MKS Instruments, Inc. — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019. Unaudited results; dollar amounts below are in millions unless otherwise noted.
Business context and reporting period
MKS supplies instruments, subsystems, process-control solutions and related services to semiconductor, industrial technology, life and health sciences, research and defense markets. On February 1, 2019, MKS completed its $1.063 billion acquisition of Electro Scientific Industries (ESI), adding the Equipment & Solutions segment. Accordingly, current-period results include ESI from the acquisition date, while 2018 comparisons do not.
Financial results and liquidity
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Revenue | $474.1 | $573.1 | $937.7 | $1,127.4 |
| Gross profit / margin | $211.0 / 44.5% | $274.9 / 48.0% | $409.1 / 43.6% | $537.7 / 47.7% |
| Operating income / margin | $63.9 / 13.5% | $151.3 / 26.4% | $87.0 / 9.3% | $282.9 / 25.1% |
| Net income | $37.7 | $122.9 | $50.2 | $228.0 |
| Diluted EPS | $0.69 | $2.22 | $0.91 | $4.12 |
| Operating cash flow | Not separately stated for the quarter | $106.6 | $182.4 |
- Q2 revenue declined 17.3% year over year; six-month revenue declined 16.8%. Q2 net income fell 69.3%; six-month net income fell 78.0%.
- At June 30, cash and cash equivalents were $366.9 and short-term investments $93.0, totaling $459.9, versus $718.2 at December 31, 2018. Total debt carrying value was approximately $937.8, versus $347.8; cash and investments less debt imply net debt of about $477.9.
- Six-month investing cash outflow was $936.6, primarily reflecting $988.6 for the ESI acquisition and $28.3 of capital expenditures. Financing cash inflow was $554.7, principally from borrowing. Cash declined by $277.4 over the period.
- Current assets were $1,370.0 and current liabilities $285.2 at June 30. The company also had an undrawn asset-based revolving facility of up to $100.0, subject to borrowing-base limits.
Material changes and drivers
- Semiconductor-related revenue declined 36% in Q2 and 33% for the first half, primarily from lower volumes in the legacy Vacuum & Analysis business. Management attributed the broader downturn to moderated semiconductor capital spending.
- Advanced-market revenue increased 10% in Q2 and 5% for the first half, mainly because of ESI. The acquisition added $55.9 of Q2 revenue and $91.1 for the six-month period, but reported net losses of $3.1 and $34.8, respectively.
- Gross margin contracted as lower revenue volumes and factory utilization weighed on product margins; service margins also declined. ESI inventory fair-value step-up charges were $2.5 in Q2 and $7.6 for the first half. Excluding those charges, ESI segment gross margin was 49.0% for Q2 and 43.6% for the first half.
- Interest expense rose materially following the acquisition financing. Six-month acquisition and integration costs were $33.4, and intangible amortization increased to $33.3 from $22.1.
- Six-month operating cash flow fell to $106.6 from $182.4, despite lower working-capital use than the prior-year period; the filing cites inventory growth, lower accounts payable and accrued compensation, among the working-capital movements.
Outlook, risks and unusual items
- No numerical revenue or earnings guidance is provided. Management said semiconductor capital-equipment spending moderation and its effects on semiconductor revenue were expected to continue into Q3; demand timing and magnitude remain difficult to predict.
- MKS identified U.S.-China tariffs and trade restrictions as risks that had already negatively affected the business. It also suspended outstanding Huawei orders after U.S. restrictions and reported cancellations by customers supplying Huawei. Further tariffs, restrictions, order delays or cancellations could reduce sales or margins.
- The company recorded a $5.0 deferred-tax-related out-of-period correction in Q2. Management said it was not material to prior or current interim or annual statements, but it raised the reported 2019 effective tax rates by 9.8 percentage points for Q2 and 7.5 points for the first half.
- ESI purchase accounting remains preliminary and could be adjusted during the measurement period, potentially affecting reported results and financial position. Goodwill and acquired intangibles increased substantially.
- A class action concerning the 2016 Newport acquisition remains pending against former Newport directors; a court trial was scheduled for Q1 2020. MKS stated that it and Newport had been dismissed from the action and that ordinary-course proceedings were not expected to have a material adverse effect.
- Assets totaling $36.8 were classified as held for sale; MKS anticipated selling properties in Portland, Oregon, and Boulder, Colorado, during Q3 2019. The company reported compliance with its term-loan covenants at June 30.
Key facts for investors to verify
- Whether semiconductor demand stabilizes after the weakness management expected to continue into Q3, and how much of any revenue change reflects underlying demand versus ESI consolidation.
- ESI’s post-acquisition operating performance, integration costs, preliminary purchase-price allocation and inventory step-up effects.
- Debt reduction, interest expense, liquidity and covenant headroom following the acquisition; confirm the effect of the new $650 million term loan and the undrawn ABL facility.
- Exposure to tariffs, China-related restrictions and Huawei-related order losses, including any further customer cancellations or cost mitigation.
- Impact of the tax correction and the approximately $40.8 million of gross unrecognized tax benefits, as well as developments in the Newport-related litigation.