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Entegris, Inc. (NASDAQ:ENTG)

Q2 2014 Earnings Conference Call

July 29, 2014 10:00 a.m. ET

Executives

Steven Cantor – VP, Corporate Relations

Bertrand Loy – President & CEO

Gregory B. Graves – EVP & CFO

Analysts

Patrick Ho – Stifel, Nicolaus & Co.

Jason Ursaner – CJS Securities, Inc.

Christian Schwab – Craig-Hallum Capital Group

Dick Ryan – Dougherty & Company

Jairam Nathan – Sidoti & Company, LLC

Vern Essi – Needham & Company

Operator

Good day everyone, and welcome to the Entegris’s Second Quarter Earnings Conference Call. Today’s call is being recorded. At this time, for opening remarks and introductions, I’d like to turn the call over to Steve Cantor, Vice President of Corporate Relations. Please go ahead sir.

Steven Cantor

Good morning everyone, thank you all for joining our call today. Earlier, we announced the financial results for our second quarter ended June 28, 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 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 Loy

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

I’m pleased to report we had a strong second quarter across the board achieving sales of $252 million, which included two months of ATMI results. This was above the high end of the revised guidance we gave in June. Overall, business trends were largely positive in the quarter. Production rates and fab utilization were positive for most semiconductor makers as demand for mobile devices continued to expand and demand for PCs stabilized.

Even so, leading IDMs and foundries are still in the early phase of implementing and ramping the latest process technologies as the semiconductor industry works through some difficult process challenges. As you know, ramps of new nodes typically drive demand for our leading edge products, and while we have benefitted from some early orders of the current leading edge fabs, sales of our most advanced filters and materials will remain somewhat lumpy until 16 and 14 nanometers are truly in high gear.

Capital spending trends in the industry was somewhat volatile during the quarter as new fab construction moderated, and certain technology driven projects were pushed out. The leading foundries and memory makers continue to digest their recent capacity additions as they focus on ramping new nodes.

In our adjacent markets, we saw some rebound in LED and some other adjacent markets, such as flat panel display. We completed the ATMI acquisition on April 30. We’re very excited about the value this combination will bring to our investors, our customers, and our employees.

As a result of changes to the organizational reporting structure in the second quarter, we’re now reporting in two business segments; critical materials handling or CMH and electronic materials or EM. CMH represents about 60% of our total sales and comprises mostly legacy Entegris businesses. CMH is focused on liquid filtration and handling technologies, and on the handling of critical substrate such as wafers.

Electronic materials or EM represents about 40% of our sales. This segment is mostly made up of the legacy ATMI business, and EM is focused on advanced chemistries and solutions or specialty gases.

During the second quarter, our sales grew 12% sequentially on a pro forma basis as we reported growth across all major product lines. CMH performed very well growing 14% on a pro forma basis driven by record shipments of our advanced groups and high priority fluid handling solutions related to key fab projects. We also enjoyed strong growth in our liquid filtration product lines.

Electronic materials grew 6% on a pro forma basis. EM growth was driven by advanced deposition solutions, key wins for formulated cleans, and solid demand for post-CMP brushes. It was also a solid quarter for our chemical filters and gas purification system.

For the longer term, we’re still in the early stages of exploring revenue synergy opportunities. Our customers have been very positive about the tremendous potential they see in our combined platform. They’ve offered numerous suggestions for ways we can leverage our technologies into new value-added, yield-enhancing solutions, and I would share a couple of examples which are still in the concept stage.

In CMP, for example, we’re exploring how we could leverage our industry leading post-CMP clean formulation with our PVA brushes to provide more cost effective and efficient cleaning. In our specialty gases business, we’re looking at ways to leverage our joint carbon expertise to enable better gas purifiers. And we’re also looking at ways to combine our purification and delivery capabilities to enable application-specific storage and delivery solutions or certain specialty gases.

In terms of the integration with ATMI, I’m pleased with the pace of our activity. We’ve already achieved several key milestones and are ahead of our original schedule for realizing our targeted $30 million of cost savings. All employees impacted by the integration have been modified. While there is little manufacturing overlap, we’ve also identified sales offices and facilities where consolidation makes sense. We expect to complete the majority of these consolidations within the first half of 2015.

