Business context and reporting period
Entegris, Inc. filed this Form 10-K for the fiscal year ended December 31, 2018. It supplies microcontamination-control products, specialty chemicals and advanced materials-handling solutions, primarily to semiconductor and other high-technology manufacturers. Its three segments are Specialty Chemicals and Engineered Materials (SCEM), Microcontamination Control (MC) and Advanced Materials Handling (AMH). The filing also reports unaudited results for fourth-quarter 2018.
Financial performance and liquidity
All amounts are U.S. dollars. Annual comparisons are 2018 versus 2017 unless otherwise stated.
| Metric | 2018 | 2017 |
|---|---|---|
| Net sales | $1,550.5 million | $1,342.5 million |
| Gross profit / margin | $719.8 million / 46.4% | $609.0 million / 45.4% |
| Operating income / margin | $292.7 million / 18.9% | $241.8 million / 18.0% |
| Net income / diluted EPS | $240.8 million / $1.69 | $85.1 million / $0.59 |
| Operating cash flow | $312.6 million | $293.4 million |
| Capital expenditures | $110.2 million | $93.6 million |
| Cash and cash equivalents at year-end | $482.1 million | $625.4 million |
| Debt principal outstanding | $950.0 million | $683.9 million |
| Working capital / current ratio | $759.7 million / 3.82 | $766.6 million / 3.63 |
Fourth-quarter 2018 sales were $401.6 million, gross profit was $179.7 million (44.8% margin), operating income was $71.3 million and net income was $80.8 million ($0.57 diluted EPS). Fourth-quarter 2017 sales were $350.6 million, gross profit was $163.7 million (46.7% margin), operating income was $71.2 million and the company recorded a $28.3 million net loss.
Non-GAAP adjusted EBITDA was $436.1 million (28.1% of sales), versus $357.1 million (26.6%) in 2017. Non-GAAP diluted EPS was $1.89 versus $1.44. These are company-defined non-GAAP measures and exclude specified items, including amortization and certain acquisition, integration and tax items.
Material changes versus prior period
- Annual sales rose 15%; excluding $80.0 million from acquisitions and $8.2 million of favorable currency effects, management reported 9% growth. Higher semiconductor demand, fab utilization and node transitions supported sales; price erosion was described as nominal.
- Gross margin improved year over year, mainly from better factory utilization and sales mix. Excluding specified inventory write-up and realignment/impairment charges, management reported margins of 46.9% in 2018 and 45.8% in 2017.
- All segments grew: SCEM sales increased 9% to $530.2 million; MC increased 27% to $552.8 million; and AMH increased 11% to $467.4 million. MC included $62.4 million of sales from SAES Pure Gas (SPG); AMH included $16.0 million from Particle Sizing Systems (PSS).
- Net income increased substantially, mainly reflecting operating growth and a much lower tax expense. The effective tax rate was 5.4% versus 54.0%; 2017 included a $73.0 million transition-tax charge, while 2018 included tax benefits tied to foreign tax credits and legal-entity restructuring.
- Cash declined by $143.3 million year over year, while debt principal increased, notably following the $341.5 million net cash acquisition of SPG and share repurchases. The company repurchased $179.3 million of shares and paid $39.7 million in dividends in 2018.
Outlook, risks and unusual items
- No specific revenue or earnings guidance was provided in the filing. Management expected 2019 capital expenditures of approximately $110 million and anticipated ER&D expense to remain relatively stable as a percentage of sales. Management cited semiconductor demand drivers including advanced manufacturing complexity, data-center and emerging technology applications, and investment in China, while noting uncertainty over the timing of some Chinese fab ramps.
- On January 27, 2019, Entegris agreed to a merger of equals with Versum Materials. Versum shareholders would receive 1.120 Entegris shares per Versum share. Closing requires shareholder and regulatory approvals and other conditions. If the merger fails under specified circumstances, Entegris may owe a $155 million termination fee; transaction costs are generally payable whether or not it closes.
- Key business risks include semiconductor cyclicality and limited order backlog, customer concentration (top ten customers represented 44% of 2018 sales), international exposure (78% of sales outside North America), single- or limited-source materials, trade restrictions and tariffs, competition, technology execution, and manufacturing or hazardous-material disruptions. Debt covenants and debt-service needs may constrain financial flexibility.
- Debt at year-end included $550 million of 4.625% senior unsecured notes due 2026 and a $400 million secured term loan due 2025. The $300 million revolving facility was undrawn apart from $0.2 million of letters of credit; the company reported covenant compliance at year-end.
- The company disclosed a material weakness in IT program-change controls after a third-party software upgrade misdirected vendor payments for about one week. The expenditures were recovered and transactions corrected; management said the weakness was remediated by year-end. SPG, representing about $434 million of assets and $62 million of sales, was excluded from management’s and the auditor’s internal-control assessment pending inclusion no later than the second quarter of 2019. The auditor gave unqualified opinions on the financial statements and internal controls.
- Other notable items include $6.9 million of cost-of-sales expense from the SPG acquired-inventory fair-value step-up, $8.4 million of deal and integration costs, and $2.3 million of debt-extinguishment loss. The 2018 accounts also reflect adoption of the new revenue-recognition standard; management said the quantified line-item effects were immaterial. The company expected adoption of the lease standard in 2019 to add approximately $40–$60 million of right-of-use assets and lease liabilities, without material annual income-statement or cash-flow impact.
- The company reported no legal proceedings expected to have a material effect on its financial position or results. It noted $12.3 million of gross unrecognized tax benefits; settlement timing could not be reliably estimated.
Important facts for investors to verify
- Separate organic growth from the contribution of acquisitions and currency; assess the sustainability of semiconductor demand and the Q4 margin decline.
- Review the drivers and repeatability of the unusually low 2018 effective tax rate, including restructuring-related benefits and remaining tax exposures.
- Track SPG and PSS integration, acquired intangible-asset amortization, and the final SPG purchase-price allocation.
- Assess leverage, interest-rate exposure, debt-covenant capacity and cash needs if the Versum transaction closes or does not close.
- Confirm that IT control remediation remains effective and that SPG is incorporated into the next internal-control assessment.
- Verify merger approvals, closing conditions, transaction costs and any termination-fee exposure against subsequent filings.