Entegris, Inc.
Q4 2016 Earnings Call Transcript

Published: 2 Feb 2017

[Operator:]

Good day everyone and welcome to the Entegris fourth quarter 2016 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.

[Steve Cantor:]

Good morning. Thanks Eric and thank you all for joining our call this morning. Earlier today, we announced the financial results for our fourth quarter and fiscal year ended December 31, 2016. You can access a copy of our press release and our supplemental slides 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 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, CFO. Bertrand will now begin the call. Bertrand?

[Bertrand Loy:]

Thank you Steve. Before I start, let me apologize for the sound of my voice. I have a bad cold today and I hope I can keep my voice through this conference call. So with that, let me get started with some comments on our performance this year in our new reporting structure. Greg will follow with more details on our Q4 financial results and provide guidance for our first quarter of 2017. We will then open the line for questions. 2016 was an excellent year for Entegris. We delivered record sales, growing 9% organically and significantly outperforming all markets during the year. Our growth initiatives are on track. We continue to gain significant design wins at key customers for their 10 and seven nanometer nodes and advanced memory processes. We enjoyed strong growth in Asia, particularly in Taiwan, where we grew by 17%, as well as in China, where we grew by 22%. We achieved record non-GAAP EPS of $0.94 and a record adjusted EBITDA margin of 22.4%. Finally, we continued to pay down our debt concluding the year with a net leverage ratio of 0.7 times EBITDA. All-in-all, 2016 was a great year, capped by very strong fourth quarter. We increased our quarterly revenue 16% from a year ago to a record level and achieved non-GAAP EPS of $0.24 for the quarter. I want to thank our customers for the trust they place in us and for choosing Entegris as their partner of choice to help them increase their yields and improve their device performance. We never take their business for granted and I am very proud of our teams around the world for their absolute dedication to delivering world-class value to our customers. As we indicated in our press release today, we are now reporting our results in three segments, microcontamination control, specialty chemicals and engineered materials and advanced materials handling. This change in our reporting offers better transparency into our core competencies and how we are leveraging our unique breadth of technologies to yield new increasingly synergistic solutions for our customers. While each segment has different product platforms and core areas of expertise, all segments share a single sales force, unified core systems and processes, global technology centers, joint technology roadmap and a share focused on a common set of customers. I will briefly describe the key technologies and strategies of each of these statements. Our microcontamination control division represents approximately 31% of our total revenue. This business segment comprises our filtration and purification solutions for both liquid chemistries and gases. These solutions are vital to controlling contamination in the fab environment and also upstream in the bulk manufacturing of certain critical process chemistries. This segment achieved a record year in 2016. With our i2M manufacturing and R&D sites fully qualified and ramped, we are in a great position to continue to benefit from increasingly more stringent cleanliness requirements of our current semiconductor customers drive to smaller geometries and more complex structures. Our specialty chemicals and engineered materials division represents approximately 36% of our total revenue. This segment includes our specialty gas bases, cleaning chemistries,, advanced deposition materials, specialty coatings and other advanced materials such as graphite and silicon carbide. This part of our business achieved strong performance across many of these product lines including a record year for our advanced deposition business. Many of these materials are very well-positioned on the technology roadmaps of key industry leaders and will be an important growth engine for Entegris going forward. The advanced materials handling division includes a broad range of solutions to handle and transport critical process chemistries as well as semiconductor wafers and other critical substrates and preserve their purity throughout the supply chain from point of manufacturing to point of use in the fab. In this segment, which accounts for approximately 33% of our revenue, we achieved a record year in sales of our advanced FOUPs which have become the preferred wafers carrier solution for advanced semiconductor fabs. We also had very strong performance for many of our fluid handling components including a new line of high purity drums. These products benefited from new cleanliness requirements for many advanced process chemistries. Our record results in 2016 are a reflection of how we are deploying a broad portfolio of technologies to solve the increasingly complex materials challenges our customers are facing. I would describe just two of the many examples of how we are achieving this. Let's discuss first the value proposition we are offering in advanced deposition materials. In this area, our leadership position is based on three factors. First, our ability to synthesize unique molecules. Second, the knowledge of how to bring these materials to the highest levels of purity. And finally third, the capability to safely transport these materials and deliver them onto the wafer at the highest throughput. We are the only company in the industry that can provide this type of integrated solution by leveraging our expertise in materials, filtration and materials handling and delivery. Second example is our filtration business where we continue to expand our leadership position in a number of key areas in the fab as well as upstream to critical chemical suppliers. A key reason for this growth relates not only to our ability to develop and make better filtration solutions, but also our ability to develop them faster because of our intimate knowledge of the chemistries we are filtering. I know of no other company that can offer this combination of expertise and semiconductor process knowledge. We will talk more about these three segments at our upcoming Analyst Meeting on March 20 in New York, which would also give investors an opportunity to meet the general managers leading these three divisions. Turning to 2017, I remain very positive about the health and prospects of the semiconductor industry. I continue to believe that we are entering a multiyear period of growth driven by the broadening of the industries and markets, which is supported by the continued adoption of smaller geometries and the introduction of increasingly challenging 3D architectures. These trends will continue to drive greater levels of wafer starts and the interrelated performance and purity challenges facing the industry will play to our strength. Our focus for 2017 continues to be on the quality of our execution and on creating even greater value for our customers, shareholders and employees. Given this focus and our current outlook for 2017, we expect to continue to outperform the industry by 200 basis points and to expand our bottom line twice as fast as our revenue growth. This would translate into a meaningful expansion of our profits and adjusted EBITDA margin greater than 24% and non-GAAP EPS in excess of $1 per share. Before turning the call to Greg for the financial details, I want to extend my personal appreciation for the Entegris teams around the world who have made our 50th year arguably best year in the company's history and more importantly we have set the stage for even greater things ahead. Greg?

