Entegris Inc (ENTG) 2008 Q2 法說會逐字稿

Good day, everyone, and welcome to Entegris' second quarter 2008 earnings release conference call. Today's call is being recorded.

At this time, for opening remarks and introductions, I would like to turn the conference over to Steve Cantor, Vice President of Corporate Relations. Please go ahead, sir.

Good morning, and thank you all for joining our call. Earlier today, we released our financial results for our second quarter ended June 28, 2008. You can access a copy of our press release on our website, www.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, and our actual results may differ materially. These risks and uncertainties are outlined in detail in this morning's press release and in our most recent 10-K report, as well as in our other filings and reports with the SEC. We encourage you to read those reports and filings carefully.

As we indicated in our last quarterly call, we will only be referring to GAAP results in our financial discussion. On the call today are Gideon Argov, President and CEO; Bertrand Loy, our Chief Operating Officer; Greg Graves, Chief Financial Officer; and Jean-Marc Pandraud, Advisor to the CEO. Gideon will now begin the call.

Thank you, Steve. Good morning, everyone. I'll make some comments on our business trends and provide an update on a few ongoing initiatives, and then Greg will provide some details on the financials.

Despite a challenging semiconductor market, second quarter sales of $148 million were even with the first quarter. Earnings per share of $0.04 improved sequentially as we benefited from the cost reductions we put in place in the first quarter.

Capital spending in the industry continued to move lower in the quarter. While our largely unit-driven model helped buffer against these declines, the lower CapEx did have a pronounced impact on our sales to OEM customers. Our OEM-related sales were down approximately 30% from the first quarter, reflecting the downturn in the cycle. This was most evident in our second quarter revenues for contamination control solutions products such as fluid-handling components and systems and liquid pumps. These products are key components of semiconductor manufacturing tools or are used in the build-outs of fabs and, as such, are heavily driven by CapEx spending.

In contrast, sales made directly to fabs increased sequentially. This increase reflected several large shipments of wafer carriers, such as our FOUPs, which we consider to be CapEx purchases because of their relatively long product lives. In addition, our sales of liquid filters were stable as utilization rates and fab production output remained at reasonably healthy levels. These filters are typically sold direct to fabs as replacements.

As a result of these effects, our mix shifted to capital-driven sales slightly in the second quarter. Unit-driven sales were 62% of total sales, down from 64% in the first quarter, due primarily to higher shipments of wafer carriers.

Sales to customers outside of the semiconductor market represented approximately 20% of total second quarter revenues. This area is an increasingly important part of our strategy, since many of the markets in this area offer growth opportunities for high performance solutions.

We are already addressing demand filtration in the flat panel and TFT market space and increasing our share there, and we're expanding our presence with our existing products in other consumer electronics manufacturing applications as well as in the solar market.

We took a major step to further expand and diversify our business with the agreement we announced earlier this month to acquire Poco Graphite, a leading provider of specialized graphite and silicon carbide products and materials. This acquisition adds a strong, established, profitable and growing business to our mix. It expands our materials science expertise, our toolset, if you will, beyond polymers which form the core of most of our products. Poco adds to our offering of consumable products in the semiconductor market while adding paths to grow and diversify the business outside of that market.

About 40% of Poco sales are to semiconductor customers. The balance addresses high performance in niche applications in the EDM or electrical discharge machining space, aerospace, specialty industrial and medical markets. As one example, Poco is the only FDA-approved supplier of graphite products for use in artificial heart valves and soft joint prosthesis.

Poco, together with the specialty coatings business we acquired last year, will form the core of a new materials business. In addition to leveraging our coatings technology to develop specialized coated graphite and silicon carbide products, we believe we can also expand Poco's relationships with North American OEMs and as well provide Poco entry into Japan, where it currently has a minimal presence. With annualized sales of approximately $65 million, Poco will not only add to the top line growth, but we expect it should also contribute approximately $0.05 per share of cash EPS in the coming year. We are awaiting HSR approval and hope to close this transaction within the next few weeks.

While we're excited about the diversification into new markets, we also remain confident about the potential of our core semiconductor business. Certainly, the addition of Poco's graphite materials expertise as well as its strong base of semiconductor business adds to our position in our core markets. But even more importantly, our new products aimed at enabling 45- and 32-nanometer technology generations should position us well.

We launched a number of these new products at Semicon West earlier this month, including versions of liquid filters that set new industry standards for particular retention. We expanded our position in 193-nanometer lithography with the introduction of the new filter media and filtration systems for controlling siloxanes in and around the lithography scanner. Siloxanes are a source of airborne molecular contamination that's become an increasingly difficult and costly problem for semiconductor manufacturers at advanced nodes.

