Entegris Inc (ENTG) 2008 Q3 法說會逐字稿

Good day, everyone, and welcome to Entegris's third quarter 2008 earnings release conference call. As a reminder, today's conference is being recorded.

At this time, for opening remarks and introductions, I would like to turn the call over to Steve Cantor, Vice President of Corporate Relations. Please go ahead, sir.

Good morning, and thank you for joining our call. Earlier today, we released our financial results for the third quarter ended September 27, 2008. You can access a copy of our press release on our website, www.entegris.com.

Before we begin, I would like to remind listeners that our comments today will include some forward-looking statements. These statements involve a number of risks and uncertainties, and our actual results may differ materially. These risks and uncertainties are outlined in detail in this morning's press release and in our most recent 10-K report, as well as in other reports and filings with the SEC. In addition, we will be referring to certain non-GAAP financial measures. These should be considered in addition to and not in lieu of comparable GAAP financial results. Please refer to our earnings release, which shows a reconciliation from GAAP to non-GAAP net income.

On the call today are Gideon Argov, President and CEO; Bertrand Loy, Chief Operating Officer; and Greg Graves, Chief Financial Officer. Gideon will now begin the call.

Thank you, Steve. Good morning, everyone. I'll make some comments on our recent quarter and our strategy and actions to contend with the current market environment. Greg will then provide details on the financials and on the specific restructuring and asset impairment charges in his prepared remarks.

We're clearly living through turbulent times, both in the semiconductor industry and in the world economy. Although our third-quarter sales were not immune from the rapid deceleration of semiconductor spending and production, our operating performance and cash flow, excluding restructuring and one-time results, was relatively solid. This is a reflection of our largely recurring business model, the importance of our Contamination Control solutions to a broad range of customers and good cost controls.

The slowdown in the semiconductor market was clearly evident across our spectrum of customers. We're seeing the effect of the capital project and tool push outs on the part of fabs, and while we only have moderate exposure to the memory makers, our IBM and foundry customers are reporting lower utilization rates.

Filtration sales held fairly stable despite the lower sales of wet etch and clean tools and track tools, which drive a portion of demand for filters. Consistent with previous downturns, Filtration customers are stretching the lives of our Filtration products and are postponing year-end preventative change outs where possible.

Although our Shipper products are more insulated from push outs of capital spending, lower fab utilization and the closures of some 200 millimeter fabs in Korea and the United States are reducing demand for some legacy wafer shippers.

Now, despite all of this, there is still a lot of activity and customer interest for our Fluid Handling Systems and Controllers, and we continue to achieve some important spec wins. Even with industry expectations for lower shipments of stepper tools, we still have a good pipeline for our liquid lens systems, which are used with immersion lithography tools.

The semiconductor market accounted for about 74% of our sales in Q3. Our sales to market outside the semiconductor industry grew sequentially as a result of the addition of Poco Graphite, which sells to a broad range of industrial and high-performance technology customers. Our sales to data storage and flat-panel display customers improved from the second quarter, although near-term demand for the end-market electronic devices that drive those markets remains unclear.

I want to highlight some of the key strategic steps we made during the quarter. I want to emphasize these steps are not simply actions to deal with the downturn in our markets; they are measures that are part of our long-term strategies put in place earlier this year and intended to kick start our business, increase growth and profitably.

First, in July we consolidated the office of Chief Operating Officer under Bertrand Loy. Bertrand is no stranger to the Company, having been the Chief Administrative Officer since our 2005 merger and the Chief Financial Officer of pre-merger Mykrolis. Since taking on his new role, Bertrand has combined business unit management, global supply chain and sales and service under a unified umbrella. Through this structure, we have been able to flatten the organization, eliminate a layer of management and speed decision-making.

