MKS Instruments, Inc. — Q3 2014 Form 10-Q
Reporting period: Three and nine months ended September 30, 2014. Financial amounts below are in U.S. dollars; millions unless stated otherwise. Comparisons are with the corresponding 2013 periods unless noted.
Business context and reporting period
MKS supplies instruments, subsystems and process-control products and services for semiconductor and other advanced manufacturing markets. Semiconductor capital-equipment and device customers accounted for approximately 70% of revenue in the first nine months of 2014, up from 66% a year earlier. International revenue was approximately 42% of nine-month sales.
On May 30, 2014, MKS acquired Granville-Phillips, a vacuum measurement and control instruments business, for $87 million. Its results are included from the acquisition date; management said pro forma results assuming acquisition on January 1, 2013 would not differ materially from reported nine-month results.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Revenue | $186.8 | $166.5 | $577.8 | $465.0 |
| Gross profit | $79.3 | $62.2 | $248.3 | $178.9 |
| Gross margin | 42.5% | 37.4% | 43.0% | 38.5% |
| Operating income | $28.2 | $12.3 | $96.6 | $27.4 |
| Net income | $29.1 | $2.5 | $81.6 | $15.5 |
| Diluted EPS | $0.55 | $0.05 | $1.52 | $0.29 |
| Operating cash flow | Not presented quarterly | $67.7 | $41.8 |
Q3 product revenue was $158.5 million and service revenue $28.3 million. Product gross margin improved to 43.7% from 37.2%, while service gross margin declined to 35.3% from 38.3%. Operating margin was 15.1% in Q3 and 16.7% for the first nine months.
At September 30, cash and cash equivalents were $295.5 million and short-term investments $140.0 million; together, $435.5 million, versus $589.6 million at year-end 2013. Including $134.7 million of long-term investments, cash and investments totaled $570.2 million. Total assets were $1.217 billion and stockholders’ equity $1.059 billion. There were no borrowings outstanding; a Japanese subsidiary had unused short-term credit lines of up to approximately $21.0 million.
Nine-month investing cash use was $8.7 million, including the $87.0 million GP acquisition, partly offset by investment maturities and sales. Financing cash use was $46.0 million, including $26.1 million of dividends and $20.8 million of share repurchases. Capital expenditures were $9.4 million.
Material changes versus the prior comparable period
- Revenue grew 12.2% in Q3 and 24.3% year to date. Nine-month Advanced Manufacturing Capital Equipment revenue rose 30.6%; the GP acquisition and higher semiconductor-related sales contributed to growth.
- Management attributed higher product margins primarily to increased volume and favorable mix, and to lower excess-and-obsolete inventory charges. The 2013 comparison included a special inventory charge related to a solar-market product.
- Net income increased substantially, but comparisons were affected by income taxes: Q3 2014 included a $0.6 million tax benefit and a negative 2.0% effective tax rate, while Q3 2013 had a 10.1 million tax provision and an 80.4% effective rate. 2014 benefited from releases of tax reserves and foreign tax credits; 2013 included a charge related to accumulated earnings of an Israeli subsidiary.
- Goodwill increased to $193.1 million from $150.9 million and net intangible assets to $48.8 million from $13.1 million, principally reflecting the GP acquisition. Amortization expense also increased.
Outlook, management commentary, risks and unusual items
- Management reported a pause in semiconductor-market spending in Q2 and Q3: semiconductor-related revenue declined from $150 million in Q1 2014 to $127 million in Q2 and $126 million in Q3. It said the timing and extent of future demand or industry weakness were uncertain. No numerical forward guidance is provided in the supplied filing text.
- Other advanced-market revenue increased approximately 12% year to date, with general industrial markets the primary driver. Management reported four consecutive quarters of growth in these markets beginning in Q4 2013.
- Customer concentration is material: two customers represented 30.7% of Q3 revenue and 32.3% of nine-month revenue. Management also noted reliance on semiconductor-industry demand and the risk that products may not be designed into future customer equipment generations.
- Nine-month restructuring charges were $2.0 million, primarily severance associated with a workforce reduction of approximately 111 people. MKS sold a Colorado facility for $1.3 million net of commissions and recorded an immaterial loss.
- Gross unrecognized tax benefits were approximately $32.3 million at September 30, 2014; tax examinations, uncertain tax positions and future tax-rate changes could affect results. Management said ordinary-course legal proceedings were not expected to have a material adverse effect. The filing reported no material change in risk factors or market-risk exposure and no material change in internal control over financial reporting.
- MKS was evaluating the effect and transition method for the new revenue-recognition standard; it had not determined the impact. The new going-concern disclosure standard was not expected to affect its financial statements or disclosures.
Important facts for investors to verify
- Whether semiconductor demand stabilized or weakened further after the reported Q2–Q3 pause, and how much of revenue growth reflects the GP acquisition.
- Whether improved product margins persist as the benefit from lower inventory charges and favorable volume or mix changes.
- The sustainability of reported earnings after discrete tax-reserve releases and other tax benefits, and the resolution of open tax examinations.
- Customer concentration, inventory growth, and the conversion of earnings into operating cash flow.
- Use of cash for investment purchases, dividends, repurchases and acquisitions, including the level of funds held by foreign subsidiaries and any tax consequences of repatriation.