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SunEdison Semiconductor Limited (NASDAQ:SEMI)

Q2 2014 Earnings Conference Call

August 7, 2014 09:00 ET

Executives

Chris Chaney - Director, Investor Relations

Shaker Sadasivam - President and Chief Executive Officer

Jeff Hall - Chief Financial Officer

Analysts

Vishal Shah - Deutsche Bank

Gabriela Borges - Goldman Sachs

David Wong - Wells Fargo

Atif Malik - Citigroup

Operator

Ladies and gentlemen, thank you for standing by and welcome to the SunEdison Semiconductor Second Quarter Earnings Call. At this time, all parties are in a listen-only mode. Later we will conduct a question-and-answer session. (Operator Instructions) As a reminder, this call is being recorded.

I would now like to turn the conference over to our host, Director of Investor Relations, Mr. Chris Chaney. Please go ahead, sir.

Chris Chaney

Thank you, Brett. Good morning and thank you all for joining SunEdison Semiconductor’s second quarter 2014 results conference call. As Brett mentioned, I am Chris Chaney, Director of Investor Relations. With me today are Shaker Sadasivam, President and Chief Executive Officer and Jeff Hall, Chief Financial Officer.

After my remarks, Shaker will provide an overview of the significant events and commentary on the company’s second quarter performance and Jeff will then review the financial results. Our discussion today will refer to certain non-GAAP financial measures. A reconciliation of these non-GAAP measures has been provided in our earnings press release financials published earlier this morning.

Note that this call will include forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially from management’s current expectations. Please also note that this call contain – I am sorry, we encourage you to review the Safe Harbor statement contained in the press release today for a more complete description of these statements. In addition, this call includes only information available to us at this time. To the extent that you are listening to this call at a later date via a replay, please note that the information maybe outdated or complete.

With that, I will now turn the call over to Shaker.

Shaker Sadasivam

Thanks, Chris and thank you all for joining us today on our first conference call as a public company. Q2 was a good quarter for us. We made solid progress on many of our top objectives, including profitable growth quarter-on-quarter with gross profits, one of our key metrics, up 145%. We also successfully closed our IPO and are now a solely semiconductor focused business. In today’s call I will start with my view of the current semiconductor market environment and cover some of our Q2 highlights. I will then discuss our focus items and strategy for the next few quarters. Jeff will later take us through our Q2 results in a little bit of – little more detail and we will open it up for questions.

First, I would like to begin by acknowledging our entire team for the successful completion of our IPO in late May. And I would like to thank SunEdison’s executive team for their support. Being an independent company allows our team to focus on our core markets, products and customers. And we believe our new capital structure gives us the flexibility we need to make the decisions necessary to maximize returns to our shareholders. Over the last several months we have seen some signs of gradual improvement in the semi wafer market environment.

Demand across nearly all segments is strong. 300 millimeter wafer demand has increased and the industry is at or near capacity levels. We believe this is due to higher demand for logic and memory devices used in computing and communication products. 200 millimeter and 150 millimeter utilization levels also improved though they are still below industry capacity. ASP was slightly up for the quarter, if 300 millimeter demand continues to grow over the next six months, we expect to see gradual recovery in prices in 2015. Improved pricing is an important step to meet our goals and to allow us to continue investing in R&D and the capacity needs of our customers. Over the long-term we believe our unique global footprint with facilities located next to our biggest customers, our industry leading technologies in EPI and SOI and our strong focus on operational execution and cost will allow us to continue to gain share and improve margins.

Now, coming to the specifics of our second quarter results, revenue increased by 4% to $215 million as a result of increasing volumes and improving ASP, which resulted from a better mix and a flat to slightly higher pricing on some products. This revenue growth combined with better factory utilization and lower costs led to strong sequential growth in two of our key metrics; gross profit and EBITDA. As we progress through the year, we are focused on increasing our ASP by improving our mix of premium products and driving price increases where possible, improving operational efficiencies to improve cost and delivering the leading edge products our customers need.

Finally just two weeks ago we had all of our company’s top leaders from around the world together for several days to discuss our Q2 results and progress on various initiatives. The energy was high and I continue to be excited by the progress we are making and the vision for our future. I would like to thank all the employees that made our IPO possible and continue to deliver strong results everyday.

Now I will turn it over to Jeff who will go through Q2 results in more detail.

