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

Thank you. Good morning, everyone, and thank you for joining our call today. Earlier, we announced the financial results for our third quarter ended September 27, 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 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, Chief Financial Officer. Bertrand will now begin the call..

Thank you, Steve. I will make some comments on the quarter's performance, business trends and our integration of ATMI. Greg will then provide more details on our financial performance. I am pleased with our Q3 results, which demonstrated the financial and operational potential of the new and expanded Entegris platform.

To summarize, sales of $273 million were at the high-end of our expectations. We achieved an adjusted operating margin of 18.3% and non-GAAP earnings per share of $0.21, which were above our target model. We generated $68 million of cash from operations, which allowed us to both grow our cash balances and repay $25 million of long-term debt.

Finally, our integration of ATMI is progressing ahead of plans. Overall, trends in the semiconductor market continued to reflect the patterns we have seen over the past several quarters. Pockets of strength offset by softer sectors in both unit production and capital spending.

Against these trends, the approximately 80% of our business that is leveraged to unit production grew modestly in the quarter, driven by device makers with exposure to launches of new smartphones.

The portion of our business driven by capital spending declined due to lower sales of FOUPs and fluid handling products which, combined, were about $11 million lower than in Q2, as we expected.

In our adjacent markets, which represent approximately 20% of our revenues, we benefited from a modest pickup in utilization in Q3, in solar, LED and flat panel display. However, capacity additions in these markets remain limited. The performance of Critical Materials Handling, or CMH, was in line with our expectations.

Q3 sales declined from a very strong Q2 due to the lower sales of FOUPs and fluid handling products I just mentioned. These product sales, which are fab project specific, are typically very lumpy. Other major CMH business lines performed well, as sales of Liquid Filtration Products benefited from strong demand in Taiwan.

The Electronic Materials segment, or EM, had an excellent quarter. Sales for our ThinFab, SDS gas delivery solutions and our gas micro-contamination products were very strong. Sales of our surface prep products grew modestly. And we also did see strong demand for our formulated cleans chemistry related to the ramp of 20-nanometer node technology.

The integration of ATMI is progressing very well, following an aggressive integration timetable. I am very proud of the hard work and dedication of our teams. And I am very pleased with the progress thus far.

We have already achieved a number of key milestones, which have included eliminating duplicated corporate costs, integrating key HR policies and practices, and setting in motion plans for consolidating overlapping sales offices.

To put this in perspective, by the end of the second quarter of 2015, which will be approximately 1 year following the closing of our acquisition of ATMI, we expect to have the full $30 million of synergies in place.

We expect to be running our operation from 1 common ERP system and to have 1 unified front for our customers, with our global sales teams operating from the same offices around the world. This is ahead of our original schedule which called for completing the integration by the end of fiscal 2015.

But needless to say, we have already been very active in introducing the new Entegris platform to our global customers who are facing ever greater challenges as they ramp their '14 and '16 processes and start developing their next nodes.

These challenges are requiring new innovations in advanced materials, and tighter filtration and purification methods, more precise and reliable on-site blending and delivery, as well as cleaner and safer packaging solutions. This is good news for us since solving these challenges is clearly in the wheelhouse of our strength.

We have a compelling value proposition for our customers that leverages our unique combination of strength, technology breadth and depth, global infrastructure and operational excellence.

Given this strength, over the next 2 to 3 years, we will be able to take share and grow, achieve annual free cash flow of approximately $130 million and deliver EPS in excess of $1 per share. I will now turn the call to Greg for the financial detail.

Greg?.

Thank you, Bertrand. I was very pleased with our Q3 results. We performed well, exceeding our target model in generating strong cash flow and EBITDA. Our sales of $273 million, which includes a full quarter of ATMI results, compared to pro forma sales of $281 million in Q2.

By segment, CMH revenues of $165 million declined 8%, as expected, from a Q2 pro forma revenue number of $179 million. The operating margin for CMH was 21.5%, which compared to 23.5% on a pro forma basis in Q2.

