Entegris' (ENTG) CEO Bertrand Loy on Q2 2016 Results - Earnings Call Transcript

| About: Entegris, Inc. (ENTG)

Entegris, Inc. (NASDAQ:ENTG)

Q2 2016 Earnings Conference Call

July 27, 2016 10:00 AM ET

Executives

Steve Cantor - Vice President of Corporate Relations

Bertrand Loy - President and Chief Executive Officer

Greg Graves - Chief Financial Officer

Analysts

Dick Ryan - Dougherty

Patrick Ho - Stifel Nicolaus

Christian Schwab - Craig Hallum Capital Group

Chris Kapsch - BB&T Capital Markets

Amanda Scarnati - Citi

Todd Morgan - Jefferies

Operator

Good day, everyone, and welcome to the Entegris Second Quarter 2016 Earnings Call with Analysts. 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.

Steve Cantor

Thank you. Good morning, everyone, and thank you all for joining our call. Earlier today we announced the financial results for our second quarter ended July 2, 2016. You can access a copy of our press release on our website.

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, CFO. Bertrand will now begin the call. Bertrand?

Bertrand Loy

Thank you, Steve. I will make some general comments on the quarter, and Greg will then provide more details on our financial results.

Simply stated, it was a great quarter. We grew our sales more than 13% sequentially to a record high of $303 million. We achieved GAAP EPS of $0.23 and non-GAAP EPS of $0.28. We generated strong cash flow and achieved an adjusted EBITDA margin of 23.5%. We repaid $25 million of debt reducing our net debt ratio to 1.1x, down from 2x when we announced the ATMI deal in 2014.

Our growth was steady across all market segments including leading-edge logic and memory makers, as well as legacy fabs and our industrial markets. The increase in revenue was broad-based across our product portfolio with strong growth in filtration, FOUPs and our specialty materials. In particular, our liquid filtration and advanced deposition businesses, which benefited from new product introductions, reported record quarters.

At our Analyst Meeting in San Francisco, we discussed how the Entegris value proposition to our customers rest on three pillars. First, the unique technology portfolio. Second, the comprehensive global footprint. And third but not least, the relentless dedication to operational excellence.

Our performance in Q2 provides compelling evidence that our strategy and the quality of our execution are yielding results.

We have a rich pipeline of new technology and breakthrough products that are leveraging the breadth of our technology portfolio to deliver unique value to our customers. Our new product revenue in Q2 grew sharply, driven in part by leading-edge filters, high purity liquid containers, advanced FOUPs, new cleaning chemistries and next-generation deposition materials.

Regarding our global presence, the expansions of our tech centers in Taiwan and Korea are facilitating even deeper engagement with our major customers in Asia. This will allow us to shorten the development time of our tailored solutions.

In addition, a number of investments in new manufacturing operations around the world has alleviated capacity constraints and has improved lead times. The flagship of these investments is obviously our i2M Center. I am pleased to report that we are in the very final stages of customer qualifications. 90% of the UPE filters sold in Q2 were based on i2M made membrane which has driven our filtration sales to record levels. We are on track to exit the legacy Millipore facility in August.

I think the best technology and a global footprint is only one part of the value proposition. The investments we have made over the past several years in our quality systems, cleaner manufacturing processes and statistical process capability, as well as our constant focus on operational excellence are paying off.

For the first half of 2016, we have approached 5.5 Sigma levels of quality. This is a vast improvement from where we were just a few short years ago. If you consider that we manufacturer and commercialize more than 15,000 SKUs across our global operations, achieving this kind of world-class result is a great accomplishment. Over the past few years, Entegris has been consistently recognized by its most demanding customers as one of their most reliable and most critical suppliers.

In terms of our financial performance, our second quarter results demonstrated the earnings and cash flow generation potential of Entegris. The quarter marked a clear step toward achieving a $1 per share of annual earnings.

I am also pleased with our path to de-lever our balance sheet and to execute our capital allocation strategy to increase shareholder value. We have been thoughtful and transparent in how we have deployed capital and you should expect us to continue to deliver on our commitments.

