Entegris Inc (ENTG) 2016 Q3 法說會逐字稿

Good day, everyone, and welcome to the Entegris third-quarter 2016 earnings 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.

Great. Thank you, and thank you all for joining our call this morning.

Earlier we announced the financial results for our third quarter ended October 1, 2016. You can access a copy of our press release on our website, entegris.com.

Before we begin, I would like to remind listeners that our comments today will include some forward-looking statements. These statements involve a number of risks and uncertainties which are outlined in detail in our reports and filings with the SEC.

On this call we will also refer to non-GAAP financial measures as defined by the SEC in Regulation G, and you can find a reconciliation table on our website.

On the call today are Bertrand Loy, President and CEO; and Greg Graves, CFO. Bertrand will now begin the call. Bertrand?

Thank you, Steve. I will make some general comments. Greg will then provide more details on our financial results and our Q4 guidance. We will then open the line for questions.

I am pleased with the third-quarter results, which put us squarely on track to achieve a record year for Entegris in both sales and profits. Year to date, we have grown 6% organically -- a performance that we believe exceeds our markets and the growth rates of most other electronic materials companies.

Our ability to outpace our markets provides evidence of the soundness of our strategies, the success of our customer engagement model, and the quality of our execution. For the third quarter, I want to specifically highlight a number of accomplishments: we delivered solid top- and bottom-line results. We generated record free cash flow. We continued to pay down our debt. And, finally, I want to recognize our global manufacturing teams for achieving best-in-class levels of quality.

Our third-quarter results benefited from relatively favorable trends in our markets. Wafer fab activity was better than expected relative to the seasonal softening we had anticipated. End market demand for smartphones and 3D NAND devices remained strong.

We also capitalized on the initial efforts by some of our customers to ramp their 10-nanometer nodes. Our liquid filtration business once again performed at record levels as we continue to capture new filtration opportunities and grow our share. The i2M facility is now fully commissioned, and we are ideally positioned to drive the increased cleanliness requirements for bulk photoresist manufacturing.

A number of our other product platforms reported strong performance in Q3. Continued high levels of new fab construction and retrofit activity as well as new investments in 10-nanometer technology helped drive continued strength in our fluid handling and microenvironment businesses.

Sales of our formulated cleans in Q3 reflected the high level of fab activity and were in line with our expectations, with good demand for our post-CMP cleaning chemistries. In addition, our advanced deposition business performed at near-record levels, driven by adoption of new materials used in advanced CVD processes.

Turning to our specialty gas product lines, strong sales of gas filters and diffusers were offset by weaker sales of some of our specialty gas solutions, which were impacted by the timing of fab customer demand.

One of the outcomes of our customer engagement model and our many customer collaborations is the clear indication of the criticality of our solutions in addressing the industry's emerging process challenges across the electronics ecosystem. Our ability to leverage materials knowledge, combined with our clean and safe materials handling solutions and our contamination control expertise, is resulting in unique yield-enabling solutions -- not only for logic, but for increasingly advanced memory devices.

During our analyst day in July, we spoke about five of our top growth initiatives that demonstrate the breadth of our capabilities across all major fab processes, including lithography, implant, etch, deposition, and CMP. These projects expand our SAM and address new applications that we have not previously served.

I mentioned the bulk photoresist filtration opportunity earlier, but all five of these initiatives are progressing well and are on track to generate in total $70 million of incremental revenue by 2018. I am also pleased with our operational execution, which is another very important component of our value proposition. Over the past several years, through continuous investment and relentless focus, we have improved our quality from about 3.5 Sigma to levels exceeding 5 Sigma. Given that we manufacture 15,000 SKUs across a number of manufacturing sites in the world, this is no small feat.

As pleased as I am about how far we have come, we are continuing to drive to even higher levers levels of excellence -- excellence in our quality systems, in our technology, and in everything we do. 2016 is the 50th anniversary of Entegris. We expect it to be a year of many records for us and to be the precursor of many more successful years.

