Entegris Inc (ENTG) 2012 Q4 法說會逐字稿

Good day everyone. Welcome to the Entegris fourth quarter 2012 earnings release conference call. Today's call is being recorded. At this time for opening remarks and introductions, I would like to turn the call over of to Steve Cantor, Vice President of Corporate Relations. Please go ahead.

Thanks Tim. Good morning everyone. Thank you for joining our call. Earlier this morning we announced the financial results for our fourth quarter ended December 31, 2012. 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 which are outlined in detail in our reports and filings with the SEC. On this call we will also refer to non-GAAP financial measures as defined by the SEC and Regulation G. You can find a reconciliation table in today's press release, as well as on our website. On the call today are Bertrand Loy, President and CEO, and Greg Graves, Chief Financial Officer.

Before we begin, I also want to mention that we will be participating in the Stifel Nicolaus Investor Conference next week and the Sidoti Conference next month. Bertrand will now begin the call. Bertrand.

Thank you Steve. And good morning everyone. I will make some comments on the years' achievements. Greg will provide some details on the Q4 financials, then we will come back with some comments on our outlook and guidance for Q1. Even with the headwinds facing the industry and global economy, 2012 was a good year for Entegris, both operationally and financially. We set out at the beginning of the year with a number of goals. We wanted to grow faster than our markets, generate strong cash flow, position our technology on the industry's road map in a more meaningful way then ever before, and to continue to leverage our technology in new applications outside of the semiconductor market. I am pleased with what we achieved in 2012.

Let me provide some more detail on each of these four objectives. First, our 2012 sales were $716 million, which was down 4% from a year ago, but still compared favorably to the markets in which we participate. The semiconductor industry began in 2012 with a modest recovery in demand, we experienced a precipitous drop in capital equipment spending and fab utilization in the second half. The rapidity and the magnitude of the CapEx contraction were very similar to what the industry experienced in the downturns of 2009 and 2001. Against that as the backdrop, we are pleased that our semiconductor sales, which accounted for 74% of our total revenue, declined by only 3%.

Second, in terms of cash flow and financial results for the year, we achieved an adjusted operating margin of 16%, and non-GAAP EPS of $0.55, and we generated $115 million in cash from operations. These numbers are in line with our target model, given with the industry slowdown and our decision early in the year to sustain critical investments. Having said that, our performance in the fourth quarter fell short of our expectations. As Greg will discuss in more detail, our fourth quarter included some negative impacts on our gross margin, as well as severance costs stemming from actions to realign parts of our organization.

Third, our efforts are paying off to expand our relationships with the industry leaders, and to integrate our technology on their road maps more extensively. The technology and economic challenges facing our key customers are immense. Because of these challenges and our efforts to engage with our customers in a more compelling way, Entegris is increasingly seen as a critical strategic partner that can enable the customers' processes and tools unlike any other supplier in our space. This past year alone, we had more collaborative projects with the industry-leading companies than ever before. And have customers across the ecosystem coming to us for our expertise in contamination control, to help them ramp 2X and 1X process nodes.

These interactions will have benefits well into the future. But in the short-term, compelling proof of our success, that we grew our revenue to the leading device makers by more than 40% in 2012. This is particularly noteworthy given that fab utilization rates for much of the industry remained low in the second half of the year. What is driving this success is the acceptance of our solutions, which are enabling 2X processes. In 2012, sales of liquid filtration and flow control products were at record levels, and sales of our FOUPs almost reached an all-time high. Given the industry road map, you will see these favorable trends continuing. For example, our filtration purification business, which accounted for about 40% of our total revenue in the year is already seeing very strong initial acceptance of new solutions developed for 1X process nodes.

Fourth, we have significantly expanded our product portfolio to leverage our technologies in new markets. For example, in LED we have developed new on-tool purification capability for MOCVD process tools, and new chamber crucibles made using our silicon carbide materials. Several of these products are currently being evaluated by customers. Clearly the LED, solar, and some of the other emerging markets had a very challenging year in 2012. But our new products have positioned us well for growth when these markets eventually recover.

