Entegris, Inc. (NASDAQ:ENTG) Q3 2023 Earnings Call Transcript

Entegris, Inc. (NASDAQ:ENTG) Q3 2023 Earnings Call Transcript November 2, 2023

Entegris, Inc. beats earnings expectations. Reported EPS is $0.68, expectations were $0.61.

Operator: Welcome to Entegris Third Quarter 2023 Earnings Conference Call. [Operator Instructions]. I would now like to turn the call over to Bill Seymour, Vice President of Investor Relations.

Bill Seymour: Good morning, everyone. Earlier today, we announced the financial results for our third quarter of 2023. 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, and actual results could differ materially from those projected in the forward-looking statements. Additional information regarding these risks and uncertainties is contained in our most recent annual report and subsequent quarterly reports that we have filed with the SEC. Please refer to the information on the disclaimer slide in the presentation. On this call, we will also refer to non-GAAP financial measures as defined by the SEC and Regulation G.

You can find a reconciliation table in today’s news release as well as on our IR page of our website at entegris.com. On the call today are Bertrand Loy, our CEO; and Linda LaGorga, our CFO. With that, I’ll hand the call over to Bertrand.

Bertrand Loy: Thank you, Bill, and good morning. I will start by saying that I am pleased with another quarter of solid performance. In an industry environment that continues to be challenging, the Entegris team delivered results that were in line or better than our guidance and we made good progress on all our key commitments. First, on our financial performance. Sales were $888 million, and EBITDA margin was 26.5%, both squarely at the midpoint of our guidance range. Non-GAAP EPS was $0.68, exceeding our guidance range. Let me make a few additional comments on our sales performance. Sales were down 1% sequentially, in line with our guidance. The drivers of that decline were similar to last quarter for our unit-driven products, down across most product areas as utilization rates in both logic and memory continue to bump along the bottom.

However, we did see growth in product lines that are of increasing importance to our customers’ technology road maps. In particular, we saw growth in advanced deposition materials and [indiscernible] clean liquid filters. In addition, we had another strong quarter in SiC slurries and pads, reflecting the growth of that industry segment and our strong market position. In addition, like last quarter, our performance was mixed in our CapEx-driven solutions. Sales were down for FOUPs and other products tied to WFE in contrast to the steady demand for our gas purification systems and sensing and control products, which are tied to new fab construction. Next, I would like to provide an update on the key commitments the team is focused on. First, on the CMC integration.

We wrapped up all the ERP conversion on time in August, and we are on track to achieve the $75 million run rate cost synergy target this quarter. We executed 4 ERP conversions within 13 months of the closing of the CMC acquisition. This is a major accomplishment for the team and a testament to our integration capabilities. Having the whole company on one common ERP platform will allow us to better serve our customers with streamlined end-to-end supply chain and operational capabilities. On the revenue synergies, we have seen early wins in combining products in the CMP module, including slurries, pads, formulated cleans and filters. Looking further out, there’s growing interest from our customers in our end-to-end solutions and our ability to codevelop solutions to support the adoption of materials like molybdenum and other precursors.

Our customers see great benefits in Entegris solutions as they enable faster development times and improve speed, which ultimately for them means faster time to market. Next, divestitures and pay down. Here, we have made significant progress on our commitments. On October 2, we closed the sale of our Electronic Chemicals business to Fujifilm. Regarding the termination of our distribution agreement with Element Solutions, the deal is largely wrapped up and customer transitions are almost complete. We expect to receive the balance of the proceeds for this transaction by the end of the year. Finally, on the PIM business, which sells drag-reducing agents for the oil and gas industry, as we mentioned last quarter, we are working on the sale of the PIM business.