That optimism is based on our unique position in what is a growing and dynamic market. It is also based on our demonstrated ability to be viewed by our customers as their partner of choice by virtue of the quality of our execution, our unique value proposition, and the role we play across the entire semiconductor and microelectronics ecosystem.

I will now turn the call to Greg for the financial detail.

Thank you, Bertrand. I am pleased with the results of the quarter. Our sales were at the high end of our guidance, and we delivered solid net income in EPS and record cash flow. On a year-to-date basis, sales were up 6% above last year.

Non-GAAP EPS was up $0.07 or 11% over last year, excluding the impact of a $0.03 unusual currency gain we highlighted in Q3 of last year. Third-quarter sales of $297 million declined modestly from Q2, reflecting normal seasonality, but were up 10% from a year ago.

Foreign exchange was a 1% sequential tailwind in the quarter and positively impacted revenues 2.5% on a year-over-year basis. The operating results included an impairment charge of $5.8 million related primarily to certain 450-millimeter production assets and severance charges of a $2.4 million related to a realignment of our organization to drive greater customer focus and internal functional alignment.

By segment, sales for Critical Materials Handling, or CMH, declined 1% to $193 million from Q2; and the non-GAAP operating margin for CMH of 27.4% in Q3 was essentially flat with 27% in Q2. Sales for Electronic Materials, or EM, of $104 million was 4% lower than $108 million in Q2, as EM's non-GAAP operating margin of 20.4% declined from 25.4% in Q2. For both CMH and EM, the non-GAAP results exclude the impairment and severance charges previously mentioned.

Third-quarter non-GAAP gross margin was 43.6%, which was below normalized levels. The lower margin was the result of lower factory utilization in one of our high-margin products, which coincided with a modestly unfavorable product mix, higher scrap rates, and greater than expected spending on a number of one-time procurement and quality initiatives. We expect gross margin to be flat to up modestly in Q4, in spite of expected seasonally lower revenue levels.

We controlled our expenses well in the quarter. Excluding amortization of $11 million and the previously mentioned severance charges, non-GAAP operating expenses in Q3 were $75.4 million. We expect non-GAAP operating expenses to be $74 million to $76 million in the fourth quarter.

Adjusted operating margin was 18.2%. Net interest expense was $9.3 million in Q3, consistent with the past several quarters. Our GAAP tax rate for the quarter was 15%, and our non-GAAP rate was 23%. The tax rate reflected a favorable geographic income mix. Our non-GAAP earnings per share was $0.24, in line with our expectations.

Adjusted EBITDA for the quarter was $67.7 million, giving us an EBITDA margin of almost 23%. Cash flow from operations for the quarter was $72 million, and free cash flow was a record-high $59 million. The excellent cash flow was driven by good working capital management and lower capital spending.

Accounts receivable declined by $13 million as DSOs improved to 52 days in Q3 compared to 54 days in Q2. Inventories increased by $5 million sequentially. Inventory turns of 3.6 were consistent with Q2.

Third-quarter CapEx was $13.1 million, and year-to-date CapEx was $45 million. We are now expecting full-year CapEx of approximately $60 million to $65 million.

We grew our cash balance to $412 million, of which $172 million was in the US. Total long-term debt, including current maturities, was $608 million, as we continued to de-lever the balance sheet.

We repaid $25 million in Q3 and expect to repay an additional $100 million over the next 12 months. Our net leverage ratio is less than 0.8 times, which is consistent with what we expected at the time of the ATMI acquisition. We are continuing to execute our capital allocation strategy, which balances debt repayment, building liquidity for potential M&A, and opportunistic share repurchases.

Turning to our outlook for Q4, we expect sales to range from $275 million to $290 million, reflecting current demand trends. The fourth quarter is typically seasonally down from the third quarter. At these revenue levels, we expect non-GAAP EPS to be $0.19 to $0.23 per share, consistent with our target model.

In summary, we performed well in the quarter and are on pace to achieve a record year and to outpace the industry. We generated record cash flow. And finally, we are excited about our new product pipeline and our strategic initiatives that position us to outperform our markets in 2017 and beyond.

Operator, we will now take questions.

