Entegris Inc (ENTG) 2013 Q2 法說會逐字稿

Good day, everyone, and welcome to the Entegris second-quarter 2013 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 Mr. Steve Cantor, Vice President of Corporate Relations. Please go ahead, sir.

Thank you, Kyle. Good morning, and thank you all for joining our call today. Earlier we announced the financial results for our second quarter ended June 29, 2013. 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 Bertrand Loy, President and CEO, and Greg Graves, Chief Financial Officer. Bertrand?

Thank you, Steve. I will make some comments on the quarter's achievements, and then Greg will provide detail on the second-quarter financials and on our guidance for the third quarter.

I am very pleased with the second-quarter performance. We grew our sales 8% sequentially, and exceeded our forecast. We executed well, achieving an adjusted operating margin of 16%, and cash earnings per share of $0.15, both ahead of our target model. We generated strong cash flow, $35 million in cash from operations, and achieved some key milestones on our product and technology roadmaps.

In terms of our sales mix for the quarter, our revenue shifted slightly towards the semiconductor market. Semi-related sales represented 75% of total revenue, and grew 10% sequentially, driven by a record quarter for liquid filtration products, and solid growth of fluid-handling components and legacy wafer-handling products. Overall, the demand in our overall industrial markets picked up, but the level and extent of the strength was not uniform. There was strong demand from leading-edge fabs, although in aggregate, fab utilization rates, one of the key drivers for our business, remained well below peak levels for the industry.

Sales in our non-semiconductor markets were 24% of total revenue, and declined 1% from Q1. While there was strength in some of our mature electronics markets such as display, our data storage business was down modestly. Our PV, LED, and energy storage-related revenue grew modestly.

We had another quarter of strong cash flow from operations. Consistent with the clearly defined capital allocation strategy, we are deploying our cash to achieve our goal of both driving above-market growth through the cycles, and creating long-term shareholder value. There are four components to our capital allocation strategy -- invest in new products and technologies for the advanced nodes; invest in our R&D and manufacturing infrastructure and capabilities; make focused acquisitions; and return excess cash to shareholders. I will provide an update on each of these.

First, we are sustaining and selectively expanding our investment in R&D, consistent with our target model in order to accelerate new product development and collaboration with key industry leaders and consortium. We are pleased with the results so far. As an example, our 450 millimeter wafer-handling solutions were recently selected by New York-based G450C, the industry consortium leading the development in this area. While the precise timing of the adoption of 450 process technology has yet to be finalized, the decision by this leading consortium is an important endorsement of our technology and capability.

Second, we will continue to make progress with our investment in key technology and infrastructure capital projects, the i2M center in Massachusetts and the ATC center in Colorado. The i2M facility will be one of the most advanced centers of its kind in the world for membrane and coatings manufacturing and R&D. The ATC is focused on technology development and volume manufacturing for 450 and EUV-handling products. As we have discussed with you before, magnitude and scope of these projects are unusual for us. Typically, our business does not require this level of capital investment. But we are confident that when these facilities are fully up and running in 2014, they will provide us with a compelling competitive advantage, and extend our leadership in our served markets. As of today, almost two-thirds of the capital outlays for both of these projects are already behind us, and we expect that the vast majority of the spending will be completed by year end.

The third element of our cash deployment strategy is to acquire businesses or technologies that complement our existing capabilities, or that bolster our presence in adjacent markets. The acquisition of Jetalon, which was completed in April, is a good example. While Jetalon is small, and will not have a meaningful impact on our results in 2013, its unique fluid concentration measurement technology is generating considerable interest from both OEM and device makers in the semiconductor industry, as well as in life sciences. Since becoming part of Entegris, Jetalon is already leveraging our technical capabilities and has launched four new products. We are continuing to seek out businesses that can augment our technology portfolio.

The fourth priority of our capital allocation strategy is to return excess cash to shareholders. In Q2, we repurchased nearly 600,000 shares, and have purchased about 1 million shares since the program began in February. Our intent is to return excess cash to shareholders through a sustained and opportunistic share repurchase program.

