Entegris Inc (ENTG) 2015 Q3 法說會逐字稿

Good day everyone, and welcome to Entegris' third-quarter 2015 earnings 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. Earlier today we announced the financial results for our third quarter ended September 26, 2015. We have accelerated the timing of our press release in this conference call to comply with Reg FD requirements, to address an inadvertent premature disclosure of our third-quarter results. You can access a copy of our press release on our website.

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 a reconciliation table in today's press release.

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

Thank you, Steve. I will make some general comments on the business, Greg will then provide more details on our financial results. Overall, I am pleased with our Q3 performance, particularly given the challenging industry environment we experienced in the quarter. We flexed our operations while adjusting our spending to the general softening in the industry.

We met our target model and achieved Non-GAAP EPS of $0.23. We generated solid cash flow and continued to reduce our debt with a $25 million repayment in the quarter. After a strong Q2, our third quarter sales declined 4% sequentially, and were at the low end of our guidance. While we saw growth in some areas of our business, the scenario of slower production rates and lower fab project activity materialized as we moved through the quarter. This was further amplified by the negative impact of foreign exchange.

Semiconductor sales were down 1% versus the second quarter, as some customers decelerated their fab utilization rates and pushed out investments to match the soft near term demand. Sales in our adjacent markets contracted 11% sequentially, and represented approximately 22% of our revenue in Q3. We achieved modest growth in data storage and display, but sales of graphite material declined in Q3, after reaching record levels in Q2. This anticipated decline resulted from the normalization in new orders after an initial surge, driven by the adoption of our graphite material in a new glass application earlier this year.

Turning to our business segments, Critical Materials Handling, or CMH, declined 5% sequentially, but was about flat with the third quarter a year ago. On one hand, the decline on a sequential basis reflected lower sales of wafer handling and specialty materials products. Sales of wafer handling products as you know, such as our FOUP, can be lumpy, and were impacted by the low level of new fab capacity build outs. On the other hand, we achieved growth in our filtration business, driven by continued strength in our leading-edge solutions for advanced wet etch and clean, and litho applications.

The Electronic Materials, or EM, segment declined 2% sequentially was down 3% year-over-year. Our advanced deposition materials business posted a record quarter in Q3, boosted by the introduction of new products. This performance was offset by lower sales of gas microcontamination products, as a result of weak OEM demand. For the nine months of 2015, our sales grew 1% from last year on a pro forma basis. When adjusted for a 3% headwind from the stronger dollar, this represented a 4% gain compared to the prior year.

Looking to the fourth quarter, we anticipate business conditions to remain soft, as we expect chipmakers to continue to work down inventory and moderate their capital investments. Accordingly, we will be taking additional steps to control our expenses, while maintaining critical investments to grow our business. We are confident in the prospects for Entegris. We like the relative stability of our business model, we have a rich pipeline of new opportunities which cuts across our broad portfolio of products, markets and technologies, and we are fully committed to deliver on our short-term and long-term financial commitments.

I'll now turn the call to Greg for the financial details. Greg?

Thank you, Bertrand. While Q3 sales were at the low end of our expectations, I'm pleased with our execution for the quarter. We flexed our spending and achieved an adjusted operating margin, in line with our target model.

Non-GAAP EPS was $0.23. The results included a $0.03 benefit from currency gains and a $0.02 benefit from a lower than anticipated tax rate. Results excluding these benefits were still in line with our target model. Q3 sales of $270 million were 4% lower on a sequential basis, and included a $3 million or 1% headwind from foreign exchange. Compared to a year ago, sales were down 1%, and included a $13 million or 4% negative impact from foreign exchange.

Gross margin of 43% declined from 45.6% in Q2. The decline in margin was due to costs resulting from supplier quality issues, as well as costs related to the closure of a small manufacturing operation, and to lower sales volumes. In spite of our expectations for lower sales in Q4, we expect gross margin to be approximately 43.5%, or essentially flat with Q3.

Q3 results included amortization of $12 million and integration expense of $2.1 million. Excluding these costs, non-GAAP operating expenses were $71.5 million in the quarter. This was below the low end of our guidance, and reflects tight spending controls and lower variable compensation.

We expect non-GAAP operating expenses to be $71 million to $73 million in the fourth quarter. We will have approximately $1.5 million of integration costs in Q4, related to the merger of our legal entities. These costs are slightly higher than initially anticipated. In addition, the final steps of the integration will result in even greater ongoing benefits.