Before turning the call over to Greg for some additional financial detail on the quarter, I want to thank my friend and colleague Jean-Marc Pandraud for his many contributions over the past 30 years with Entegris and its predecessor companies, Mykrolis and Millipore. I also want to welcome Bertrand Loy in his new role as Chief Operating Officer. Bertrand is no stranger to the company, having served previously as Chief Financial Officer with Mykrolis and as Chief Administrative Officer for Entegris since the 2005 merger.

Greg will now provide some additional financial detail on the quarter.

Thank you, Gideon. Good morning, everyone.

Before discussing the second quarter results in detail, I want to mention our announcement this morning that we will file an amended 10-Q with the SEC to restate upward our financial results for the first quarter of fiscal year 2008. The restatement does not affect Q1 revenue or cash flows but does result in an upward correction to gross margins of $2.5 million and an upward correction to EPS of $0.02 in the first quarter.

The restatement related primarily to the incorrect application of foreign exchange rates to certain intercompany profit eliminations. We intend to file restated first quarter financial statements concurrent with the filing of our 10-Q for the second quarter of 2008 on or about August 7. I'd also like to point out that the restatement impacts only the first quarter and has no impact on our fiscal 2007 results.

As Gideon described, we were pleased with the financial results this past quarter, given the weakening trends in the semiconductor market. Sales for the second quarter were $148 million, even with Q1. We improved our operating performance and generated $31 million in cash from operations. Gross margin for the second quarter was 40.5% of sales, compared to the gross margin of 43.2% in Q1. The decline related primarily to two factors -- product mix and overhead absorption. Specifically, Q1 included a more favorable product mix, while in Q2 we shipped a greater proportion of lower-margin microenvironment products.

In addition, we reduced inventories by $7 million in Q2, which resulted in lower overhead absorption compared to the first quarter, where we had higher factory output, an increase in the inventory level by $4 million.

Material costs for the quarter remained relatively stable compared to Q1, although we expect the higher cost of oil to negatively impact prices for some of our raw materials such as resins as well as our transportation and freight cost going into the second half of the fiscal year. We anticipate this will result in a 50 to 100 basis point negative impact to our gross margins in the second half. However, we expect to mitigate this impact through a number of initiatives, including our product transfers to Malaysia, which are intended to reduce the manufacturing and transportation costs of these products. The costs associated with these manufacturing moves and product transfers were approximately $700,000 in Q2 or about even with Q1.

Second quarter SG&A was $37.1 million, a decline of $6.7 million from Q1, as we realized about $3 million of ongoing quarterly savings as a result of our Q1 cost reduction initiatives. The first quarter SG&A had included about $3.8 million of non-recurring severance costs related to these measures. ER&D was $10.4 million, or 7% of sales, which is about level with the first quarter.

We reported Q2 income tax expense of $2 million, reflecting a 26.8% tax rate for the quarter. We currently expect the effective tax rate for the full year to be approximately 30% as we achieve higher relative income associated with production in Malaysia, where we are currently enjoying a 10-year tax holiday.

Net income in Q2 was $4.9 million, or $0.04 per diluted share. I want to point out that these results included $4.6 million, or $0.04 per share, of amortization expense.

Shares outstanding on a fully diluted basis at quarter end totaled $113 million, a decrease of about $1 million shares from Q1. During the quarter, we repurchased approximately $12 million worth of shares out of our authorized $49 million stock buyback plan. We have approximately $20 million remaining in the authorization.

Inventory turns were 4.8 times, up from 4.5 in Q1, as we reduced our inventories by almost $7 million. Accounts receivable, in dollars, of $107.6 million, and DSOs of 66 days, also declined from Q1.

Depreciation totaled approximately $6.1 million, and capital expenditures for the quarter were $5.2 million.

Cash, cash equivalents and short-term investments totaled $132.4 million at the end of Q2, a decline of $6.5 million from Q1, reflecting the cash used to repurchase shares and to pay down long-term debt.

As for our Q3 guidance, sales of unit-driven semiconductor products should remain stable given current chip production levels. However, further weakening of capital spending in the overall semiconductor market may lead to project push outs that could impact the capital side of our business. As such, we currently expect Q3 sales to be down slightly in the range of $140 to $146 million. We expect gross margin to be at similar level to Q2, as the benefits from our production moves and other efficiencies offset the unfavorable impact of raw material price increases. We expect EPS to range from $0.03 to $0.05, which includes approximately $4.3 million, or $0.04 per share of amortization expense.

With that, we'll take your questions. Operator?