[Greg Graves:]

Thank you Bertrand. Fiscal 2016 was indeed an excellent year for Entegris. Sales of $1.2 billion or 9% above last year and we grew non-GAAP EPS and $0.94 per share. For the fourth quarter, our sales exceeded our guidance and we delivered solid net income, EPS and cash flow. Fourth quarter sales of $309 million grew 4% from Q3 and 16% from year ago. The strong sales were driven by strength across the board as we grew sequentially in all regions except Japan. Sales in the quarter were unfavorably impacted 1% due to foreign exchange, specifically the Yen which weakened sharply against the Dollar beginning in November. As Bertrand indicated, we elected to report our results in three segments. A table of the Q4 and fiscal results by these segments can be found in the press release. I will now summarize the results. Fiscal 2016 sales for microcontamination control or MC of $363 million grew 15% from the prior year. MC achieved a non-GAAP adjusted operating margin of 30.5%, increasing its profitability by 33% from 2015 or more than twice the rate of growth in sales. In Q4, MC sales of $98.7 million grew 4% from Q3 and were up 20% from Q4 of last year. The strong sales reflected strength in liquid filters for wet etch and clean and bulk photo applications and strengthen in gas filter products driven by strong industry tool shipments. Fiscal 2016, sales for specialty chemicals and engineered materials or SCEM were $428 million, grew 2% from a year ago. SCEM segment non-GAAP adjusted operating margin was 22.6%. In Q4, SCEM sales of $111 million grew 6% from Q3 and were up 8% from Q4 of last year. The quarterly growth was driven by healthy rebound in sales of specialty gas solutions and continued record levels of demand for our advanced deposition materials related to the industry's ramp of 10 nanometer and 3D NAND processes. Fiscal 2016 sales for advanced materials handling or AMH of $384 million grew 11% from a year ago. AMH's segment non-GAAP adjusted operating margin of 20.9% was up from 19.2% in 2015. In Q4, sales of $98.8 million grew 1% from Q3 and were up 21% from Q4 of last year. The strong year-over-year sales reflected strength in wafer handling products, specifically our new generation of FOUPs, which benefited from strong investments in 3D NAND and advanced logic. Fourth quarter non-GAAP adjusted gross margin was 42.7%. The lower margin was primarily the result of the impact of foreign exchange, particularly the Yen which weakened sharply beginning in November. Although the fact that we both sell and manufacture in Japan generally give us a natural hedge against movements in FX, the sharp drop of the Yen over a very short period of time put temporary pressure on margins. Excluding the impact of FX and variable compensation expense, gross margin would have been consistent with our guidance. Assuming relatively stable exchange rates for the Yen, we expect gross margin in Q1 to be approximately 43.5%. Excluding amortization of $10.9 million, non-GAAP operating expenses in Q4 were $76 million. We expect non-GAAP operating expenses to be $76 million to $78 million in the first quarter. Adjusted operating margin was 18.1%, in line with our expectations. Net interest expense was $9 million in Q4 for $400,000 lower than in Q3. We expect interest expense to be approximately $8.3 million in Q1 as we continue to pay down debt. Our GAAP tax rate for the quarter was 25%. Our non-GAAP tax rate was also 25%, up from 23% in Q3 due to a slightly less favorable geographic income mix. For 2017, we are expecting our non-GAAP tax rate to be approximately 24%, consistent with the 2016 rate. Our non-GAAP earnings per share was $0.24, which was above the high end of our guidance. Adjusted EBITDA for the quarter was $70.1 million or 22.7% of our topline for the quarter. Cash flow from operations for the quarter was $57 million and free cash flow was $37 million. Accounts receivable and inventories declined modestly from Q3 as DSOs improved to 49 days in Q4 and inventory turns were 3.8, up from 3.6 in Q3. Fourth quarter CapEx was $20 million and was $65 million in 2016, which was slightly below our initial spending plans. For fiscal 2017 we expect full year CapEx to be $80 million to 90 million. Our cash balance was $406 million, of which $140 million was in the U.S. During the quarter, we reduced our long-term debt by an additional $25 million. Total long-term debt including current maturities was $585 million and our net leverage was 0.7 times EBITDA. Since clothing the ATMI acquisition in 2014, we have repaid $226 million of debt and we expect to repay an additional $100 million over the next 12 months. We also repurchased $4 million of stock in the quarter to offset dilution from share-based compensation and we expect to continue this practice each quarter going forward. We are continuing to execute our capital allocation strategy which balances debt repayment, building liquidity for potential M&A and opportunistic share repurchases. Turning to our outlook for Q1, we expect sales to range from $295 million to $310 million, reflecting continued strong demand for our solutions. At these revenue levels, we expect non-GAAP EPS to be $0.23 to $0.27 per share, consistent with our target model. In summary, we are very pleased with our overall performance in 2016. We grew our revenue 9% and adjusted EBITDA 13% to record levels. Once again we demonstrated our ability to grow faster than our markets and in this case by a significant margin. Finally, we like our growth momentum going into 2017, a year when we expect again to outgrow the industry on the topline and to expand our bottomline at twice that rate. Operator, we will now take questions.