Looking out to the second half of the year, we continue to see a mixed picture, as there are signs of potential slowing in chip demand and shifts in timing of capital spending. Having said that, our long-term goal remains to grow 300 basis points faster than our markets' through the cycles. We have proven our ability to do this over the past four years, and we believe that our market and technology position, combined with our critical investments, put us in a good position to continue to achieve this. And as we do that, we will be able to provide very attractive returns for shareholders.

As I discussed in our last earnings call in April, and more recently at our Analyst day in June, the semiconductor industry is in the midst of an unprecedented period of R&D intensity, driven by the introduction of a number of new process technologies -- FinFET, 3D, EUV and 450-millimeter wafers. We believe that our expertise in contamination control and the breadth of our solutions position us to play an increasingly important role to help the industry develop and ramp up this critical technology.

Greg will now provide more details on the financials for the quarter.

Thank you, Bertrand. Good morning, and thank you all for joining the call. It was an all-around excellent quarter. We executed well, and achieved results which exceeded our target model. Sales of $178 million were above our guidance, and up 8% from Q1. Our non-GAAP EPS was $0.15.

Geographically, Asia sales were $76 million, and grew 8% sequentially, primarily due to strength at the major foundries. Sales to Japan were $25 million, up 1%, even in light of the weaker yen. Sales to North America were $52 million, up 8%. Sales to Europe were $24 million, up 14%. Foreign currency exchange rates had a negative impact of approximately $3 million on our revenues compared to Q1.

In terms of quarterly performance by division, sales for the contamination control solutions division, or CCS, grew 10% sequentially to $114 million. Record quarterly sales of liquid filters, and higher sales of fluid-handling components, contributed to CCS's strong financial sales performance. The operating margin for the CCS division improved to 25% versus 21% in Q1. Sales for the microenvironments division, or ME, were up 4% sequentially to $46 million, driven largely by higher sales of legacy products. ME's operating margin was 20%, down from 21% in Q1. Sales for the specialty materials division, or SMD, were $17 million, or even with Q1. As planned, SMD's operating margin of 11% declined from 13% in the first quarter, reflecting higher investments in new products for the LED and semiconductor markets.

Overall gross margin of 43.7% improved approximately 3 points from Q1, reflecting improved mix, better absorption, and solid execution at our manufacturing plants. In Q3, we expect gross margin to be approximately 43%, which reflects slightly less favorable mix and lower absorption.

Operating expenses for Q1 were $49 million, or 27.5% of sales, and were in line with our expectations for the quarter. This was up modestly from Q1, reflecting sustained investments in R&D and other customer-facing initiatives. In Q3, we expect operating expenses to be approximately $48 million to $50 million.

Our GAAP tax rate was 28% in Q2. For the balance of the year, we would expect the tax rate to be 27% to 29%, which is slightly better than our expectations coming into the year. Our working capital management for the quarter was solid. DSOs were 56 days, down from 57 in Q1. Inventory turns were 4.0, unchanged from Q1.

We generated $34.8 million in cash from operations in Q2, up from $7.4 million from Q1. Consistent with our stated cash allocation strategy, there were three significant uses of cash in the quarter. First, CapEx for the i2M Center; second, payment of the purchase price for the Jetalon acquisition; and third, share repurchases.

In terms of CapEx, we spent $18 million on capital investments in Q2, the majority of which related to the i2M facility. To date, we have spent approximately two-thirds of the capital required for this project, and expect to have these capital outlays largely behind us as we go into 2014. Depreciation expense was $7.3 million in Q2.

We used $13 million of cash to purchase Jetalon, and we spent $5.6 million to repurchase approximately 600,000 shares as part of our ongoing share repurchase plan. Since the plan was initiated in February, we have purchased about 1 million shares. Given these cash outlays, we ended the quarter with $343 million in cash on the balance sheet, an increase of $5 million from the end of Q1.

In terms of our outlook for the third quarter, demand trends and industry trends remain somewhat mixed. We expect Q3 sales to be in the range of $165 million to $180 million. Given these levels, our target model calls for adjusted operating margins, 13% to 15%, and we would expect non-GAAP EPS to be $0.11 to $0.14.

Before taking your questions, I want to highlight two key points. We achieved good growth and executed well in Q2, delivering results ahead of our target model. We have a clear capital allocation strategy that is enabling us to invest to extend our technology and market leadership over the next several years, and to build long-term shareholder value.

