Entegris Inc (ENTG) 2014 Q3 法說會逐字稿

Good day, everyone. Welcome to Entegris's third-quarter earnings conference call. Today's call 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.

Thank you. Good morning, everyone, and thank you for joining our call today. Earlier we announced the financial results for our third quarter ended September 27, 2014. You can access a copy of our press release on our website, 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 in Regulation G. You can find reconciliation tables 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. Bertrand will now begin the call.

Thank you, Steve. I will make some comments on the quarter's performance, business trends, and our integration of ATMI. Greg will then provide more details on our financial performance.

I am pleased with our Q3 results, which demonstrated the financial and operational potential of the new and expanded Entegris platform. To summarize, sales of $273 million were at the high end of our expectations. We achieved an adjusted operating margin of 18.3% and non-GAAP earnings per share of $0.21, which were above our target model. We generated $68 million of cash from operations, which allowed us to both grow our cash balances and repay $25 million of long-term debt. Finally, our integration of ATMI is progressing ahead of plans.

Overall, trends in the semiconductor market continue to reflect the patterns we have seen over the past several quarters - pockets of strength offset by softer sectors in both unit production and capital spending. Against these trends, the approximately 80% of our business that is leveraged to unit production grew modestly in the quarter, driven by device makers with exposure to launches of new smartphones. The portion of our Business driven by capital spending declined due to lower sales of FOUPs and fluid-handling products, which, combined, were about $11 million lower than in Q2, as we expected.

In our adjacent markets, which represent approximately 20% of our revenues, we benefited from a modest pick up in utilization in Q3 in solar, LED and flat panel display. However, capacity additions in these markets remain limited.

The performance of critical materials handling, or CMH, was in line with our expectations. Q3 sales declined from a very strong Q2 due to the lower sales of FOUPs and fluid-handling products I just mentioned. These product sales, which are fab-project-specific, are typically very lumpy. Other major CMH business lines performed well. Our sales of liquid filtration products benefited from strong demand in Taiwan.

The electronic materials segment, or EM, had an excellent quarter. Sales for our in-fab SDS gas delivery solutions and our gas micro-contamination products were very strong. Sales of our surface prep products grew modestly. And we also did see strong demand for our formulated cleans chemistry related to the ramp of 20-nanometer node technology.

The integration of ATMI is progressing very well, following an aggressive integration timetable. I am very proud of the hard work and dedication of our teams. And I am very pleased with the progress thus far. We have already achieved a number of key milestones, which have included eliminating duplicative corporate costs, integrating key HR policies and practices, and setting in motion plans for consolidating overlapping sales offices.

To put this in perspective, by the end of the second quarter of 2015, which will be approximately one year following the closing of our acquisition of ATMI, we expect to have the full $30 million of synergies in place. We expect to be running our operation from one common ERP system, and to have one unified front to our customers, with our global sales teams operating from the same offices around the world. This is ahead of our original schedule, which called for completing the integration by the end of FY15.

But, needless to say, we have already been very active in introducing the new Entegris platform to our global customers, who are facing ever greater challenges as they ramp their 14nm/16nm processes, and start developing their next nodes. These challenges are requiring new innovations in advanced materials, in tighter filtration and purification methods, more precise and reliable on-site blending and delivery, as well as cleaner and safer packaging solutions. This is good news for us, since solving these challenges is clearly in the wheelhouse of our strength.

We have a compelling value proposition for our customers that leverages our unique combination of strengths: technology breadth and depth, global infrastructure, and operational excellence. Given this strength, over the next two to three years, we will be able to take share and grow, achieve annual free cash flow of approximately $130 million, and deliver EPS in excess of $1 per share.

I will now turn the call to Greg for the financial detail. Greg?

Thank you, Bertrand. I was very pleased with our Q3 results. We performed well, exceeding our target model, and generating strong cash flow and EBITDA. Our sales of $273 million, which includes a full quarter of ATMI results, compared to pro-forma sales of $281 million in Q2.

By segment, CMH revenues of $165 million declined 8%, as expected, from a Q2 pro-forma revenue number of $179 million. The operating margin for CMH was 21.5%, which compared to 23.5% on a pro-forma basis in Q2.

EM Q3 revenues of $108 million grew 6% sequentially from Q2 pro-forma revenues of $102 million, due primarily to strength in specialty gases and deposition materials. EM achieved an operating margin of 30.9%, which compared to 28.5% in the second quarter on a pro-forma basis.

By geography, Asia sales represented 54% of total revenue. North America sales were 23% of total revenue. And sales to Japan and Europe were 13% and 10% of total revenue, respectively. The impact of currency fluctuations was not meaningful in the quarter, although the weaker yen and euro may be a headwind in Q4.