Thank you. (OPERATOR INSTRUCTIONS). And we'll take our first question from Timothy Arcuri at Citi.

Hi, guys. Gideon, I just wanted to rectify something that I heard. I thought you said that revenue from OEMs was down 30% sequentially, but then I thought you also said that the CapEx-driven piece was actually 38% of revenue, which would mean that it was actually up, so I'm just wondering if you can reconcile that.

Yes. Tim, this is Greg. A portion of our CapEx sales go into the fab environment. For instance, FOUPs are a CapEx-related product, and they're sold to the fabs. So while the portion of our CapEx that went to OEMs was down considerably, your point is exactly right on. Overall, CapEx sales were slightly ahead of last quarter.

And then, Greg, a question on margins. They seem to always be somewhat lighter than we would think, and it seems like every quarter there's some kind of raw material cost issue or some kind of incremental cost that you didn't expect, and I'm wondering what can be done to sustainably control margin better. It just seems like there's always these one-timers that come up. Can you actually hedge more against raw material price increases? What can be done to avoid these ongoing disappointments on the margin side?

Tim, I would say on the margin side we're doing all the right things. We're focused on reducing our freight cost. We're focused on reducing our duty costs. We've closed three small facilities in the last year. In the current quarter, we were clearly hampered. This is the lowest volume of production that we've had in the past 12 quarters. We also had probably the least favorable product mix that we've had in the last three or four quarters. So when I look at the margin for this quarter, I always would like the margins to be higher than they are, but I'm comfortable, actually, with where the margin ended up, given the mix and the volumes.

You also have to remember, we reduced inventory $7 million for the quarter, which, in this environment, is a positive thing. We do not want to be carrying inventories because then we run the potential risk of excess and obsolete and other things. So overall, I feel quite good about where we ended the quarter on the margin front.

Well, Greg, let me ask it this way. Let's say that you got up -- and not that this will happen or won't happen, but let's say that the revenue got back up until the mid-$170 million range like it was in the back half of '06. Given your current cost structure, would you have similar 44% to 45% gross margin at that $175 million revenue?

Absolutely. I still hold with our model, which we say at a mid-cycle revenue run rate, we would have mid-40s gross margins.

Tim, if you -- Tim, Gideon here. If you look at what this company's doing in terms of how we're attacking costs, and you look, for example, at what happened in the OpEx side here in the last quarter, now obviously OpEx is volume independent, and gross margin is not, and that's the major difference. So we took a significant additional whack at OpEx here. You see the results in this last quarter. You're going to see them over the balance of the year. What we're doing in terms of the things Greg was describing -- dealing with freight issues, dealing with issues in terms of number of facilities, dealing with issues including terrorists, for example, moving products over to Asia. Those things don't leave major footprints until you see increases in volume, which -- to your point -- as you see that, we're going to see the kind of fall down to the bottom line or carry through to the bottom line that is, I think, in line with what Greg was just talking about. That's the nature of how these cost moves get actually translated into results over time as volume picks up.

Okay, thanks.

And we'll go next to Christopher Blansett at JP Morgan.

Hi, guys. When you look into the third-quarter guidance, are you already starting to reflect some of the Poco revenues? And if you could give us some sort of quantification of that.

Chris, the guidance does not reflect revenue from Poco because we don't have a significant degree of certainty around when it's going to close. We would expect that it's going to close, if the HSR filing takes the normal time, in the next couple of weeks, but we don't know that, and so we have not included that in our guidance.

All right. And then, given the tough times that the industry's seeing and Gideon's comments just a moment ago, is it likely we would expect either additional facilities shut down as the transition to Malaysia occurs? Is that something that is probable, not necessarily absolute?

We are constantly -- Chris, we're constantly looking at our cost structure. It's not something we -- I think you've seen that over the past number of quarters. We don't tend to do that once a year or in isolation, and our model continues to emphasize moving capacity over to -- really to be closer to our customers. Let me ask Bertrand to make a comment on that as well. Bertrand?

Yes, hi, Chris. This is Bertrand. Just to add on to what Gideon was saying, we have actually a very active program to fill up the Kulim facility, and the horizon for us is to have a facility in Malaysia fully occupied by 2010. So we currently have a number of programs related to parts. We're moving all of the reticle part business into Malaysia, and the next product launch would be around the PVA brushes. After that, it's probably a little too earlier for us to comment. But again, the thought I want you to be left with is that we have a very clear program to fill up the facility within the next two years.

All right. And then just some housekeeping. CapEx and depreciation and headcount during the quarter?

CapEx was -- depreciation was $6.1 for the quarter. CapEx was $5.3. And so we hold, as it relates to CapEx, at our $25 million target for the year.

