Entegris Inc (ENTG) 2011 Q2 法說會逐字稿

Good day, everyone, and welcome to Entegris second quarter 2011 earnings release 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. Steve Cantor: Good morning, and thank you all for joining our call today. Earlier we announced the financial results for second quarter ended July 2, 2011. 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 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 Gideon Argov, President and CEO, Bertrand Loy, Chief Operating Officer, and Greg Graves, Chief Financial Officer. And Gideon will now begin the call.

Thank you, Steve, and good morning. Thanks for joining the call. We delivered another quarter of excellent results. Our performance was highlighted by record sales, earnings, and operating cash flow. We achieved an operating margin approaching 21% and generated $52 million in cash from operations. And we continue to grow share in our core business and make inroads into key emerging adjacent markets. Specifically sales in the second quarter were $209 million, up 3% from the first quarter.

The semiconductor portion grew 1% and accounted for 72% of the second quarter total. Within semi, our sales fab customers grew at a faster rate due to good performance of our filtration and purification products for leading edge semiconductor processes.

Production output at many of our customers through much of the quarter remained at relatively high levels. We also grew our sales to OEMs, although demand related to new fab infrastructure projects paused after being strong in recent quarters as some of these projects had been completed.

Outside of the semiconductor market, we also had good performance. Sales to these markets grew 9% sequentially and accounted for 28% of our total Q2 sales. This reflected growth in TFT LCD and other high-tech industrial markets, as well as continued traction in emerging markets such as solar.

Looking at our sales by type of product, our mix shifted slightly to the unit driven side of sales of unit driven products, such as our filters and wafer shippers, represented 62% of our sales and grew 6% in the quarter. Our CapEx driven sales were 38% of total sales and declined 2% sequentially, after growing 17% in Q1. We believe this performance over the past few quarters compares quite favorably against the industry's recent capital spending trends. Across our divisions, the Contamination Control Solutions division, or CCS, had an outstanding quarter with record sales of $137 million for the quarter and a record operating margin of 33%.

We had excellent performance in liquid filters, fluid handling components, and gas purification systems used in lithography. CCS continues to fill its product pipeline with a number of new offerings, including flow controllers and consumables for wet, etch, and clean, and CMP applications.

Second quarter sales in our Micro Environments division, or ME, grew 6% to $51 million, a level last achieved in 2007. The growth was driven by demand for shippers, including our 300 millimeter wafer shippers which reached a record quarterly sales level. The ME operating margin was 17%. The division continues to move forward in a number of critical initiatives related to advanced wafer and reticle handling, including versions of the new 300 millimeter FOUP carriers made of barrier materials, as well as products to support the industry's move to 450 millimeter wafer size and EUV.

During the quarter, we improved our manufacturing performance and were able to fill a number of orders for the new FOUPs. After very strong 25% sequential growth in the first quarter, sales our specialty materials division declined 6%. Most of the decline reflected lower semiconductor sales for graphite components for etch applications, while the industrial side of this business and demand for solar products remain solid. Roughly 60% of specialty material sales are outside the semiconductor market. Operating margin for specialty materials was 20% in Q2, ahead of our expectations for this business at these revenue levels.

While there were many positives in the quarter, looking ahead there are some signs of softening in portions of the semiconductor industry. Industry volatility is not new to us. What is different is the strategy and operating model we have put in place over the past three years. Our results show that we have accelerated and focused our efforts to take market share by leveraging our strengths in controlling contamination in the industry's most challenging manufacturing environments.

We have also been bringing the technology to emerging markets, non-semi markets, that have a growing need for greater contamination control in their manufacturing processes, but at the same time, we have been extremely careful about adding fixed costs. As a result, we have not only grown faster than many of our peers, but we have delivered much higher operating results and cash flow than any time in the past cycles. We believe this business model, combined with the diverse product offering in our largely unit-driven portfolio of products, is the right recipe to deliver attractive operating performance throughout the cycle.

I will now turn it over to Greg for some additional commentary on the financials and on our outlook for the third quarter. Greg?

Thank you, Gideon. I am extremely pleased with our financial results for the second quarter. We continue to execute well both near term and long-term growth initiatives, and achieved another quarter of record sales, operating profit, and cash flow.