Coming out of 2012, we have a lot of confidence in our strategy and our future, our customers engineering teams typically use downturns to accelerate development of new technologies, and I believe we have made the best use of this opportunity in the second half of 2012, which puts us in a great position as the industry recovers in 2013. Greg will now provide some detail on the quarter.

Thank you Bertrand. Good morning, and thank you all for joining the call.

For the fourth quarter, sales of $168 million were at the midpoint of our guidance, and were down from Q3 as anticipated. Excluding severance costs of $2.4 million, or $0.01 per share, our non-GAAP EPS would have been $0.10, or at the low end of our guidance.

Shifting to Q4 quarter performance by division, sales for the Contamination Control Solutions division, or CCS, declined 2% sequentially to $110 million. Revenue decline reflected weakness in sales of fluid handling components to OEMs, offset in part by record-high quarterly sales of liquid filtration products. Operating margins for the CCS division were 20.3%, versus 24.1% in Q3. The decline was largely attributable to lower factory absorption and unfavorable mix.

After a particularly strong quarter in Q3, sales for the Microenvironment division, or ME, declined 22% sequentially to $43 million. The decline was expected, given the softer industry conditions and a tough comparison against Q3, which included several large FOUP shipments and one-time IP licensing revenue. ME's operating margin was 15%.

Sales for Specialty Materials, or SMD, declined 13% to $15 million. The decline was a result of a very weak semiconductor equipment market for SMD products, as well as continued weakness in the solar market. While SMD's operating margin declined to 7%, it was consistent with our expectation given the revenue level.

We experienced several factors that adversely impacted our Q4 operating results. Gross margin of 40% included the impacts of reducing manufacturing output downward in reaction to lower customer demand levels, and also to reduce finished goods inventory in anticipation of continued slowness in Q1. The lower absorption of fixed costs accounted for about half the shortfall in gross margins. The remainder of the margin shortfall is related to customer and product mix. For Q1 we expect these factors to moderate, and anticipate gross margin to be approximately 40% to 41%. Operating expenses for Q4 were $50.2 million. This included severance costs of approximately $2.4 million related to organizational realignments. Excluding these costs, OpEx would have been at the low end of our guidance, and reflected a balance of tight control over discretionary costs, while sustaining investment in both R&D and critical customer-facing initiatives.

Moving into 2013, we expect operating expenses to be approximately $47 million to $48 million in Q1. Our GAAP tax rate was 24% in Q4, and 31% for the full year. The lower rate in Q4 reflected a more favorable geographic mix of income. For 2013, we are planning for a rate of approximately 28% to 30%. Q4 EPS on a non-GAAP basis was $0.09 per share. This includes the $0.01 severance charge, but excludes amortization expense.

We continue to have very strong working capital management and as a result, we generated $38 million in cash from operations for the quarter. Strong cash flow both for the quarter and the full year boosted our cash and short-term investments to $350 million, which is up $35 million over Q3, and up $77 million from a year ago. As we move into 2013, we are committed to use our cash strategically to increase long-term shareholder value. This includes meaningfully reducing our outstanding share count over time. To this end the Board has approved a new $50 million share repurchase plan, which will enable us to opportunistically repurchase stock. This replaces an existing authorization and trading program we put in place last year.

Moving forward, we have adjusted the price of targets for our repurchase plan, and would expect to be buying shares in Q1. In addition to share repurchases, we tend to be opportunistic in making strategic and more focused acquisitions to fill technology gaps, enable our diversification efforts, or expand the product line in our CCS division. In addition to share repurchases and potential acquisitions, we are using our capital to complete two ongoing projects, our I2M advanced membrane and coating facility and our 450-millimeter technology center.