With that, we will open it up for Q&A. Operator?

(Operator Instructions)

We will take our first question from Krish Sankar from Bank of America Merrill Lynch.

Thanks for taking my question. A few of them. Bertrand, what was the percentage mixture of consumables versus CapEx in June quarter? And, how do you expect that to trend in September?

Right. Krish, the split was 66% unit-driven, 34% CapEx-driven, which was actually a slight shift towards unit-driven from Q1 of this year. We expect actually the shift to continue to evolve more towards unit-driven as we get into the second half of this year.

If I look at the midpoint of the guidance, it's roughly down 3 percentage points. Should we assume both units and CapEx will be down in Q3? Or, is one better than the other?

We certainly -- this guidance actually is a reflection of the fact that we expect CapEx to be softer into second half of the year and certainly that to be the case in Q3. In terms of MSI, the reason why guidance is actually so broad is we are actually reflecting on a potential scenario on the high end of the guidance which suggests some -- the continuation of strong wafer start trends through the end of Q3. But, there is another scenario that could play out which would be a deceleration of wafer starts some time in September, and that actually is the assumption behind the lower end of the guidance.

Got it. That's very helpful. I don't know if you have a view of this, but it seems like most industry forecasts for wafer starts is somewhere in like the low- to mid-single digits for this year. Even if you get into the upper end for Q3, it seems like Q4 has to be strong to get to those levels which is against normal seasonality. So, I'm just kind of curious if low- to mid-single digits wafer starts for the year is actually a little too optimistic for the industry?

Yes, I think, Krish -- that's really what we all are trying to make sense of, right. The trends are really very mixed right now. We have spent a lot of time with our customers trying to understand what the near-term trends are for their business. And again, I think the general consensus is that signals, again, are very mixed. I think that the reality is that logic and memory maker output will be influenced by the near-term trends in PC and mobile devices which are both signs of weakness. I guess that's why we are fairly cautious in our outlook in terms of MSI for Q3, and it's too early to comment, obviously, on what to expect in Q4.

Got it. And, a final question for Greg. How much -- is it $37 million you have left on the buyback? Is that the approximate number?

We had a $50 million authorization, Krish. Year to date, we've spent right around $10 million. So, we've got about $40 million left.

Got it. Thank you.

We will take our next question from Patrick Ho from Stifel Nicolaus.

Thank you very much. Can you just give a little more color in terms of the CapEx outlook? You did mention that 3Q sounds a little bit softer. At this point in time, do you see that coming back in Q4? Or, is there something that pushes out into 2014?

Hi Patrick, this is Bertrand. Again, it's hard for us to comment on Q4 at this point again. I would limit my comment to Q3, and we are seeing some softening in our CapEx business as we enter the quarter. We are hearing from a lot of our customers that they are working really hard at optimizing their capital spending allocation decisions and trying to push out some of their spending into 2014. I don't know exactly what the impact of all of that would be on to Q4.

I think that generally speaking, we agree with the view that the industry will need to continue to invest aggressively over the next two years to add capacity and to continue to aggressively march on the industry technological roadmap. Having said that, I think that the timing of these investments are really difficult to predict. While we remain very optimistic around the prospects for 2014, I would say that, again, there is a fair amount of uncertainty and likely soft environment ahead of us in the next couple of quarters.

Okay. Fair enough. Just going to the unit side of the business, typically as we enter both June and September, that is traditionally the seasonally stronger period time of the year. Did you experience any pull-ins to the June quarter that may be taking some away from the September quarter in terms of seasonality aspects? Because I would have assumed that that would have been up a little bit as well going into the September quarter. Can you give a little bit of color in terms of the outlook there?

That's a good question. I don't think we've seen much of that, frankly speaking. I think that the current velocity of our unit-driven business going into Q3 is about the same as exiting Q2. Which is again a reflection on a lot of the fabs operating at roughly similar levels of production right now.

Again, I think our guidance is just a reflection of the fact that if indeed their Q3 -- their Q4, I'm sorry -- proves to be soft. And again, a lot of the device makers would suggest that Q4 -- their Q4 revenues will be weaker than their Q3 revenues. The likely impact on us is that factory loading would start slowing down some time before the end of Q3. We are really not sure about when that will happen. That's really what we're trying to reflect into our guidance.