EM Q3 revenues of $108 million grew 6% sequentially from Q2 pro forma revenues of $102 million, due primarily to strength in specialty gases and deposition materials. EM achieved an operating margin of 30.9%, which compared to 28.5% in the second quarter on a pro forma basis. By geography, Asia sales represented 54% of total revenue.

North America sales were 23% of total revenue and sales to Japan and Europe were 13% and 10% of total revenue, respectively. The impact of currency fluctuations was not meaningful in the quarter, although the weaker yen and euro may be a headwind in Q4.

On a consolidated basis, our GAAP financial results for the third quarter included $31 million of charges related to the ATMI acquisition. These are outlined in the reconciliation chart on Page 11 of our press release.

Specifically, cost of goods sold in Q3 included a charge of $24 million related to the remaining portion of the amortization of the fair value markup of acquired ATMI inventory. In accordance with purchase accounting rules, ATMI inventory was adjusted to fair market value and essentially written up to near sales price.

There are no additional inventory step up charges remaining. SG&A in Q3 [indiscernible] $67 million of integration expenses. To date, these expenses have amounted to approximately $10 million. We expect to have integration expenses through 2015, although the level of cost should start to taper off beginning in Q1.

At this point, we are more than comfortable with the $35 million overall integration cost estimate we previously provided. In Q4, integration expenses will be approximately $7 million. Q3 operating expenses also included amortization of $13 million, which relates primarily to the ATMI acquisition.

Amortization expense will continue at similar quarterly levels for the next several years. As Bertrand indicated, our integration activities have been very productive. And we are tracking to realize the $30 million in annual cost synergies faster than originally expected.

At the end of Q3, we have realized more than half of the annualized savings and we expect to exit 2014 at a $20 million annualized run rate. On a non-GAAP basis, excluding the inventory revaluation charge mentioned above, gross margin was 45.1%, up just slightly from Q2.

Although we had a favorable product mix in the quarter, this was offset by a lower absorption and a modest drag from the i2M facility as we complete the necessary customer qualifications to begin ramping production in the middle of 2015. For the fourth quarter, we expect gross margins to be flat with Q3.

Excluding amortization and other transaction-related cost, non-GAAP operating expenses were $73.2 million in Q3. For the fourth quarter, we expect non-GAAP operating expenses to be $73 million to $76 million. Interest expense was $10.1 million in Q3, reflecting 3 months of interest and amortization of financing cost.

We expect interest expense to be $250,000 lower in Q4 as a result of the debt paydown in Q3. The tax rate for the quarter, of 79% on a GAAP basis, was skewed by the purchase accounting and integration-related cost. On a non-GAAP basis, in Q3, we had a tax rate of 27%, which is consistent with our planned rate, going forward, of 27% to 29%.

Adjusted EBITDA for the quarter was $64 million. Cash flow from operations of $68 million, which illustrates the cash generation power of the combined company. The cash flow allowed us to both increase our cash balance and paydown $25 million of our term loan. Our cash balance at the end of Q3 was $390 million, up $24 million from Q2.

Approximately 80% of our cash is held offshore. After the $25 million repayment, total long-term debt, including the term loan in the notes, was $793 million.

Over the next 3 to 6 months, as we complete the legal entity integration of our foreign subsidiaries with the former ATMI subsidiaries, we will be opportunistic with respect to cash management and expect to bring a portion of the foreign cash back to the U.S.

We are very comfortable with our financial position, and our current net debt ratio is less than 1.8x trailing pro forma EBITDA. Capital spending in Q3 was $15 million. In Q4, we are planning for CapEx of $15 million to $20 million, with depreciation of approximately $14 million.

In terms of our outlook for Q4, we anticipate slower wafer starts consistent with seasonal trends, with continued patchiness in industry capital spending. Given this outlook, we expect our Q4 sales to be in the range of $260 million to $275 million.