Q2 sales of $209 million were up 3% from Q1, which reflected growth in North America as well as Japan which recovered from the earthquake and tsunami disaster that occurred in Q1. Sales to Asia dipped slightly, and Europe declined after a very strong Q1. As a percent of Q2 sales, Asia was 38%, North America was 29%, Japan was 19%, and Europe was 14%.

As we expected, the second quarter gross margin improved two points to 45.5%. In the second quarter, our manufacturing operations across the Company performed very well. Q2 operating expenses of $51.6 million were slightly higher than our guidance due to higher variable compensation costs. R&D expense was $12.5 million, or flat with Q1, even as we continue to invest to support initiatives in advanced wafer handling, CMP, and lithography applications.

For Q3, we expect operating expenses to be down $2 million to $3 million, or approximately $49 million to $50 million. Our Q2 adjusted operating margin was 20.8%. This was a record high for the Company and reflects the strong operating leverage in our business model.

Our tax rate for the quarter was 23%. Based on our current expectations for geographic mix of income, we expect the full year to be approximately 22%.

EPS on a GAAP and non-GAAP basis were $0.24 per share. The non-GAAP number excludes amortization expense and a $1.5 million noncash gain from the sale of an equity investment.

Cash flow from operations for the quarter reached an all-time high of $52 million. The strong cash flow was due in part to continued attention to working capital management. Inventories increased just over 3% and DSOs were essentially flat for the quarter.

Our balance sheet continued to improve. We ended the quarter with no debt and $191 million in cash and short-term investments. This is an increase of $49 million over Q1.

Depreciation expense was $6.8 million in Q2 and CapEx was $7.8 million. We are on track to spend approximately $30 million in capital investments for the year, which includes investments in our Asia operations and equipment in tooling for 450 millimeter wafer handling products.

Looking ahead to Q3, given the industry volatility, we are currently expecting sales of $180 million to $190 million. At these revenue levels, our target model calls for operating margins of 16.5% to 19% and non-GAAP EPS of $0.18 to $0.21 per share.

In summary, in Q2, we continued to execute very well, both on the top and bottom line. We also continue to add to our pipeline of products for advanced semiconductor processes and for applications in adjacent markets. Although the industry outlook near-term is somewhat unclear, we remain committed to delivering financial results consistent with our target model. We feel very good about our prospects for long-term growth and about our ability to deliver strong cash flow and create shareholder value throughout the cycle.

With that we will now take your questions. Operator?

Thank you so much. (Operator Instructions). Our first question comes from Wenge Yang with Citi.

Hi, thank you for taking my questions. A couple things. First of all, yesterday, one of your competitor guided wafer starting second half look more flattish and want to hear your view on the wafer starts in the second half.

So good morning, Wenge. As you know, we are a turns business, we don't tend to forecast wafer starts and we don't pretend to know what they will be. Obviously, if you look at a long-term trend over 15 years, wafer starts have grown at something like a 7.5% rate. Certainly over the intermediate to longer term, that will be the case. It is very possible that you would have a flat quarter next quarter. We can't forecast that, but those things do happen despite a long-term trend that we think is very positive.

Okay, so if I look at your guidance, the revenue is down a little more than 10 percentage points. Can you give a little more color on the unit-driven business versus CapEx-driven business? Which is seeing more revenue decline and at what magnitude at the mid-point?

Sure, Wenge. So our business in Q2 was 68% unit-driven -- excuse me, 62% unit-driven, 38% capital. And so with those kind of ratios, if you were to think that the capital side of the business could be down in the 25% range in a flattish unit side, you come to about that down 10%-type number. We think -- I mean, the weakness on the capital side will be largely in what we sell into the OEM world, so that's going to be largely within our components and subsystems business. And the unit side I think, as Gideon pointed out, it's a turns business so we're not going to forecast that specifically other than to say the environment is a little bit unclear on the unit side.

That's very helpful. One last question. Can you comment on your non-semi business trend in Q3?

In Q3, the non-semi business should be flattish I would expect.

Okay, thank you.

Our next question is going to come from Krish Sankar with Bank of America Merrill Lynch.