All right, and headcount?

Twenty-five hundred, Chris.

Thank you, guys. Appreciate it.

(OPERATOR INSTRUCTIONS) We'll go next to Jim Covello at Goldman Sachs.

Hi, this is Kate Kotlarsky for Jim Covello. Question about your non-semi business. I was just curious if there is a specific target you have over the next couple of years in terms of what that could represent as a percentage of your total revenues. And maybe specifically around the solar business, what you see, the opportunity there, and if you can provide us with some numbers around that at this point.

Kate, hello. Let me make a couple of comments and then ask Bertrand as well to say a couple of things.

First of all, the non-semi portion of our business is about 20%. On a pro forma basis, once we add Poco in, that will be about 25% of our revenues. I would be surprised if that number does not increase over the next couple of years. It would not be surprising to see that number go into the 30% to 40% range. That would depend on growth rates on some of the consumer electronics markets that we're making inroads into. We have a team of people, Asia-based, that's working diligently to make inroads into markets where we can apply our filtration technology, particularly, to markets that are not related to semiconductor but that use some of the same basic technology roadmaps and products that we have. And I'd say the evidence is early, but it's quite encouraging in that vein.

Number two, we shouldn't be surprised to see us make some additional acquisition moves over the next year or two, and those would typically be involved adjacencies of the kind that Poco represents, okay? It wouldn't surprise me to see that number go to 30%-plus, certainly, in the next 12 to 24 months.

Bertrand?

Yes, thank you, Gideon. I believe you have addressed very fully the question, but let me just add, with respect to your comment on solar. Solar today is a very minimum business for us. It's literally a few million dollars per year. The biggest opportunity for us will be around thin film, and that's something that we are currently looking at, probably to a greater extent than we have ever done in the past.

The other area would be to look for new business opportunities for the liquid filtration products. And again, arguably, we've seen some tactical initiatives in the region, and one of the major priorities for me in my new role will be to really drive diversification efforts, focusing on the liquid filtration capabilities that we have internally.

So you should expect -- back to Gideon's comment, you should expect the non-semi part of the business to be probably around 35 to 40% over the next two years or so.

And then, just as a follow-up, you mentioned one way we should think about it is potential acquisitions that you could make. How should we think about R&D that's required for you to ramp up some of these capabilities? I know there's a direct leverage in terms of the products that you currently have that you can use in some of these other areas. Are there certain investments that we should expect you to be making over the next couple of years in order to further develop the capabilities?

Well, Kate, our R&D is running at about $50 million a year. I don't think you're going to see that number go up dramatically at all. I think that we tend to make tradeoffs between different kinds of R&D, but internally right now, we don't see -- it's more like $40 million than $50, excuse me. We don't see that number going up dramatically, and that's because many of the products we will be introducing in these markets are derivative products. Some of them are going to be actually with partners involving manufacturing and outsourcing, so we don't necessarily have to make everything ourselves. And we're going to be pretty careful about not ramping up internal R&D more than is required to make these moves.

Okay, thank you. And just one final question on Malaysia. As you continue to move products there and perhaps increasing your supplier base in the region, how should we think about the margin benefit that you're going to be getting over the next couple of years as you transition?

Kate, as we talk about the move to Malaysia, we don't quantify that in terms of specific number of basis points, and we look at that as that's one of the tailwinds that we have in our overall margin picture. That's a tailwind. Getting closer to the customer and lower freight costs we view as a tailwind.

The other thing I want to point out with regard to Malaysia, about 60% of the benefit of the move to Malaysia relates to the tax line, and so this particular quarter, where we reported lower taxes, part of that -- the onus for that was really a greater proportion of our revenue generated from our Malaysia facility, where we enjoy a tax holiday today and don't pay any income taxes. So you've got to look at the benefits from Malaysia, both as it relates to the gross margin, but also the impact on the tax line.

Okay, thank you. And then, since you mentioned the taxes, how should we be thinking about the tax rate going forward?

For this year, we expect the rate to be in the 30% range for the entire year, and over time, as I said, we would expect that rate to move down into the high-20s. I would expect -- two years, three years from now, I'd expect that rate to be 26%, 27% as we build up Malaysia and drive more of our volume out of there.

Great. Thank you so much. That's it for me.

Thanks, Kate.

And it would appear we have no further questions in the queue. Mr. Argov, I'd like to turn the conference back over to you for any additional or closing remarks.

Thank you for joining us on the call. We look forward to speaking with you again. Good day.

This does include today's presentation. We thank everyone for their participation. You may disconnect your lines at any time.