(Operator Instructions) Weston Twigg, Pacific Crest Securities.

(technical difficulty) pretty substantial drop in Q3. You mentioned some wafer scrap -- or not wafer -- sorry, not wafer scrap. You mentioned some material scrap and mix. And I'm wondering, can you give us a little bit more color on what the scrap was related to? Is that part of the drive for quality, and should we expect more moving forward?

And with respect to the mix, just wondering if you have worked through the startup issues in the i2M facility, and if that had any relation to the lower GM?

Okay. So, really, two parts to your question, Wes. First of all, with regard to the gross margin in Q3: overall, by business unit our margins were excellent. We had one area where we had weakness in our gross margin due to lower volumes and lower manufacturing volumes. And that was really in our arsine and phosphine product lines. We don't expect that to recur in the next quarter.

The scrap issue related to the same thing. It was just a number of products that just did not meet our quality standards, and so we ultimately scrapped them out.

So as we move into Q4, we would expect those issues to be behind us. We expect higher volumes in those gas related businesses and would expect our margins to be flat to up modestly, in spite of the fact that our volumes will be down a little bit.

So the second part of the question related to the i2M Center, I am happy to say that that transition is completely behind us. I will say we spent a little bit more money in Q3 than we anticipated.

But overall, our liquid filtration margins, which that business is part of, were very strong. We are completely out of the Millipore facility, and so those recurring costs will be gone in Q4.

So overall, when I think about the margins moving into Q4, I feel pretty good. When I think -- just to put it a little bit in context, if you were to look at our margins over the last eight quarters, we have got a quarter where they were 41% and a quarter where they were 46%, but mostly they run in that 44%/45% range. And so while this margin was a little bit weaker than we would have liked, it certainly wasn't -- you know, it wasn't alarming to us or sort of out of the range of reason.

Okay. That's helpful. And then, just as a follow-up, I think last quarter you mentioned that some of your trailing-edge customers have started buying some of your more leading-edge products, particularly the filtration. And I was just wondering if that trend is still accelerating, or is that more of a one-time increase related to new product availability?

Wes, I think this is a trend that I hope would be continuing in the future. We have, as I mentioned before, invested a lot in increasing the level of coverage and the level of support to the trailing-edge fabs, and they are constantly evaluating a number of new solutions -- filtration solutions, but also other products and materials. And we hope that we are going to continue to capitalize on those new engagement levels.

So this is part of our business that has done well year to date. And I would expect that to continue to be a source of strength in our top line going forward.

All right. Thank you very much.

Patrick Ho, Stifel.

Bertrand, first, in terms of some of the growth initiatives you have talked about in terms of the different markets, what has been the biggest surprise on the upside -- surprise for you? Has 3D NAND helped on the deposition side of things? Where have you seen probably the fastest growth among those five market opportunities you highlighted at your analyst day?

Patrick, if you recall, during the analyst day we classified those five opportunities in, I would say, three buckets. The first two -- the bulk photoresist filtration solutions and the new families of boron mixtures are products that are launched and will have an immediate impact to the top line. And that was the expectation. This is, in fact, what we have been experiencing since the beginning of the year. So those two products have been meaningfully contributing to our growth trajectory since the beginning of the year.

The other products are still in the early stages of development and evaluation by our customers. The progress for our new family of coatings, the new deposition materials, continue to be very exciting. So a lot of really good, positive feedback, but still very early stage and fairly limited impact on our top line so far this year.

And then, the last is really something of a slightly different nature, and that is really putting together the knowledge that we have of the CMP process; combine that with the silicon carbide and coating technology knowledge that we have in developing a pad conditioner. So this is a fairly small team, but the results are very promising. We have been primarily engaging with logic customers so far this year -- a lot of success there. And I think the team will start engaging with memory makers in the very near future.

And next on the horizon will be the trailing-edge fabs. As you know, the value proposition for that product is around -- increasing the life of the pad conditioners and the life of the pad themselves by a factor of 2X. And in doing so, we significantly contribute to improving the cost of ownership of our customers. So we would expect that those products would be very relevant not just for leading-edge, but also for trailing-edge.