[Operator:]

[Operator Instructions]. We will take our first question from Patrick Ho with Stifel.

[Patrick Ho:]

That's a very nice year. Bertrand, you gave some good color today on the advanced deposition materials market opportunity that just started seeing gain traction. As you look forward in 2017, which are some of those other new market opportunities you have discussed in your Analyst Day? Do you see reaching an inflection and being "the next growth driver for the company", specifically for 2017?

[Bertrand Loy:]

Thank you, Patrick, for the comment on the quality of deposition in 2016. Relating to 2017, you are correct that out of the four growth opportunities that we characterized at our Analyst Day, the one that had the most immediate impact on our 2016 performance was the photoresist, the bulk photoresist opportunity and going into 2017, I would expect deposition materials, but I would also expect our new CVD and PVD coating solutions to have a much greater impact on our overall growth trajectory. And again, if you look at the current momentum that those technologies have had in the marketplace as we exit 2016 and those expectations are totally intact.

[Patrick Ho:]

Great. That's helpful. And given your broad-based product portfolio, the coverage both wafer starts as well on the CapEx side of things, given that demand trends on both of those markets continue to be very healthy as we enter the early parts of 2017, how are you managing your supply chain in keeping up with the tight demand needs for a lot of your customers today?

[Bertrand Loy:]

Patrick, we have been serving this industry now for many, many years and this industry has always been very extreme over the years. So we have a very scaled supply chain organization that is very versed at managing expansion and contraction that we see regularly in demand for our products. So this is not a new challenge and one that we are certainly well equipped to manage. So I don't expect that to be an issue going forward as we expect to see continued growth across a number of our product lines.

[Patrick Ho:]

Great. Thank you.

[Operator:]

And the next question is from Chris Kapsch with Aegis Capital.

[Chris Kapsch:]

Yes, Aegis Capital, Chris Kapsch. So I don't know if you heard the great news out of Silicon Valley this morning, but apparently the semiconductor industry saw a chatter which means we have at least six more years of Moore's law. So that's good news.

[Bertrand Loy:]

Thanks for sharing.

[Chris Kapsch:]

So I wanted to follow-up on just the capital allocation on M&A and maybe juxtaposed against the new segmentation. To the extent that you have actionable acquisition opportunities, should we assume that those would the preferred to like any one segment versus the other? Are the more opportunities, for example, in specialty chemicals and engineered materials? Or would it be potentially across the board in these new segments?

[Bertrand Loy:]

So Chris, if you look at our M&A pipeline, it really cuts across all of those segments and we are, again, very focused on that. We continue to believe that a well calibrated M&A is a preferred way for us to deploy our capital and the best way to create shareholder value. Having said that, again, you should expect us to be disciplined and potentially patient about that. As I reminded everyone on our last call, we have very exciting organic growth opportunities ahead of us and that will continue to be our number one priority as we start 2017. We need to execute flawlessly and I know we will. So in summary, if we find actionable and affordable targets, expect us to be active on the M&A front. And if we not, you should expect us to double down our focus on organic growth and steadily pay down our debt.