At these revenue levels, we expect non-GAAP EPS to be $0.15 to $0.21 per share, consistent with our target model and the timing of the realization of our cost synergies. In summary, we executed very well and maintained a strong focus on the customer. We exceeded our target model and generated strong cash flow.

Consistent with our stated capital allocation strategy, we are using that cash to paydown debt. We feel good about how the ATMI integration is proceeding and about our ability to achieve our stated cost synergy goal of $30 million on an accelerated basis. With that, we'll now take your questions.

Operator?.

[Operator Instructions] And we'll go to our first question from Patrick Ho with Stifel, Nicolaus..

Bertrand, first, in terms of the fourth quarter outlook, can you give a little more color on some of the pulls and pushes in terms of the market segments where you're continuing to see some wafer start strength versus some of the seasonal declines that you typically get? What are some of the pulls and pushes there?.

Hi, Patrick. Well, as Greg was mentioning, when we we're characterizing the guidance for Q4, we expect our unit driven business to be down modestly sequentially. We expect overall fab activity to slow down, pretty much in line with normal seasonal patterns.

I think we certainly expect a different base of operation depending on the customers, but that's not something that we will want to be characterizing on this call. And as it relates to our CapEx-driven product lines, I think the picture will also be mixed. As you know, different components and product lines would have exposure to different tool sets.

And the picture will also likely be mixed in that regard, going into Q4. So for instance, we'd expect components going into iron implanters or track to do well, as for example. But we are expecting others to be more muted, and finally, we expect continued softness in sales of products that are tied to new fab construction projects..

Great, that's helpful. Maybe bigger picture, since you mentioned the 16- and 14-nanometer foundry since that ramp.

From a percentage basis, big picture, how do you see your intensity rising as the industry goes to those new processes? How do you see your overall product portfolio intensity rising?.

Well, we've been anxiously waiting for some of those new nodes to start really ramp up. As you know, typically, the opportunities available to Entegris are those most advanced nodes are greater than some of the legacy nodes. Having said that, we all know that there have not been a lot of volume activity at 16 and 14.

So we are certainly waiting for those process nodes to hit our volume manufacturing sometime next year..

Great. Final question, Greg, in terms of the paydown of the debt.

If you keep generating the cash flow that you generated over the last few quarters, can we expect this kind of $20 million, $25 million type of paydown of debt on a quarterly basis?.

I think, to debt -- I mean we'll move down, over the next 12 months, in 2 forms. One is you'll see consistent paydown from cash flow which -- call it in that $20 million range per quarter. And then the other thing I commented on is we think we'll have the opportunity to bring some cash back from outside the U.S.

sometime over the next 3 to 6 months, and we'll apply some portion of that to debt reduction. And we really said, since the beginning, that number is probably somewhere, in order of magnitude, about $100 million..

And we'll go to our next question from Jason Ursaner with CJS Securities..

Just first, for Greg, appreciate all the detail in the prepared remarks on the balance sheet. You mentioned you're comfortable with the $35 million total integration costs.

Just what's the timing for some of the cash outflows of those costs? I mean, are they all in the cash flow number?.

The bulk of the cash outflows will be over the next 2 quarters. I mean, the largest components of the integration cost are professional fees. Much of that is around our ERP integration and some of our legal entity integrations.

The other component of it is -- a significant component is retention dollars and most of those will be behind us by the end of Q1, a little bit will trickle into Q2. So, by the time we get into Q2 of next year, the integration cost should be pretty nominal on a quarterly basis. Like maybe a couple of million dollars a quarter.

And like I said, I said more than comfortable with the $35 million. I'd be really disappointed if we spend anything close to $35 million..

Got it. I guess I'm just more -- I'm looking at the cash flow number. I mean, you did almost $0.40 in cash earnings, I think. So I just want to -- I don't want to build that, going forward, if there is going to be some cash outflows that kind of....

