Entegris, Inc.
Q4 2015 Earnings Call Transcript

Published: 9 Feb 2016

[Operator:]

Good day everyone and welcome to the Entegris Fourth Quarter 2015 Earnings Call with Analysts. 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:]

Thank you. Good morning, everyone and thank you all for joining our call. Earlier today we announced the financial results for our fourth quarter and fiscal year ended December 31, 2015. 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 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. Bertrand?

[Bertrand Loy:]

Thank you, Steve. I will make some general comments on the results for the year and for the fourth quarter. Greg will then provide more details on our financial results. Overall, I am very proud of the performance for Entegris and our many accomplishments in 2015. It was an extremely busy and productive year and I wanted to thank the entire Entegris team around the world for their hard work and focus in making 2015 a success. To list a few of our achievements, our sales of $1.1 billion reached a record high for Entegris and grew faster than our markets. We grew our adjusted earnings per share 23% to a record high. We completed the integration of ATMI, achieving the full $30 million of synergies ahead of schedule and at a lower cost. Sustained our investments in new products and new technologies both in our semiconductor business and in our adjacent markets. We generated strong cash flow and achieved a new EBITDA margin of 21.5%. Finally, we met our debt repayment target and paid down $100 million of debt during the year, which reduced our net leverage to less than 1.4 times. I was particularly pleased with these achievements given the soft industry environment in the second half of the year and the significant currency headwinds we faced. After a strong Q1, wafer production slowed for the year and was below seasonal trends as device makers lowered their production to reduce inventories and pushed out the timing of adoption of new process technologies. Given these industry trends, we performed well. Our sales of nearly $1.1 billion for the year were up 3% on a pro forma basis when adjusted for a $32 million currency headwind. This year we made very good progress to leverage our expanded technology platform and greater scale to address opportunities in ways we could not before. The intensity and quality of customer engagements this past year were greater than were greater than anything I've seen in the past. These projects are resulting in solutions not only for the leading edge, but also for pockets of growth or the trading notes. During our Analyst Day in July, we described how we're positioned to grow and expand our share by leveraging our unique strength, the breadth of our technologies, our drive for manufacturing excellence and our larger scale. This past year we made great progress in delivering even more differentiated materials and solutions to enable cleaner and higher purity process chemistries that are helping our customers reach acceptable yields faster. For example, we're developing a new series of liquid filters targeting photo chemical suppliers to enable them to meet more exacting purity requirements demanded by leading fabs. For Entegris this represents an opportunity to expand our served available market and to leverage the enhanced capabilities of our i2M center. In addition, we continue to develop a number of materials that are critical to the next generation notes. For instance, we expanded the offering of our gas or specialty gas solutions business with new borrow-on gas mixtures for advanced iron implant applications. These mixtures help reduce the buildup of tungsten in the implant tool chamber, thus improving the life time of the iron source and increasing the stability of the iron beam. By using our specialized gas connectors to deliver these boron mixtures and our deep knowledge of implant gas applications, we will be ideally positioned in these growing market segment. These two examples I just described are just samples of how we're using our capabilities to enable our customer’s roadmap. More generally speaking we're delighted with the quality of our new product pipeline as we enter 2016. This past year we generated healthy operating cash flow of $121 million and we deployed that cash consistent with our stated capital allocation strategy. That strategy seeks to balance debt repayment, building liquidity for targeted M&A and opportunistic share repurchases. In 2014 and 2015 our objective was to use our excess cash to pay down on our debt, which we did. We repaid $51 million in 2014 and another $100 million in 2015, which reduced our net leverage from two times when we announced the ATMI deal in 2014 to around 1.4 times. Today with our shares trading at what we believe are below fair market levels and with our growing U.S. cash balances, the Board has authorized the repurchase of up to a $100 million of stock. Turning to the fourth quarter results, sales of $267 million were slightly above the high end of our guidance as the month of December proved stronger than expected. Semiconductor sales, which represented 77% of revenue were down 2% versus the third quarter, modestly better than the industry trends. Sales in our adjacent markets were up 1% sequentially and represented approximately 23% of our revenue in Q4. This reflected higher sales in data storage, solar and glass forming, which was offset by lower sales related to flat panel display. On an operating basis our non-GAAP earnings per share of $0.20 included both the impact of a lower gross margin and a favorable tax rate. During our last call, I indicated that we would take steps to proactively manage through what we conservatively expected maybe a six to nine months rough patch. Accordingly we throttled back our expenses and took steps to aggressively reduce our inventory. We knew these measures would put pressure on margins in the short term, but will provide us with greater cash flow and flexibility in our working capital management. Greg will have more details on this in his remarks. Looking forward, we are excited about what lies ahead for Entegris. This year we will be celebrating our 50th anniversary as a company and we're optimistic it will be another record year for Entegris. While we expect business conditions to remain soft in the first quarter, which tends to be seasonally weak, we expect demand to strength as we move through the second quarter into the back half of the year. I'll now turn the call to Greg for the financial details. Greg?