Jeff Hall

Thank you, Shaker. Overall, we had a solid quarter. We successfully completed the IPO and related financing transactions giving us a strong independent capital structure. We drove sequential growth and profitability by increasing revenue and lowering costs. We ended the quarter with $115 million in cash. As I go through the quarter in more detail, I will focus my comments on the metrics we believe are most important in managing our business. Gross profit, adjusted EBITDA as defined and reconciled on our press release and cash. Revenue for the quarter was $214.9 million, up 4.3% sequentially as a result of increases in both volume and average selling price or ASP. Although the increase in ASP was small and primarily the result of improving mix, we did see price increases in some products. We believe gross profit is a key management metric and in the second quarter it was $20.4 million or 9.5% of revenue, up from $8.3 million or 4% of revenue in the first quarter. This improvement was the result of higher volumes, lower cost, and better ASP.

Compared to the prior year, however, both revenue and gross profit were down primarily as a result of lower pricing. Over the next several quarters, our top priority is continuing to grow gross profit by improving price mix and cost. We have the broad products that our customers need. We have a unique business model with sites close to our customers, capacity in the industry of getting full, and our team is relentlessly pursuing cost savings opportunities.

SG&A and R&D in the quarter totaled $29.9 million combined, $9.6 million and $10.3 million respectively, approximately in line with first quarter levels. SG&A was down $6 million from the prior year as a result of lower expenses post-IPO. R&D was consistent with prior year levels as we continue invest in the next generation technology our customers need.

In the quarter, we realized a $10.8 million benefit to operating expenses from the reversal of previously recorded restructuring reserves. The majority of this benefit was the result of the settlement of intercompany items before the IPO. Excluding this benefit, adjusted EBITDA, another key metric for us was $20.1 million, up from $15 million in Q1. Depreciation was $29.8 million in the quarter and we expect it to remain at about this level for the balance of the year.

Share-based compensation was $1.7 million for the quarter and we expect it to be approximately $3 million in Q3. Interest expense was $1.5 million as the debt was only outstanding for part of the quarter. For Q3, we expect approximately $3.5 million of interest expense. As part of the separation from SunEdison and the formation of SunEdison Semiconductor Limited, we are reformulating our corporate structure and reevaluating our tax positions around the world.

In the second quarter, we determined that a valuation allowance for a deferred tax asset in one jurisdiction was no longer necessary. As a result, we realized a non-cash benefit of $29.6 million in the quarter. We do not expect our 2014 effective tax rate to be indicative of our tax rate going forward. In future years, we expect to have approximately a 20% tax rate. Cash from operations in the quarter was negative $125 million, primarily as a result of IPO related activities. More importantly, we ended the quarter with a $115 million in cash.

Looking forward, we are excited about the opportunities we see to continue to grow both gross profit and EBITDA. We think that our unique business model and strategic footprint, structural cost advantages, solid product positions and intellectual property, relationships with top customers and strong team focused only on the semiconductor business positioned us well for the future.

Thank you for joining us today. And now, we will open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question will come from Vishal Shah with Deutsche Bank.

Vishal Shah - Deutsche Bank

Yes, hi. Thanks for taking my question. I just wanted to maybe better understand the competitive environment and what you think about consolidation trends in the sector, I know that some of the international players may not have the same kind of focus that you guys have and your market share has been gradually improving and you are seeing any changes in the landscape and how the competitors are behaving both from a pricing and volume standpoint?

Shaker Sadasivam

Vishal, this is Shaker. As we had talked about in the roadshow, industry has gone through consolidation over the last 20 years and we expect that trend to continue. And it’s important for the trend to continue for us to have the same transformation that’s happened in the hard disk drive and the memory industries. And what we see now with the fewer players that are left is definitely an awareness on focusing more on profitability. And as the supply demand comes more into balance, we expect the players to be more disciplined. With that said, there is the supply demand picture has to continue to improve through the second half for us to see that behavior patterns set with our competitor, because we haven’t seen much of that over the last year and a half to two years, while capacity has been over demand. And in terms of where they are for in terms of looking at consolidation, I think each one has got their own strategic process and plan on what they want to do to execute, but I think the industry is looking at what’s happening with our customers more willing to talk about it than what the mindset was before.

Vishal Shah - Deutsche Bank

Great, that’s helpful. Thank you. And just you mentioned in your comment – you mentioned that the pricing is firming up can you talk about how you think about 200-millimeter pricing for the rest of the year? What kind of percentage changes are we assuming as you look at the rest of the year?