It is Entegris’ 50th year as a company. While it is very gratifying to celebrate this milestone with the type of performance we reported today, I am even more excited about what lies ahead. We have a unique value proposition for our customers and we have built very promising pipeline of growth opportunities. This gives us the conviction that we can continue to expand our served available market, grow our share, outpace the industry and create lasting value for our shareholders.

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

Greg Graves

Thank you, Bertrand. Second quarter sales of $303 million were record levels and above the high-end of our guidance. Sales were up 8% from a year ago. On a sequential basis, sales were up 13.5% and included 1% favorable impact from currency. For the first half of 2016, revenue grew 4.8%, which outpaced our markets.

Our non-GAAP earnings per share of $0.28 was also a record high and above our expectations. The strong EPS was driven by gross margins of 45.9%, which improved from 43% in Q1 due to favorable mix, higher volumes and better manufacturing efficiencies. Qualification and start-up costs at the i2M Center were about the same as in Q1 as we finished the last remaining membrane qualification and prepare to complete the i2M transition in the current quarter. We expect gross margins to be approximately 45% in the third quarter.

By segment, sales for Critical Material Handling, or CMH, grew 17% to $195 million from Q1, while the operating margin for CMH grew to 27% in Q2, up from 22.8% in Q1. Sales for Electronic Materials, or EM, rose 7% sequentially to $108 million as EM’s operating margin of 25.4% increased from 21.4% in Q1. The margin improvements in both CMH and EM were largely due to favorable product mix and greater manufacturing efficiencies.

Excluding amortization of $11.1 million, non-GAAP operating expenses in Q2 were $81.7 million. Operating expenses were higher than initially expected due to unplanned severance, higher variable compensation costs and other one-time expenses. We expect non-GAAP operating expenses to be $76 million to $78 million in the third quarter of 2016.

Adjusted operating margin was 19%. Excluding the one-time cost mentioned above, the operating margin would have been over 20%.

Net interest expense was $9.1 million in Q2, consistent with the past several quarters. Our GAAP tax rate for the quarter was 14% and our non-GAAP rate was 18%. Lower tax rate reflects more favorable geographic income mix. For the full year, we expect the non-GAAP tax rate to be 23% to 25% or down about 300 basis points from our prior guidance.

Adjusted EBITDA for the quarter was $71.3 million, giving us an EBITDA margin of 23.5%. Cash flow from operations for the quarter was $61 million and free cash flow was $47 million. The excellent cash flow was driven by strong earnings and good working capital management. Even with the strong growth in revenue, inventories increased by only $3 million sequentially. Turns of 3.6 improved from 3.4 in Q1. DSOs in Q2 were 54 days compared to 51 days in Q1.

Second quarter CapEx was $14.3 million and year-to-date CapEx was $32 million. We are now expecting full year CapEx of $70 million to $75 million, which is down slightly from the $80 million we had discussed earlier in the year. Our cash balance at the end of Q2 was $374 million, of which $176 million was in the U.S.

Total long-term debt including current maturities was $632 million. We repaid $25 million in the last week of Q2 and expect to repay an additional $50 million over the next 12 months. Our net leverage ratio is 1.1x, which is consistent with what we expected at the time of the ATMI acquisition.

We continue to execute our capital allocation strategy, which balances debt repayment, building liquidity for potential M&A and opportunistic share repurchase.

Turning to our outlook for Q3. We expect sales to range from $285 million to $300 million, reflecting current demand trends. The third quarter is typically seasonally flat or down slightly from the second quarter.

We generated strong cash flow of $71 million in EBITDA and $47 million in free cash flow. And finally, we are excited about our new product pipeline in our strategic initiatives that position us to outperform our markets in 2016.

Operator, we’ll now take questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] We’ll pause for just a moment to allow everybody the opportunity to signal. We'll take our first question from Dick Ryan, Dougherty & Company.

Dick Ryan

Thank you and congratulation on a strong quarter guys. So Greg, you mentioned 1% favorable impact in FX in Q2. How are you looking at that for either Q3 or the remainder of the year?

Greg Graves

We were 1% favorable in Q2, which is about $3 million, primarily related to the Japanese yen. For the balance of the year, we would expect only nominal impact from currency as well.

Dick Ryan

Okay. So whatever you get hit from Europe, Japan probably helps you the other way?