The sale process remains ongoing, and we will update you when we have more to share. Summing and up, so far this year, we have sold 3 businesses, not including the PIM business. And we are using the $1 billion in proceeds from those sales to significantly bring down our debt, just as we said we would. In addition, as you will hear from Linda, these transactions are driving both gross margin and EPS accretion. Lastly, as we discussed, we are focused on improving our free cash flow and play inventory turns. We saw very good improvement in inventory reductions in the third quarter, which put a bit of pressure on gross margin, but contributed to improving cash flow for the quarter. Linda will also discuss this in more detail shortly. Let me now cover a few other important items before moving on to the outlook.

First, on our new facility in Taiwan, as planned, we have begun initial shipments from the Kaohsiung facility. These volumes remain very small, but reflect the steady progress our local team is making. We continue to expect to ramp to higher volumes of production during the second half of 2024. Our new capacity and new facility in Taiwan is critical to addressing our long-term needs. Last quarter, we shared that we were combining the SCM and EPS divisions starting in the third quarter. This combination has been completed. The new division is called Material Solutions. Material Solutions will provide our customers the opportunity to leverage our end-to-end capabilities, which we believe will accelerate their road maps by reducing their time to yield and by providing better device performance and superior cost of ownership.

I believe that this division has tremendous opportunity for growth and margin expansion. Last week, we submitted an application for Chips Act funding for our new Colorado Springs facility, which we originally announced in December 2022. We believe that this project is clearly in line with the goals of the Department of Commerce to strengthen the domestic semiconductor ecosystem and improve the resiliency of the domestic supply chain. We look forward to doing our engagement with the Chips program office on our project. Turning to the recently released export controls for China, we do not expect to see any new material direct impact to our business. Next, a few updates on our corporate social responsibility program. In the next few weeks, we will be publishing our latest CSR report.

We are proud of the progress we have made since launching our program in 2020, but we also know we can do even more. Entegris recognizes climate change is a critical issue for the world [indiscernible] and our communities. On that note, I am pleased to announce that one of the new goals we are introducing is the commitment to reduce our Scope 1 and Scope 2 greenhouse gas emissions by 42%. In addition, we are pleased that Entegris was recently awarded the Gold sustainability rating from EcoVadis, which puts us in the top 3% of all companies demonstrating our strong commitment to corporate social responsibility, our colleagues and corporate values. Now looking at the rest of 2023, a little less changed in our view of the market. We believe the industry, both for logic and memory has likely reached the bottom in terms of utilization rates.

However, we do not expect any meaningful improvement in the market in the short term. As it pertains to Entegris, given our strong market position, we continue to expect to outperform the market by at least 6 points in 2023. Despite the challenging short-term market conditions, we remain very optimistic about the long-term growth prospects for the semiconductor industry and for Entegris. The market will return to growth on the way to doubling in size to $1 trillion. At the same time, the industry is entering in a period of unprecedented technology change and device complexity with Chips shrinking below 1 nanometer and with the proliferation of 3D structures across most device architectures. And this means the industry is moving toward Entegris because our value proposition is unique and increasingly important to our customers’ road maps, especially in the areas of material science, materials purity and end-to-end solutions that enable faster time to yield.

This will ultimately translate into rapidly expanding content per wafer and superior growth for Entegris. Let me now turn the call over to Linda. Linda?

Linda LaGorga: Good morning, everyone, and thank you Bertrand. Our sales in the second quarter were $888 million, down 11% year-over-year and down 1% sequentially. FX negatively impacted revenue by approximately $4 million over a year and negatively impacted revenue by about $6 million sequentially in Q3. As a reminder, the third quarter results and our original guidance still included the full revenue impact of the Electronic Chemicals business and the business we are selling to Element Solutions. Gross margin on a GAAP basis was 41.3% and was 41.4% on a non-GAAP basis in the third quarter, within our guidance range. The expected sequential decline in the non-GAAP gross margin was driven by lower plant volumes from our continued focus on inventory reduction, the temporary impact of the termination of our distribution agreement with Element Solutions and the continued ramp of our new facility in Taiwan.