On a consolidated basis, our GAAP financial results for the third quarter included $31 million of charges related to the ATMI acquisition. These are outlined in the reconciliation chart on page 11 of our press release.

Specifically, cost of goods sold in Q3 included a charge of $24 million related to the remaining portion of the amortization of the fair value markup of acquired ATMI inventory. In accordance with purchase accounting rules, ATMI inventory was adjusted to fair market value, and essentially written up to near sales price. There are no additional inventory step-up charges remaining.

SG&A in Q3 included approximately $7 million of integration expenses. To date, these expenses have amounted to approximately $10 million. We expect to have integration expenses through 2015, although the level of cost should start to taper off beginning in Q1. At this point, we are more than comfortable with the $35-million overall integration cost estimate we previously provided. In Q4, integration expenses will be approximately $7 million.

Q3 operating expenses also included amortization of $13 million, which relates primarily to the ATMI acquisition. Amortization expense will continue at similar quarterly levels for the next several years.

As Bertrand indicated, our integration activities have been very productive, and we are tracking to realize the $30 million in annual cost synergies faster than originally expected. At the end of Q3, we have realized more than half of the annualized savings, and we expect to exit 2014 at a $20-million annualized run rate.

On a non-GAAP basis, excluding the inventory revaluation charge mentioned above, gross margin was 45.1%, up just slightly from Q2. Although we had a favorable product mix in the quarter, this was offset by lower absorption and a modest drag from the i2M facility as we complete the necessary customer qualifications to begin ramping production in the middle of 2015. For the fourth quarter, we expect gross margins to be flat with Q3.

Excluding amortization and other transaction-related costs, non-GAAP operating expenses were $73.2 million in Q3. For the fourth quarter, we expect non-GAAP operating expenses to be $73 million to $76 million.

Interest expense was $10.1 million in Q3, reflecting three months of interest and amortization of financing costs. We expect interest expense to be $250,000 lower in Q4 as a result of the debt paydown in Q3.

The tax rate for the quarter of 79% on a GAAP basis was skewed by the purchase accounting and integration-related costs. On a non-GAAP basis in Q3, we had a tax rate of 27%, which is consistent with our planned rate going forward of 27% to 29%.

Adjusted EBITDA for the quarter was $64 million. Cash flow from operations was $68 million, which illustrates the cash generation power of the combined Company. The cash flow allowed us to both increase our cash balance and pay down $25 million of our term loan.

Our cash balance at the end of Q3 was $390 million, up $24 million from Q2. Approximately 80% of our cash is held offshore. After the $25-million repayment, total long-term debt, including the term loan and the notes, was $793 million.

Over the next three to six months, as we complete the legal entity integration of our foreign subsidiaries with the former ATMI subsidiaries, we will be opportunistic with respect to cash management, and expect to bring a portion of the foreign cash back to the US. We are very comfortable with our financial position, and our current net debt ratio is less than 1.8 times trailing pro-forma EBITDA.

Capital spending in Q3 was $15 million. In Q4, we are planning for CapEx of $15 million to $20 million, with depreciation of approximately $14 million.

In terms of our outlook for Q4, we anticipate slower wafer starts consistent with seasonal trends, with continued patchiness in industry capital spending. Given this outlook, we expect our Q4 sales to be in the range of $260 million to $275 million. At these revenue levels, we expect non-GAAP EPS to be $0.15 to $0.21 per share, consistent with our target model and the timing of the realization of our cost synergies.

In summary, we executed very well, and maintained a strong focus on the customer. We exceeded our target model, and generated strong cash flow. Consistent with our stated capital allocation strategy, we are using that cash to pay down debt. We feel good about how the ATMI integration is proceeding, and about our ability to achieve our stated cost synergy goal of $30 million on an accelerated basis.

With that, we will now take your questions. Operator?

(Operator Instructions)

Our first question from Patrick Ho with Stifel Nicolaus.

Thank you very much. And congrats on a nice quarter. Bertrand, first, in terms of the fourth-quarter outlook, can you give a little more color on the pulls and pushes in terms of the market segments where you are continuing to see some wafer start strength versus some of the seasonal declines that you typically get? What are some of the pulls and pushes there?

Hi, Patrick. As Greg was mentioning, when we are characterizing the guidance for Q4, we expect our unit-driven business to be down modestly sequentially. We expect overall fab activity to slow down, pretty much in line with normal seasonal patterns. We certainly expect different base of operation depending on the customers, but that is not something that we would want to be characterizing on this call.