Greg Graves

Correct.

Dick Ryan

Okay. And can you give us a general breakdown unit versus CapEx, and again Q2 and kind of how we should look at that going forward?

Bertrand Loy

Right, so the [indiscernible] unit driven and that was confirmed in Q2 with our unit driven business representing about 77% of total revenue. Very much in line with what we experienced in Q1 and CapEx represented of course 23%. Both sides of the business actually performed very strongly in Q2.

Dick Ryan

Okay. And Bertrand, you mentioned strength across the trailing-edge, leading-edge. And I think trailing kind of drove results in Q1. Can you give us a little more perspective on both sides there?

Bertrand Loy

So yes, so we saw actually strength across the board. On the trailing-edge, we continued to see a lot of strength in our consumable business, so think about the filters and the chemistries that are used every day in the production environment of those trailing-edge fabs. But we continued to see some interest by those legacy fabs in the retrofit kits that we have that can represent some interesting cost effective alternatives to increase the throughput and improve the capacity that they can get from the older generation tools. So in other words, this is a nice alternative for them to having to purchase an expensive new tool. So a perfect example of this startup solution would be our photoresist pumps and we continued to see strength for that particular product line.

As it comes to the leading-edge, I know Dick that you were attending our Analyst Day in San Francisco a few weeks back and we provided a lot of details around a number of growth opportunities that we are particularly excited about. And all of those opportunities actually had lot of success in Q2, chief among them are photoresist filtration product lines that we introduced earlier this year but we also saw a lot of strength in our specialty gas business and a number of new products that we introduced.

Dick Ryan

Great, thank you. And again, congratulations on the quarter.

Greg Graves

Thank you.

Operator

Thank you. We'll take our next question from Patrick Ho with Stifel Nicolaus.

Patrick Ho

Thank you very much and congrats as well. Bertrand, maybe just as a follow-up to some of the new products that you mentioned on the call, as it involves the filtrations, the new chemistries and some of the new materials. Are those primarily focused on leading-edge applications, or are some of those also being applied to, as you mentioned, the trailing-edge?

Bertrand Loy

It’s a great question, Patrick. It’s a little bit of both. So if you think about the photoresist filters, it’s mostly targeting the leading-edge. But you should think about the new boron mixtures. This is actually targeting both the leading and the trailing-edge fabs. Think about the value proposition for our customers here. It’s really about providing a cleaner material that improves the ion source lifetime and increase the beam stability. And for the customer, the value proposition is increased uptime and reduced cost of ownership. So you can imagine that those types of attributes are equally important for the leading-edge fabs as it is for the trailing-edge fabs.

If you continue down the list, the other three I would say are in fact - so the other - the next two would be the coatings and the pad conditioners. The pad conditioners are both leading-edge and trailing-edge. The coatings are really mostly leading-edge, and the advanced deposition material, I think we talked about the tungsten material, this is clearly leading-edge. Leading-edge logic are also lot of applications obviously on the memory side.

Patrick Ho

All right, that's really helpful. And maybe a question for Greg in terms of the operating model. Now with the i2M headwinds behind you, what are some of the key levers we should be looking at for gross margins on a going forward basis? Is it simply mix, utilization, what's going to be kind of the biggest drivers for gross margins as we look forward?

Greg Graves

I think, Patrick, if you look at margins really over the last eight quarters, I mean, they've been - with the exception of Q4 last year, they've been quite stable in that 44%, 45% range. We've had a couple of quarters where it’s touched 46% and we've had a couple of quarters where it's been below that. I think moving forward, you will see more stability in the margin.

But in terms of levers, I don't see a lot of upside. I mean, I’ve said this consistently, I don't see this as 47%, 48% margin business. I mean, obviously as volumes move up over 300, we'll see margins like we saw this quarter. But I think you need to be thinking about it as more stability in the margin but a margin in that kind of 45-ish plus or minus.

Patrick Ho

Great. Thank you very much.

Operator

Thank you. We'll take our next question from Christian Schwab from Craig Hallum Capital Group.