Great. That's helpful. And maybe as a follow-up to the details you just provided there: it is fair to assume that some of these new opportunities, like you mentioned on the deposition side -- the deposition materials that you mentioned -- they will start contributing to revenues in 2017?

That would be my expectation. Again, I think the development of those new class of precursors really ties to the new complexity of the device architecture as the industry continues their efforts to scale up vertically. And what we are trying to do here is not only to develop the material itself, but really to come up with the material that is purer than anything that exists in the market today; and to develop an integrated solution, including a delivery system that leverages our fluid handling knowledge, our coating capabilities, our in-line monitoring technology, as well as our knowledge of gas contamination control.

So this is really what we are after, is really this system solution for our OEM and fab customers. And again, feedback from the market has been extremely promising. But to your point, I don't expect this particular technology and this particular platform to have any meaningful impact on our top line until later in 2017 and early 2018.

Great. Final question for me, maybe for Greg in terms of the financials as well as the way you have been able to generate cash and your balance sheet management: as you get some of these new products to the marketplace, how are you managing the supply chain to maintain the high turns you have been able to deliver as well as this cash flow generation?

The inventory -- I think you are talking specifically about inventory. Maintaining inventory at current levels and current terms, and even looking for some modest improvement over time, is one of our core corporate objectives. It is front and center with everyone in the supply chain. So I would expect you will continue to see inventory turns in the ranges we are at now or, like I said, slightly better.

Overall, though, I would say I am very pleased with our cash generation. I am really pleased with the amount of cash we have been able to drive back to the United States. I think we will continue to repatriate cash over the next year. So we have got excellent liquidity in the US to reduce the debt and still have firepower for M&A.

Great. Thank you.

Dick Ryan, Dougherty.

Greg, in your fourth-quarter guidance, can you give us a sense of what you are thinking about for both the unit and the CapEx side of the businesses?

I think the downside -- you know, we are guiding down slightly. And that guidance -- I mean, I think that would be equal on both sides of the business.

Yes. I can help with that question. And to say this: again, right now we are still experiencing very healthy levels of bookings in our business entering the quarter. But we expect normal seasonality to set in and the fab activity to slow down in the back end of the fourth quarter.

So as Greg mentioned, we continue to expect some very healthy industry conditions, in line with seasonal pattern. To put that in perspective, the midpoint of our Q4 guidance represents an increase of 6% versus the same quarter of last year. So I think that we are going to finish the year on a very strong note.

Okay. Great. Could you give us a sense of what CapEx might look like for 2017 versus 2016?

Very preliminarily, I would expect it to be in the $80 million to $90 million range next year. A number -- we came into this year talking about an $80 million number. We had a number of projects, because of customer ramps, a number of projects where we delayed putting capacity into place. And so those will end up happening next year.

Okay. And I think you review your --.

I was just going to say, we will put a finer point on that coming out of Q4.

Sure. I think you review your capital allocation strategies in the fall; and, I mean, great success to date, and another $100 million over the next year in debt paydown expectations. How do you handicap that? Does debt paydown -- was -- or it seemed to be the top priority. How do you handicap that with M&A opportunities or stock buyback now?

Well, Dick, you are correct. I think short-term, our preference will be to pay down the debt, but we continue to believe that M&A is our preferred capital allocation option.

As we have reviewed with you, we believe that the ATMI acquisition was a great success; that it allowed us to create significant value for all stakeholders. And frankly, that has given us confidence and, hopefully, credibility among the investment community that we can be an effective consolidator in our space.

But the other thing that we learned with the ATMI acquisition is that we need to be disciplined. And what it means for us is that we are going to be thoughtful and potentially patient before we act.

So I would argue that right now, again, the focus and the priority remains organic growth. We have many very exciting opportunities right in front of us. And we need to execute flawlessly. And in that context, as Greg mentioned, our preference would be to pay down the debt; de-lever the balance sheet; regain flexibility without compromising our dry powder. And when the time is right, you should expect us to acquire some high-quality businesses at the right price.