And as it relates to our CapEx-driven product lines, I think the picture will also be mixed. As you know, different components and product lines would have exposure to different tool sets, and the picture will also likely be mixed in that regard going into Q4.

So, for instance, we'd expect components going into ion implanters or track to do well, for example, but we are expecting others to be more muted. And, finally, we expect continued softness in sales of products that are tied to new fab construction projects.

Great, that's helpful. Maybe bigger picture, since you mentioned the 16- and 14-nanometer foundries since that ramp, from a percentage basis, big picture, how do you see your intensity rising as the industry goes to those new processes? How do you see your overall product portfolio intensity rising?

We have been anxiously waiting for some of those new nodes to start to really ramp up. As you know, typically the opportunities available to Entegris, those most advantaged nodes are greater than some of the legacy nodes.

Having said that, we all know that there have not been a lot of volume activity at 16 and 14. So, we are certainly waiting for those process nodes to hit our volume manufacturing sometime next year.

Great. And final question, Greg, in terms of the paydown of the debt, if you keep generating the cash flow that you've generated over the last few quarters, can we expect this $20 million, $25 million type of paydown of debt on a quarterly basis?

I think the debt will move down over the next 12 months in two forms. One is you will see consistent paydown from cash flow, which -- call it in that $20 million range per quarter.

And then the other thing I commented on is we think we will have the opportunity to bring some cash back from outside the US sometime over the next three to six months, and we will apply some portion of that to debt reduction. And we've really said since the beginning that number is probably somewhere order of magnitude of about $100 million.

Great, thank you again.

And we will go to the next question from Jason Ursaner with CJS Securities.

Good morning. Good quarter. First for Greg, I appreciate all the details in the prepared remarks on the balance sheet. You mentioned comfortable with the $35 million total integration cost.

What is the timing for some of the cash outflows of those costs? Are they all in the cash flow number?

The bulk of the cash outflows will be over the next two quarters. The largest components of the integration costs are professional fees. Much of that is around our ERP integration and some of our legal entity integrations.

The other component of it -- significant component -- is retention dollars, and most of those will be behind us by the end of Q1. A little bit will trickle into Q2.

So, by the time we get into Q2 of next year, the integration costs should be pretty nominal on a quarterly basis, like maybe a couple million dollars a quarter. And, like I said, more than comfortable with the $35 million. I would be really disappointed if we spend anything close to the $35 million.

Got it. I'm looking at the cash flow number. You did almost $0.40 in cash earnings, I think. So, I don't want to build that going forward if there's going to be some cash outflows that kind of (multiple speakers) --

No, I think the things that you need to think about on a cash outflow basis is in Q1, we have pretty significant -- our incentive plan pays in Q1. That is always a meaningful charge to cash flow in Q1. And that number is somewhere $20 million to $25 million this year.

And then we will pay out -- the retention and severance payments start paying out beginning in April. But that won't have a positive or negative impact on the cash flow.

It's essentially just a salary continuation for various periods of time. So there's not big one-time payments.

Got it. And the term loan portion of the debt that you are paying down, just remind me, there is no prepayment charges on that piece of the overall capital structure?

No, there are no prepayment charges.

Okay. And then just focusing on the SG&A line, adjusted down to a little bit below $50 million run rate. When you are talking about synergies, I just want to make sure, I was looking at Entegris was a mid-$30 million run rate, and ATMI standalone would have been $15 million to $20 million a quarter. Is that the same way you guys are looking at it pre-acquisition when you talk about synergies and where you made progress to today, versus exiting 2014 at a $20 million annualized run rate?

The combined G&A -- forget the S -- of the two companies was a little over $100 million. And that's where a very significant portion of the synergies will come from, will be out of that $100 million.

Okay. And the speed at which you've made progress so far, are you finding that the synergies on the cost side were maybe a bit more expensive than you first thought? Or it's just been successful timing so far to date?

There have been a number of things where we just did better, where we achieved the synergies faster than we thought we would. I mean, initially -- one example, I would say, is cost of our insurance. We initially thought that we would run multiple insurance plans for a period of time, and we were able to push those two insurance programs together very quickly, and begin realizing those synergies sooner than we thought. That is a for instance.

We have a few more people in the queue, so can we come back to these after we get through everyone?

Yes, no problem. We'll jump back. Thanks.

Our next question is from Christian Schwab with Craig-Hallum Capital Group.

Great quarter, guys. Greg, we are way ahead on the OpEx, right? At your analyst day in June, you thought you would get to $73 million maybe by Q3 or Q4 of next year, and exit the year at $72 million.

So, good job on that. I'm just wondering on this next $10 million -- we're going to be at $20 million, as we exit the year -- of that remaining $10 million, what is the mix between OpEx and COGS?