Christian Schwab

Hey, congratulations on great success in the quarter and guidance. Bertrand, as we look to your three growth strategies that you highlighted at your Analyst Day, can you just remind us between market share gains and new applications in SAM expansion? What you’re most confident in drive growth over the course of the next year at rates that look to continue to be faster than the industry?

Bertrand Loy

Right, so Christian I think you’re referring to the growth model that was really based on the three layer assumption. The first layer was a 2% GDP growth assumption. Then an additional 1% link to the IOT trends, which we believe will drive greater wafer starts and additional industry CapEx. Then finally and most importantly, the final layer was an additional 100% to 200% of growth coming from a number of new opportunities. I think that’s where your question is, is how much of that will be served available market expansion as opposed to share growth. And I would say that actually a lot of it is going to be market expansion and I think that’s probably what is so different from the growth opportunity pipeline that we had - or that we’ve had for the last five to 10 years.

I think that there is a greater emphasis and there has been a greater emphasis in expanding the application of our technology and capabilities outside of the traditional applications that we’ve been serving and this is starting to pay off. So certainly a little bit of share growth, but I would say the vast majority is really about an expansion.

Christian Schwab

Great, thank you. And then just on the operating model, Greg. We shouldn't assume any different adjusted operating margin goals than we kind of previously talked about like 20% plus revenues above 310 and times when the market may contract a little bit that 17% to 19% at 280, that’s you just don’t - kind of what we should be thinking about?

Greg Graves

At this point, I think you should consider the model that we have in place and had in place for over two years now to be kind of the model going forward. Obviously as we move into 2017 and start thinking about higher revenue levels, we'll need to think about what that model looks like at the upper end.

Christian Schwab

Perfect. Great. No other questions. Thanks guys.

Bertrand Loy

Thanks, Christian.

Greg Graves

Thank you.

Operator

We'll take our next question from Chris Kapsch with BB&T Capital Markets.

Chris Kapsch

Yes. So my question is sort of a follow-up to the previous question and your discussion about, I guess, sort of outsized growth being a function of expanding the market. In this quarter though specifically I think your comment - your formal comments were that you exceeded the market growth and that’s apparent in the results. I'm just wondering if you could provide some color in this quarter what contributed to the - again, your growth exceeding the market growth, maybe if you could provide a little bit more color by segment? Was it newer products and advanced technologies, or was it - was there some market share? Was there some pent-up catch-up demand associated with the i2M transition? Any sort of color on that would be appreciated.

Bertrand Loy

Sure. So first of all let me say that - start by saying that everything played out the way we had hope it would in Q2. The industry environment was certainly positive with the start sequentially up in the mid-to-high single digits. And I think that was driven by strong demand from the mid-to-low tier smartphones and steady demand by IOT-related applications. But more importantly, as we mentioned, we benefited from a number of successful new product introductions. So we cited liquid filters, not just for the photoresist application but also we introduced a new Torrento platform with a focus on wet etch and clean application. So that family of filter performed extremely well during the quarter as well. As did a series of new products in our specialty gas business as well and deposition materials.

Another product platform that did very well and remain actually very steady during the quarter was our FOUP business, which recorded revenue of approximately $16 million. That was up from $14 million last quarter, which was not a record quarter but that was the second highest quarter ever recorded for this product line as well. And as you know this is a business that can be lumpy but a business where we enjoy a very significant market share. So as I said a lot of strength across a number of product lines - and I’m not sure I want to necessarily provide more details, so this will be too long, but again very well balanced performance across the portfolio.

Chris Kapsch

Okay, that’s helpful. And then just if I could follow-up on, I guess it’s more on the M&A topic. And out in San Francisco you did make the case that you felt like you were in the right to be a consolidator in a space that probably is likely to see some consolidation and you mentioned you're evaluating various, or I guess, you have a pipeline of potential targets. And given the situation now you’re at 1.1x, you mentioned this morning building your cash balance to - for the purpose of having liquidity for M&A, just wondering like where would you feel comfortable taking this business in terms of leverage if you found a compelling acquisition that has meaningful bite-size. Just how - what kind of leverage would you be willing to go to in order to do what you feel is a strategically compelling deal?