Capital spending in 2012 was $50 million. For 2013, we are planning for CapEx of $60 million to $70 million, which includes about $25 million of maintenance spending and approximately $40 million for the two projects. Depreciation expense was $7.2 million in Q4.

Before turning the call back to Bertrand for comments on business trends, and our outlook for the first quarter, I want to highlight two key points. Despite the difficult industry environment, we are executing our strategy well, and are seeing growth in key areas related to advanced process nodes, and we continue to generate strong cash flow and are strategically deploying our cash with the new $50 million buyback plan, that will enable us to repurchase shares in a deliberate and opportunistic manner.

With that, I will turn the call back to Bertrand.

Thank you Greg. As we look to 2013, we are getting more opportunistic about the outlook for the semiconductor industry. We see 2013 as another year of critical transformation, as the industry invests to support of continuing rise in mobile computing, changes to the fabless foundry remodel, and ongoing major technology developments in EUV, 450-millimeter wafers, 3-D, and 1X process innovations.

Earlier this month at ISS, Intel displayed a fully-patterned 450mm wafer. This key milestone generated much interest and excitement in the industry, as it confirmed the timing of the 450 wafer size adoption, which could result in pilot manufacturing as early as 2015. We will be ready. We are working closely with the industry-leading players on 450-millimeter and other next-generation technologies. While the adoption of EUV lithography may be slower than originally hoped for, we are well-positioned when this technology is adopted. Until then broader deployment of double or triple patterning that use current 193 wavelength technology is good for Entegris, since it requires more dispense and cleaning steps in the process.

Given the stronger than anticipated CapEx plans announced this month by the leading fabs, we are cautiously optimistic that the cycle is bottoming, and that the industry is poised for a stronger second half in 2013. As such, we expect Q1 sales to be in the range of $160 million to $170 million. Given these revenue levels, we expect non-GAAP EPS to be between $0.08 and $0.11 per share.

Before we take your questions, I want to leave you with these points. The factors which negatively impacted our Q4 results should moderate, and we expect margins to improve in the first quarter. We are working on exciting opportunities that enable the industry to move to the next node. As a result, we expect to be one of the major beneficiaries of the upturn in 2013. We have a new capital allocation strategy in place to increase long-term shareholder value.

Operator, we will now take your questions.

(Operator Instructions). We will pause for a moment to assemble the queue. We will take our first question from Krish Sankar with Bank of America Merrill Lynch.

Hi. Thanks for making my question. A couple of them. Did you guys tell what your consumables and CapEx was in Q4?

Yes, we did. The ratio was about 69% unit driven for us. And 31% was CapEx driven, which is a ratio that is typically indicated with a downturn. Just as a note here, the last same we have seen a ratio of that magnitude was in Q3 2009.

Got it. Got it. And then how do you expect that to trend in the March quarter?

I would expect the ratio to be essentially the same with hopefully some pick-up on the CapEx front, as we start seeing OEM orders coming our way.

Got you. Along with that, have you guys started seeing any OEM orders coming through, or are you still anticipating it?

Well, it is a good question. I think what we are seeing is that our shipments still as we start Q1, the shipments are relatively low. But we have seen some increased momentum on the order front. So it is a little hard to read right now. We would expect probably some more clarity after the Chinese New Year. But I think we have all indications that we are really bottoming out and reaching an inflection point in our business.

Got it. And then just a final question on the Specialty Materials side. I understand that it has a mix of both semi and industrial in it. But if you look at your 2012 quarterly progression in that business, it seems to have followed the semi CapEx trend, when it has been down in the second half of last year. Should we assume that the Specialty Materials would also follow the semiconductor CapEx trajectory in 2013?