The majority of that, or all of it, essentially, is OpEx. I would say if we have upside anywhere in the synergies, that will come more in the supply chain and cost of sales area. But as we talk about our committed synergies, they are 95% OpEx.

Okay. And then was it just conservatism? When we first announced the acquisition, we talked about generating $100 million in annual free cash flow, and now we have taken that up, it sounds like, to $130 million a year. Was that just needing a little bit more time to make sure that everything was as stated, or is there something more positive going on in (multiple speakers) --

What we have done, really, over the last three to four months, we have gone through an extensive strategic planning process of the combined entities. That $130 million is really just a number that drops out of our free cash flow, as we get out to about 2016. It's a much more refined estimate than when we were dealing with essentially deal models back in February.

Right. That makes sense. Then, have we had a chance to figure out the math yet on wafer starts at FinFET 16 and 14, what the potential dollar amount that may positively impact you on wafer starts yet?

You have a good memory, Christian. I think I would go back to the answer I was giving to Patrick just a moment ago. We need, really, to see some real activity over some period of time at those 14- and 16-nanometer fabs, to really fully understand the consumption rate of certain of the materials and solutions we are providing for those fabs, is going to behave like. So, it's too early for us, really, to answer the question.

Having said that, again, I think that over the last six months we have been reintroducing the new platform, the Entegris new platform, to customers, and I would tell you they really are very positive about the value. They really like the idea of having one supplier that can synthesize molecule, can define best known methods of filtration and purification, and come up with the right packaging solution that is clean and safe for the operators.

And I think that this is a very unique value proposition that Entegris is providing. So, we are continuously very excited about the promises of the merger.

Okay. No other questions. Thanks, guys.

And we will go to the next question from Dick Ryan with Dougherty.

Thank you. Greg, on the adjacent markets you talked about a 20% contribution there. Could you give us a little more sense of the mix and how you're looking at that into Q4?

I will talk a little bit about the mix and I will let Bertrand comment broadly on adjacent markets. From a mix perspective, Dick, what I would say is it's really -- and the reason we don't comment on markets specifically is it's a very broad mix of markets.

If you think about it, there is some LED in there, there's some solar in there, there's some data storage in there, there's some flat panel in there, there's some industrial markets. None of those markets individually approach a level of being material.

What I would say is, in general, the bulk of that 20% is what I would refer to as other, call it, microelectronics markets. And, so, we're going to participate in trends similar to what you see in those markets.

Okay. Thank you. How should we look at segment profitability, now that you have provided some of the historicals in CMH and EM? Is there any guidelines you'd give us on segment profitability for either sector there?

I think what you saw this quarter would be how I would think about it. We had a very strong quarter and a very good product mix in the EM business. So, we saw an operating margin that was 240 basis points higher than last quarter, at about 30%.

If I look back over time, that business on a pro-forma basis has tended to have operating margins that have averaged somewhere in the 27%, 28% range. And with good mix they have been up, like this most recent quarter, at 30.9%.

The CMH business, which is largely the historical Entegris businesses, over time has run in that 21% to 22% range. Last quarter they had a very strong quarter and we were at 23.5%. This quarter with the lower volumes it was 21.5%.

But, Dick, I just would want to add to that. I think this pro-forma information is really merely here for you to understand better some of the mix, and the margin mix, of those two segments. From a corporate standpoint, we only have one target model and we only make a commitment to this corporate target model. I don't think that we would ever thought of introducing target models or expectations by business segment.

Sure. The sequential decline in CMH, was that -- I wasn't sure if I caught the reasoning. Was that the legacy Entegris CapEx business there?

Yes, that was really -- Bertrand made the comment that we saw a big quarter in FOUPs in Q2 that did not continue into Q3. But that decline was really a combination of the decline in FOUPs and a decline in fluid-handling products, primarily related to project business, which is typically outfitting a fab.

Sure. Okay.

If you'll remember, Dick, during our Q2 call we were actually characterizing that we were expecting our FOUP business to be down about $10 million to $11 million in Q3. They were down about $10 million, so essentially in line with our forecast.

And our PureLine revenue was a bit stronger than expected. I think we were expecting it to be down $4 million. They were down about $3 million.

So, overall, however, I think what I really want to be sure you understand is that those product lines really boosted record revenue in Q2, and the revenue levels that we recorded in Q3 are very much in line with normal levels of business. So, very solid performance from those two product lines.

Great, thank you. Good job on the quarter.

The next question is from Jairam Nathan with Sidoti.