Greg Graves

Chris, this is Greg. So we talk a lot about the net leverage and it being down to 1.1x from about 2x at the time. We did the ATMI acquisition. The external markets and the credit markets in particular tend to look at the gross leverage ratio. So today that growth leverage is still up around 2.25x. We know from talking to the rating agencies, we could essentially maintain our existing rating with gross leverage up at 3.5x and we certainly wouldn't go any further than that.

Chris Kapsch

Got it. Thank you.

Operator

[Operator Instructions] We'll take our next question from Amanda Scarnati from Citi.

Amanda Scarnati

Hi. Just a question on the tech centers in Asia that you had mentioned, Bertrand. You said that it was - you were deepening relationship within those regions and allowing for shorter development lead times. Are you working more closely with the R&D team as the big players in Asia in order to kind of get a head start for say on the leading-edge, or is this more on the new technologies that you're working on that the new product that you're building rather than just purely the traditional products that you work on heading towards the leading-edge?

Bertrand Loy

No, Amanda, it’s actually both. I mean we’ve had tech centers in all of the large electronics market for a number of years. We keep adding talent. We keep adding capabilities to those centers. And the reason we are doing that is because the model works. We talked during the Analyst Day about the Entegris customer engagement model, which is really based on our desire to be viewed as an extension of the engineering teams of our customers and you hear a lot of companies talk about collaboration but they mostly flag the need for collaboration which is clearly a necessity indeed in this industry as process and metrology challenges continue to grow and become more complex, but there are very few companies that really know how to actually do it. And I think that if you look back at Entegris, we’re being framing that concept, that vision for the last seven, eight years and it's starting to hold and that strategy has actually let us to make a number of consequential decision. You were talking about the local tech centers but it's only part of the solution. It also made us we think how we want to be managing our new product development process.

It forced us to rethink the type of skill sets and the location of the talent on a global basis. We reshaped of number of internal processes to help us be more efficient and faster. And more importantly I would say it really transformed the mindset of the company. And that’s probably what I’m the most proud of, and frankly to a great extent I think that is what is really translating into the series of new opportunities that have emerged from those close partnerships with our customers.

Amanda Scarnati

Okay. And then just in terms of the revenue line, obviously this quarter was a very large quarter, well above seasonal and above expectations, and we are also starting to see inventory rising as a lot of the semiconductor companies in general. Were you seeing any sort of pulling of revenues or any expectations that there could be a contraction, deeper contraction than what you’re expecting in the third quarter heading through the second half of the year?

Bertrand Loy

Yes, I mean certainly something that we are watching very carefully, Amanda. Having said that, again, we expect a very solid third quarter for the Entegris business. I mean, if you think about the midpoint of our guidance for Q3, this represents an increase of 8% versus the same quarter last year. And the reason why we believe we can do it is we expect continuous strength in our new product sales, but when we see the current booking levels as just as strong as momentum that we’re experiencing at the end of Q2, we expect some level of seasonality to impact fab utilization later in Q3 and we wanted to take that into account in our guidance.

So in summary, a very solid Q3 guidance that I think will position us really well to make 2016 a record year for the company.

Amanda Scarnati

Great. Thank you.

Operator

We will take our next question from Todd Morgan with Jefferies.

Todd Morgan

Thanks. Thanks for holding the call. Kind of a follow-up on that too is Q2 revenues - pretty strong Q2 revenue. I think you had guided sort of flat to down slightly sequentially kind of from historical purposes. Is that really the right way to think about the revenue potential in the third quarter though given the new products and all the other initiatives you've launched? Thanks.

Bertrand Loy

Yes. So again, I think I want to summarize my previous answer. I would say that what our Q3 guidance is taking into account is normal seasonality for Q3, offset by continued strength in our new product sales. And again, if you think about the Q3 guidance that we’re providing, this represents a very meaningful increase from same quarter last year.

Todd Morgan

Fair enough. Thank you very much.

Operator

It appears there are no further questions at this time. Mr. Cantor I’d like to turn the conference back over to you for any additional closing remarks.

Steve Cantor

Thank you. Before closing I want to note that we will be presenting at the Pacific Crest Tech conferences and Needham Industrial conferences in August. Thank you all for joining us this morning. We look forward to updating you at the next conference call. Have a good day.

Operator

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

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