Yes. First, no question the back half of this year was heavily impacted by declines in semi-cap equipment. And this primarily related to a lot of their products are sold into ion implant applications. We would expect that the other place that business was really weak, particularly in the back half of this year, was on the solar side. As we come in to 2013, the patterns in that business, I would say should follow, if we see some improvement in semi-cap equipment, we will see some very good improvement in that business. And that business, as we have talked about before, from an operating leverage standpoint, has the greatest amount of operating leverage. So as we see that come back in semi-cap equipment, we should see a decent pick-up in the profitability as well.

Got it. All right. Thank you, guys.

Thank you, Krish.

We will take our next question from Patrick Ho with Stifel Nicolaus.

Thank you very much. Bertrand, maybe just a bigger picture question as you talked about in your prepared remarks, about the content of Entegris' products at each successive technology node. What is your thought right now as the foundry segment goes to 16 and 14-nanometers with thin set technology, what kind of step-up percentage-wise do you see, in terms of the increasing use of your products for that technology node?

Well, the thing for that technology node, it is a little early for us to really - in a number, again a lot of that work is still very much in development. Having said that, the way I would answer the question is a little bit more broadly, is if you look at revenues coming from our new products, it would represent about 25% to 30% of our total revenues, and most of those new products have been developed with the node of 3X and below in mind. Though as you can see, we are very much node driven, and we have a lot of exposure to the leading edge fabs.

Great. Two-part question on the I2M facility. I think in the past I think you said it would be operational in 1Q 2013. First question, is an update on that status. Secondly, maybe for Greg specifically, how do you see, as that facility begins to ramp, the potential impact to the gross margin line, given that it is at the early stages? There may be start-up costs and all. That how do you see that impact I guess affecting the overall corporate margin profile?

Let me give you the answer to your first question, and I will let Greg answer the second question. The first question was around the timing of the opening of the facility, and just again to make sure you are clear on that. There will be a number of different technologies that would be developed and manufactured into this facility. But there will be some specialty coating products and chuck products. I would expect most of those product lines to be transferred around the end of this year, 2013. And then the overall membrane manufacturing is a longer process for us, that will require fairly extensive customer requalification. And that is the one that won't be up and running until the end of Q1 of 2014.

And then with regard to the transition, I mean, we wouldn't expect to see in the first half of this year we wouldn't expect to see much at all. As we move into the back half of 2013, we will have transition costs of $2.5 million to $3 million, which will have a small impact on our gross margins in Q3 and Q4.

Great. Final question in terms of your cash allocation strategy. I think you provided a good, I guess clarification, in terms of your buyback, your M&A activities. Are those the two primary functions, or are there other avenues, whether it is a dividend, given your strong cash flow, or are those two that you mentioned already the primary focus for cash allocation on a going-forward basis?

Sitting here today, those are our two primary areas of focus. I think as we have talked to you and others, I mean, we have said that we have considered the dividend. But it is certainly not anything that we would plan to implement in the short-term.

Great. Thanks a lot, guys.

Thank you, Patrick.

Let's go next to Terence Whalen with Citigroup.

Good morning. Thanks for taking the question. I believe in the prepared comments you made a remark that revenue at the leading customers grew 40% annually. I believe it was a comment to that effect. I was wondering if you could help quantify the portion of sales, what you were referring to there? Thanks.

Terence, this is Bertrand. Yes, you are correct. What we said is that if you look at the leading-edge fab customers, our revenue year-over-year grew 40%. I won't go beyond that. I will not give you exact customer names that add up to that grouping. But we just wanted to give you some idea of the trajectory of our sales, and again give you some different perspective on how much exposure we have to the leading edge, and again how much of our business is really node driven.

Terence, to put it in broad perspective, we have talked about our top three customers in 2011, they accounted for 14% to 15% of revenue. And as the industry becomes more and more concentrated, we moved into 2012, those same top three customers accounted for about 20% of revenue.

Okay. Terrific. That is helpful. And then perhaps as a follow-up question, I believe you did refer earlier to there being some delays in EUV and that having some effect on some of the more advanced filtration. Can you just give us a prognosis for some milestones to look forward to for some of the advanced filtration products, for investors over the next year? Thanks.