Hi. Thanks for taking my question. First, can you give us an update on revenue synergies, what are the actions being taken to get some of these timings, and on the cross-selling opportunities, as well?

Jairam, this is Bertrand. I would just say again that a lot of the new solutions, what we characterize internally as the blue ocean value that we will be creating by combining the capabilities of legacy Entegris and ATMI, will most likely not be introduced in a fab environment probably until 10-nanometer and below. We are actively working with all of the leading edge fabs on those new nodes, but at 10-nanometer and below.

So, for now, I would say that our commercial effort is really focusing on cross-selling existing products and leveraging existing customer relationships. And I would expect, again, to start seeing the benefits of that sometime going into next year.

Okay. Thanks. Greg, just a clarification. You said you guided Q4 OpEx to between $73 million and $76 million, is that right?

Correct.

So, given $5 million in synergies that you are talking about in this quarter, what drives the increase in a flat to down revenue environment?

We are focused on achieving that target model and we are running well ahead of the target model the last two quarters. So, we do have the opportunity to make incremental investments in the business at this point. So, I would say nothing specific, but our goal long term is to operate to the target model and approve funds above that to have them to invest back in the business.

Okay, good. And last question, did you have any 10%-plus customers this quarter? Or any 10%-plus customers in [September]?

I do not have that right in front of me. If you will bear with me -- I don't believe so but give me a second here. We did have one customer greater than 10% in the quarter.

Okay. Thanks. That's all I had.

And we will go to our next question from Frank Jarman with Goldman Sachs.

Thanks for taking my questions. And congrats on the quarter. Just with regards to the debt paydown this quarter, can you talk a little bit about what your target gross debt levels might be going forward?

Our goal, Frank, is to pay the term loan down as quickly as we possibly can. If you think about it longer term, it would leave us essentially with $360 million of notes. If somebody said: what is the target? I would say in terms of a permanent level of debt, you think about that broadly. We have consistently said, though, that let us wear the debt, if you will, for a year, year and-a-half, before we set a permanent target for our capital structure.

Got it. That's helpful. And just along those lines, your bonds are currently around par, just 1 point or so above par. Have you thought about buying those bonds back in the open market, given the more attractive interest cost savings?

We have not thought about that. They had been trading about 103, 104, but with them back here it's certainly a consideration.

Got it. Thank you. And then just the last question I had for you guys was you talked a little bit about the potential for some cash repatriation. Are there any more details you can provide with regards to how much of that cash you could bring back, and how you are thinking about redeploying some of that cash? Thank you.

I think order of magnitude in the near term, we think it will be somewhere around $100 million over the next three to six months. Our commitment, when we bring that back, is that we will use that to reduce debt.

Great. Thanks very much, guys.

(Operator Instructions)

We'll go to our next question from Todd Morgan with Jefferies.

This is Chris filling in for Todd. I have two quick questions. One is a follow-up.

I'm looking at the analyst day slides, I'm seeing a $150 million figure for that cash repatriation. I was just wondering, I think it has always been in the $100 million to $150 million range. Are you still planning the $150 million total or are you finding it's looking more like $100 million, like you previously mentioned?

Over time, I think it will be well in excess of $100 million, certainly approach that $150 million. But when we think about it over the next three to six months, though, it's going to be something on the order of magnitude of $100 million.

Okay. Thank you. And, secondly, back to the ATMI acquisition, you guys talked a lot about cost savings and it sounds like that is all on track. I wanted to touch on the revenue side of that.

Are you expecting to see any revenue synergies, like product bundling, cross-pollination, anything like that? And the timing of any ramp there?

Chris, this is Bertrand. Yes, actually, that is the answer I was providing to earlier questions. I would answer the question in two ways.

Short term, it's really around, again, cross-selling existing products and solutions. Typically, customer evaluations of those solutions would take 6 to 12 months, depending on the products. So, therefore, the time frame I was suggesting earlier, which is you probably won't see any meaningful impact from those commercial efforts until sometime in the beginning of next year.

Then, what is more exciting about the merger is really the ability of combining the capabilities of ATMI and Entegris. But, really, for that to be a reality, we really need to get on the road map of some of the leading-edge fabs. And right now we believe that the best insertion point for us would be 10-nanometer or below.

So, then the question would be, when will those more advanced nodes be in production? And I would say we don't really know quite yet, but probably two to three years from now.

Okay, great. Thank you.

Different time frames depending on, really, the type of solutions and the type of opportunities.

That concludes today's question-and-answer session. At this time, I would like to turn the conference back over to Mr. Bertrand Loy for any additional comments or closing remarks.

Thank you for being on the call with us today, and thank you for your participation. Have a great day.

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