Shaker Sadasivam

For 200-millimeter, the utilization levels are still below capacity. There are some pockets, where we have been able to hold pricing better than other. So, what we need to fundamentally see is sustained growth in demand for us to be able to start seeing some real price increases. So, the area where we expect to see the price increases first will be 300-millimeter. And I think typically what happens is since 300-millimeter is such a big part of the market, there will be some drag on benefit to 200-millimeter also. So, that will be the first effect. And after that as capacity tightens, we would see more of an increase in 200-millimeter. So, what we do is typically look at the pockets and target pricing increases as and when we see the right opportunity.

Vishal Shah - Deutsche Bank

That’s helpful. Thank you.

Shaker Sadasivam

Thank you.

Operator

And the next question will come from Jim Covello with Goldman Sachs.

Gabriela Borges - Goldman Sachs

Hi, good morning. Thank you for taking the question. This is Gabriela Borges on behalf of Jim. I wanted to ask a little more on the mix shift dynamic between 200-millimeter and 300-millimeter, maybe you could just talk about the proportion of your business, that’s 200-millimeter and older versus the newer products and the type of premium that you are realizing just as we try to get a sense of the tailwind to ASP this will move to the next couple of quarters?

Shaker Sadasivam

Okay, this is Shaker again. In terms of the industry, 300-millimeter is about 60% to 65% of the total mix. And for us, it’s closer to about 55%. So, we are lower than the industry. And in terms of the pricing delta or the pricing premium between 300-millimeter and the other products, the excess supply situation of the last two to three years has really eroded much of that premium for 300-millimeter compared to the other products. And so really the opportunity over the next few quarters in the next year, this has demand exceed supply just for that premium to start building backup again.

Gabriela Borges - Goldman Sachs

That’s very helpful. Thank you. And maybe just a longer term question on gross margin as we think about growing from current levels to maybe the 20% target level. I think you mentioned maybe the three factors, mix, price and cost. Maybe you could just elaborate a little bit on the magnitude of expansion that each of these factors could drive into the second half and then longer term as well? Thank you.

Shaker Sadasivam

So, the thing that we – the way we look at it is the levers that we control – we can be a lot more certain about and the levers that we control are absolutely the cost piece of it and also which is the one that we control the most. The next is the mix piece, where we can preferentially try to move our product mix towards a higher margin product base within the constraints of our capacity and the last one will be pricing which depends very much upon the supply demand dynamics and how our competitors behave. So, that’s the way we look at it and it’s hard for me to put specific numbers around each.

Gabriela Borges - Goldman Sachs

Understood. Thank you for the color. Maybe just one more follow up if I could. There have been a few data points on the adoption of SOI technology over the course of the quarter, maybe you could just talk about what you are hearing from your customers and the traction you are seeing there? Thanks very much.

Shaker Sadasivam

Okay. SOI is a growth opportunity for us and we talked about in the roadshow in terms of our position in SOI relative to competitors. And we are definitely seeing more interest in SOI than what we have seen previously over the last six months to a year and we expect to continue to see improved demand for the product going forward.

Operator

And our next question will come from David Wong with Wells Fargo.

David Wong - Wells Fargo

Thank you very much. As you pointed out your overall revenues were down year-over-year in the June quarter, but was this true specifically in your SOI segment and your EPI segment or were one or both of these up year-over-year?

Shaker Sadasivam

So, if you look at SOI in particular, it goes up and in terms of the EPI, it was also up.

David Wong - Wells Fargo

Okay, great. So, it was only polished wafers that were down, which is what led to that decline, is that correct?

Shaker Sadasivam

Overall, yes, there will be a fair assessment.

David Wong - Wells Fargo

Great. And can you give us some idea as to what visibility you have at any point in time, would you get orders in, do you have backlog that stretches out over sort of months to quarters? Do you roughly know what your pricing will be in the September quarter now or does that have – do those things get adjusted regularly?

Shaker Sadasivam

Yes, this – we typically do a majority of our pricing negotiations in the 6 months to 12-month timeframe and a smaller amount on a quarterly basis. So, going into the – though there are some big customer accounts that do it on a quarterly basis. So, the bigger changes in pricing would happen, starting 2015.

David Wong - Wells Fargo

Right, but certainly when you are hopeful that your pricing will be flat to a bit up in the coming quarter, that’s with very high visibility then, is that correct?