We’re also moving forward on an aggressive schedule for integrating our ERP and other systems, and I want to commend our teams around the world for their hard work as they have come together over the past month while keeping our customers as our top priority.

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

Gregory B. Graves

Thank you, Bertrand. I was very pleased with our Q2 results. The adjusted operating margin of 18.8% and non-GAAP EPS of $0.20 for the quarter clearly demonstrate the earnings power of the company following the ATMI acquisition.

Our GAAP financial results for the second quarter reflected a number of transaction-related charges. These are outlined in the reconciliation chart on page 10 of our press release. The $74.7 million of charges breaks down as follows:

The $24 million charge in cost to goods sold reflects the fair value markup of acquired ATMI inventory that was sold in Q2. In accordance with purchase accounting rules, ATMI’s balance sheet was adjusted to fair market value with inventory essentially written up to near its sales price. The total impact of this fair value adjustment was approximately $48 million, and we expect the remaining $24 million to flow through cost of goods sold in the third quarter.

SG&A in Q2 included $38 million of one-time items including $8 million of deal-related fees, $27 million of transaction costs, primarily change in control payments and accelerated vesting of equity grants from employees of ATMI, and approximately $4 million of integration expenses.

Q2 operating expenses also included amortization of $9 million, of which $7 million related to the ATMI acquisition. The final component of the acquisition-related charges was the write-off of the $4 million fee related to the bridge financing commitment that was put in place to support the acquisition.

As we move into Q3, deal related fees, transaction costs, and bridge financing fees will not recur. The final portion of the inventory valuation adjustment will flow through in Q3. We expect to have integration expenses for the next four to five quarters, and we’re comfortable with the $35 million overall integration cost estimate we previously provided.

In Q3, integration expenses will be approximately $7 million to $8 million. The amortization expense will continue for the next several years and will be approximately $13 million in Q3.

As Bertrand indicated, our integration activities have been productive and we believe we’re ahead of our original schedule for realizing the $30 million in annual cost synergies. During Q2 we realized approximately $8 million of utilized and we expect to exit 2014 at a $20 million annualized run rate.

On a non-GAAP basis, excluding transaction related costs, gross margin was 44% essentially in line with our expectations. For the third quarter we expect gross margin to be flat up slightly. Excluding amortization and other transaction related charges, non-GAAP operating expenses were $65.8 million in Q2. For the third quarter which will include a full quarter of ATMI, we expect non-GAAP operating expenses to be $75 million to $78 million.

Interest expense of $12.3 million in Q2 includes a $4 million bridge fee write-off for two earlier as well as a full quarter of interest on the nodes and two months of interest on the term loan. For the third quarter we expect interest expense to be approximately $10 million reflecting three months of interest and amortization of financing costs.

The unusual tax rate for the quarter on a GAAP basis reflected a geographic mix of profits in the quarter. The one-time charges resulted in significant taxable losses and in turn tax benefits in the relatively high tax rate U.S. jurisdiction. This is offset in part by taxable income outside the U.S. that was taxed at relatively low rate. On a non-GAAP basis in Q2, we had a tax rate of 27% which is consistent with our planned tax rate of 27% to 29%.

Adjusted EBITDA for the quarter was $58 million, cash flow from operations is $11 million which reflected the impact of certain transaction related costs. Excluding these items we would have generated approximately $35 million in cash from operations. We expect operating cash flows will return to more normalized levels in Q4.

Capital spending in Q2 was $15 million. In Q3, we’re planning for CapEx of approximately $17 million and depreciation of approximately $13 million reflecting a full quarter of ATMI. These levels are in line with our normalized levels of capital spending and depreciation.

Our cash balance at the end of Q2 was $367 million in line with our expectation. Approximately $270 million of cash was held offshore. Total long term debt including the term loan and the nodes was $818 million, giving us a net debt ratio of less than two times trailing pro forma EBITDA.

Consistent with our stated capital allocation strategy, we intend to begin making meaningful debt reduction payments in the fourth quarter.

With that I’ll turn it back over Bertrand for some comments on our outlook for the third quarter. Bertrand?