Second, we accelerated the alignment of our manufacturing infrastructure to better meet customer demand. As part of these steps, we are closing one of the two manufacturing facilities in Chaska, Minnesota and moving the production of those products to other existing facilities in the Company. By closing this facility, which is our largest one in North America, we expect to save approximately $8 million annually, in part through increased utilization of our remaining facilities, lower product transport costs and lower taxes. We expect to complete the closure within the year 2009 and are using this opportunity to discontinue several thousand older and largely inactive part numbers which require significant cost to maintain and to build. When this transition is complete, capacity utilization of the remaining facilities within the Company will increase by approximately 20% to around 60% to 70% utilization, even at current depressed levels of volume.

Third, we took a key step to further diversify our business with the acquisition of Poco Graphite, a maker of consumable specialized graphite and silicon carbide products and materials. About 60% of Poco's sales are outside the semiconductor industry and address aerospace, specialty industrial and medical markets. The integration has gone well and we are pleased with Poco's contribution in the quarter, which included about a penny of earnings excluding purchase accounting.

To summarize, we're taking significant steps to reduce our expenses and expect it to be profitable on a cash operating basis during this turbulent economic period. Two, we're using the downturn in the semiconductor industry to our advantage, both in terms of expanding and accelerating our manufacturing moves, as well as launching new products and completing product qualifications with customers. And three, we're diversifying our business beyond the semiconductor market, not just with the acquisition of Poco Graphite, but in terms of core polymer-based technologies.

Looking out into the fourth quarter and 2009, the volatility and uncertainty of the economy and our markets make it very difficult to provide specific guidance with any degree of precision. Although we're not providing specific guidance, we are conservatively managing the business. We've seen difficult market environments before. The leadership team has long, extensive experience and has successfully managed through various industry downturns as well as other transitions.

Throughout my career as CEO as well as in the private equity world, I've experienced numerous economic cycles and have been exposed to business models with a wide variety of companies. Compared to our peers in the semiconductor industry, we have an extraordinary breadth of products and customers. For some investors, this may make us harder to understand. However, let me assure you, this works to our advantage during periods such as today.

While many of the peers in our industry are seeing their orders come to a jarring halt, our business model with its high percentage of recurring revenue, much of which is consumable, and the importance of our contamination control solutions make us relatively stable during these difficult times.

Greg will now provide some additional financial detail on the quarter. Greg?

Thank you, Gideon. Good morning, everyone. In the conference today, I will be referring both to GAAP and non-GAAP results. I encourage you to refer to the reconciliation table contained in the Q3 press release issued earlier this morning.

Given the difficult environment and the lower sales in our base business, we were satisfied with the operating performance, excluding some non-cash charges incurred in the quarter.

Before I provide additional detail on our Q3 operations, I want to explain the accounting charges. First, we wrote down $375 million pretax of goodwill in accordance with FASB Statement 142. This was triggered by the substantial decline in our market capitalization.

Second, there were purchase accounting adjustments in the quarter in accordance with FASB 141 totaling $5.7 million related to the acquisition of Poco. This adjustment, which impacted cost of goods sold, related to the fair-value markup of the acquired Poco inventory which was sold during the quarter.

Third, in view of current market conditions and the continued migration of our manufacturing to Asia, we concluded that our ability to use certain foreign tax credits was uncertain. As such, we established a valuation allowance of $30.7 million against our deferred tax assets. Note, this is an accounting convention and does not affect our ability to ultimately use the credits when our profitability improves.

We reported third quarter sales of $146 million and a net loss of $3.68 per diluted share on a GAAP basis.

Excluding charges in one-time items, net income from continuing operations was $6.2 million or $0.06 per diluted share.

We generated $11.7 million in cash from operations.

Sales of unit-driven products increased sequentially in dollar terms and were 65% of the total, reflecting the addition of almost $10 million of Poco consumable product sales.

Capital-driven sales were 35% of total Q3 revenues, reflecting lower capacity driven sales of our wafer transport products. Excluding Poco, our Q3 total sales were down about 8% from the second quarter, as slowing CapEx spending impacted demand for certain Microenvironment products such as wafer transport carriers and FOUPs.