Great. Thank you.

Amanda Scarnati, Citi.

Just kind of continuing on that M&A question, what is the size of the acquisition that you would be considering down the road? Would it be another transformative acquisition the size of -- relative size of ATMI, or would it be something smaller, like a $50 million specialty chemical company?

Amanda, again, as you would expect, we are working on -- like any other company that wants to be an effective M&A player, we are building up a pipeline of potential M&A targets. And in that pipeline, as you would expect, you would see companies of many different sizes.

The question will be one of actionability and affordability. So we will continue to test all of that, and when the time is right, we will share more with you.

Then, Greg, what is the percentage of cash that is currently onshore versus offshore?

There is $172 million onshore out of the $412 million. So a little bit less than half.

Okay. And then, the last question I have is just with operating margin. Are there any levers that could be used to improve operating margin into the 20% range? Or is this kind of mid-teen range the more appropriate range -- run rate to be in for operating margin?

No, I think our target model at $300 million-plus is to have operating margins of 20%, and I think we are well positioned to deliver on that.

All right. Thank you.

And, in fact, if you look back at last quarter, we were right at 20%, excluding some of the one-time items.

(Operator Instructions) Tom Diffely, D.A. Davidson.

I guess I have a longer-term question here on the margin front. So if you do get the [$70] million-plus of incremental revenue from these five new product lines, what is the impact to margins on a go-forward basis? And then, similarly, what would the impact be if you got a substantial amount of growth from IoT at the trailing edge?

So from a gross margin perspective, our new products do have higher margins. When you think about the IoT, the gross margins on those businesses would be lower, but I always -- you know, the operating margin would be in line with corporate operating margin, because where -- well, some of those products over time, we have experienced modest ASP erosion. But we are not spending much in terms of the way of ER&D, because it is primarily -- IoT is primarily legacy products. So lower gross, but consistent operating margins.

When you think about the margin long-term, I mean, I have consistently said, think about this business as kind of a mid-40s operating margin. And it would be great to say that I think we will get to 47% or 48%, but I don't really see that. I mean, I think at the end of the day, the customers are going to allow us to have something in the mid-40s.

Okay. And then you mentioned that the newer products were higher gross margin. Are they also higher operating margin? Or is there a level of R&D in there that keeps them in check?

I would say across the portfolio, the operating margins are, legacy versus new, I would say relatively consistent on and operating margin perspective.

Okay. That's helpful. And then, when you look at some of the write-offs, do you have any active 450-millimeter programs left, or are they at this point all shut down?

No. Right now, this entire initiative is really on ice. I mean, it is pretty clear that the industry will not be transitioning to 450-millimeter wafer anytime soon. So as a result, that is what really led us to decide to record this impairment charge in Q3.

Having said that, we continue to view the transition to larger wafer as a potential growth opportunity for Entegris, if and when the industry decides to migrate to 450. So again, if and when that happens, we will be ready to re-engage. But at this point in time, there is really no development effort within the company.

Okay. Good to know. And then, finally, you talked a lot about the cash. What is the cost of repatriating your cash at this point?

We have probably got another $100 million or so that we can repatriate on a highly efficient basis. We will bring back about half of that $100 million in the next six months, and the remainder over the next, I would say, 6 to 18 months. But, like I said, it won't' be zero, but it will be very close to zero. And then beyond that, it would be the delta between the rate where the cash was earned and the US rate.

Okay. When you look at the generation of cash going forward, what percent do you think will be generated onshore versus offshore?

We are generating approximately 40% of our free cash flow in the US.

Okay. Great. Thanks for your time this morning.

There are no further questions at this time. I will now turn the call over to Steven Cantor for additional comments and closing remarks.

Great. Before closing, I do want to note that we will be in New York for investor meetings tomorrow, and we will be participating in the Morgan Stanley Global Chemicals Conference in November.

If you want more information about those activities, you can contact me. And we look forward to updating you on our next quarterly call. Thank you and have a great day.

That concludes today's conference. Thank you for your participation. You may now disconnect.