Thanks, Gideon. A couple of questions. In Q3, if I look into your specialty materials business, how does that trend in Q3 given that industrials is looking pretty strong, but the implant business might be weak?

In Q3, we would expect our specialty materials business to be stronger than it was in Q2. Krish, that's a relatively lumpy business. It is not usual to have orders in that business that are a million dollars, and so when one of those shifts from one quarter to the other, it can have an impact on a quarter. So what I would say is what we saw in that business in Q2, while it was down 6%, that doesn't relate to any fundamental weakness in the business, it really relates to the fact that we had a big order ship at the very end of Q1. We do have good momentum in that business going into Q3 and we have some good opportunities there in some of our newer markets.

Got it. That's helpful. And then can you give us an update on the wafer shipper business and where your share is now versus three or six months ago?

Hello, Krish, this is Bertrand. Wafer shipper business has performed really well in Q2. The trend actually extended beyond our performance in 300 millimeter FOSB. 300 millimeter FOSB set a record quarter in Q2, and right now we are probably, in terms of growth margins, we are probably at about in the low teens and tracking toward the mid-teens. So we are tracking favorably against our overall target to be in the 20%, 25% market share in a couple years. But as I said, overall this business needs to perform well, and that strength is reflected across all diameters.

And, Krish, just to clarify, when Bertrand talked about the low teens, he was referring to market share, not gross margin. We don't break the margin by product line out individually.

And final question, in terms of the R&D spend for 450 millimeter, especially I guess you guys have been doing some 450 millimeter wafer handlers, how much have you enlisted so far and what do we think about investment going forward just on 450 specifically?

So on 450, we are very, very committed to being a market leader at that particular diameter and substrate size. We have been a very active player with ISMI and Sematech. And today we want to be a facilitator, if you want, in the ecosystem as more OEM companies start embarking into their own development programs to support 450.

So as you know, the overall timing of the adoption of 450 is still a little unclear, but given where we are in the ecosystem and the minute you start having a number of companies working on 450 programs, you need to have wafers being transported from one side to another and, therefore, again, we need to be one of the first companies to make those investments. Today, our investment has been prudent.

Again, we are cautious. We want to be the leader, but we are investing prudently. We have made a commitment to a new building in Colorado to home these development efforts, and we are currently looking at when to make the next investment in terms of building the tool set for those products.

And then a final question for Greg. Any update on the share buy-back or use of cash, and can you tell us what is the right level of cash you need to run the business? Thank you.

Okay, yeah, Krish, to actually run the business day-to-day, I think we'd be comfortable with cash, something probably less than we have today, $150 million or so. We look every quarter at the options for our cash, and so we aren't going to comment specifically on a buy-back or anything like that. What I would say is we also believe that we'll start to see opportunities for smaller tuck-in acquisitions as we move forward, and we want to make sure we have the liquidity to be able to participate in good opportunities without using leverage. So today, I think you will see us accumulate cash for a period of time as we begin to spend a little more time on the M&A front.

Krish, was there anything else?

No, thank you. I am done.

And with that, we'll move to our next caller, Dick Ryan with Dougherty.

Good morning. So, Greg, you mentioned being careful to add fixed costs. What has your employee count done in Q2 versus Q1?

It is a little over 2,800. Actually, our permanent headcount over the last 12 months has been relatively stable right around 2,800. As we've ramped over the last six months, we have made heavy use of temporaries.

With your guidance and commentary on the outlook, it doesn't look like you are doing any any major shifts to shutdown or close down any facilities at all?

No, and I'll let Bertrand comment on this as well. But, I mean, we don't necessarily look at what we're seeing this quarter as a long-term trend, and we're not going to rebuild the Company around the third quarter of 2011 revenue outlook. What I will tell you is within the organization, we've made it very clear that we want people to be especially cautious around discretionary spending in Q3, things like T&E. We are also focused -- we're not in a hurry to fill open headcounts, but we are not at this point making fundamental changes.

Right, I totally echo your comment, Greg. The internal view is really that this is really a mid-cycle correction. This is really (inaudible) in the cycle, so we want to find the right balance between being prudent and ready in the event the industry contracts more than we expect it to be the case. As Greg said, we remain very, very committed to hitting our target models at different revenue levels, and I think the organization is well-tuned to react favorably against that objective.