Net interest expense was $9.2 million in Q3. The GAAP tax rate for the quarter was 15%. On a non-GAAP basis, our tax rate was 21%, which was lower than initially anticipated, due to favorable geographic income mix. For Q4, we expect the GAAP tax rate to be approximately 19%, and the non-GAAP rate to be approximately 25%.

Adjusted EBITDA for the quarter was $58.2 million, giving us a very healthy EBITDA margin of 21.5%. Cash flow from operations for the quarter was $33 million. Our cash balance at the end of Q3 was $301 million, a decline of $13 million from Q2. This reflects the cash flow from operations, less the $25 million debt repayment, and $21 million of capital expenditures.

Total long-term debt, including current maturities was $667 million, giving us a net leverage ratio of 1.5 times. With the $25 million of debt repayment in Q3, we have fulfilled the commitment we made at the time of the ATMI acquisition to repay $150 million of debt by the end of 2015. We plan to continue to reduce our debt further in the beginning of 2016. In Q4, we are planning for CapEx of approximately $10 million to $15 million, with depreciation of approximately $14 million. For the year, we expect CapEx to be up approximately $65 million to $70 million.

Turning to our outlook for Q4, we expect sales to range from $250 million to $265 million, reflecting continued softness in our markets. At these revenue levels, we expect non-GAAP EPS to be $0.15 to $0.19 per share, consistent with our target model.

In summary, we executed well in a challenging environment. We're demonstrating the relative stability of our business model, and we remain committed to delivering on our long-term and short-term commitments. Operator, we will now take questions.

(Operator Instructions)

Todd Morgan, Jefferies.

Two quick things. First of all, Bertrand, I know you talked about the medium-term story here being the creating synergies between the two companies, and then being able to provide next-generation products to your current customers. Is there anything tangible you can point to at this point, in terms of any kind of design wins or product development, things like that?

Secondly, just looking at the balance sheet, good to see the continued cash debt reduction. Is there a way to characterize the domestic versus international cash these days, and I don't know if you care to offer any magnitude of planned continued debt repayments that you referenced earlier? Thanks.

Let me take the first question and then I will transition to Greg to answer some of the cash-related question. As it relates to the positive synergies that we're expecting to unlock from the combination with ATMI, as we mentioned before, we would expect some new solutions to be introduced when the industry transitions to 10 nanometer and down the road to 7 nanometer. I think saying that, we have been very actively engaged with the number of technology leaders in this space, and I think we have now tangible evidence that the combination of capabilities of the two companies are really creating value for customers.

One example of that could be some of the recent wins that we recorded in our advanced deposition materials. As you know, we provide not only precursor materials, but we also provide delivery systems to supplement the material to the gas phase. In other words, think of it as really as the unique ability to provide a comprehensive solution, including solids, purification, packaging and delivery solution for our customers. As you know, those solid precursors are used in LED and CVD markets, which have been growing actually at an order of magnitude faster than the MSI Index. I believe we have some interesting times ahead of us, as those materials are introduced into production.

On the cash-related question Todd, slightly more than $300 million of cash on the balance sheet. Of that approximately $70 million is held in the US. The balance is offshore. With regard to debt reduction, we don't plan to make additional payments in Q4. I would expect we will pay, we've classified $50 million of the debt as current, and I expect we will pay the $50 million sometime in the first half of 2016.

Great, thank you very much.

Patrick Ho, Stifel.

Thank you very much. The CapEx portion of your business is obviously a small portion, but given some of the weakness that is out there in the industry right now, from your vantage point, have you seen any significant changes in terms of fab projects, whether they are pushing out? What is your view from your vantage point on that end of the business?

Patrick, yes. So as you mentioned, this is a minor part of our business. As you know, 20% of our business is impacted by the fab equipment activity. Having said that, as we mentioned in our prepared remarks, we saw a softening FOUP business which typically correlates to new fab buildouts, and we also saw a softening in our OEM business, in particular, softer trends for our gas filtration products that are usually solutions that we send to our OEM customers. Certainly, we saw some slowing down in the rate of orders from OEMs, and we have seen some push-outs in terms of new fab buildouts.