[Chris Kapsch:]

Great. Okay. And if I could just follow-up and parse the recent trends under the new segmentation. As you mentioned, it looks like growth accelerated across all three of these new segments, but the acceleration does feel a little more pronounced and I guess what you are calling now MC and AHM. And so I am just wondering if those two segments are disproportionately benefiting from the shift to advanced geometries like 10 and seven nanometers and 3D NAND? Or is it that they are just a little bit earlier cycle? In other words, is it possible that the strength, the acceleration in those segments actually portends a lag benefit in the specialty chemicals and engineered materials portion of your overall portfolio?

[Bertrand Loy:]

Yes. This is really the second interpretation. If you think about those divisions, first of all, you should appreciate the fact that it will contribute to the financial success of Entegris in many different ways. And you are right that the microcontamination division has been and is expected to continue to be a very strong contributor both to the top and the bottom line of the company. This is a business in which we have invested a lot. Remember, we completed the investment of our i2M center. We have added since then new capabilities in terms of new surface modification technology, new cleaning recipe. So we expect to see lasting recurrence from those investments. And then this is a division, obviously, where we expect to benefit from the increasingly more challenging contamination control that the semiconductor industry will be experiencing. If you think about specialty chemicals and engineered materials, that division had a good year in 2016, but we expect to see better performance in the years to come. I am sure it's not lost on you that four out of the five growth initiatives that we presented in our Analyst Day last year belong to this division. So to your point, we are a little early in the adoption cycle of many of the technologies mainly advanced deposition materials, boron mixtures, the new series of families of coatings as well as the patents and technology, but as I said earlier, whenever answering the previous question, all of those initiatives have showed great promises in 2016 and as they grow in size and maturity they would start having a more meaningful impact on the divisions growth rate.

[Chris Kapsch:]

That's great. That's for that additional color. Just one quick follow-up on that. Based on that commentary and based on the fact that there does sound like more innovation opportunity in that particular segment, is that how we should think about your R&D spend that it's disproportionately skewed towards of the SCEM segment? Or is your R&D spend also balanced across the three new segments? Thank you guys.

[Bertrand Loy:]

So I would only say that, in general terms, you would expect maybe a little more on the intensity in both specialty chem. and microcontamination.

[Chris Kapsch:]

Fair enough. Thank you.

[Bertrand Loy:]

And the implication of that is that if you think about AMH division, it has a slightly different profile. First of all, there is much greater exposure to the CapEx side of the industry. About 55% of the revenue for the division is really driven by the industry CapEx. Remember that this division is the home of our FOUP platform, fluid handling products, advanced valves for controllers and dispense systems. So this is a business that inherently would be in a bit more volatile and will likely not be playing as much of a role in terms of the overall growth of the company. But at the same time, it is certainly a division that we expect to be a very meaningful cash flow contributor.

[Chris Kapsch:]

Got it. That's very helpful. Thank you.

[Operator:]

[Operator Instructions]. We will go next to Edwin Mok with Needham & Co. Please go ahead. Your line is open.

[Edwin Mok:]

Hi guys. Sorry about that. Again, I am grateful. And thanks for [indiscernible]. I have a question about your filtration business. So you guys talk about ramping up the i2M facility that obviously drove really good double-digit growth this year in 2016. I am just curious how much of that growth was driven by the i2M facility? And do you see that ramp behind us? Or do you see more option to grow? I mean obviously 15% is a really strong growth for this business. I am just curious if that's sustainable going into 2017?

[Greg Graves:]

So Edwin, there were three major growth vectors for that division. One was the bulk photoresist filtration applications which grew very meaningfully and significantly in 2016 and that is really driven by the i2M investment. Another part of the portfolio for the division that enjoyed very strong growth was our wet etch and clean filtration products. We introduced a number of new solutions for bulk filtration and point of use filtration and that business also recorded a record year in 2016. But that business didn't meaningfully benefit from the investments we made in the i2M center. And the last product line were the gas filters and the R&D center for our gas filtration business is in the i2M center and benefited from the investments that we made there. Those filters are used most prominently on a number of CVD, PVD tools and as you know, the industry enjoyed a very significant growth rate for those types of toolsets and our products benefited from that.

[Edwin Mok:]

Great. Actually very thanks for your color. I noticed that the specialty chemicals segment profitability was down in 2016. Was it because of some of the investment you guys are doing? And what gives you confidence that you can grow that profitably as you go through 2017?