Greg, on the non-semi business, I don't think you break out the revenue from the various other markets, but is there any major shift within those segments?

No, I would say today, we've been talking about the new frontiers or the new markets being about 5% of revenue, and that would be consistent in Q2, as well.

Great, thanks.

We will move next to Patrick Ho with Stifel Nicolaus.

I know the current environment is pretty fluid right now and there is a lot of moving parts, but from your perspective, where do you see fab utilization across the industry in 3Q, and do you believe that this could be potentially the bottom, at least on the utilization rates level?

So we don't know specifically utilization rates by fab, and actually I can report that direct sales to fabs actually grew faster than our overall sales in the last quarter. There are some indications that some fabs are lowering wafer production and utilization. We have seen, historically, that sometimes when that occurs, they can over-correct on the downside, and so you may see production rates pick up late in the second half of the year. It is unclear; there is some -- I'd reference the first answer we gave today, which is to the extent we have any visibility at all, we would see a flattening of wafer production in the second half, which is below the long-term trend. The long-term trend has been 7%, 8% growth, and that would not be surprising if we saw that in the second half of the year.

Great. And you guys have a good exposure to the lithography market and with the changing dynamics there, especially as we go to EUV, can you just describe your progress and your work on that front with customers for these next generation tools?

So we have a lot of very exciting and active partnerships going on across the industry from OEM to leading edge fabs and industry consortium, and that cuts across a very broad technology platform from UV reticle parts to the most advanced filtration requirements at the point of dispense, around the tool, but also around the ambient environment in the cleanroom. As you know contamination control would be a very critical problem to solve at those advance nods and contamination control is what we do, so we are actually welcoming all of the challenges that EUV is providing the industry. We feel pretty good about the opportunities ahead of us.

Yes, maybe as a follow-up to that, and I know you probably can't get too specific, but do you see your investments in R&D efforts and EUV increasing at least over the next six to 12 months?

Well, it has already been increasing over the last several quarters. I don't necessarily expect to see an additional incremental spend for those projects, but I would expect those investments to continue for the next several quarters.

Right, thank you.

And we will take our next question from Avinash Kant with DA Davidson & Company.

Good morning, Gideon, Greg, Bertrand, and Steve.

Good morning, Avinash.

A few questions. First, of the near-term weakness that you have kind of guided to, could you give us some color in terms of, first when did you start seeing it, and the second one, any particular customer base like memory, foundry, logic, where is that weakness more pronounced at?

Well, as it relates to when did we start to see the weakness, our revenue through the second quarter was relatively linear. In fact, June was better than March. And so we have just now in the last few weeks started to see some of the weakness around the edges. With regard to customer specifics, I will turn that over to Bertrand.

Yeah, and I don't think I necessarily want to go into customer specifics, but you are right I think the slow down has been relatively recent, and we are in the process of, again, trying to decipher what it all means, and, therefore, the guidance we provided.

Okay, to ask it another way then, typically, what has been the mix -- within your semiconductor, what has been the mix of logic, foundry, and memory compared to what you have kind of guided to in your third quarter? Has there been a meaningful change?

We don't provide -- we don't provide a guidance on that mix. We don't talk about that mix. We are, in general, Avinash, memory is a smaller -- quite a small percentage relative to both logic and foundry. That's as much as I will say. And I would also remind you that we're somewhat agnostic between the percentages of those different categories because of the nature of the products and the mission of our Company in the industry. So it really is not going to impact us that dramatically in terms of the mix between the different technologies.

Okay. And a little of an update. Earlier during the year you talked about some of the initiatives you were taking in terms of share wins and also trying to grow some of the segments, specific segments of the market that you had talked about, could you give us some update? Does that number also change, or it's still kind of intact when you talk about incremental opportunity?

I just want to say that we have a goal in 2013, as you well know, of running at a billion dollar level. We don't see any reason that we can't get to that goal regardless of whether Q3 is flat or down in the capital side or not. The reason for that is we have a continuing series of initiatives that are really aimed at the advanced nodes. If you listen to the calls of the large device manufacturers, what you hear repeatedly is that they are moving rapidly through 32, 28 and in some cases you hear that they are preparing the groundwork for even much, much more stringent and advanced nodes.