Great, that's helpful. And maybe, Greg, for you on the financial model, given that you have maintained your run rates on the target models, give me some of the volatility that we're seeing now both for you in the wafer structures, as well as the CapEx side of things? What are some of the measures and tactics you are taking to keep your target model in line as we go forward?

At this point, we've really tightened up on discretionary spending, like travel and entertainment, we have reduced some of our variable engineering and project-related costs. Like I said, at this point, it has been general belt tightening around some of the variable costs. We're also looking closely today at the manufacturing environment and the staffing levels there.

Great, thank you very much.

Dick Ryan, Dougherty.

Greg, the last comment on your manufacturing staffing levels, would that suggest this pause might be more than one quarter event, do you see this lingering into 2016? What are you hearing from customers, and how would you color the rebound?

I will pass that to Bertrand.

I will take that. The industry environment right now is pretty murky, and we certainly do not have more visibility than anybody else in the ecosystem. What I can share with you is that internally we are planning for a softer industry environment for the next two to three quarters, and we will be taking steps to ensure that we control our spending levels and that we do that while protecting all critical investments. We've done that before. We have an experienced management team at Entegris and I'm convinced we will be able to manage the uncertainty of the environment very effectively.

Greg, what sort of FX impact are you assuming for Q4?

Q4, we are assuming rates stay essentially where they are today. Sequentially, we wouldn't expect a lot of rate impact. In year-over-year, the impact of foreign exchange will obviously be less in Q4 because the big move in rates was in October 2014.

Your buyback program can you refresh me where that is, and how much is left?

At this point, we don't actually have a buyback program.

That expired. Okay. Great, thank you.

(Operator Instructions)

Jairam Nathan, Sidoti.

I dialed in late, but Bertrand, did you talk about non-semi, and you had a pretty good quarter in June on the non-semi side. Can you talk about that business, how is that doing versus the semi side?

I mentioned that the non-semi business has grown since last year. It is presenting today about 22% of our total revenue. Certainly, Q3 was a challenging quarter for our non-semi-business, with the decline of 11%, but it is mostly attributable to one factor, and let me give you a little bit more details around that. At the end of last year, we uncovered a new application for graphite material. For this application the coefficient of thermal expansion of our material is actually the perfect match for the glass substrate, and as the result of the unique properties of our material, our customers have been able to generate very significant yield gains, and improve their cost of ownership.

Earlier in the year, we did benefit from a surge in orders as our customers converted all their production sites to the Entegris material. We believe that the rate of order has receded somewhat in Q3, and we believe that the current revenue levers in Q3 are more in line with what we would consider to be normalized levels of business, for this application going forward. What I want to say is that in spite of the lumpiness of that business in the early stages of the business, it's certainly a very positive development for us.

As you know, we do not have a lot of new opportunities and new markets that would exceed $10 million on an annual basis, and this is one of them. Again, if you look at the performance of our non-semi-business over time on an annual basis, we are very pleased with the progress and very pleased with the growth rate that we have been enjoying year to date.

Could you also give some color on the supply issue you talked about for the gross margin? Does that continue into fourth quarter or is that solved?

Jairam, no, I would not expect that to continue into the fourth quarter. It was an isolated incident, the vast majority of it related to one specific situation.

My last question is regarding, Entegris has historically benefited when the industry moves, changes nodes, and increases the proportion of newer next-generation nodes. You would think that kind of, we saw that slows down in 2016 so compared to the industry should we expect -- how should we expect Entegris perform in that light?

I think, again, this overall, this remains absolutely true. I think that the contraction that we saw in our business in Q3 is really a reflection of significant reduction in fab capacity utilization, and we saw that reduction at the trailing edge, but also at the leading edge. Some of our customers were operating their leading edge fabs at or below 80% capacity utilization. That is really what is behind the softening in our business, as the industry and some of the technology leaders in the industry transition to tighter nodes next year, we would expect certainly to benefit from that.

Okay, thank you. That's all I had.

(Operator Instructions)

Amanda Scarnati, Citi.

Just a question on the debt and the reason, Greg, that you had mentioned that you won't be paying any debt down next quarter. Is it higher expenses, and maybe year-end bonuses or something that you have to concern yourself with on the cash side, or is there something else going on there, that we should be aware of?

No, there is, no, I don't have any specific concerns. The primary reason is, if I make a debt payment after January 1, it will be applied toward our -- any potential 2016 excess cash flow repayment requirement we would have. I am saying, I might as well take advantage of that opportunity. If you said, could we pay some debt in Q4, the answer is absolutely yes, but from the mechanism of the credit agreement, it just makes much more sense to make that payment in Q1 versus Q4.

