Entegris' (ENTG) CEO Bertrand Loy on Q1 2016 Results - Earnings Call Transcript

| About: Entegris, Inc. (ENTG)
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Entegris, Inc. (NASDAQ:ENTG) Q1 2016 Earnings Conference Call April 26, 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

Amanda Scarnati - Citi Investment Research

Operator

Good day everyone and welcome to the Entegris First 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 Steve Cantor, Vice President of Corporate Relations. Please go ahead, sir.

Steve Cantor

Great. Good morning, everyone thank you all for joining our call today. Earlier we announced the financial results for our first quarter ended April 02, 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. Greg will then provide more details on our financial results.

Let me start by saying that I am very pleased with our performance for the first quarter. We achieved sales of $267 million which was above the high end of our expectations. We recorded non-GAAP EPS of $0.17. We generated solid cash flow and achieved an EBITDA margin of 20.4%. Finally, current trends point to a strong second quarter and we are positive about our prospects for the remainder of the year.

So we performed well in the first quarter which typically is a seasonally soft one for the industry. Overall, demand from fab customers strengthened through the quarter as end market trends reflected improving demand for low and mid tier smartphones and IC inventory re-stocking.

Continued fab reduction of next generation technologies drove demand for our FOUPs liquid packaging solutions and advanced deposition materials. Sales of our other products were in line with our expectations and with normal seasonal trends.

In 2016, we believe three Entegris specific factors will enable us to outperform the market. Market share gains for our infab solutions, expansion of our served markets with the emergence of new applications, deeper into supply chain and finally new Entegris capacity coming online which will ease current constraints.

Let me provide some details around these three factors. First, the industry continues to drive the adoption of advanced materials and process technologies which require ever greater levels of purity and cleanliness. This is not new for us. This most stringent requirement as well as the increasing number of process steps into semiconductor fabrication environment continued to be fundamental drivers of our business and our new product development cycles.

In the first quarter, the strength of our FOUP solution is a perfect example of how we are helping our fab customers address their increasingly complex contamination issues and how we can achieve and maintain significant market shares. Second, many leading edge chip makers are pushing Entegris solutions deeper into their supply chain and are asking Entegris to help reduce their ability during the manufacturing and transportation of critical process materials.

This is creating new incremental market opportunities for us which we are addressing with a comprehensive range of solutions including advanced bulk filters and high purity chemical packaging solutions designed specifically for electronic chemical supplies.

Entegris is the only supplier in the industry with the combination of [broad] materials science knowledge, contamination control expertise and deep understanding of fab processes. This unique array of capabilities allows us to develop high value solutions for the manufacturing, transport, delivery and usage of critical materials across the supply chain.

Third, over the past 18 months we have contended with capacity constraints that have limited our ability to meet demand for some key new products, such as our UPE filters for photo resist production and high purity drums used by many chemical manufacturers. I am pleased to report that with the significant progress achieved and the qualification of i2M made UPE filters by our customers and a new capacity coming online for a high purity drums we now have adequate capacity to meet growing demand for these products.

In addition, the completion of these projects will benefit our margins as we eliminate redundant cost and customer qualification expenses which have been a headwind for the past 12 months.

As we look out to the balance of the year, we expect modest growth for wafer starts. While the precise outlook for the industry in the second half of 2016 is unclear we are very excited about the Entegris specific opportunities and our rich pipeline of new products which include new generation of deposition materials, borrow-on gas mixtures speciality coding and new filtration solutions.

Finally, I would like to announce that we will be holding an Investor meeting on July 12 in San Francisco during SEMICON West and in conjunction with the celebration of the 50th anniversary of Entegris.

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

Greg Graves

Thank you, Bertrand. First quarter sales of $267 million were above the high end of our guidance driven by sales of our advanced micro environment and liquid packaging solutions. Sales were up 1% from a year ago, on a sequential basis the impact of currency was negligible and on a year-over-year basis was less than 1% headwind.

Our non-GAAP earnings per share of $0.17 was at the high end of our expectations. Gross margin of 43% improved from 41% in Q4 due to higher production volumes and better manufacturing efficiencies which were offset in part by qualification and start up cost at the i2M center.