No, I think the things that you need to think about, kind of a net cash outflow basis is, in Q1, we always have a pretty significant -- our incentive plan pays in Q1. So that's always a meaningful charge to cash flow in Q1, and that number will be somewhere $20 million to $25 million this year.

And then we will pay out the retention and severance payments start paying on beginning in April, but that won't have a positive or a negative impact on the cash flow. I mean, it's essentially just a salary continuation for various periods of time, and not big one-time payments..

Got it. And the term loan portion of the debt that you're paying down, just remind me, there's no prepayment charges on that piece of the overall capital structure..

No, there are no prepayment charges..

Okay. And then just focusing on the SG&A line, adjusted kind of down to a little bit below $15 million run rate. When you're talking about synergies -- I guess I just want to make sure. I was looking at it, Entegris was kind of mid-30s run rate and ATMI standalone would have been kind of $15 million to $20 million a quarter.

Is that the same way you guys are looking at it, pre-acquisition, when you talk about synergies and where you made progress to today versus exiting '14 at a $20 million annualized run rate?.

Yes. I mean, the combined G&A, forget the S, of the 2 companies was a little over $100 million. And that's where a very significant portion of the synergies will come from. It will be out of that $100 million..

Okay.

And the speed which you've made progress so far, are you finding that the synergies on the cost side were maybe a bit more extensive than you first thought or it's just been successful timing so far to date?.

There have been a number of things where we just did better, where we achieved the synergies faster than we thought we would. I mean, initially -- and one example I would say is cost of our insurance.

I mean, we initially thought that we would run multiple insurance plans for a period of time and we are able to push those 2 insurance programs together very quickly and begin realizing those synergies sooner than we thought. That's a for-instance..

And we'll go to our next question from Christian Schwab with Craig-Hallum Capital Group..

So Greg, we're kind of way ahead on the OpEx, right? Your real estate, in June, you kind of thought you'd get to $72 million maybe by Q3 or Q4 of next year and kind of exit the year at $72 million. So good job on that. I'm just wondering on this next $10 million, right? We're going to be at $20 million as we exit the year.

Of that remaining $10 million, what is the mix between OpEx and COGS?.

The majority of that, or all of it essentially, is OpEx. I mean, if I were to say if we have upside anywhere in the synergies, that will come more in the supply chain and cost of sales area. But as we talk about our committed synergies, they're 95% OpEx..

Okay, okay. And then just -- was it just conservatism? When we first announced the acquisition, we talked about generating $100 million in annual free cash flow. And now, we've taken that up, it sounds like to $130 million a year.

Was that just -- it may need a little bit more time to make sure that everything was as stated or is there something more positive going on because [indiscernible].

So what we've done -- really, over the last 3 to 4 months, we've gone through kind of an extensive strategic planning process, the combined entities. And that $130 million is really just a number that drops out of our free cash flow as we get out to about 2016. Yes.

I'd say it's a much more refined estimate than we were dealing with, essentially, deal models back in February..

Right, right. That makes sense.

And then have we had a chance to figure out the math yet, on wafer starts at FinFET, 16 and 14? What the potential dollar amount that may possibly impact you on wafer starts yet?.

You have a good memory, Christian. I think I would go back to the answer I was giving to Patrick just a moment ago.

I think we need, really, to see some real activity over some period of time at some, at those 14 and 16-nanometer fabs, to really fully understand what the consumption rate of certain of the material solutions we're providing to those fabs is going to behave like. So it's too early for us, really, to answer the question..

Having said that, again, I think that, over the last 6 months, we've been reintroducing the new platform, the Entegris new platform to customers. And I would tell you that they're really all very positive about the product value.

They really like idea of having one supplier that can synthesize molecule, can define best-known methods of filtration/purification and come up with the right packaging solution that is clean and safe for the operators. And I think that this is a very unique value proposition that Entegris is providing.

So we are continuously very excited about the promises of the merger..

And we'll go to our next question from Dick Ryan with Dougherty..