Bertrand Loy

Thanks, Greg. For the third quarter, the pace of the ramp of leading edge fab is still somewhat uncertain. Given this and the record Q2 full proofs and for fluid handling products, we expect our Q3 sales to be in the range of $255 million to $275 million. This includes a full quarter of ATMI and compares to pro forma Q2 revenue of $281 million. Given these revenue levels we expect non-GAAP EPS to be $0.15 and $0.20, consistent with our newly revised target model and the timing of the realization of our cost synergy.

In summary, we achieved good execution in Q2 in terms both sales and operating margin. We’re pleased with the pace and the quality of the integration as well as the timetable for realizing the cost synergies. Given the growing importance of materials for next generation chip performance, we believe we’re a must have strategic partner for ease enabling materials and materials handling solutions. We believe we’ve an excellent platform for realizing increased value for our investors as we continue to execute our business strategy, focused on the quality of our earnings and implement our capital allocation strategy.

Operator, we will now take questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question is from Patrick Ho of Stifel, Nicolaus & Co, your line is open.

Patrick Ho – Stifel, Nicolaus & Co.

Thank you very much and congratulations on a nice quarter. Bertrand, first in terms of the results from June and the outlook for 3Q, did you experience any pull-ins or was this just more dependent on the timing of projects and that’s why you saw the very, very strong 2Q whereas things kind of flattened out and declined somewhat for 3Q. So, if you could just give a little color whether it’s some pull-ins or whether it’s just the timing of the projects?

Bertrand Loy

Hi Patrick, thank you for your comment. It’s really mostly driven by the timing of the projects as we mentioned earlier. If you think about our full business, a normal quarter would be in the range of $10 million to $11 million. We recorded sales well in excess of $17 million in Q2, and our manufacturing team did really a great job and surpassed by quite a margin what we really frankly viewed as our theoretical maximum capacity. To fulfill some very urgent orders for Entegris barrier material FOUPs that an important Taiwanese customer was requiring. In the case of the fluid handling product lines, this really relates to our Pureline productlines which came from an acquisition we completed in 2010/2011. This is really a series of products that are used in the sub fabs, and again, a typical quarter for this product line would be about $4 million, and in Q2 we recorded sales in excess of $8 million for that particular business as we were competing a very important facility project in Korea.

Patrick Ho – Stifel, Nicolaus & Co.

Great that’s really helpful. And maybe a question for Greg in terms of the cost synergies and some of the pulls and pushes given that you’re just integrating ATMI now, and given that obviously a lot of volatility that goes on in the semiconductor world, how are you managing I guess these cost saving projects versus the potential of, you just witnessed in 2Q where fab projects demand that quick turnaround, how are you managing, I guess, the levers of getting those cost synergies in place versus meeting your customer demand?

Gregory B. Graves

For us Patrick, the vast majority of the synergies are in, what I’d call, corporate-type functions, so I think in terms of finance, IT, to a lesser degree some of our global field operations as we work to consolidate facilities. So, we’re reducing costs through the synergies that really doesn’t have an impact on our ability to deliver for the customer because we’re doing very little, in fact, we’re not doing anything initially on the manufacturing side of the house.

Patrick Ho – Stifel, Nicolaus & Co.

Great, thank you very much.

Operator

(Operator Instructions) And we’ll move next to Jason Ursaner of CJS Securities.

Jason Ursaner – CJS Securities, Inc.

Good morning. I’ll echo Patrick’s comment to see your stock down a bit, but congratulations on a strong quarter with the combined ATMI. Just first question on the revenue guidance, the entire range is a bit lower than I would have expected, and even if I take out the $6 million for FOUPs versus normal baseline, with the additional month of ATMI, the guidance is implying flat to even modest sequential decline even at the high end of the range. Generally, I haven’t seen any companies raising the alarm on sequential trends in that direction, hearing utilization more flattish, but still expected to strengthen into the holiday season. So, just trying to understand better what you’re seeing in providing that guidance or whether it’s simply some conservatism?

Bertrand Loy

Yes Jason, thank you for your question. Let me maybe help you a little bit with the math, I think you have a lot of the components right, but not all of the components. So, let me start first with the assumptions that we’re using for the industry going into Q3. We’re currently expecting CapEx to be down about 5% to 10%, and we expect MSI to be essentially flat sequentially, and that again is a reflection of uncertainty surrounding the pace of the ramp of the leading edge fabs.