Okay, fair enough. Final question. Maybe for Greg in terms of the operating model. You did really well this quarter, and it looks like those positive trends are continuing into the September quarter in terms of the margin profile. I guess, what's the biggest maybe shift and what's the biggest occurrence that has led to what I would consider pretty sharp improvements, particularly on the gross margin profile, given where you were a quarter ago and even a few quarters ago?

Yes. I mean really when we talked about our results, Patrick, for Q4 and Q1, we suggested that we had adverse mix and we had relatively low manufacturing volumes. We really just had a much better mix in Q2. We would expect the mix to stay good as we move into Q3. But, if you think about the Q2 mix, it was heavy on legacy ME products. It was heavy on liquid filtration products. All of which are good products for us as it relates to margin.

On the operating line, we just continue to -- I mean, we're focused on investing in the R&D, but we continue to keep a sharp eye on SG&A side. And so, our spending continues to be in a reasonable range. Like I said, at the revenue levels, you get to revenue levels at $170 million and above, it's much more comfortable for us to make the model.

Great. Thank you very much.

We will take our next question from Jason Ursaner from CJS Securities.

Good morning. I had a question on liquid filtration. Greg, you just mentioned margin on those products is favorable. I know in the past you have talked about how the true Leading Edge filtration products, there is higher costs when you haven't fully set your manufacturing scale. And, that it is important to set the standard, but that it may not show up in margin immediately. So, just wondering if you can maybe give an update on that trend? And, if the margin is now beginning to more show up on some of those products?

I don't think we really have seen any specific change in terms of the margin on some of those leading-edge products as much as the fact that we've just seen much higher volumes of those products in Q2 than we saw in Q1.

So, in terms of absorption, are those products --?

Our absorption was much better. We still work -- on a number of those products, we're still working on getting them to what I call full RTM, or ready to manufacture, which is where we'll begin -- we should begin to see better margins on those products.

Okay. And then, for Bertrand, excluding the timing -- Q3 versus Q4 versus next year, can you just go over broadly what's driving the expectations for this aggressive growth in capacity that you're going to need over the next couple of years? Particularly, if there is capacity in the legacy nodes and if PC sales and smartphone demand may be softening relative to some expectations, why you would still need the capacity growth and investment?

Right. So, Jason I would try to characterize that in simple terms, but if you look at the various segments of the industry in terms of semiconductor makers and start with memory, I think there is a clear case there for capacity to be constrained. I think that we've all been looking at all of those players, and we are at one level pleased with the fact that we've been a lot more disciplined in the way they've been timing their new capacity additions. But, we all know that they will have at some point in time to act, and that we will have to add to spend additional CapEx to add capacity.

You should look on the logic side of the equation. I think that the CapEx decisions will be driven by different considerations depending on the players. I think some device makers will need to add capacity because they are currently running actually at near full capacity on their Leading Edge nodes and fabs. And, for some other players, I think their CapEx will be driven by the desire to remain in a leadership position in terms of process technology. They may not need the additional capacity, but the decision to invest will be driven by more strategic considerations.

So again, different reasons. I think depending on the industry participants. But again, having spent a lot of time with all of those companies, I'm comfortable with the statement that CapEx should be up or could be up most likely in 2014. And again, we are still left with the timing of that recovery, and when actually we would start to see some precursory signs.

Okay. Appreciate those details. Thanks.

We will take our next question from Avinash Kant from D.A. Davidson & Company.

Good morning, Bertrand and Greg. A few questions. You talked about the weakness in the bookings near term. Now, could you give us some idea about where have you seen some weakness coming from? Is it from the memory side or logic side or foundries side? Or, is it all over it?

Actually, we didn't say that. I think what we said is the opposite. We said that the bookings right now are at about the same level as what we've been experiencing in Q2. What we are saying is that we are concerned that there may be a softening in our bookings and in our shipments as we get closer to the end of the quarter.

Okay. So, is it just some indication? You have not seen it in your bookings yet?

No.

Okay. In the guidance, did you talk about going forward in the guidance -- Q3, what do you see from the non-semiconductor businesses? And, what do you see from the semiconductor side?