We expect gross margin to be approximately 43.5% to 44.5% in the second quarter. As previously discussed, we will complete the full transition to the i2M center early in the third quarter and will exit the redundant facility. At that point, with the i2M transition cost behind us gross margins should continue to strengthen through the year.

By segment, sales per critical material handling or CMH declined modestly to $166.2 million from Q4, while the operating margin for CMH improved to 22.8% in Q1, up from 20.2% in Q4.

Sales for electronic materials or EM rose 5% sequentially to $100.8 million as EM’s operating margin of 21% grew slightly from Q4. The margin improvements in both CMH and EM were largely due to greater manufacturing efficiency. Excluding amortization of $11.3 million, non-GAAP operating expenses in Q1 were $73.9 million which included approximately $2 million of unplanned cost for severance and bad debt expense.

We expect non-GAAP operating expenses to be $74 million to $77 million in the second quarter of 2016. Adjusted operating margin was 15.3% and should improve to 16% to 18% in Q2.

Net interest expense was $9.1 million in Q1 down modestly from the fourth quarter. Our GAAP tax rate for the quarter was 23% and our non-GAAP rate was 27%. As previously discussed this reflects a higher tax rate compared to 2015 largely due to the exploration of a tax holiday in Malaysia. Adjusted EBITDA for the quarter was $54.5 million giving us an EBITDA margin of 20.4%.

Cash flow from operations for the quarter of $17.3 million was consistent with our expectations and reflected $24.1 million of annual incentive compensation payments. Inventories increased $11 million sequentially as we prepare for higher sales activity in Q2 and beyond.

Turns of 3.4 were flat with Q4. DSOs in Q1 were 51 days compared to the record low of 48 days we achieved in December. First quarter CapEx was $18 million and we are expecting CapEx through the full year to be in the range of $75 million to $85 million which includes about $15 million year marked for key growth initiatives.

We repurchased $4 million of stock under our share repurchase authorization during Q1. Our cash balance at the end of Q1 was $344 million of which approximately $128 million was in the U.S.

Total long-term debt including current maturities was $657 million giving us a net leverage ratio of 1.4 times. Under the terms of the debt agreements, we're not required to make any mandatory repayments in 2016, although we expect to repay $50 million during the course of the year.

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 Q2, we expect sales to range from $270 million to $285 million reflecting both seasonal and Entegris specific trends. At these revenue levels, we expect non-GAAP EPS to be $0.18 to $0.22 per share consistent with our target model.

In summary, we performed well in Q1 achieving sales above the high end of our guidance. We achieved an improvement in gross margin and expect further improvement in Q2 and into Q3 as we complete the i2M transition.

Finally, we are excited about our new product pipeline and our strategic initiatives that position us to outperform our markets in 2016.

Operator, we'll now take questions.

Question-and-Answer Session

Operator

[Operator Instructions] And we’ll go first to the side of Dick Ryan. Please go ahead. Your line is open.

Dick Ryan

Hey, Greg, just a couple housekeeping items. It looks like from the 10-K to today's announcement there has been some reclassification or adjusted entries, debt, some other assets. Can you explain what went on there?

Greg Graves

Yes. The most significant one was a change in the accounting convention around debt. So our debt what we didn't make any payments in the quarter is actually $10 million lower. You're now net the unamortized issuance costs against the debt for classification purposes. And that's the primary one that primary change.

Dick Ryan

Okay. And you talked about the margin enhancements as qualification issues get behind you, but can you kind of ballpark how much of a hindrance they've been margins the last couple of quarters or what you might expect not so much maybe in Q3 but Q4 and beyond?

Greg Graves

Well, by the time, so they've been running $2 million plus in Q4 and in Q1. We expect that to move down incrementally in Q2 which is in part where we guided slightly higher margins. By the time we get to Q3 there should be a small amount of residual, but by the middle of Q3 we intend to be out the redundant facility. We should be qualified at all of our customers and continue to see some upward bias to the margin.