Microenvironment products represent about one-third of our sales. The process product portion of this business, such as FOUPs, is highly leveraged to capacity expansions at new and existing fabs, which have been cut back significantly during this slowdown. Wafer shippers, another key Microenvironment product, were about flat sequentially, as higher sales of our 300-millimeter products offset lower sales of shippers for wafer sizes 200 millimeter and below.

Sales of Contamination Control products were about 60% of the total in Q3 and were down a modest 2% from the second quarter. Sales of Filtration products were slightly lower as semiconductor fabs and consumer electronics manufacturers reduced output. Sales of Fluid Handling Components, which are used in wet tools and fab infrastructure were slower due to push outs of some capital projects.

Sales by geography were as follows -- Asia, 36%; North America, 32%; Japan, 19%; and Europe, 13%. The relative increase in North American sales as a percent of the total was due primarily to the inclusion of Poco Graphite sales, the majority of which are U.S.-based.

Foreign exchange fluctuations had a negative $2.6 million impact on Q3 sales, primarily as a result of the dollar's strength relative to the euro.

Non-GAAP gross margin for the third quarter was 41.9% of sales, which increased from 40.5% reported in the second quarter. The Q3 gross margin benefited from two factors. First, we had a more favorable product mix since in the second quarter we shipped a greater proportion of lower margin Microenvironment products. And second, our manufacturing team delivered a solid performance in the quarter.

Despite the additional operating expense from Poco, third quarter operating expenses of $50.5 million on a non-GAAP basis declined sequentially compared to as reported Q2 expenses. Specifically, SG&A was $35.4 million, which declined $1.7 million from Q2 due in part to lower variable compensation accruals.

ER&D was $10.3 million, about level with the second quarter, and amortization was $4.9 million.

Q3 income tax expense of $15.8 million reflected the increase in the allowance for deferred tax assets I mentioned earlier. Our non-GAAP tax rate is 16% year-to-date.

Shares outstanding on a fully diluted basis at quarter end totaled $113 million.

The acquisition cost of Poco was $158.5 million, which we financed using our revolving credit facility and cash on hand. At the end of Q3, we had used $104 million of the $230 million available under the credit facility.

Cash, cash equivalents and short-term investments totaled $74 million at the end of the third quarter.

In summary, despite the unprecedented market conditions, our margins are stable, and we have a solid balance sheet and stable cash flow. We are continuing to invest in developing new products and markets, both in the semiconductor market and other high-performance industries. And while we can't control the larger market forces, we are taking steps internally to lower our cost, not just to weather the short-term, but for the long term. With the steps we have announced today, we have lowered our quarterly break even since the beginning of the year by about $10 million to approximately $135 million, including the Poco operations.

With that, we'll now take your questions. Operator?

(OPERATOR INSTRUCTIONS). And we'll take our first question from Jim Covello at Goldman Sachs. Please go ahead with your question.

Great. Good morning, guys. Thank you very much. With all the changes with the acquisitions and with the restructuring activities, could you help us understand a little bit about what you think your new long-term model looks like both in terms of what your targets are for long-term revenue growth and what your targets are for long-term margin prospects? I understand it's difficult to give guidance for the short term, which is completely understandable, but maybe if we can get some idea from a modeling perspective for your thoughts about the intermediate or longer term. Thank you.

Hi, Jim. This is Greg. Since the beginning of the year, we've taken about $12 million out of our operating cost structure, and $6 to $8 million out of the gross margin line. As I mentioned in my formal remarks, this has reduced our breakeven about $10 million a quarter to $135 million including Poco. Going forward, clearly the moves that we're making to migrate the production closer to our customers will have a favorable impact on our gross margin. If you look at the current savings on a stand-alone basis of $6 to $8 million, that represents approximately a point of gross margin with all other things being equal. Given that we've done so much this year and are really still moving through the process of making adjustments in some areas within the Company, our intent is when we announce our fourth quarter to provide a comprehensive look at our long-term model. So suffice it to say, we're driving the breakeven down, doing the right things in terms of investing in new product development, and so it feels good about where we're going with the Company.

