MKS Instruments, Inc. — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016. Financial amounts below are in millions of dollars unless otherwise noted. Newport Corporation’s results are included from its April 29, 2016 acquisition date.
Business context
MKS supplies instruments, subsystems, process-control solutions, and related services to semiconductor, industrial, life sciences, and research markets. Following the Newport acquisition, the company reported Vacuum & Analysis and Light & Motion divisions.
Key financial metrics
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Revenue | $325.9 | $218.0 | $509.5 | $431.8 |
| Gross profit / margin | $135.9 / 41.7% | $98.8 / 45.3% | $213.8 / 42.0% | $195.8 / 45.3% |
| Operating income / margin | $19.2 / 5.9% | $46.0 / 21.1% | $41.7 / 8.2% | $93.0 / 21.5% |
| Net income | $9.2 | $33.2 | $26.8 | $67.0 |
| Diluted EPS | $0.17 | $0.62 | $0.50 | $1.25 |
| Operating cash flow | Not separately provided for Q2 | $49.4 | $58.2 |
- Q2 revenue increased 49.5%; six-month revenue increased 18.0%. Growth primarily reflected Newport, while legacy MKS revenue declined.
- Cash and cash equivalents were $354.3; short-term investments were $71.4. Combined, these totaled $425.6, down from $658.2 at December 31, 2015. Current assets were $1,001.5 and current liabilities $207.7.
- Total debt on the balance sheet was approximately $709.6, including $696.9 of long-term debt and $12.7 of current debt. The term loan’s reported principal was $723 million at June 30; its interest rate was 4.25%. MKS had not drawn on its $50 million asset-based revolving facility.
- Operating cash flow was $49.4; investing cash flow was negative $595.6, principally reflecting Newport; financing cash flow was positive $677.0, largely from borrowing. Cash increased $126.7 during the half.
- Q2 dividend was $0.17 per share. The board declared another $0.17 quarterly dividend on July 25, 2016.
Material changes versus prior periods
- Despite higher revenue, Q2 net income fell to $9.2 from $33.2, and operating income fell to $19.2 from $46.0. For the first half, net income declined to $26.8 from $67.0.
- Gross margin fell 3.6 percentage points in Q2 and 3.3 points for the first half. Management cited product mix and higher material costs, including $10.1 of Newport inventory step-up amortization.
- Q2 SG&A rose to $71.4 from $33.3; the filing attributes much of the increase to Newport, including compensation and integration costs. Q2 acquisition costs were $8.2, and intangible amortization rose to $8.9 from $1.7.
- Newport was acquired for $1,007.3 of total consideration, including repayment of Newport debt; net of acquired cash, the stated purchase price was $945.8. The preliminary allocation included $395.8 of goodwill and $394.8 of identifiable intangible assets. Purchase accounting remained subject to refinement.
- Debt financing introduced significant interest expense: interest expense was $8.5 for the first half, versus $0.1 in the prior-year period. The June repricing lowered the LIBOR margin to 3.50%; MKS also prepaid $50.0 of principal and paid a $7.3 repricing premium.
Outlook, risks, and unusual items
- The filing gives no quantified revenue or earnings guidance. Management said semiconductor demand is difficult to predict and described the market as subject to rapid shifts. It expected semiconductor customers to represent approximately 50% of future sales, versus 61% of first-half 2016 revenue.
- Management expects continued significant R&D investment and identified product development, customer adoption, manufacturing capacity, and successful Newport integration as important factors. It cautioned that expected acquisition benefits may not be realized and integration costs may continue.
- Key risks include semiconductor cyclicality, customer concentration, acquisition integration and purchase-accounting estimates, variable-rate debt and restrictive covenants, foreign-exchange exposure, international operations, and potential goodwill or intangible-asset impairment. Applied Materials represented 13.5% of Q2 revenue; Lam Research represented 8.9%.
- Newport-related effects included $10.1 of inventory step-up amortization, $8.2 of quarterly acquisition costs, integration-related SG&A, and increased amortization. Foreign-currency translation reduced Q2 other comprehensive income by $8.9; total comprehensive income was $0.1.
- Two putative Newport shareholder class actions concerning the merger were consolidated. The company disputed the claims and said it would defend them; management did not expect the legal matters to materially affect results, financial condition, or cash flows.
- Cash and short-term investments included $351.9 held by foreign subsidiaries, substantially all potentially subject to U.S. tax if repatriated. Management said domestic cash and available ABL borrowing capacity were adequate for anticipated domestic needs.
Investor verification priorities
- Assess Newport’s standalone contribution and integration progress, including whether anticipated synergies offset ongoing costs.
- Review final purchase-price allocation, acquired-asset lives, inventory step-up effects, and impairment exposure for goodwill and intangibles.
- Verify debt principal, interest-rate exposure, amortization schedule, covenant requirements, and dividend restrictions.
- Track legacy MKS revenue trends, semiconductor demand, customer concentration, and gross-margin recovery after acquisition-related charges.
- Monitor tax uncertainties, foreign-cash access, and the status and potential exposure of merger-related litigation.