[Greg Graves:]

Thank you, Bertrand. Fourth quarter sales of $267 million were above the high end of our guidance driven by stronger sales across a number of business including liquid filtration and specialty materials. Sales were down 2% from a year ago, but were flat when you consider we faced the 2% or $5 million negative impact of foreign exchange. Our non-GAAP earnings per share of $0.20 also topped our expectations. As Bertrand highlighted gross margin of 41% declined from 43% in Q3 primarily as a result of sharply lower manufacturing output. This enabled us to reduce our inventory levels by $15 million or 18%, or excuse me, 8%. In addition we incurred higher membrane product sampling expense related to customer qualifications as we entered the final stretch of the transition to the i2M center. The transition to the i2M center currently represents a drag on margin of approximately $2 million to $3 million per quarter, due to customer sampling costs and duplicate of overhead. We expect these costs will go away when we complete the transition and close the old facility in the middle of this year. Therefore we expect gross margin to improve to approximately 42% to 43% in the first quarter and to improve further in the second quarter. Finally we expect gross margin to reach higher normalized levels in the third quarter as we achieve the full benefit of the i2M transition. Q4 results included amortization of $11.4 million and the final trench of integration expense of $5.6 million. The integration expense included litigation-related costs from pre-acquisition ATMI events, the write down of a warehouse facility built prior to the acquisition and higher than expected transfer cost related to the integration of our Asian legal entities. Excluding these costs, non-GAAP operating expenses were $72.2 million in Q4. This was within our guidance. We expect non-GAAP operating expenses to be $71 million to $73 million in the first quarter of 2016. Adjusted operating margin was 13.9%, slightly below our target model. By segment the operating margin for CMH of 20.2% in Q4 declined from 22.3% in Q3. EM's operating margin of 21.3% declined from 22.4%. Both CMH and EM were impacted by the volume related gross margin headwind I just described. Net interest expense was $9.7 million in Q4. The slight increase from Q3 was due to the additional five days in Q4. Our GAAP tax rate for the quarter was at 33% net benefit and on a non-GAAP basis, was a 3% net benefit. The lower tax rate was driven primarily by two factors. Congressional reenactment of the R&D credit in the fourth quarter and lower taxable income in the U.S. as most of the gross margin impact related to lower production was at U.S. facilities. For Q1 we expect the GAAP tax rate to be approximately 25% and the non-GAAP tax rate to be approximately 28%. The higher tax rate in 2016 is largely due to the expiration of a long-standing tax holiday in Malaysia. Adjusted EBITDA for the quarter was $51.4 million giving us an EBITDA margin of 19.3%. CapEx was $16 million in Q4 and $72 million for the full year. For 2016 we’re expecting CapEx to be $75 million to $85 million as we continue to invest in a number of focused growth initiatives. Cash flow from operations for the quarter was $52 million. Our cash balance at the end of Q4 grew $49 million to $350 million. This reflects the cash flow from operations plus $16 million of capital expenditures plus the cash proceeds related to certain asset dispositions. Our domestic cash balance stood at nearly $150 million. Total long-term debt including current maturities was $667 million giving us a net leverage ratio of 1.4 times. Under the terms of the debt agreements, we're not required to make any mandatory repayments in 2016, although we expect to repay $50 million during the course of the year. As Bertrand indicated, the Board has authorized a repurchase of up to $100 million of stock in open market purchases or under 10b5-1 trading plans. In addition to these repurchases, we expect to continue to execute the other elements of our capital allocation strategy; namely debt repayment and building liquidity for potential M&A. Turning to our outlook for Q1, we expect sales to range from $250 million to $265 million due to soft seasonal business trends. At these revenue levels, we expect non-GAAP EPS to be $0.13 to $0.17 per share consistent with our target model. In summary, Q4 capped off a very good year for Entegris with record revenue and EPS. We significantly improved our working capital and generated strong cash flow. We expect to deliver results consistent with our target model in Q1 and the balance in 2016. Finally, our balance sheet continues to improve and we have liquidity available for buybacks, debt reduction and possible small acquisitions. Operator, we'll now take questions.

[Operator:]

[Operator Instructions] Our first question comes from Patrick Ho with Stifel Nicolaus. Please go ahead. Your line is open.