Even today, they are preparing the groundwork. And we are aiming to be there with them every step of the way. Those kind of products, those technology nodes are tailwinds for our business, our products are super important at those nodes, and that's the fundamental reason that we think we will be at those kind of levels by 2013, regardless of a short-term variability this year, for example, in Q3. That's a longer term answer to your question.

Right. And on the same way, Gideon, the one thing I was trying to focus on a little bit, lithography and CMP seems to be the two areas you are trying to grow, especially through new product offerings and additional growth could come from there. How do you see your growth in those markets over the next two years because of the new product that you may be introducing?

Well, as Gideon mentioned, we are really looking at partnering better than ever before with the leading edge fabs, and they are most critical and most complex challenges are in the area of lithography, so we are indeed spending a lot of time and efforts and resources to come up with very relevant and indispensable solutions for this particular process. So we feel really good about where we are. We feel really good about the development pipeline and opportunity pipelines around litho.

In the case of CMP, that's relatively new area for us, and, as you know, we have been expanding our product offering for that particular process step. And we have a number of very exciting qualifications going on right now for CMP products from filters to brushes used in the post-clean process. But also most recently, we have been introducing a new product line of pad conditioners.

So, again, very exciting times for us and CMP. But I will also flag to you a third very critical process step -- wet etch and clean, which is for us a fast-growing opportunity, not only for our filtration product, but also for our sensing and control products. So we have -- there, again, a number of very exciting opportunities in the fabs, but also directly working with the OEMs and getting designing to their newest platforms.

Perfect. And the final question, any color in terms of how this feels more of a shorter term, or when would you know when things are starting to come back? Typically what is the timeline? How quickly do you find out from your customers?

We don't have a hotline that rings. There is no red phone on our desk that rings. So we have to, obviously, be very, very close to our customers. Our sense is that this is more of a pause than a prolonged downturn. Our sense is that there is a tremendous amount of innovation going on in the industry that the end markets continue to be robust in many parts of the world, and that the requirements -- and most importantly for us, the requirements for contamination control at 32 and below are basically in order of magnitude and more challenging than they have been previously, and that is the most important thing that helps us to feel very good. You know, we don't know today whether the third quarter will be flat in wafer starts. We don't pretend to know, but it doesn't feel at this point like a prolonged kind of downturn.

Perfect. Thanks so much, Gideon.

And with that, we will move to our next question from Steve Schwartz with First Analysis.

Good morning, guys.

Good morning, Steve.

Greg, incremental margin first quarter to second quarter was quite nice. You picked up $7 million in gross profit on $6 million in additional revenue. Is that just because the mix of product and unit driven held up versus CapEx?

It really has more to do, Steve, with what we commented on when we reported Q1, and that is Q1 was really hampered by some accounting-related things in terms of how our inventory produced in December flowed through the Q1 P&L. I would say from an operating perspective, we clearly operated better in Q2 than we did in Q1, but a lot of it, like I said, the improvement had to do with that Q1 anomaly.

Okay. And then just talking a little about your CapEx, is it the former credit agreement where you had a limit on capital spending? Is that limit now abolished with the new agreement?

Yes, it is.

And can you give us an update on what's going on with those various facilities? I know you've got some activities for 450 in Colorado, and there are one or two other facilities where you are spending this money, isn't that right?

Right now we are spending capital primarily on two facilities, and that is we are establishing a manufacturing, a small manufacturing presence in Taiwan. We have been investing in that through the year, and you will continue to see investment in that through the third and fourth quarter. And we are investing in a facility in Colorado Springs to do primarily our 450 applications and our EUV-related applications. And we continue to invest in Malaysia as we transition some additional products there.

How does Taiwan work in with Malaysia? Is it complimentary? Is it a completely separate group of products?

It's largely a different group of products. I would view Taiwan as kind of more of a niche manufacturing facility. It is not a high volume facility like Malaysia. We are going to start out with two or three product lines there, and those are primarily CCS products, as well as some specialty materials applications.