Well, I am not sure I will be really very specific in terms of the milestones. The way I would want you to look at this is that every time a leading-edge customer is actually transitioning from one node to another, typically more process steps are being used, and then typically every time the transition from one node to another, they see some increased pressure on their yields. So everything that we do is really around enabling yield optimization for those customers. And every time they transition from one node to another, we very often are in task force mode with them to define, first of all, to understand the root cause of their yield challenges, and tailor solutions to help them optimize their yields. So again, I think it is a very positive trend for us. It is not something that can easily pin a particular deliverable and timeframe. But I will tell you that again, we are engaging in much more collaborative work than before. And I think that the opportunities for our products will be much more substantial going forward then they were at the 6X nodes.

Thanks, Bertrand. Helpful feedback. Thank you.

And we will take our next question from Avinash Kant with D.A. Davidson and Company.

Good morning, Bertrand and Greg.

Hi, Avinash.

A few questions. Did you give out your breakdown of revenues by region?

Actually we did not. But I can,if you would like that. By region our revenue for the quarter was 39% Asia, 17% Japan, 31% North America, and 12% Europe.

Okay. And one quick question on the guidance, especially on the EPS front. In one of the most recent presentations that you made at a conference only two weeks ago or so, I was looking at the slides, and you had said that on $117 million in revenues, you are kind of giving us the operating margin assumptions and the earnings per share on a non-GAAP basis was roughly between $0.11 to $0.13. The midpoint comes in at $0.12. The high-end of your guidance at this time on the revenue front is $170 million. Exactly 170. But the EPS guidance at the top end is $0.11. Of course, it is minor. But a penny for you makes a difference, given that 138 million shares. So is that something that has changed, or is that something that is conservative?

No. I would say the latter, to be conservative. But I do want to say, I mean our guidance is the $0.08 to $0.11. I look at the target model, and as you point out at $170 million, we look for an operating margin of $0.13 to $0.15, and an EPS of $0.11 to $0.13. At the top end of our guidance at $170 million, we are within the range of that target model. We are still very committed to the target model. If you look at our year overall, we averaged about $180 million in revenue a quarter, we had a 16% operating margin. And that is squarely right in the middle of our target model. As we move forward, we are committed to that model.

Avinash, I would just add to that, again as confirmed that we are very committed to the target model. I think what you are seeing us do here is really manage short-term with an eye on the mid-term. As we stated earlier on the call, we are really counting on an upturn coming our way, hopefully as early as Q2. And that is really the type of decisions that we are internally making right now, is just making sure that we can do some soft landing on an acceptable level of short-term profits, while making sure that we can ramp up and satisfy customer demands, when those orders start coming our way.

Bertrand, of course, last quarter is already gone. Some other companies have been talking about a bit lower margin too, in your space. Has there been any pricing pressure from any of the customers?

No. I think it really around again, as we described, it is really around product mix, customer mix, and the fact that we had a fair amount of under-absorption in our plants. And the reason why we had under-absorption again, is our desire to be able to be ready for the ramp when it comes. So no particular pricing pressure, or nothing really out of the ordinary.

I would just add that on some of these product transitions, as we move to more and more advanced products, the margins on the products tend to start out lower. And as we refine the manufacturing process, they increase over time. I mean, we have seen that historically. And I expect we will continue to see that as we move forward.

Thank you.

And we will take our next question from Christian Schwab with Craig-Hallum Capital Group.

Great, thanks for taking my question. Just a follow-up on the previous gentlemen's questions regarding operating margin leverage, looking at it a different way. If we look at the contamination control systems, we had 20% operating margins this quarter. Mid-cycle historically would be somewhere between 23% and 28% operating margins. What revenue range should we be thinking about for that?

I am sorry, Christian. When you say what revenue range we would be thinking about for that?

