MKS Instruments, Inc. — FY2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016. This is an annual filing, not a standalone fourth-quarter report. Financial amounts below are in U.S. dollars; figures are rounded.
Business context
MKS supplies instruments, subsystems and process-control solutions for advanced manufacturing, with significant exposure to semiconductor equipment and device makers. Its two reporting segments are Vacuum & Analysis (legacy MKS) and Light & Motion (legacy Newport).
MKS acquired Newport on April 29, 2016 for approximately $1.007 billion, including repayment of Newport debt and settlement of share-based awards. Newport contributed $423.1 million of revenue from the acquisition date through year-end. The acquisition broadened MKS’s exposure to scientific research, defense/security, microelectronics, life sciences and industrial markets.
Financial performance and liquidity
| Metric | FY2016 | FY2015 |
|---|---|---|
| Revenue | $1,295.3 million | $813.5 million |
| Gross profit / margin | $565.6 million / 43.7% | $362.9 million / 44.6% |
| Operating income / margin | $157.3 million / 12.1% | $156.6 million / 19.3% |
| Net income / diluted EPS | $104.8 million / $1.94 | $122.3 million / $2.28 |
| Cash provided by operations | $180.1 million | $138.3 million |
| Capital expenditures | $19.1 million | $12.4 million |
- Revenue rose 59.2%, largely because Newport was consolidated for eight months. MKS reported that legacy Vacuum & Analysis revenue increased $58.8 million; Newport accounted for $423.1 million in revenue.
- Gross margin declined 0.9 percentage points. Product margin fell 1.8 points, including the $15.1 million Newport inventory fair-value step-up charge; Light & Motion’s reported gross margin was 41.9%, or 45.5% excluding that charge.
- Operating income was nearly flat despite the acquisition-related revenue increase. FY2016 expenses included $27.3 million of acquisition and integration costs, $35.7 million of intangible amortization, and a $5.0 million investment impairment. Interest expense was $30.6 million versus $0.1 million in 2015.
- Net income decreased 14.3%; reported diluted EPS declined from $2.28 to $1.94. FY2016 also included acquisition-related charges and a $2.0 million withholding tax, partly offset by tax benefits, including a $5.0 million benefit from legal-entity restructuring.
- Operating cash flow increased to $180.1 million; working capital absorbed cash, including a $58.1 million increase in receivables and $13.8 million in inventory. Approximate operating cash flow less capital expenditures was $161.0 million.
- Year-end cash and cash equivalents plus short-term investments totaled $418.1 million, excluding restricted cash. Working capital was $761.5 million. Total assets were $2.212 billion and stockholders’ equity was $1.242 billion.
- Reported debt was $612.2 million, including $11.0 million current debt and $601.2 million long-term debt, net of financing costs. Term-loan principal was $626.6 million at year-end after $150 million of voluntary prepayments; $335 million was fixed through a swap to September 2020. The $50 million asset-based revolver was undrawn. The company reported compliance with loan covenants.
- FY2016 dividends were $0.68 per share. The board declared a $0.175-per-share quarterly dividend in February 2017, subject to the credit-facility restrictions described in the filing.
Changes versus prior period and fourth-quarter data
The reported year-over-year results are not directly comparable because Newport was included only from April 29, 2016. Unaudited pro forma results, assuming Newport had been acquired at the start of each year, show 2016 revenue of $1.476 billion and net income of $111.1 million, compared with $1.413 billion and $69.1 million in 2015; the filing cautions that these figures are not necessarily indicative of actual or future results.
For Q4 2016, revenue was $405.1 million, gross profit $183.4 million, operating income $62.5 million, net income $45.5 million and diluted EPS $0.83. Q4 2015 results were $172.4 million, $72.8 million, $22.2 million, $25.5 million and $0.48, respectively. The large reported quarterly increase reflects the acquisition and should not be read as organic growth.
Semiconductor-related revenue was 58% of total revenue in 2016 versus 69% in 2015; management estimated the combined company’s future semiconductor share could be about 50%. The top ten customers represented 39% of revenue, down from 49%; Applied Materials represented 13.6% and Lam Research 11.2%.
Outlook, risks and unusual items
- The filing gives no specific numerical revenue or earnings guidance. Management expects continued substantial R&D investment and says cash, investments, borrowing capacity and expected operating cash flow should cover working capital, planned capital expenditures and potential dividends for at least the next 12 months.
- Management describes semiconductor demand as cyclical and difficult to forecast. Customer order timing, cancellations or rescheduling, capacity constraints, supply interruptions and product mix can materially affect quarterly results.
- Key risks include successful integration of Newport and realization of synergies; substantial secured debt, variable interest exposure and restrictive covenants; customer and semiconductor-market concentration; international, currency, trade-compliance and geopolitical exposure; and product, technology, supply-chain and goodwill/intangible-asset impairment risks.
- Goodwill and intangible assets totaled approximately $996.6 million, or 45% of assets. The annual goodwill assessment found no impairment; management said an impairment was not reasonably likely over the next 12 months, while noting deterioration in markets or performance could increase risk.
- A putative shareholder class action relating to the Newport merger sought monetary damages. MKS said it considered the claims meritless and intended to defend them. Management stated ordinary-course legal matters were not expected to materially affect results, financial condition or cash flows.
- PwC issued an unqualified opinion on the consolidated financial statements and reported effective internal control over financial reporting for the company as assessed. Newport was excluded from the 2016 internal-control assessment and audit because of the acquisition; it represented 22% of year-end assets and 33% of annual revenue.
Most important facts for investors to verify
- How much post-acquisition growth is organic, by segment and end market, and whether the pro forma trend continues.
- Newport integration progress, expected synergies, recurring costs and any further purchase-accounting adjustments.
- Debt repayment pace, interest costs, covenant headroom and the effect of rates on the unhedged variable-rate debt.
- Whether margins recover as the Newport inventory step-up and integration charges roll off, while monitoring amortization and other acquisition-related costs.
- Semiconductor-cycle conditions, backlog conversion and customer concentration; backlog is cancellable or deferrable in many cases and is not a reliable forecast of sales.
- Resolution of the Newport shareholder litigation, tax exposures and the recoverability of substantial acquired goodwill and intangible assets.