Jim, Gideon here. Just an additional point. So today we're really talking about a reduction of cost, which will be about $8 million given what we're doing in the Chaska campus, plus another $12 million from other cost-reduction efforts -- $20 million a year, $5 million a quarter, just to recap what Greg said. I just want to make it clear that these are aggressive, extensive actions that are meant to have a significant impact on the Company's competitive posture over not just the short run, but as you said, the medium and longer run. So we're not sitting around waiting for the economy to improve or get worse. These are obviously very significant actions.

Okay, thank you very much.

And we'll take our next question from Steve Schwartz at First Analysis.

Good morning, gentlemen. I guess the first question is just on CapEx and D&A for the year. It looks like because of the impairments and so forth, those numbers are changing. Can you give me some guidance there?

Steve, we really don't -- we haven't made any significant changes in our CapEx plan for the year. We've really through the year talked about a $25 million number as the total for the year. So that really hasn't changed. We will have some additional CapEx going into next year as we facilitize some of the accepting facilities for the changes that we're making with regard to the plant closing that we just announced this morning. But overall, the CapEx picture for us has not changed significantly.

Okay. And as far as D&A. Because when I look at quarter --

Okay, D&A -- the assets that we wrote off as far as impairment were goodwill, which we don't amortize. So the D&A picture should not change significantly going forward. Either we are at $5 million in amortization for the quarter, and that's what I would expect us to be as we run through most of next year. Some of the amortization related to our initial acquisition is declining, but at the same time, we're adding additional amortization from the Poco acquisition. Depreciation has run about $6.5 million to $7 million per quarter over the past couple of years, and we expect that to continue at a similar rate.

Okay, so --

My assessment is that at breakeven when you take in -- at a breakeven operating income that we would generate -- when you take out stock-based comp, which is a non-cash charge, amortization and depreciation, that at breakeven we would have an EBITDA run rate that would approach $75 million if you include the Poco acquisition.

Okay. If I look at the third quarter, your D&A was actually a draw on cash, which means if what you're telling me, Greg, you're going to end up just, say, around $44 million at the end of the year. That means your D&A in the fourth quarter is going to be like $33 million. That's a significantly larger number from what you would normally have.

Steve, I'm not following the question exactly.

Okay, I'm just trying to figure out --

You talk about the D&A be a draw on cash.

Right, right. Well, if you just look at your nine-month cash flow statement, D&A is about $11 million. Normally, you're at about $32 million.

And D&A -- the three-month cash flow, it's about $11 million.

Your cash flow statement is three months. Okay, got you. Very clear.

Moving on, how much of the Chaska closure, of that manufacturing, is going to end up in Malaysia.

Steve, this is Bertrand Loy. Just about three-quarters of what is being produced in building 4 -- what we call building 4 in Chaska, Minnesota -- are Microenvironment products, and I would say that all of the 300-millimeter products as well as Process and Storage products will go to Kulim, Malaysia. There could be a smaller portion of those products going into the existing Colorado Springs facility, and that will likely be the Chip Trade products. But that's a smaller portion of what will use in building for Chaska.

Okay. And Greg, on the $3.3 million in restructuring, if I back that out as a special, what tax rate should I use on that?

Our tax rate on an ongoing basis is going to be 30% moving downward as more moves to Malaysia. Today, Steve -- and so I think you have to think about our long-term rate in that range. Today the calculated incremental rate, because we're so close to breakeven, that's a very difficult proposition.