And then my last question just relates to PV. There is a correction in photovoltaics that is pretty well known. Is that part -- is that end market big enough for you yet that that has factored into your third quarter guidance?

The end market, and this is Bertrand, Steve, the end market that -- I mean, we don't really split revenues per all of those new market opportunities, but solar has been increasing very nicely for us, and it is starting to present a fairly meaningful portion of our total revenues. Yes, we have factored into our guidance what is currently expected for solar-related CapEx.

The other component, obviously, is that overall production of sales in panels is not expected to slow down, and that obviously should, for us, offset some of the weakness that we expect under capital side. Just order of magnitude, our solar sales would break down probably two-third unit-driven and about one-third CapEx driven, so that could probably explain a little more why we are not overly concerned about the expected contraction on the solar CapEx front.

You know, there is some talk, and I have heard a number as many as 500 panel manufacturers that industry appears to be over-supplied at this point. How does that play into your strategy if there is consolidation in the manufacturing base and so forth? Does that at all affect you guys?

No, we don't think it would impact us meaningfully.

Okay, great, thanks for taking the questions.

Thanks, Steve.

Before I move to the next caller, I would like to give everyone a final queue for questions. (Operator Instructions). Our next question comes from Christian Schwab with Craig-Hallum Capital Group.

Good morning, guys. Just a few other quick questions. Talking about the capital equipment side mix to wafer starts at the beginning of the call, kind of going from 38% to potentially 25% in Q3 and Greg your comments regarding --

No. I don't think I said anything --

Did I not -- did I write that down wrong?

I said that if the industry is down 25% and we're roughly 40% capital-related, you would expect us to be down about 10%.

Perfect. All right, that helps. I couldn't make that math work. So then given the weakness that you saw in the last couple weeks that you commented on, is that -- when you talk to the capital equipment side of the scenario regarding this pause, have they given you any indication about how long they expect it to last?

No, we don't know more than what you have been hearing. We all were at semiconductor -- SEMICON West last week, there was a lot of chatter, and I think that, again, everybody is really trying to sort out what we have been hearing and what everybody has been commenting on over the last couple of weeks and what we see in our most recent business trends. But we don't have any specific knowledge.

That's fair. On the Contamination Control Systems portion of your business, is there any profitability difference between your CapEx products and your consumable products?

What I would say is we have high margin consumable products and we have high margin CapEx products. I would also say it depends where you are in the cycle at this point in the cycle. I mean, our CapEx-related products are operating at relatively high volume, so the margins on those products are pretty strong right now.

That makes sense. And then do you have a new -- can you remind us what your long-term objective in the Contamination Control System is for an operating margin target besides improvement?

We don't have a target division. We have a corporate -- what we have, which we are very transparent about, obviously, is we have a target model for the corporation. Obviously, that is anchored by specific target models for the division, which we do not publicize. We are delighted with the performance of the CCS business; 33% operating margin is an all-time record for that business. And it has a very attractive combination of being a growth business, as well as a high profit and high cash flow business. And we think that is a pretty good combination.

Yeah, we would agree. And then lastly, my last question, is your sales per wafer start that you guys talked about at your Analyst Day, is that continuing to move up and to the right?

The data hasn't been published yet for Q2, the industry SICAS data, but in Q1 that data -- the Q1 data was just recently published, and that showed that in Q1 we continued to increase our content per wafer start.

Perfect. And then given the 300 millimeter share gains we talked about, you would expect that to modestly improve going forward? Is that fair?

We have no reason to believe that the trend would be any different in Q2.

Perfect. Thanks, guys.

And with no further questions, I would now like to turn the call back over to Mr. Gideon Argov for any final and closing remarks.

Just to remind folks that we believe that the combination of products and the technologies that we have is well-suited to the needs of the industry at advanced nodes. We believe we have executed for a number of quarters at a very, very excellent rate in terms of our profitability and on a comparative basis, as well, comparable basis, and we are very optimistic and excited about our business longer term, as well as our performance during the second quarter which was excellent. Thank you for joining us on the call. We look forward to speaking with you again.

And with that, once again, ladies and gentlemen, that does conclude today's call. Thank you for your participation and have a great day.