Shaker Sadasivam

Yes. So, in terms of our backlog and visibility, we typically have visibility through the quarter and we also have visibility going and pricing it all that through the quarter or two.

David Wong - Wells Fargo

Okay, great. Thank you very much.

Shaker Sadasivam

Thank you.

Operator

And our next question comes from Atif Malik with Citigroup.

Atif Malik - Citigroup

Hi, thanks for taking my question. Congratulations on strong profitability in the second quarter. Shaker, if you can talk about the decision tree in terms of your future investments for capacity addition in 300-millimeter, so, let’s say, if a company gives you guarantee or a contract say Samsung to increase supply with attractive volume, I mean, how would you consider expanding your 300-millimeter capacity?

Shaker Sadasivam

Well, it’s a great question, something that we think about. And one thing we need to be careful about is to make sure that we get the prices up first, because the current pricing levels are not where we wanted to be to be able to justify investment, but that said, if your – the conditions that we would look for or the criteria that we look for in adding capacity at exactly one would be having committed volume and pricing from customers and that the capacity addition makes financial sense, the sense, okay, they have the right ROI. And if we have those two, the clear visibility to demand and pricing and the right cost structure and the capital structure for making the investment, we will make the investment.

Atif Malik - Citigroup

Got it. And then second one for Jeff, Jeff assuming revenues stayed flat here, how should we think about incremental gross margins as you transitioned from $55 per kilogram in poly pricing last year to 30 this year to 20 kilograms next year. Is there a number we can use for incremental gross margins?

Jeff Hall

Yes. So, we think about incremental gross margin, our goal is always to bring 50% of whatever growth in revenue we get through EBITDA. So the true incremental margins for us are about 50%. We do have upside on lower poly costs. We did see most of that benefiting in Q2. We are down to about where expected to be in Q2. We had some inventory burn off in Q1. Q2 is kind of at about our run rate and the next real inflection point for poly will be when the SMP poly comes online which at this point we are expecting to start using that poly towards the end of 2015.

Atif Malik - Citigroup

Okay. And then one last one for me, how should we think about your seasonality in the fourth quarter, I know you guys are not guiding it, but if you look at the wafer start environment, some of the consumable peers have talked about flattish wafer starts in 3Q and down high single-digit wafer starts declined in 4Q, but you guys are gaining share at Samsung, please if you can just qualitatively talk about your expectations for outgrowing the wafer start market for second half?

Jeff Hall

We like our position. We think we have a strong product set. We have a strong execution. We have the right relationships with the top growers. So we think we can continue to grow towards the high end of industry averages. But I think as you all know this is an incredibly difficult industry to predict and there are lots of data points moving around. So our focus really is to continue to be at the higher end of industry averages and we think we are well positioned to do that.

Atif Malik - Citigroup

Thank you.

Operator

(Operator Instructions) Our next question comes from Vishal Shah with Deutsche Bank.

Vishal Shah - Deutsche Bank

Yes. Thanks for taking my follow-up. Just Jeff, you kind of mentioned the poly cost improvement, but as you think about the second half, should we see further improvement in margins because of lower poly costs and assuming revenues to stay at the current levels, what would be some of the other drivers for EBITDA improvement in the back half of the year?

Jeff Hall

Yes. So – what I was saying is that in Q2 we are at about the level of poly cost that we would expect for the balance of the year, so I don’t see a lot more upside coming from there. As we think about our benefits going forward longer term we have SMP, in the short-term here we continue to drive efficiencies in our plants and some of the manufacturing efficiencies, we have talked about there we have the benefit from mix as we continued to improve our mix and potential for pricing improvements and continued focus on costs. Those are really the drivers for the rest of the year.

Vishal Shah - Deutsche Bank

Okay, that’s helpful. And can you just remind us what percentage of your revenues in Q2 were from EPI and SOI and how the percentage will apply for the rest of the year? Thank you.

Jeff Hall

Yes. We don’t breakout individual product details, SOI remains a very small percentage of our overall revenue and we expect it to remain a very small percentage in the foreseeable future. There is some growth, but it’s growing from a small base. EPI will continue to grow and we are positive about the outlook there as increasing demand is driving.

Vishal Shah - Deutsche Bank

Okay. Thank you.

Operator

And at this point there are no further questions in queue.

Jeff Hall

Alright. Well, thank you everyone for joining us. And we look forward to talking to you again next quarter.

Operator

And that does conclude our call for today. Thanks for your participation and for using AT&T Teleconference service. You may now disconnect.

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