Right. So historically, your previous targets were mid-cycle operating margins on the Contamination Control Systems has been 23% to 28% operating margins? Correct?

Yes.

Great. I just want to verify that I am thinking correctly.

Oh, I think that still holds. And really as you get into revenue levels in that $120 million range, you go back to Q2 at $123 million in revenue, they were at 28%. The other thing you need to recall is when we adjusted our target model last May, the largest beneficiary in terms of spending was the CCS division. That was very deliberate. That is our fastest growing division, most profitable division. So their mid-cycle operating margins would be slightly below what we saw last mid-cycle, because of that additional investment.

Great. Perfect. I just wanted to make sure that there was still, what I was thinking about that type of massive leverage on only an additional $10 million to $15 million in quarterly revenue. Another follow-up on capital intensity, maybe looked at a different way, TSM has talked about their 28-nanometer volume tripling in 2013 versus 2012. Is there any way for you to quantify, either by wafer starts, the increased spending benefit, as we migrate more volume to that node, and the yield pressures that they continue to experience?

Christian, this is Bertrand. I think you are asking a very similar question to what Terence asked earlier. And as I stated then, it is very difficult for us really to quantify that. We have tried many different ways internally. We have a lot of product lines that are impacted. Each of them follow different buying cycles. And it is really hard to lump all of that into an easy model. And so we are not really ready to quantify that quite yet.

Alright. Let's make it simpler. It is more?

It is more. And I think as I said earlier to Terence, we know that it is more, and it is more by quite an order of magnitude. I would say that based on some early internal work, I would just frame it as potentially as much as 2X to 3X what legacy nodes would carry, in terms of size of the opportunities available to us.

Perfect. Thanks for actually quantifying it, sir. As we move, another question on mid-cycle operating margin leverage, as we look to the Specialty Materials area, another area of big leverage. We have talked about before that mid-cycle operating margins in that business should be 15% to 20%. So more than double from what we just did. What revenue, Greg, should we be thinking that we experience that type of leverage?

I think we have been pretty consistent. We have said at $20 million they will do 20%. I think we would hold with that.

Excellent. Thanks, guys.

Thanks.

And we will take our next question from Jairam Nathan with Sidoti & Company.

Hi. Thanks for taking my question. I just wanted to get some more information on the gross margin side. If I look at your 39.6% margins, you had to go back to like mid-2009 for that level. If I look at your inventory levels, inventory declined significantly, it declined $3 million on a sequential basis. Can you give us some more information on the mix, like an example? Because this doesn't seem like, it is a big decline.

Sure. I mean I can give you a for instance, as it relates to mix. We came into the quarter, we expected the mix in our ME business to be quite different than what it actually turned out. Some of the legacy products in ME, if you think when volumes slow down, what really slows down is the trailing edge. In the ME business, some of our stuff, 200-millimeter and below, processed products, 150-millimeter and below wafer shippers, those products continue to have very sound margins. In a quarter like this, those businesses fell off precipitously, compared to what we would have expected. At the same time, we saw some strength in data storage, which is inherently just a lower margin business. That is a for instance.

The other thing I would just say, commenting on the absorption, I mean, as we came through the quarter, we saw things continue to slow. We clearly slowed our manufacturing facilities down to stay inline with customer demand, and to keep inventory at moderate levels. At the same time I would say we haven't gotten to the point where we are being overly aggressive about cost-cutting on the manufacturing side. We do know that when things come back, they come back relatively quickly, and we don't want to get caught flat footed. So I guess what I am saying, if we thought we were going to run at $165 million for the next three quarters, you would see probably a different margin profile, because we would be a lot more aggressive on the cost side. But we do expect things to turn up.

Okay. And given your answer, the other question about second half could see a $2.5 million to $3 million impact from the, as I2M comes online. Should we kind of think, at least your target model is longer term. But for fiscal 2013, even at $170 million, your target model talks about the 44% to 46% for gross margin. Should be it closer to 42% for this year, just based on what you mentioned in the second half, and what is happening in the first half here?