Operating expenses on a GAAP basis were $250 million in Q3. Operating expenses on a non-GAAP basis in Q3 were $172 million below our guidance. Adjusted EBITDA in Q3 was $235 million or 26.5% of revenue at the midpoint of our guidance range. The GAAP tax rate was negative in Q3. The non-GAAP tax rate was 9.3% below our guidance. Both our GAAP and non-GAAP tax rates were positively impacted by the recent IRS announcement that temporarily allows for certain additional foreign tax credits. GAAP diluted EPS was $0.22 per share in the third quarter. Non-GAAP EPS was $0.68 per share above our guidance driven by lower operating expenses, modestly lower interest expense and the positive impact of our lower tax rate. This was partially offset by the negative impact of the FX and in our other income and expense line.

Now [indiscernible] said, our third quarter results now reflect the combination of the SCEM and EPS divisions into the new division, Material Solutions. We’ve provided historical recast financials for the 3 divisions in our earnings slides. MC sales in the quarter of $286 million were up 2% from last year, and up 1% sequentially. The modest sequential sales growth was driven primarily by wet edge and clean liquid filters, which are unit driven and gas purification solutions, which are tied to facilities-based CapEx. An operating margin for MC was 35.4% for the quarter, essentially flat sequentially. AMH sales in Q3 of $180 million were down 14% versus last year and down 5% sequentially. The drivers of the sequential sales decline in AMH were similar to last quarter.

Products, which are more tied to fab construction like sensing and control solutions continue to grow, and products more tied to WFE like FOUPs declined. Adjusted operating margin for AMH was 17.8%, down sequentially, primarily driven by lower volumes. For the new division Materials Solutions, sales in Q3 of $436 million were down 16% year-over-year and down 1% sequentially. The modest sequential sales decline was driven by lower volumes across certain product lines, particularly in memory applications. This was offset by strong growth in SIC slurries and pads advanced deposition materials and specialty coatings. Adjusted operating margin for MS was 16.8% for the quarter. The modest sequential margin decline was primarily driven by the temporary impact of the termination of our distribution agreement with Element Solutions.

Moving on to cash flow. We continue to be committed to improving free cash flow. And as an organization, we have put a lot of focus on lowering inventory to that end. [indiscernible] are showing great results with inventory down almost $80 million sequentially in Q3. CapEx for the quarter was $78 million. We continue to expect to spend approximately $450 million in total CapEx in 2023. Third quarter free cash flow improved significantly to $122 million. This was driven primarily by our progress toward our goal to reduce inventory this year by approximately $100 million. Next, let’s discuss our capital structure. At the end of Q3, our growth was $5.5 billion, and our net debt was $4.9 billion. Gross leverage was 5.5x and net leverage was 4.9x pro forma for our announced cost synergies.

During the third quarter, we made a $75 million voluntary debt payment and executed a 25 basis points reprice in our term loan. During the fourth quarter, we will pay down approximately $730 million of debt with the proceeds from the electronics chemicals divestiture and the remainder of the proceeds from the Element transaction. As a result of this pay down, by the end of the year, we expect our gross debt to drop to approximately $4.8 billion and gross leverage to approximately 5x. The blended interest rate on our debt portfolio will be approximately 5.5% and the proportion of the portfolio that is variable will be close to 0. Moving on to our Q4 outlook. Before I start, to be clear, our guidance and our results for the fourth quarter will not include the sold Electronic Chemicals business and will include only a minimal P&L impact from the business we sold to Element Solutions.

We expect sales to range from $770 million to $790 million in Q4. To the point I just made, this does not include approximately $90 million of sales from the sold Electronic Chemicals and Element businesses. So on a comparable basis, it implies an approximate 2.2% sales decline from Q3 to the midpoint of our guidance for Q4. We expect the EBITDA margin to be approximately 26% to 27%. We expect GAAP EPS to be $0.25 to $0.30 per share and non-GAAP EPS to be $0.55 to $0.60 per share. Let me provide some additional modeling items. We expect gross margin to be 42% to 43% in Q4, both on a GAAP and non-GAAP basis. The higher margin compared to Q3 reflects the positive impact of the divestitures and strong cost controls, offset by the impact of further inventory reductions.