[Patrick Ho:]

Thank you very much and congrats on a nice year. Bertrand, you mentioned some comments about your overall trends as you look forward to 2016. But given the work done of your inventory in Q4 and some of the comments from your customers to date about their inventory levels, how do you see one, their inventory levels and two, what kind of demand trends do you potentially see that would drive I guess a restocking of inventory at your customers?

[Bertrand Loy:]

Hi Patrick. Thank you for the comment. Well, many of our customers have commented that they believe their inventory levels or the inventory levels in their trial are currently at healthy and normal level. So that's really our operating assumption as well. If you think about the guidance that we provided for Q1 and the guidance we provided for the year ahead, the guidance for Q1 reflects some caution about the overall IC demand and fab activity early in 2016 and that's a view that is consistent with the comments that we made in October of last year and that's really the view that led us to take some of the actions that we took in terms of custom payment and inventory management. But we expect things to turn fairly rapidly and probably and hopefully as early as Q2 and we expect growth in our business in 2016 as a result of two factors. The first factor is we expect MSI to grow in the low single digits during fiscal '16 and the second factor is that we expect Entegris to benefit from the initial ramp, the initial 10 nanometer ramp at several fab customers later in the year. So if you take those two factors, coupled with the planned introduction of a number of new products, I think we will be in a good position to outgrow the industry yet again by 200 to 300 basis points.

[Patrick Ho:]

Great. That's helpful and maybe as a follow-up question given some of the qualifications that you're seeing at the i2M facility, obviously from an intensity standpoint you mentioned that it's at a very high point. How much of it is for the leading edge as you mentioned 10 nanometers or is this kind of broadly based in terms of the qualifications that you're seeing with customers?

[Bertrand Loy:]

That's a great question. Actually the qualifications that are taking place right now at i2M really covers the full range of products. So trailing edge as well as leading edge, but you're correct that the reason why this i2M project is so strategic and so important for us is coming from a number of different reasons. First the i2M Center will give us access to a cleaner, more capable manufacturing process and that’s going to be essential in order for us to develop the next generation of printers required at 10 nanometer and 7 nanometer. Second, once we complete the qualification of the i2M Center, it will essentially double the capacity for those filters and ultimately that’s going to really lift the cap that -- lift the lid has been plaguing the growth potential of those products now for a number of quarters. So again I think as we closed the year, as we close '15, I’m extremely pleased that nearly all of our internal qualifications are complete and that we’re moving extremely fast now and supporting and completing the customer qualifications. So I think we will be in a very good place in a couple of quarters from now.

[Patrick Ho:]

Great. Thank you very much.

[Bertrand Loy:]

Thank you.

[Operator:]

[Operator Instructions] Our next question comes from Weston Twigg with Pacific Crest Securities. Please go ahead. Your line is open.

[Weston Twigg:]

Hi, thanks for taking my question. First just on the inventory, can you give us an idea if you expect to continue to take that down in Q1 or if you think it will stabilize or maybe increase a bit?

[Greg Graves:]

In Q1 we’d expect inventory levels to be stable to maybe up modestly and I think that will be a function as we move through the quarter what we are expecting as we move into Q2.

[Weston Twigg:]

Okay. Helpful and then also just wondering on adjacent market revenue or non-semi revenue, can you help us understand the revenue trends you see in Q1 and expectations through 2016 for that segment?

[Bertrand Loy:]

Yes Wes, this is Bertrand. So Q1 I would expect actually modestly favorable growth for the non-semi business and I would expect actually modest contribution to the overall growth in 2016. In other words, the bulk of the growth I was referring to will most likely come from our semi markets in 2016 as a result if some of the activity that we expect to see around 10 nanometer later in the year.

[Weston Twigg:]

Very helpful. Thank you.

[Operator:]

Our next question comes from Dick Ryan with Dougherty. Please go ahead. Your line is open.

[Dick Ryan:]

Thank you. Hey, Greg you mentioned the margin on AM having the same kind of gross margin headwinds as the previous quarter, but if you look last year, I think the contribution was like 29%. Anything else going on in that story, are you seeing any pricing issues?

[Bertrand Loy:]

No, there is really nothing else going on in that story. I would just say that the comparability between last year is not prefect because we brought most of the EM business on to our common SAP system and on to the Entegris costing methodology. So there is nothing that’s fundamentally changed in that business. I would say when we talk about potential price pressure, we have less price pressure in CMH than we do in EM, but that’s not an overarching concern.

[Dick Ryan:]

Okay. And I think I got your topline FX impact for the quarter and the year, did you mention profitability impact from FX alone in the quarter or the year?