Greg, on the adjacent markets, you talked about a 20% contribution there.

Could you give us a little more sense of the mix and how you're looking at that into Q4?.

I'll talk a little bit about the mix and I'll let Bertrand comment broadly on adjacent markets. But from a mix perspective, Dick, what I would say is it's really -- and the reason we don't comment on markets specifically is it's a very broad mix of markets.

I mean, if you think about it, there's some LED in there, there's some solar in there, there's some data storage in there, there's some flat-panel in there, there's some industrial markets. So none of those markets, individually, approach a level of being material.

I mean, what I would say is, in general, I mean, the bulk of that 20% is what I would refer to as other, call it, microelectronics markets. And so we're going to participate in trends similar to what you see in those markets..

Okay.

How should we look at segment profitability now that you're starting or you've provided some of the histories in CMH, in EM? Is there any kind of guidelines you're trying to give us on segment profitability for either sector there?.

I think kind of what you saw this quarter would be -- and how I would think about it. I mean, we had a very strong quarter and a very good product mix in the EM business. And so we saw an operating margin that was 240 basis points higher than last quarter at about 30%.

I mean, if I look back over time, that business, on a pro forma basis, has tended to have operating margins that have averaged somewhere in the 27%, 28% range. And with good mix, they've been up like, this most recent quarter, at 30.9%. The CMH business, which is largely the historical Entegris businesses.

I mean, over time, it's kind of run in that 21%, 22% range. Last quarter, they had a very strong quarter and we were at 23.5%. This quarter, with the lower volumes, it was 21.5%..

But, Dick, I just would want to add to that. I think that this pro forma information is really nearly here for you to understand better some of the mix and the dynamics of those 2 segments from a corporate standpoint. We only have 1 target model and we only make a commitment to this corporate target model.

I don't think that we would ever thought introducing target models or expectations by business segment..

Sure. The sequential decline in CMH, is that -- I wasn't sure if I caught the reasoning.

Was that the legacy Entegris kind of CapEx business there?.

Yes. That was really -- I mean, Bertrand made the comment about -- we saw a big quarter in FOUPs in Q2. That did not continue into Q3. But that decline was really -- it was a combination of the decline in FOUPs and a decline in fluid handling products primarily related to project business which is typically outfitting a fab..

And if you remember, Dick, during our Q2 call we were actually characterizing that we were expecting our FOUP business to be down about $10 million to $11 million. In Q3, they were down about $10 million. So we're essentially in line with our forecast and our pure line revenue was a bit stronger than expected.

I think we were expecting it to be down $4 million. They were down about $3 million. So I think, overall, harder [ph]. I think what I really want to be sure you understand is that those product lines really posted record revenue in Q2. And the revenue levels that we recorded in Q3 are very much in line with normal levels of business.

So very solid performance from those 2 product lines..

And we'll go to our next question from Jairam Nathan with Sidoti..

First, can you give us an update on revenue synergies? So what are the actions being taken to get some of these timings? And on the cross-selling opportunities as well..

Yes, Jairam, this is Bertrand. So I would just say, again, that a lot of the new solutions, what we characterize internally as the Blue Ocean value that we will be creating by combining the capabilities of legacy Entegris and ATMI, will most likely not be introduced in a fab environment probably until 10-nanometer and below.

So we are actively working with all of the leading edge fabs on those new nodes but at 10-nanometer and below. So, for now, I would say that our commercial effort is really focusing on cross-selling existing products and leveraging existing customer relationships.

And I would expect, again, to start seeing the benefits of that sometime going into next year..

Okay. And Greg, just a clarification. You said you guided Q4 CapEx to between $73 million and $76 million.

Is that right?.

Right..

And so given the $5 million in synergies that you're talking about in this quarter, what drives the increase in a flat to down revenue environment?.

I tell you, I mean we just continued -- I mean, we're focused on achieving that target model and we're running well ahead -- that we run well ahead of the target model the last 2 quarters. So we do have the opportunity to make incremental investments in the business at this point.

