MKS Instruments, Inc. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019. Unless noted, amounts are in U.S. dollars; financial figures below are in millions.
Business context
MKS supplies instruments, subsystems and process-control solutions for semiconductor and other advanced manufacturing markets, and provides related services. On February 1, 2019, MKS completed its acquisition of Electro Scientific Industries (ESI) for approximately $1.063 billion, including assumed share-based awards. ESI added the Equipment & Solutions reportable segment; its results are included from the acquisition date.
Financial performance and liquidity
| Metric | Q1 2019 | Q1 2018 |
|---|---|---|
| Revenue | $463.6 | $554.3 |
| Gross profit / gross margin | $198.1 / 42.7% | $262.9 / 47.4% |
| Operating income / margin | $23.1 / 5.0% | $131.6 / 23.7% |
| Net income | $12.5 | $105.1 |
| Diluted EPS | $0.23 | $1.90 |
| Operating cash flow | $29.1 | $72.8 |
| Capital expenditures | $14.5 | $9.4 |
- Revenue fell 16.4% year over year. Product revenue declined to $397.4 million from $496.7 million, while service revenue rose to $66.2 million from $57.6 million.
- Cash and cash equivalents were $418.0 million and short-term investments were $44.3 million at quarter-end, totaling $462.3 million, versus $718.2 million at December 31, 2018.
- Debt carrying value was $987.1 million at March 31, 2019, compared with $347.8 million at year-end. This includes $976.8 million of long-term debt, net, and $10.3 million of short-term debt. The $650 million incremental term loan funded part of the ESI acquisition; its stated rate was 4.7% and maturity February 2026. The existing 2016 term loan principal was $348.5 million, at 4.5%, with maturity in April 2023. MKS reported compliance with debt covenants.
- Current assets were $1,360.4 million and current liabilities were $296.6 million. Inventory rose to $475.6 million from $384.7 million at year-end.
Material changes and unusual items
- Semiconductor customer revenue decreased $93.2 million year over year, while advanced-market revenue increased $2.5 million, principally reflecting two months of ESI contribution. Semiconductor-related revenue represented approximately 48% of Q1 revenue, versus 57% a year earlier.
- Vacuum & Analysis revenue was $234.4 million, Light & Motion $194.0 million, and Equipment & Solutions $35.2 million. ESI contributed $35.2 million of revenue and a $31.7 million net loss after acquisition.
- Lower revenue volume and factory utilization were cited as key drivers of margin compression. ESI’s reported gross margin was 20.6%, including $5.1 million of purchase-accounting inventory step-up expense; excluding that charge, management reported a 35.1% margin.
- Q1 operating expenses included $30.2 million of acquisition and integration costs, $5.8 million of incremental-term-loan fees, and a $1.7 million customer-contract obligation charge. Intangible amortization increased to $15.7 million from $11.2 million.
- Operating cash flow was lower than the prior-year quarter, with management citing $45.0 million of working-capital use, including decreases in accrued compensation and accounts payable and higher inventory. Investing cash outflow was $874.1 million, primarily reflecting the ESI purchase; financing cash inflow was $618.6 million, primarily from borrowings.
Outlook, risks and contingencies
- Management said semiconductor capital-equipment spending had moderated and expected the effect on semiconductor revenue to continue into Q2 2019. It noted that industry demand shifts are rapid and difficult to predict. The filing provides no specific numerical revenue or earnings guidance.
- MKS expects to continue significant investment in research and development. Management highlighted risks from product-development timing, changing customer needs, competition and whether products are selected for successive generations of customer equipment.
- International revenue was approximately 52% of Q1 sales. The company uses currency and interest-rate hedges; it reported no material change in market-risk exposure from year-end.
- ESI-related former-stockholder class actions were settled through supplemental merger disclosures; plaintiffs dismissed individual claims with prejudice and class claims without prejudice. A separate Newport shareholder class action against former directors remained in discovery. Management said ordinary-course legal matters were not expected to materially adversely affect results, financial condition or cash flows.
- Gross unrecognized tax benefits were approximately $40.7 million at quarter-end. MKS said about $1.5 million of previously net unrecognized benefits could be recognized over the next 12 months; tax examinations and uncertainty in tax positions remain relevant contingencies.
- The company adopted lease accounting on January 1, 2019, recording a right-of-use asset and lease liabilities. At March 31, operating lease liabilities totaled $68.9 million.
Important facts for investors to verify
- Whether semiconductor demand and MKS’s revenue and margins stabilized after the expected Q2 weakness.
- ESI’s post-acquisition revenue, profitability, integration progress and final purchase-price allocation; reported acquisition values were preliminary and could be adjusted.
- Cash generation, inventory levels and debt reduction following the acquisition financing, including interest costs and covenant compliance.
- The extent to which Q1 acquisition, financing and purchase-accounting charges are nonrecurring versus ongoing, and how reported results compare with the filing’s unaudited pro forma results.
- Developments in the Newport litigation, tax positions and other contingencies; the filing does not quantify a clear potential loss for these matters.