Second, I want to remind you that I continue to expect Entegris to outperform the industry by about 200 basis points. And then, lastly let me help you normalize the [Q2] results. There are two components, one is the FOUP and then the other one is again the record revenue posted by our Pureline product lines. And some of those two factors is an approximate adjustment of about $12 million to our Q2 revenues.

So, if you take the pro forma number of $281 million and you adjust it to the normal levels of FOUP and fluid handling products and you apply the industry assumptions to that, you will get to the guidance that we’re providing of about $255 million to $275 million.

Jason Ursaner – CJS Securities, Inc.

Okay, I appreciate those details. And on the gross margin non-GAAP of 44%, as we look forward and model blended rates, was there anything you’d call out in the two months of ATMI or the full quarter for your business that would skew the quarter performance in either direction, the excess Pureline or FOUP, would that have an impact on the margin?

Bertrand Loy

Not really, I mean, we’re obviously running at high utilization rate, so that has a favorable bias toward the margin. As we look forward, I said flattish with the slight upward bias, and that slight upward bias is a function of the fact that we will have ATMI for the full quarter and historically their margins have been in the 48% to 50% range for their microelectronics business versus our margins which have tended to be in that 43%, 44% range.

Jason Ursaner – CJS Securities, Inc.

Okay. And last question for me, you mentioned being ahead of schedule on the timing of the cost synergies, and I know at the analyst day you gave lot of good detail about locking it in and being prepared to give advance notice. At this point, is there any upside to the $30 million given what you’re seeing with the integration?

Bertrand Loy

Jason, at this point our focus and the teams focus is really to realize the $30 million of savings that we’re targeting and to realize those savings at a faster pace than planned. Once we’ve past that point then we will be commencing on your question, but it’s too early for us delve.

Jason Ursaner – CJS Securities, Inc.

Okay, I appreciate it.

Operator

Our next question comes from Christian Schwab of Craig-Hallum Capital.

Christian Schwab – Craig-Hallum Capital Group

Great, thanks for taking my question. Is really the CapEx, there is next order here going to September obviously looks to be a pause for lot of the frontend manufactures are optimistic about a Q4 snapback and then recovery, also expending recurring in 2015 again. As we look to the December quarter are you seeing initial indications of recovery in CapEx or is it a little bit too early for you?

Bertrand Loy

Christian, it’s too really for us to really comment on Q4. I would just say that we continue to be optimistic that 2014 will be an up year for the industry and for Entegris, but at this point it’s too early for us to comment specifically on the trends for Q4.

Christian Schwab – Craig-Hallum Capital Group

Great. And then, I think we talked about this at the analyst day, the significant increase in process steps as we shrink nodes below the 20 nanometer level and more reliance on materials such as the 14 nanometer nodes and you guys really doing some work and trying to figure out if you could quantify the potential impact to your business and your growth outlook given why materials matter, I guess? Have you been able to do that work yet or is that still work in process?

Bertrand Loy

Well, you have a good memory Christian, and certainly this is something that we’ll be working on. We’ve not completed the work yet and it’s really primary function of the fact that if you think about 16 and 14 nanometer, the fabs are still ramping and it’s really hard for us to have a good sense for to consumption rate of some of the products that we provide to those fabs and its hard to have a good handle on the frequency of replacement of certain of our filters in particular. So, I think that we will have to wait for some of those fabs to really be operating in a more steady and stable way to get a better handle on all of that.

Christian Schwab – Craig-Hallum Capital Group

Okay. This is my last question. Greg, the capital allocation goal on an annualized basis is at least $100 million of repurchasing of debt, is that correct?

Gregory B. Graves

I mean, we haven’t given specific guidance on that but I think if you look at what kind of free cash flow we think will generate, I mean that’s a reasonable assumption.

Christian Schwab – Craig-Hallum Capital Group

Alright, fabulous, no other questions, thank you.

Bertrand Loy

Thank you.

Operator

We’ll take our next question from Dick Ryan of Dougherty, your line is open.

Dick Ryan – Dougherty & Company

Thank you. Hi Greg, I’m not sure that the lines are too blurred, but if you stripped out ATMI could you give us what you guys saw as a unit driven in CapEx split in Q2?