[Greg Graves:]

No, we tend to be pretty naturally hedged because our biggest headwind on currency on the topline tends to be the Yen and that also ends up being a tailwind on the cost side because we manufacture in Japan as well. So for the year, currency was between $30 million and $35 million headwind, but when you think about it on an operating margin basis its relatively neutral.

[Dick Ryan:]

Okay. In your Q1 guidance $250 million, $265 million can you handicap or would need to go on halfway through the quarter to hit either end of that? Are you factoring anything in from the Taiwan earthquake, maybe it's too soon for that, but anything there or what’s your assumptions on unit and CapEx contribution?

[Bertrand Loy:]

If you think about both ends of the guidance for Q1, again as I mentioned earlier, we’re trying to capture some caution around fab activity starting the year. Remember that we left 2015 with a number of fab customers operating in the low to mid 80% utilization rates. We haven’t seen any meaningful improvement from those rates so far this quarter. So that talks to the low end of the range. On the high end of the range, again it has to do with some early activity around 10 nanometer and then some scenario where fab activity could actually improve above and beyond our expectations in the second part of Q1. Another part of your question was around the impact of the recent earthquake that shook the Southern part of the Taiwanese Island. As of this point and again the information coming from our customers is still preliminary and still very much postured, but we do not expect that the impact would be very significant and we are obviously working very closely with our customers. We have to mitigate any negative impact the earthquake could have on their operations, but again we try to factor the impact of the earthquake into our guidance the best we could.

[Dick Ryan:]

Okay. Great, thanks and congratulations on good execution.

[Bertrand Loy:]

Thank you.

[Operator:]

And our next question comes from Christopher Kapsch with BB&T Capital Markets. Please go ahead. Your line is open.

[Chris Kapsch:]

Yes, good morning. I had a follow-up question on the guidance for first quarter. If I look at that range, the high end of your sales range would be comparable to the fourth quarter. So roughly flat sequentially and given that you I guess don’t have this inventory drawdown penalty in the first quarter presumably gross margins would be healthier. So I’m wondering why the guidance range on the EPS line is in at least the high end, at least comparable to what you did in the fourth quarter. Is there some mix effect that’s going on?

[Greg Graves:]

Yeah, the big change between Q1 and Q4 is really around the tax rate. We're talking about the tax rate of 28% in Q1 where it was a benefit of 3% in Q4. We would expect our operating margins to be better than they were in Q4.

[Chris Kapsch:]

Got it. Okay, and then just can you talk about sequentially how your order demand patterns trended during sequentially throughout the quarter and thus far into the first quarter and as a follow-up to that, can you discern any bifurcation around demand trans for your products that go into leading edge versus lagging edge?

[Bertrand Loy:]

I think the first part of the question is what trend did we experience in our order pattern in Q4? And I’d say that it remained pretty soft throughout the quarter. As I mentioned a number of our customers were operating at very low levels of fab utilization. What came as a surprise in Q4, a positive surprise was that the last two weeks of the quarter were stronger than expected. In particular, we experienced very strong demand for our UPE and Teflon filters and as a result, our liquid micro-contamination business grew 3% sequentially and finished the year on a very high note. To think about the velocity of our orders going into Q1, I think they are at about similar levels of what we experienced in Q4 and that’s really the basis for the guidance that we provided for Q1. Go ahead.

[Chris Kapsch:]

Okay. Is there -- yeah as a follow-up to that, is there any difference between the strength or weakness at the leading edge versus the lagging edge in terms of the fab utilization rates or demand for your products into those applications? Thanks.

[Bertrand Loy:]

Good question, but I would say that the fab utilization rates were actually very depressed across nodes so -- at the leading edge as well as the trading edge. So there was not really a lot of differences between nodes and between customers.

[Chris Kapsch:]

Thank you.

[Operator:]

And we will take our next question from Christian Schwab with Craig-Hallum Capital Group. Please go ahead. Your line is open.

[Christian Schwab:]

Great, congratulations on a solid quarter and good execution. Bertrand can you please elaborate on what you specifically believe could cause demand to strengthen in Q1? Is that unit driven? Is that CapEx driven? Is it a combination of both? Is it leading edge? Is it trailing edge? Is it a industry comment or is it more line of sight to improve SAM to liquid filtration or specialty gas going on into the IM implant market. So a little clarity of one, two, three punch there would be very helpful.