[Greg Graves:]

The growth drivers in that business or one of the main growth drivers in that business is the deposition business. That's a business that as ramp it frankly the margins will be lower until we get to volume. The other thing I would say is overall, as Bertrand said, four of our five key growth initiatives that we highlighted at the Analyst Day in that division. So in general the investment levels there are higher.

[Edwin Mok:]

So you expect leverage to improve the profitability?

[Greg Graves:]

That business should have meaningful leverage, particularly as our the deposition business ramps as well as the coating applications ramp, which are also tied up on level to depositions.

[Bertrand Loy:]

Yes. So think about normalized levels of operating income for this division in the mid-20s.

[Edwin Mok:]

Okay. Great. Very helpful. Last question. One of your peers and actually some of your peers in the industry talk about maybe handset chip inventory a little high exiting 2016 and therefore maybe sound a little more cautious on the first quarter. Your guidance always imply you think this looks really good on the first quarter. Just curious, are you seeing any of that? Or is that already factored in your guidance? Can you give perhaps any color on that?

[Bertrand Loy:]

Edwin, you are right. We, in fact, expect wafer starts to contract by about 4% sequentially in the first quarter. And that is really the assumption that potentially gets you to the low end of our guidance. Having said that, we expect to continue to outperform the industry in Q1 as we did in 2016. And the reason is really that we introduced a number of new products last year in filtration and deposition materials. We talked about all of them earlier. And these new product introductions have been not only very successful in 2016, but we are seeing again very strong momentum for those technologies going into 2017. And that's what gives us the degree of confidence to guide the way we did. So in summary, we anticipate softness in fab activity with normal seasonality, but we expect continued strength in our new product sales.

[Edwin Mok:]

Sound great. Thanks for the color.

[Bertrand Loy:]

Thank you.

[Operator:]

And the next question is from Amanda Scarnati with Citi.

[Amanda Scarnati:]

Thanks for taking the question. Just starting off with China. Any sort of growth that you are seeing there? I am hearing from a few competitors that trying a lot of growth in China in different areas. Just wanted to see what your exposure there was and what expectations you have going forward?

[Bertrand Loy:]

Hi Amanda. The Chinese market is a very important market for us and certainly an area that we are very, very focused on. We grew 22% in China in 2016 and that was after a very strong performance in 2015. We expect that growth momentum to continue going into 2017. We expect to benefit from the activity that we see in the indigenous fabs as well as in the fabs controlled by foreign investors. But more importantly, we are also very focused on what we expect to be a busy second half of the year when some of the new investments are taking place in China. So we have increased our degree of investment in China in the form of direct sales coverage, but also increased the number of partnerships that we have been securing in the region.

[Amanda Scarnati:]

Thanks. And then on gross margins. The last quarters they have dipped down quite a bit off the peak. Do you see in terms of linearity in margins going forward. And do you expect them to be able to get back up to that the 55.5%, 56% peak that you saw in June quarter of the last two years? Thanks.

[Greg Graves:]

As we move into Q1, first of all, we don't see the impact occurring to be so dramatic. In addition, we did have some headwinds in Q4 related to logistics costs which we don't expect to re-occur in Q1. So we do expect the margin in Q1 to get back to that mid-43s. And then as we move through the year, we should see the margin continue to improve. I think you said 55%, 56%. It's actually 45%, 46%. And I would say, that 45% number is certainly something that's in our expectations.

[Amanda Scarnati:]

Great. Thank you guys.

[Operator:]

We will go next to Dick Ryan with Dougherty.

[Dick Ryan:]

Thank you. Say Greg, with your new segment reporting, can you give us some kind of unit CapEx split in Q4? And I think Bertrand, you said you expect the unit side to be down 4% in Q1?

[Bertrand Loy:]

Yes. I can provide just that high levels of color. As you think about microcontamination, it's about 80% unit, 20% CapEx. If you think about specialty chem., it's about 100% unit driven. There is a very modest component of CapEx. And then the last division AMH, it's about 55% CapEx, 45% unit.

[Dick Ryan:]

Great. Thanks for that split, Bertrand. Thank you.

[Operator:]

And with no questions in the queue, I will turn the call back to Mr. Cantor for any additional remarks.

[Steve Cantor:]

Great. I would like to thank everyone for joining the call today. As a reminder, if you are interested about our Analyst Meeting on March 20, you can contact me for more information. Thank you. Have a great day.

[Operator:]

This concludes today's call. Thank you for your participation. You may now disconnect.