Gregory B. Graves

Actually Dick, I do not have the data in front of me, I would say that given what the comments Bertrand made with regard to the two big projects that our capital piece was probably a little bit higher than it has been historically is because of the strengths of those two items.

Moving forward, I mean we’re going to really move away from breaking that out, I mean, the business going forward is about 80% unit driven and we won’t be providing kind of the detail on the same level of granularity that we have in the past because we view ourselves as primarily a unit story at this point.

Dick Ryan – Dougherty & Company

Sure. On your CapEx expenditures you said Q3 will go back down to a more normal $17 million and I think you –

Bertrand Loy

It was actually up slightly from Q2, Q2 was 15, it will be 17 in Q3.

Dick Ryan – Dougherty & Company

Okay. And then, but going into next year we should still be looking at the 53ish, $50 million to $55 million range you provided earlier?

Bertrand Loy

Yes.

Dick Ryan – Dougherty & Company

Okay, thank you.

Operator

(Operator Instructions) We will take our next question from Jairam Nathan of Sidoti & Company.

Jairam Nathan – Sidoti & Company, LLC

Hi, thanks. Just following up on the earlier question, like you mentioned that you had ATMI revenues for the quarter was kind of in the $60 million range that seems almost flattish from what they might have done on March, so and surprising that they didn’t kind of get the benefit of the seasonal growth we’ve seen in June, so is there anything in there that’s like share loss or something?

Bertrand Loy

I would comment that ATMI’s revenue we’re not going to give you specifics on that. We report on a segment basis which is totally but their revenues would have been mid single digits if they were a standalone company.

And Jairam again, as we stated earlier in our prepared remarks, starting this quarter we’re moving to a new reporting structure. I think it’s important that you start getting familiar with that reporting structure.

Having said that if you want us to help you a little bit, I would suggest that you look at CMH as a fair proxy for Entegris was and electronic material proxy for legacy ATMI. It’s not perfect, it’s not a perfect match but this is a good approximation.

Jairam Nathan – Sidoti & Company, LLC

Okay, thanks. And as far as you know, your outlook for a flat kind of stats for September that seems to be little different from what some of your customers have been saying, so is there, you think, should we think about a different level of seasonality for someone like Entegris since you supply, there could some inventory issues here with the end customer. So, seasonally will it be any different?

Bertrand Loy

Jairam, what I was saying when I was characterizing the assumptions beyond the guidance is that we expect wafer start to be flat and I think that be consistent with what we’ve heard across the industry at this point. But you’ve also heard me say that we expect outpace the industry growth rate by about 200 basis points. So in other words you should expect our unit driven business to grow sequentially going into Q3.

Jairam Nathan – Sidoti & Company, LLC

Okay, thank you, thanks a lot.

Operator

And we will take our next question from Vern Essi of Needham & Company, your line is open.

Vern Essi – Needham & Company

Thank you, sorry I got interrupted on the call here. Greg I wonder if you just revisit, I think you had some OpEx guidance, do you mind just revisiting that please.

Gregory B. Graves

I had said that on a combined basis our OpEx was about $65 million in Q2 and we expect it to be $75 million to $78 million in Q3, which reflects a full quarter of ATMI.

Vern Essi – Needham & Company

Okay. And then, also on the new breakout to CMH versus EM and I apologize if you have said this already, are you going to provide a historical schedule of this on a backwards basis including ATMI or we just going to kind of play this as, your rollout of the quarters?

Bertrand Loy

We’re in the process of putting the historical pro forma data together, I mean our goal is to provide, we don’t have it today, but our goal is to provide back to the beginning of 2013 what those segments would have looked like on a historical basis.

Vern Essi – Needham & Company

Okay. Alright, that’s helpful, thank you very much.

Operator

There are no further questions at this time, I would like to return the conference over to Mr. Bertrand Loy for any concluding remarks.

Bertrand Loy

Thank you, Leo. This concludes our call, I want to thank you all for joining us today and for your interest in Entegris.

Operator

Thank you. This does conclude Entegris’s second quarter earnings conference call, you may now disconnect your lines and everyone have a great day.

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