Dick Ryan

Okay. Bertrand, it looks like in CapEx you're going to spend $15 million in some key growth initiatives. Can you give us a high level or outline what those initiatives might be?

Bertrand Loy

Sure. I was referring in my prepared remarks that we expect actually to see a number of new product introductions in the year, some of which would be around advanced deposition materials and the new range of boron mixtures. And those products require a new fleet of cylinders and canisters, so we are really investing in those containers ahead of launch of those products and materials.

Dick Ryan

Okay. And as you look at kind of a leading-edge, lagging nodes out there, can you comment on what you're seeing in utilization as a kind of stabilized Q1 and do you expect that to improve for the year?

Bertrand Loy

What we saw in Q1 was actually interesting. We saw a fair amount of positive activity in the trailing edge-fabs and we expect to see that continuing in the year. And some softness at the leading-edge fabs, so that really was -- really the story beyond our performance during the quarter.

Dick Ryan

Okay, great. Thank you.

Operator

And we'll take our take question from the side of Patrick Ho. [Operator Instructions].

Patrick Ho

Thank you very much. Bertrand, in terms of I guess industry trends and particular at the leading-edge, as the industry starts building out their fabs and 3D NAND as well as for 10 nanometers, when do you think you'll start see some of the I guess your wafer starts products benefiting from the leading-edge in terms of your products there?

Bertrand Loy

So, as you know we have different types of products and the adoption of those solutions will depend depending on those different product platforms. So we have started to see some adoption of our advanced FOUPs at some of the customers that are planning to ramp the 10-nanometer node, so that in Q1 and we expect to see more of that in Q2 and Q3.

We're also benefiting from good demand from our OEM customers for some of the high value components that are built into the OEM tools and started seeing some momentum there in Q1 and we expect to see more of that in Q2.

As it comes to really seeing momentum for our consumable products such as the advanced chemistries, advanced materials of filtration products, we're going to have to really wait until those leading-edge fabs reach high volume manufacturing so that's going to be later in the year or early next year. So, later in the year as to get ready for the ramp and then again there would be we expect to see them in full ramp starting the beginning of next year.

Patrick Ho

Great. That's helpful.

Bertrand Loy

So, the demand for our new products related to the 10-nano ramp will be going crescendo throughout the year.

Patrick Ho

Great. That's helpful. Maybe as a follow-up, in terms of some of your core non-semis business and some of the new opportunities there, can you just give a little bit of color how you see some of those businesses trending for 2016 as a whole?

Bertrand Loy

Well, we expect those businesses to do well. If I look at Q1, in Q1 with the exception of data storage which was down after a record quarter in Q4, we saw strength across all of our non-semi markets. We saw strength in solar display, LED and even in life sciences and life sciences is going to be an interesting area, an interesting market for us. We are about to rollout and introduce a number of new products for single use bags. During the INTERPHEX show this week in New York, so we expect actually this particular market segment to be bright spot for us in 2016.

Patrick Ho

Great. Thank you very much.

Operator

And we'll take our next question from the site of Christian Schwab. Please go ahead.

Christian Schwab

Hey, great; good quarter, guys. Bertrand, I just want to be clear. The strength, the outperformance in the quarter in Q1 from an end-market and the product perspective was non leading-edge fab strength. Is that correct?

Bertrand Loy

Yes. That's correct. As I've said in my prepared remark the PC market contracted sharply, right and that was offset by healthy demand for low and mid-tier, mobile devices and IoT related IC. So when you think about all of that, what it means for Entegris is that translated into solid demand for our products at our trailing edge customers and somewhat subdued activity at the leading-edge fabs.

Christian Schwab

Yes. That's great. And then as we look to the current positive trends for Q2, can you talk about what you're seeing that's going to drive that strength from an end-market perspective. Is it a pickup and demand at the leading-edge, is it a continuation of the strength of the non leading-edge, is there are some share shifts going on and any color there would be helpful?