[Bertrand Loy:]

Hey Christian, I tried to address that question earlier in a comment and I think that, there are many reasons behind our conviction that 2016 could be a really good year for Entegris. The first is that we believe that MSI will grow or be at the low single digits in 2016 and the reason for that is we believe that PC sales will be stabilizing in '16. We expect to see some pockets of strength on the mobile device sales front and we expect to see continued growth on some of the internet of things application. So all of that combined will help MSI to be in positive territory in 2016. The other thing as I mentioned earlier is that a number of our fab customers have finally made a commitment to ramp their 10 nanometer process technology later in the year and as you know, many of our development efforts over the last couple of years have been targeting enabling technologies around the 10 nanometer note. So we would expect some good positive momentum as we see evidence of those rents later in the year. So that’s essentially really what will be driving the growth momentum in '16. It's really leading edge primarily and most specifically again the earlier ramps of 10 nanometer nodes.

[Christian Schwab:]

Great. Well congratulations, in the last conference call you were kind of first to be kind of grumpy about the market and murky and this actually was at 683. Today we sit at 16% lower, now you're optimistic. So love to hear your optimism. I don’t have any other questions. Thanks.

[Bertrand Loy:]

All right.

[Operator:]

[Operator Instructions] Our next question comes from Amanda Scarnati with CitiBank. Please go ahead. Your line is open.

[Amanda Scarnati:]

Hi, thanks for taking the question. Just a quick question on the debt and I might have missed this. What are the expectations for debt repayment in 1Q in 2016 and is there a moderating of the aggressiveness of the debt repayment in order to maintain cash for a potential acquisition?

[Bertrand Loy:]

So, I think it's unlikely that we'll make a payment in Q1. We do intend to pay at least $50 million during 2016 and we got that classified as current on our balance sheet. In the second half of the question it was that we -- this has changed our -- is there a moderating and I would say, if you were to roll the clock back 12 months ago to today, today we're more focused on maintaining liquidity and maintaining flexibility than we probably were 12 months ago. What we've been saying is for every dollar or cash we generate, we'll take a dollar and continue to build liquidity and then we'll take a dollar and use it for share repurchases or debt repayment. Whereas a year ago, we had set everything over a 125 in liquidity, we're going to use to reduce debt. So we have -- we’re focused on being a little bit more flexible.

[Amanda Scarnati:]

Okay. And then on -- Bertrand, you mentioned that when i2M center fully ramped during -- and now its double capacity, do you risk of significantly lowering ASPs and hurting margins if you double capacity or is there enough room that you need all that excess capacity? Is there enough demand.

[Bertrand Loy:]

No, and the reason why we made the investment that we knew that the current manufacturing line was not sufficient based on the forecasted demand for those products. So I actually do not expect to be facing a situation where there would be a lot of excess capacity. If things go as plan, I would tell you that we could find ourselves in a position where we will need to add capacity to meet what we expect to be a great growth opportunity for those UP filters. Remember that those filters are essentially the line of defense for many of our fab customers. So think about those filters as really being part and parcel of the fab process recipe. Think about those filters as becoming almost a requirement in terms of bulk filtration for the resist chemical manufacturers. So I think that the SAM for those filters has expended tremendously and I think our market share is also expanding quite a bit recently. So I would expect these products to be a great success going forward and a very important ingredient to our overall growth.

[Amanda Scarnati:]

Great. Thank you.

[Bertrand Loy:]

Thanks Amanda. Thank you.

[Operator:]

[Operator Instructions] Our next question comes from [Eric] [ph] with Jeffries. Please go ahead. Your line is open.

[Eric:]

Good morning. Thanks for taking my call. Most of my questions are already answered, but on the debt side, is there a target leverage that you guys are looking for?

[Greg Graves:]

I'll say, we don't have a specific target leverage ratio. We were comfortable and we were up at 2.00 when we announced the transaction. Our goal is continue to drive that net leverage ratio down however in the absence of a meaningful M&A transaction, you should expect to see the net leverage continue to come down.

[Eric:]

Thank you. And just in terms of cash, I know you guys have about $150 million of domestic cash or puts at about $20 million of offshore. How much of that can you repatriate without adverse cash consequences?

[Greg Graves:]

We repatriated about $70 million near the end of 2012 or excuse me, 2015 and we would expect this year that we should repatriate somewhere between $50 million and $75 million as well most likely in the first half of the year.

[Eric:]

Okay. Perfect. Thank you.

[Operator:]

And we have no further questions at this time. I would like to turn the call back to Bertrand for closing or additional remarks.

[Bertrand Loy:]

Well, thank you all for joining us today. This concludes our Q4 2015 earnings call and have a great day.

[Operator:]

And ladies and gentlemen, this does conclude today's program. You may disconnect at this time. Thank you and have a great day.