Okay. Well, just --

Today, if you backed -- if you backed it out today looking at our year-to-date numbers of 16%, our year-to-date tax rate on a non-GAAP basis is 16%, if you backed it out today, I would think, in terms of the 16%. But longer term, as we get this as -- well, kind of mid-cycle profitability, think of a 30% tax rate with a downward trend.

Steve, this is Steve Cantor. We have some other people in the queue to ask questions. Can we come back to you if you have some more?

Yes, certainly, Steve. Thanks for taking the questions.

And we'll take our next question come from Brett Hodess at Merrill Lynch.

Good morning. I know you're not giving guidance here for the short term, but I just wanted to ask, if you look at some of the other component companies and the OEMs as they look into the next quarter, a lot of them are talking about drops in the mid-teen percent range, and a lot of the materials companies, some of the wafer makers and other chemical companies, similarly, are talking about declines in the mid-teen percent range on a revenue basis sequentially. Given the recurring nature of your business that you've talked about and the addition of Poco and the parts of your business outside of semiconductors, do you think that that range is in the cards? Or is that too steep? Or can you give us some feel for that relative to what the peers in the industry are saying?

Sure. Good morning, Brett. Gideon here. I would say we would view that scenario as unlikely given business trends for the quarter and the nature of the recurring business model that we have. So even though we're not giving specific guidance, that would be my answer to your question, and that is what makes us have a conviction about remaining profitable on a cash operating basis as we move forward into the fourth quarter as well.

And then a quick follow-up. If you look at the mix of business outside of your semiconductor business, which is about 26% now, when Poco's factored in for the full quarter, it looks like that'll probably take you up maybe closer to 30%. Is that roughly right?

Yes, you've got it.

And just a quick follow-on to that. Is Poco beneficial to the gross margins then at that point? Or is it in line with the corporate average? Or how do we think about that?

Poco's gross margins, Brett, are in line with the corporate average based on where we're running today.

Great. Thank you.

And we'll take our next question from Christopher Blansett at JPMorgan.

Hi guys. Two things here. Earlier, Gideon, you mentioned that you were accelerating the manufacturing transition to Malaysia. Is this contained in the move from the Chaska building floor to Malaysia? Or is there other areas that are moving faster?

No, we have had a plan that's been a long-term plan for moving product lines to Malaysia, and we've moved a number of them. We've moved certain Process Carrier product lines over there. We've moved reticle product lines over there. We've moved some certain Filtration products. And that has been something that we've been pretty clear and consistent about. Now, when we have conditions, as we do in the markets today, they naturally lend themselves -- in the best time -- there is a best time to make significant moves of this type. It is obviously when the markets are relatively low and when the disruption on many levels is lower than it would be if markets were stronger, particularly customer disruptions. So we're taking advantage of that, of the timing and of the situation in the end markets to make a move that sort of continues our strategy of moving product closer to our customers.

I know, Bertrand, you'd like to add something to that as well.

Yes, thank you, Gideon. What I wanted to -- yes, I wanted to echo what you said, Gideon, around the fact that we have a long-term strategy to optimize and align manufacturing and to move that closer to our customer base. And as you know, we've been sharing that with you in prior calls. We've described our decisions to move smaller manufacturing sites. We closed, as you know, the European site in Bad Rappenau. We closed some California-based facility earlier this year as well as a few service centers in the U.S. and Singapore. So all of those transfers have been consistent with the long-term strategy to produce more outside of the U.S.

So just to translate that into numbers, today, our current operating levels, which still have about 74% of our manufacturing output that is coming from the U.S., as we complete the closure of B4, and as we complete the closure of the San Diego manufacturing operations, which was announced earlier this year, we will be lowering that number to about 60% of the output being manufactured in the U.S. Our long-term goal is to have no more than 50% manufactured in the U.S.

All right. That's [sort of good].

And the other question here is we've seen a rolling over of global commodity prices, and I wasn't sure if you're seeing any impact on this on your cost of goods sold and if you could maybe provide some color around that.