Bertrand Loy

So, if you think about Q2, we believe that we will benefit from what is seasonally a stronger quarter, but I think if you compared that to seasonal norms we would expect Q2, 2016 to be maybe not as strong on a relative basis than what we've seen in other years. So in other words think about wafers starts maybe in the low single-digit sequential growth rate. And that's really what our guidance covers. Its covers really different levels of fab activity, but more importantly what is driving our guidance for Q2 is different rates of adoption of a number of new products.

So in Q2 specifically we expect to benefit from greater adoption of bulk photoresist

filtration solutions and those are UPE-based filters and we continue to expect greater penetration from our FluoroPure packaging solutions. Those are – this is full platform of drums and containers for specialty materials requiring high degrees of cleanliness. And I would expect to see actually again continued adoption of those solutions by our customers.

Christian Schwab

Okay. That's great. And then my last question, Greg, why are inventories up sequentially? Is that indication of demand for the June quarter and your confidence in that or is that have to do with some of the new facilities moving around?

Greg Graves

No. It’s really has to do with the former. As I said in my script, I mean, we increased inventory and anticipation both of a strong June quarter and strengthen the balance of the year.

Christian Schwab

Okay. Perfect. No other questions. Thanks guys. Good quarter.

Operator

[Operator Instructions] And we'll go next to the site of Amanda Scarnati. Please go ahead.

Amanda Scarnati

Hi. Thanks for taking my question. Just first on use of cash, Greg, there's an expectation to pay about $50 million in debt throughout 2016 which is unchanged from last quarter. But beyond that what is the priority for use of cash throughout the year, is it just to build up the cash position and hopes of potentially doing an acquisition long term or repurchasing shares on a similar rates that we've done this quarter or is there something else that you would like to use the cash flow potentially paying more debt down, et cetera?

Greg Graves

No. Really our capital allocation strategy remains unchanged and what we started talking about in the fall. Beginning six months ago we said we're going to take our U.S. liquidity up to a 10 million and every dollar above 100 million. We take – for every dollar above a 100 million we'd use $0.50 to build U.S. liquidity and $0.50 to paydown debt. That continues to be our approach.

The share repurchase program as we said at the time of the announcement is an opportunistic program and so if the stock were to be weak you would definitely see us in the market for the shares. But they are really unchanged in terms of the overall capital allocation strategy.

Amanda Scarnati

Great, thanks. Then Bertrand, just your exposure to China, we see China as a growing market, increasing in CapEx spend, increasing in semiconductor growth over the next couple of years. What is Entegris's exposure to China? And do you see this as an opportunity to grow revenue and to expand your market in the next coming year or so?

Bertrand Loy

So China is certainly being an area of growth and an area of strength for us. We saw that in Q1. We saw that throughout the year in 2015. In Q1 specifically, we saw great activity at some of the foreign companies operating in China but more interestingly some of the indigenous Chinese IC manufacturers and that benefitted all of our product lines including our FOUP platform. We saw great demand for advanced FOUPs in some of those trailing-edge Chinese customers, so again, very important market for us and an area where we will be focusing going forward.

Today, as you may know, we are really limited to a commercial presence in China. So like everybody else is we are actually looking at whether or not our commitment to this market would require us to rethink this strategy and to start thinking about I think some additional tech center capabilities and potentially some level of local manufacturing as well. So those are questions that we will be contending with over the next few years as we recognized that again, China is a very important growth market for us.

Amanda Scarnati

Great. Thank you.

Operator

And we will take our next question from the side of [Tom Diffely]. Please go ahead. Your line is open.

Unidentified Analyst

Yes. Good morning. So another question on the trailing-edge strength you saw in the quarter. Now, I guess first, do you see that as the beginnings of an IoT buildout? And then do you think that's sustainable at least through this year?

Bertrand Loy

So certainly, I mean to start with the latter part of your question, we believe that this is a trend that will be sustainable at least through this year. What is really interesting at the trailing-edge is that we are seeing two different types of drivers for our business. One is just a greater consumption of our consumable product, be it filters, chemistries, deposition materials and so on and so forth.