I would say, we don't give specific gross margin guidance. Nor does our target model have specific gross margin targets. Our target model recall is really a commitment on the operating line. But I would, my comment with regard to your 42, is I would just say that is a little bit too cautious.

Okay. Okay. Thanks. That is great. Thank you.

Sure.

And we will take our next question from Dick Ryan with Dougherty.

Thank you. Say Greg, a little more aggressive commentary on the buy back. How much did you buy into the previous program? That was $50 million as well, wasn't it?

It was very little. It was less than $1 million. We had set our price target back in October of 2011, when the stock was trading around $7. We put it in place, and kept it in place for the full year. So what I would say this time around is we have raised our price targets, and also we have more flexibility this year in terms of our ability to change the targets as we move through the year.

Okay. And I think you just briefly mentioned here earlier, you are not cutting back on the cost controls on the manufacturing side. How about any other discretionary spending activities, whether it is mandatory time off, or hiring, or travel. What is the status now versus what you were looking at maybe two or three months ago?

So what I would say, first, I want to be clear. I mean, we are very judicious on the manufacturing side. We have reduced things. We did have some facilities that were closed over the holidays. The comment I want to just reiterate, though, we haven't been as aggressive as if we thought this was going to be three or four quarters at this level. I would say we are managing our costs in the plants quite tightly.

On the OpEx side, relative to three months ago, again I would say we are being equally if not more cautious around discretionary spending, T&E, that type of thing. We are not at the point where we are doing things like furloughs, or things of that nature.

Okay. Great. Thank you, Greg.

And we will take our next question from Steve Schwartz with First Analysis.

Good morning, guys. I guess my only question is related to 450mm. And with the recent announcement of major spending on a 450mm facility by one of the players, they did say that some of that was going to go to technology. Do you think in 2013 your share from 450mm at revenue is going to be 1% or 2%? Can you give us some idea of what share of revenue this is finally going to start to take?

Steve, this is Bertrand. I think you are talking about the share of revenue, especially to total ME revenues?

Of ME or Entegris consolidated?

Well I think that I would say that the first division that would benefit from development work that is happening in the ecosystem is really ME. And I would say that in 2013, the only real impact to the top line that I would expect would be in the ME division. Having said that, I think that the revenue will remain relatively modest. Could it be close to 1%, yes. That could be probably a good 1% of the ME total revenue. I think that is probably a fair target. In terms of our positioning, we continue to work very closely with all of the leading players in the industry, and continue to receive very good feedback on our products and solutions. So we are encouraged by that.

Okay. When do you expect, you had mentioned that you think that maybe pilot production could begin by 2015. And at what point in the ramp-up does it start to become a significant percentage of your revenue? Just based on historical trends, with 300, 200, 150?

I would say that again for the ME products, I would say very late 2014, early 2015. Again it will depend obviously on the overall timing of adoption by the one customer that you are referring to.

Okay. So it becomes meaningful for you at the pilot level. You don't need to wait for scaled commercial production and adoption?

I don't know what the definition of meaningful is. But I would say that it will become more than 1% of the ME revenues towards the end of 2014,and early 2015 is the basis for my answer.

Okay. That is very good. Okay. Thank you for the help.

(Operator Instructions). We will go next to Jason Ursaner with CJS Securities.

Good morning. First, just a question on the near-term industry cyclicality. Expectations have generally been for a trough some time in the first half, has anything changed in your mind on that outlook? I know semi book to bill jumped in December. Has there been any talk of the recovery pushing out, given the depth of the slowdown that you talked about took place in the second half of 2012?

As of right now, there is nothing that would change the comments that were made in the preliminary remarks. We still do believe that we will see some improvement in fab capacity utilization towards the end of Q1 and going into Q2. From a CapEx standpoint, I think you are well apprised of the recent news by all of the major industry participants. And again from the [inaudible] customer checks that we have had with all of them, I would tell you that they seem to be very, very committed to their CapEx plans.