You said about $50 million in the first half of 2015?

Yes. That is what we would expect.

Okay. And then, Bertrand, just one more question on the demand environment. You had mentioned that you were planning for a soft environment over the next two to three quarters, and first half tends to be stronger than second half. Should we expect a sub-seasonal first half, or is there anything that you are seeing with your customers that could offset that a little bit, hopefully?

Amanda, again, as I stated earlier, we don't have any better crystal ball than the rest of the industry. What we are seeing right now is again a contraction in fab utilization, and that is the result of two major factors. One is a softening in end demand for new mobile devices, and more specifically, a slow demand for smartphone sales in China. And then, a very concerted effort by many of our fab customers to reduce their inventory levels. We believe that both of those trends will likely -- will continue in Q4 and could continue into the beginning of next year.

Again, what I was saying earlier was that for internal planning purpose, we would prefer to be cautious and careful, and we are taking steps, assuming that this slowdown could last up to two to three quarters. Do we know that with certainty? No, we don't, but we would rather be prepared for a soft environment lasting a little longer.

Chris Kapsch, BB&T Capital.

Bertrand, I wanted to ask about, and apologies if you may have touched upon this, but just industry consolidation, generally speaking. It seems like there is a wave that is maybe accelerating downstream, and just wondering what your thoughts are behind not just the drivers of that, but what are the implications for Entegris, both threats and opportunities strategically, looking at a longer term basis, as that continues to play out? Thank you very much.

Right, so I think there is certainly has been a lot of activity, a lot of consideration in this space over the last few years, and I think it is probably a validation that scale matters in the semiconductor industry. When I think about our own recent acquisition of ATMI, I can tell you without hesitation that the new scale that we have created has created value to all of our stakeholders, be it customers, investors and employees.

When you think about our cost to market, the process challenges continue to be more complex, and our customers want to rely on fewer, more capable suppliers. Suppliers that can live up to their expectations in terms of the technology they bring, the application knowledge that they have, and the operational excellence that they can commit to. All of that requires steady investment, investment in R&D, investment in CapEx, investment in talent. I can tell you that at Entegris, with the acquisition of ATMI, we experienced the benefit of scale firsthand. We were able to increase our R&D spending from 6% of revenue to 10% of revenue. We have increased our CapEx from about 6% of sales to 7% to 8% of sales and we've been able to attract a great deal of talent in the Company in the last year, as a result of the bigger platform that we have created.

We have been able to do all of that while providing superior financial returns. So I think that scale matters. We have demonstrated that, and I think that is really the impetus behind some of the recent news that you have seen in the marketplace.

That's good context. Thank you very much.

Tony Venturino, Federated Investors.

Actually, a lot of my questions have been answered, but I just want to get a little more clarification on the gross margin guidance. You talked about three things, the supply issue, the plant closure, and volume. And it would seem with the supply issue behind us that going forward, that volume maybe is the bigger driver of the flat guide. Is that fair to say?

That is absolutely fair.

Okay, and I was actually going to ask about the consolidation issue, but that has already been answered. A couple clean-up questions. In the income statement, you had $5 million or so in other. Could you explain what that is?

The other related to gains on the revaluation of some of our assets in Malaysia, as the dollar appreciated versus the ringgit, so it is currency related, and that was the $0.03 I spelled out. We made $0.23, but we had an unusual benefit, $0.03 related to currency and $0.02 related to tax rate, but that $5 million is that $0.03.

Okay, and the working capital detail in the cash flow statement, there is an $18 million of other as well use of cash. Could you explain that?

That relates largely, so we hedge our position in Malaysia. Had we not been hedged, that gain would have been closer to, it would have been $15 million to $17 million. That offset in the cash flow statement, it was an $11 million offset, as we closed out our hedge contract. That was the vast majority of that amount.

Okay. All right. That makes sense. All right. Thank you for letting me ask questions.

That does conclude our question and answer session. I will now hand it back over to Bertrand for any additional or closing remarks.

Thank you. This concludes our Q3 earnings call, and I would like to thank you all for joining the call at short notice. Have a good day. Goodbye.

That does conclude today's program. We would like to thank you for your participation. Have a wonderful day, and you may disconnect at any time.