Can you repeat the question, Avinash?

If I were to look at the semi and the non-semi businesses separately, Q2 to Q3, what is the expectation?

I think we kind of covered that question on that semi side of things. On the non-semi side of things, I would say that we expect the environment to be relatively flat. Remember that our non-semi business is really made of a number of markets that are all subject to their own microtrends -- be it display, data storage, LED, PV, et cetera. And, we do not expect any of those markets to meaningfully depart from what we saw in Q2.

Right. And, at one point did I hear you right, that you said capital spending for the second half could be weaker than the first half?

Yes. We said that we expect actually a slowing down -- a pause in CapEx for the second half of the year.

So, slowing down at current levels? Or, the second half you think will end up being weaker than the first half?

What we've said is that we expect Q3 to be weaker than Q2. And, we said that we will not quantify -- or qualify Q4. It's too early. But, all in all, we expect again the second half CapEx to be soft.

Okay, and this is the revenues you are talking about not the bookings?

We were talking about our revenues.

Right. Thank you very much.

Just to be clear, our revenue and bookings are not that much different. Remember, we're a turns business so we typically book and ship within 30 days.

Yes. Thanks.

We will take our next question from Dick Ryan from Dougherty & Company.

Thank you. Say Greg, on your capital spending plans, you said $18 million in Q2, and if I recall, there was $16 million Q1. I thought you were looking at around $70 million for the year, but then you mentioned something about two-thirds of the way through the spending for maybe the two new facilities. Can you just kind of clarify that for me?

Yes. For those two big projects, we've essentially got about $30 million -- on a combined basis, we've got about $30 million in additional spending to go on those two large projects. Actually, a little bit less than $30 million. And, that breaks down about one-third of that relates to the facility in New England, and about -- excuse me, two-thirds relates to the facility in New England and about one-third relates to the facility in Colorado Springs. So, I would expect that we'll spend -- of that remaining amount, we will probably spend 80% of it this year. And then, we'll have -- with regard to the facility in Colorado Springs, we know that were going to have some spillover into next year. But, sitting here today, I would still hold with our thesis that we will be in that $65 million to $70 million range in spending for this year.

Okay. Shifting over to the specialty division, you talked about higher investments kind of impacting the margin there, setting up for some new product introductions. Can you give us a flavor for what you're looking at? Anything there kind of move-the-needle potential?

There are two areas that we're investing in there. One is really in our silicon carbide technology which is where the next generation of applications in the Poco business are within the semiconductor market. So, we're spending money there. We're also spending money on some advanced applications in ion implant. Both of those are opportunities that we think over the next several years could have a meaningful impact on the top line of that business.

Okay. Thanks, Greg.

(Operator Instructions)

Our next question comes from Steve Schwartz from First Analysis.

Good morning.

Hi, Steve.

Greg, just to carry that question from Dick over on the specialty materials. Where do you expect the margin in this business could go? Because you at this point you're running $70 million in revenue, and obviously, you're down 300 or 400 basis points from where you were last year at the same revenue level.

I would expect the operating margin in that business -- we've consistently said at $20 million in revenue it's a 20% operating margin business. I wouldn't change our tenor there. But, what I would say is, we will be continuing to invest in that business over the next several quarters, so on like revenue levels, I wouldn't expect to see a meaningful improvement. Now, there are some things in mix that could change that could improve -- that could change that. But, I would say in general, if we continue to operate at the same mix that we're operating at now and the same revenue levels, we'd see similar margins. As I said in my prepared remarks, the margin decline there was actually planned for me. We're making conscientious investments in that business.

Yes. They are already at the leading edge in terms of the type of carbon they produce. Can you -- without bogging down our call here with the details. But, can you in one or two sentences talk about what else they doing here for the silicon carbide or ion implant?

So, just at high level, I would say that on the Chuck technology, we've been invited to participate in some development work to again upgrade and update our Chuck technology to meet some of the requirements of the next generation ion implanters. We will actually permit the resources required for us to successfully deliver the right solution and the right technology for this application. And, that's probably the primary investment that we're making into this division. We're doing that again in the context of a very soft business environment for ion implanters there. I think that's what puts a lot of drag on the overall margin level of this division.