Yes, Chris, the impact, as we've talked about in prior calls, our polymers are largely engineered polymers, and so there tends to be a lag in the pricing. So for us, we really for the first time just in the third quarter saw the impact of higher resin prices. We talked about the margin performance in the quarter being favorably impacted by mix, favorably impacted by just the generally good operating performance, lowered scrap levels. It was negatively impacted by the 50 to 75 basis points on materials cost that we outlined actually in the call in Q2. So today, like I said, Q3 we saw the highest materials costs we've seen all year. I would expect that we would continue to see a similar level in Q4. If petroleum prices stay where they are, though, given the lag, I would expect that our prices should go back down to the levels we saw in Q1 and Q2 in the first part of next year.

And then one quick one. Since the Poco business is similar margin structure as the Entegris business, is it fair to say that their OpEx as a percentage of revenue for Poco is similar to Entegris'?

The OpEx today is lower because they're generating a higher operating margin than we are today.

All right. Thank you.

We'll take our next question from Timothy Arcuri at Citi.

Yes, hi. This is [Janaid Ahmad] calling in for Tim. Thanks for taking the call. Hello?

I'm sorry. We are having trouble hearing. Can you repeat the question, please?

Yes, there's some disturbance.

We had somebody just firing a leaf blower up outside the window. We're going out to tell them to shut that off. Sorry.

That's okay. Yes, can you hear me?

Yes. That's a little bit better, if you can repeat your question.

Yes, if you could give some idea of what you expect your new products plus the Poco revenues to be in 2009? I know you've given some earlier -- you've spoken about maybe potentially $20 million from new products in '09.

If the question is about Poco revenues, we have said that Poco on a trailing basis has been about a $60-plus million --

[$5 million business].

$5 million business. And I would just say that since 60% of their market is non-semi, they're not going to be impacted, obviously, in the same way as a semiconductor materials company, and none of their business -- zero of their business is equipment. It's all consumable products. So given all of that, we are expecting them to be a solid contributor next year. Let's put it that way. We're not going to give a separate forecast for Poco, though.

Okay. What about from your new products, organic new products that you have come out with?

Well, anytime you have a downturn of biblical proportions like we're experiencing, that impacts your legacy products. It also impacts your new products. So I would say -- I'd like to highlight one product in particular as being one where we feel pretty good about our traction, and that is the FOSB 300-millimeter shippers, where I think we're going to reasonably -- we expect to make our projections for this business for the year. We're seeing pretty positive dynamics in terms of orders and interest from device manufacturers. And that is a market that we're coming from a position of having virtually no market share in 2007 to something just under $10 million this year. Again, we expect to make our forecast for that business. However, there's no question that new products are impacted just like legacy products.

I would say this. As we all know, this part of the cycle is the best time to be working with engineers to get on new platforms and to create -- plant the seeds for market share expansion as the upturn will occur, and we're working hard to do that.

So would you say the $20 million, I think, that you have stated earlier for '09, that maybe is a little aggressive now?

I'm sorry. We're still having a hard time hearing you. Can you --

Can you speak closer to the microphone?

Yes, speak into the phone please.

Yes, the $20 million for '09 that you had earlier stated is now a little bit maybe aggressive, would you think?

Oh, the $20 million in the new product? Is that your question?

Yes, yes.

Yes, I think that given the industry trend, I think it's fair to say that $20 million may be looking a little aggressive, but as Gideon said, if you look new product by new product, the story is -- it's fairly different. So I think that in the aggregate, I would say that we will be between $15 million and $20 million of new products for the year. Is that your question?

Yes, thank you. That helps. Thank you.

(OPERATOR INSTRUCTIONS). And with no further questions left in the queue, I'd like to turn the conference back over to Mr. Argov for any additional or closing remarks.

Thank you for joining our call. We look forward to updating you as we move forward. Have a good day.

This does conclude today's presentation. We thank everyone for their participation. You may disconnect your lines at any time, and have a wonderful day.