And that’s a function of how many wafers are being produced in their fabs. But increasingly, we are seeing evidence of another type of opportunity for us related to some upgrade kits that we are providing those customers. So, we for instance have high-value components like gas filters, gas diffusers or liquid dispense systems that can be used to upgrade older generation tools and this will present a very interesting alternative for the trailing-edge fab customers as opposed to having to purchase a very expensive new tool. So, we are seeing actually a fair amount of demand in China and other parts of the world for those upgrade kits.

Unidentified Analyst

Okay. So most of that business is directly with the fab as opposed to through an OEM?

Bertrand Loy

Correct. Correct. We would actually replace for instance, photoresist dispense systems on an old track and as part of that package we would be including an improved filtration solution for the point-of-use resist filtration as well.

Unidentified Analyst

Okay. Great. I guess a longer-term question: When you look at the growth prospects for the next several years, how does it break out on a relative basis between your leading-edge, trailing edge and maybe new products?

Bertrand Loy

I think it’s a difficult question. I think again, we are encouraged by some of those new emerging opportunities for us at the trailing-edge, encouraged by the increased level of activity that we see in these fabs but we continue to be extremely excited with all of the opportunities at the leading-edge. As I was mentioning in my prepared remark, we are seeing increasing level of complexity, increased risk of contamination of critical materials in the supply chain and the leading edge and that is allowing us to increase or serve available markets by, again, working with our fab customers and helping them improve the manufacturing process of those advanced chemistries that are used in the fabs and making sure that they are transported into the right packaging solutions that are the cleanest and the safest for the chemistries and the people handling those chemistries.

Unidentified Analyst

Okay. Great. But it sounds like there is a pretty strong or potential burst of nice growth in each of those categories.

Bertrand Loy

Right. Correct.

Unidentified Analyst

Great. Okay. Thanks for your time this morning.

Operator

[Operator Instructions] We will go next to [Tony Venturino]. Please go ahead.

Unidentified Analyst

Hi. Good morning. Bertrand, I wanted to ask you, kind of related to the last question, but your comments about your customers pushing you further into the supply chain. Could you maybe give us a little bit more color on that? Is this a new occurrence, and maybe if you could size your opportunity there?

Bertrand Loy

Yes. So, I think -- again, it’s something that I have said before and you probably have heard that theme developed in many of our recent investors meetings. Contamination control, safety, cleanliness, stability of the process chemistries and materials are becoming increasingly important concern for our customers. And the challenges are really very complex, up and down the ecosystems. So, I would argue that introduction of new materials has been the dominant contributor to device performance improvements in the last generation of process technology and yet when you think about the complexity, the inefficiency of the supply chains that those chemistries have to go through it’s really mind boggling.

So when you think about Entegris we are really uniquely positioned to help the ecosystem find solutions around that. We have a broad knowledge of chemistry; we know how materials interact with one another. We have unparalled contamination control expertise and we really also understand how materials are being used into fabs. So that makes us the partner of choice for the fab customers and their chemical suppliers to understand the challenges and find solutions for again for the proper handling of those chemistries from the point of manufacturer to the point of consumption.

So that’s the same again, if you look back over the last couple of years we’ve been flagging that as an emerging trend in the industry and we started to see evidence of those increasing requirements when the industry transitioned to 2016 and 2014 and those trends are just accelerating.

Unidentified Analyst

Okay. So is this something that’s being pushed down by the -- by your customers or are you seeing a pull from further down the supply chain?

Bertrand Loy

Well, today we are dealing with a challenge that’s so complex that what you see increasingly is really much a party collaboration arrangement. So I would say this is a collective effort between a fab customer sponsoring and usually a joint development agreement between us and some chemical manufacturers. And again that’s one of the many reasons why we have this high degree of confidence that we are going to be able to sustain the pace that we seen last year and we are going to be in a position to outpace the market by 200 to 300 basis point.

Unidentified Analyst

All right. Thank you very much.

Operator

And we have no further questions. I would like to turn the call back over to Bertrand. Please go ahead.

Bertrand Loy

Well thank you for joining us on our call today and as a reminder I would like to invite you to the Investor meeting that we would be hosting on July 12th in San Francisco. Have a great day.

Operator

I would like to thank everybody for their participation on today’s conference call. Please feel free to disconnect at any time.

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