $340.0 million from $300.3 million. These increases contributed to working-capital cash use.
Outlook, risks and unusual items
- Management expected near-term moderation in semiconductor capital-equipment spending and a similar moderation in semiconductor revenue in Q3 2018. The filing provides no numerical revenue or earnings guidance and notes that industry demand shifts are difficult to predict.
- Management expects continued significant R&D investment. It identified risks from product-development delays, changing customer requirements, competition and whether its products are selected for future generations of customer equipment.
- The company added a risk concerning U.S.–China trade tensions and proposed additional tariffs. It did not anticipate material impact from the first two rounds, but said further proposed tariffs or retaliation could materially harm results; possible responses include alternative sourcing, price increases or moving production.
- Tax accounting under the 2017 Tax Cuts and Jobs Act remained provisional. Q2 included a $0.7 million tax benefit from revised estimates; future adjustments could be material. The company expected GILTI tax to increase its 2018 effective tax rate by about 1 percentage point. Reported effective tax rates were 17.3% for Q2 and 17.2% for the first half.
- Unrecognized tax benefits were $29.0 million at June 30; the company said about $1.9 million might be recognized within 12 months. An IRS audit of Newport’s 2015 tax year began during Q2.
- A Newport shareholder class action continued against certain former Newport directors; MKS and Newport had been dismissed from the action. Management stated ordinary-course legal matters were not expected to have a material adverse effect.
- Other notable items: $2.0 million of first-half restructuring costs, $1.0 million of environmental costs related to a Superfund site acquired with Newport, and adoption of ASC 606, which increased opening retained earnings by $1.8 million and had an immaterial Q2 revenue impact. Management said lease-standard implementation was underway; the financial impact was not yet known.
Important facts for investors to verify
- Whether semiconductor demand and revenue did moderate in Q3 as management expected, and how broad-based growth remained across non-semiconductor markets.
- Whether receivables and inventory growth converted into cash, and the associated effects on operating cash flow and inventory provisions.
- How much of reported earnings growth reflects operating performance versus the prior-year business-sale gain and changing tax estimates.
- Final tax effects of the Tax Act, including GILTI, transition-tax estimates and the Newport tax audit.
- Potential exposure to additional tariffs or retaliatory trade measures, given the company’s international operations and sourcing.
- Debt repayment, interest-rate exposure, dividend capacity under credit agreements, and the eventual balance-sheet impact of the new lease standard.