In terms of the silicon carbide initiative, as the industry transitions to the next nodes, they require actually more dense, more solid, cleaner materials, and we are also in the process of developing that. So, those two investments are actually relatively significant especially given the small scale of the overall division. Having said that, as Greg mentioned, we are making a conscious choice. We are deciding to invest into those opportunities, and I will tell you that the results that this division has delivered over the last couple of quarters are exactly in line with our expectations. So, they are delivering, and they are executing actually very well. And, the lower margin levels should absolutely not be viewed as sloppy executions in any shape or form.

Okay. All right. Thank you, Bertrand. Just as a follow-up on the microenvironments business. Greg, you talked a little bit about the operating margin there sequentially. If you could step into the away-back machine and just talk a little bit on the year over year basis, I thought the second quarter of '12 was pretty strong for the legacy products, and yet you had a higher margin on a year over year basis. You noted that the legacy products were strong in the second quarter of '13. Can you just talk a little bit about how you got that 130-basis-point improvement year over year?

What I would say with regard to the microenvironment business is we've been on a pretty consistent trend of improving execution over the last six or eight quarters. And, it's really not any one thing. Particularly, on the manufacturing side though that business continues to do quite well.

Okay. So, it's manufacturing.

Well, yes. So, they are doing well on the manufacturing side improving their gross margins. Unlike the CCS business, we've made very significant investments in ER&D. The spending levels in that microenvironment business have been pretty consistent for the last two to three years.

Very good.

And, there are a lot of [ingredients] in terms of improving manufacturing technology at this division, and we have brought a lot more process stability -- the processes -- remember that the manufacturing processes into CSS and ME are very different. In ME, you're talking about a fairly capital-intensive automated type of process, and we are actually seeing some very nice improvements in terms of again, process stability, the adoption of statistical process control tools which makes the environment a lot more sustainable. We are enjoying nice -- greater yields than before.

Okay, very good. Thank you.

We will take our next question from Jairam Nathan with Sidoti & Company.

Most of my questions have been answered, but a couple of ones on, you indicated your F/X impact on revenue. Is there an earnings impact which again -- is it material?

The earnings impact from an operating margin percentage perspective would not be material.

Okay. And, just on your tax rate, it looks like you had close to -- over 30% in 2012. It seems to be coming down quite a bit. What is the reason behind that? Is that sustainable into 2014?

I'm really pleased with where we are on the tax rate relative to 2012. Really, it involves around two things. One is a number of planning strategies that we've implemented over the last year or so that I don't really want to go into the specific details on. The other thing would just be we've had very strong performance in two lower tax rate jurisdictions, and that's Malaysia where we've had very good manufacturing performance and Taiwan where we've had good sales performance. And, making higher profits in those lower rate jurisdictions has certainly been helpful.

Okay, thanks. And lastly, on Jetalon, can you give us some more details on is there an addressable market that that kind of opens up for Entegris? And, where would the revenue kind of be [blanketed] once [takeoffs] start flowing in?

So again, what this technology is all about is sensing and measuring critical fluids in the fabs real-time. So, just think about possibilities that this will open up. We will be selling to both fab operators as well as OEM -- or, the semiconductor applications -- and we have a lot of evaluations happening right now. But, this technology has likely a number of applications outside of semi, and one of the particularly appealing areas would be in life sciences. And, we're working across the life sciences ecosystem with manufacturers of bioreactors and with biotech companies directly to unlock that potential.

Okay. Thanks. That's all I had.

(Operator Instructions)

We will take our next question from Christian Schwab from Craig-Hallum Capital Group.

Great. Thanks. As we look at your semiconductor related sales, can you remind me what your mix is with the device makers between foundry, logic and memory?

Christian, we don't break that down. I think again, overall the semiconductor business grew 10% to 11% sequentially. Feel pretty good about that. We don't break that down across the various types of fabs operating.

Okay. I don't have any other questions. Thank you.

All right. Thank you.

I would now like to turn the conference back over to Mr. Bertrand Loy for any closing remarks.

Well, thank you again, everyone, for being on the call today. We look forward to updating you on our Q3 performance soon. Thank you.

This does conclude today's conference call. Thank you all for your participation.