Okay. And then I want to concentrate on the commentary around gross margin. I guess both for the quarter and the improvement in Q1. Greg, you mentioned about half the impact of the quarter related to the adjusting manufacturing and selling out of inventory. My question is, it seems like this happens whenever there is a more meaningful inflection point. And it is not always an accurate gauge for product margins. Is that a fair way to think about it? Is that sort of what you meant by managing costs, and not being too aggressive if you thought you would be running this level all year?

Well, I think you hit it right on the head, Jason. It boils down when the business is moving down, and we are at these points in the cycle, hitting the margin exactly right from a forecasting perspective, it is a lot more difficult. And it is harder to hold the margin. It is harder to make the target model on the way down than it is on the way up.

Okay. So just staying with that, can you talk a little bit about how the Company was positioned at the end of the year, with respect to the internal stock? Did you go sort of below the level to avoid under-absorption sorption, or is that still a factor you would expect to impact Q1, and maybe driving some of that conservatism on the high end of the target?

Our planning, in Q4 we actually we reduced inventory. And so if you think about our manufacturing volumes, they were actually lower than the revenue levels. Our planning assumption in Q1 is that inventory will be flat. So if revenue were the same in Q1, as it was in Q4, our manufacturing volumes would be slightly better.

Okay.

Our absorption would be better.

And did you say how much you actually sold out of inventory, or what manufacturing level for revenue it would have matched for the quarter?

Our finished goods, our semi finished and finished goods inventory were down about $3 million.

Okay. And then besides the factory absorption, you mentioned an unfavorable mix in the CCS segment. I guess I am a little bit unclear on what that meant? The fluid handling -- sorry.

Well, we mentioned unfavorable mix overall. And I don't know if you heard the prior question, but I gave somebody kind of an example of the dynamics in the ME business, where when you think about when we came into the quarter, we were looking for better revenue on some of the legacy products in ME. The 150-millimeter and below shippers, 200-millimeter process products. And when things are moving down, the parts of the sector that are hurt the most are the trailing edge. And so we saw much lower volumes in some of those legacy ME products than we expected. At the same time, we saw higher volumes in data storage, which is lower margin products. So that is a for instance.

Okay. I guess I am asking within the CCS segment, though, would that be signifying any type of price pressure on the advanced liquid filters?

Yes. I would say no to your price pressure question. Within CCS, I mean, we have a number of product transitions that we are going through, where we are experiencing lower margins as we go through the transition. Usually as we improve our procurement processes, as we improve our manufacturing processes, that we will see improvement in the margins of some of those newer products. And I am very confident that is going to happen in the CCS business.

Okay. And then just last question for me. For the non-GAAP reporting, I thought you mentioned that the quarter was excluding the severance, but is now no longer adding back the amortization?

No we are adding back the amortization.

Okay. But you are not adding back the severance in your adjusted GAAP tables?

Basically our GAAP number is $0.08, there is a penny of severance, which gets to us $0.09 on a non-GAAP. If you were to add the severance package, you would be at $0.10.

Okay. Was there a reason you didn't pull it out of the non-GAAP reported number though?

Pull the severance out?

Yes.

Yes, well the main reason is I don't want to get in the habit of, this quarter the severance was a big number. I don't want to get in the habit of always having something on that non-GAAP severance, or that non-GAAP reconciliation table, other than amortization.

Okay. Understood. Okay. Appreciate all of the commentary. Thanks, guys.

Okay. Thanks.

Thank you, Jason.

And that concludes our Q&A session. I will turn it back over to Bertrand for any closing remarks.

Thank you Tim. And thank you all for being on the call with us today. We look forward to updating you on our performance and progress in April.

That concludes today's conference call. We appreciate your participation.