And so I would say nothing specific, but I don't -- I mean our goal, long-term, is to operate to the target model and funds above that to have them, to invest, like you said, back in the business..

Okay, good. And last question.

Did you have any 10%-plus customers this quarter?.

I'm sorry?.

Any 10%-plus customer in September?.

I do not have that right in front of me. I can, if you'll bear with me..

I don't think so..

I don't believe so, but give me a second. Steve, would you want to go to the next question and we can....

We did have one customer greater than 10% in the quarter..

And we'll go to our next question from Frank Jarman with Goldman Sachs..

Just with regard to the debt paydown this quarter, can you talk a little bit about what your target gross debt levels might be going forward?.

Our goal, Frank, is to pay the term loan down as quickly as we possibly can. Which would mean, if you think about it longer term, I mean it would leave us, essentially, with $360 million of notes.

So somebody said, what's the target? I would say in terms of a permanent level of that, if you think about that broadly -- we've consistently said, that they'll let us sort of wear the debt, if you will, for 1 year, 1.5 years before we sort of set a permanent target for our capital structure..

Got it, that's helpful. And I guess just along those lines. Your bonds are currently around par. Just I guess a point or so above par.

Have you thought about buying those bonds back in the open market given the more attractive interest cost savings?.

We have not thought about that. I mean, they had been trading about 103, 104. But with them back here, certainly a consideration..

Got it. And then I guess just the last question I have for you guys was, you talked a little bit about the potential for some cash repatriation.

Are there any more details you can provide with regards to how much of that cash you could bring back? And how you're thinking about redeploying some of that cash?.

I think order of magnitude, in the near term, we think it'll be somewhere around $100 million over, call it, the next 3 to 6 months. And our commitment when we bring that back, is that we will use that to reduce debt..

[Operator Instructions] And we'll go to our next question from Todd Morgan with Jefferies..

This is Chris [ph] filling in for Todd. I have 2 quick questions, 1 is kind of a follow-up. If I look at Analyst Day slides I'm seeing a sort of $150 million figure for that cash repatriation. I was just wondering -- I think it's always been in the $100 million, $150 million range.

Are you still planning the $150 million total or are you finding it's looking more like $100 million like you previously mentioned?.

Over time, I think it'll be and be well in excess of $100 million. I mean, certainly approach that $150 million. But when we think about it over the next -- when I think about it over the next 3 to 6 months, so it's going to be something in the order of magnitude of $100 million..

Okay. And secondly, back to the ATMI acquisition. You guys talked a lot about cost savings and it sounds like that's all on track. I wanted to touch on the revenue side of that. Are you expecting to see any revenue synergies like product bundling, cross-pollination? Anything like that and sort of the timing of any kind of ramp there..

This is Bertrand. Yes, actually, that's the answer I was providing to earlier questions. So I would answer the question in 2 ways. Short-term, it's really around, again, cross-selling existing products and solutions. And typically, customer evaluations of those solutions would take 6 to 12 months depending on the products.

So, therefore, the timeframe I was suggesting earlier, which is you probably won't see any meaningful impact from those commercial efforts until sometime in the beginning of next year. And then what is more exciting about the merger is really the ability of combining the capabilities of ATMI and Entegris.

But really need to -- for that to be a reality, we really need to get on the roadmap of some of the leading edge fabs. And right now we believe that the best insertion point for us would be 10-nanometer or below.

So then the question would be, when will those more advanced nodes be in production? I would say, we don't really know quite yet, but probably 2 to 3 years from now. Different timeframes. Different depending on, really, the path to solutions and the type of opportunities..

And that concludes today's question-and-answer session. At this time, I would like to turn the conference back over to Mr. Bertrand Loy for any additional or closing remarks..

Well, thank you for being on the call with us today, and thank you for your participation. Have a great day..

That concludes today's conference. We appreciate your participation..