We expect GAAP operating expenses to range from $221 million to $226 million in Q4 and non-GAAP operating expenses to range from $165 million to $170 million. Depreciation is expected to be approximately $40 million in Q4. We expect interest expense to be approximately $66 million in Q4. That amount does not include a full quarter impact of the expected debt pay down. We expect the non-GAAP tax rate for the fourth quarter to be approximately 12%. Early next year, we are planning to do a brief virtual Analyst Meeting where we will update the financial model moving forward. We’ll send more information on this in the coming few months. I’ll now hand it back over to Bertrand for some additional closing remarks.

Bertrand Loy: Thank you, Linda. In the soft industry environment, we continue to focus on the things that are within our control. And in that context, we are very pleased with the quality of our execution. We have successfully wrapped up the CMC integration and expect to realize the full cost synergies by year-end. We have made great progress in divesting noncore assets and are using the proceeds to pay down debt. We are effectively balancing short-term cost management while making critical investments for the future. We’re using this industry downturn to actively engage with our customers on their technology road maps, and we have strong conviction in the long-term growth potential of the industry and the growing importance of our value proposition. With that, operator, let’s open the line for questions.

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Q&A Session

Operator: [Operator Instructions]. Our first question is coming from Toshiya Hari with Goldman Sachs.

Toshiya Hari: I had two questions. First, Bertrand, just on the overall market backdrop. I think you mentioned that your outlook really hasn’t changed. But curious what you’re seeing in the respective applications or end markets, DRAM, NAND, leading edge logic and foundry and importantly, the trailing edge. I think things seem to be slowing down a little bit. So what you’re seeing across those 4 buckets, and I know it’s premature to talk about 2024 and don’t expect you to give us a market forecast. But what are some of the key swing factors that we should be monitoring as we think about ’24, both in terms of the market, but also importantly, your rate of outperformance? .

Bertrand Loy: Thank you, Toshiya. When it comes to the market, both in terms of Q3 and what we are expecting going into Q4, this is really largely in line with our assumptions for the second half of the year. We are seeing some modest recovery in advanced logic. So it’s good that this particular segment is stabilizing after a steady decline for 3 or 4 quarters. But on the logic side, this is offset by the contraction that we are seeing in mainstream fabs. We saw a little bit of that in Q3, and we expect a continuation and an acceleration of that contraction in mainstream fabs in Q4. Memory remains mixed. We saw DRAM improving as expected, but 3D NAND has remained fairly depressed with wafer starts continuing to come down in Q3 and we expect no real recovery in Q4.

So largely, again, industry conditions that we outlined on the previous call. When it comes to 2024, it’s a bit early for us to go into a lot of specifics. I would probably only limit my comments to saying that we expect wafer starts to be more in 2024. But again, we’ll provide some more quantification of that statement when we report our Q4 earnings in February.

Toshiya Hari: Great. And then as my follow-up, maybe one question on gross margins for Linda. So Q4 guidance, I guess, the midpoint is 42.5%. I guess you’re guiding to about 120 basis points of improvement sequentially. You talked about divestitures, cost controls and I guess, those 2 as tailwinds and then the work you’re doing on the inventory side as a headwind. Can you kind of break down some of those drivers and how they’re impacting your guide and also curious if FX is playing a role at all? .

Linda LaGorga: Yes, absolutely. So a couple of things. As we said, the gross margin will be accretive from the divestitures, but we’re not seeing the full accretion at this time because of the plant utilization, which is partly driven by the inventory reductions. The inventory reductions are incredibly important to us, right? We’re focused on free cash flow. We had an incredible third quarter with the $80 million inventory reduction and it’s allowed us to have a very strong cash flow number this quarter. So you have that tailwind from the divestitures slightly offset by some of our core initiatives, including the inventory reduction. So as we continue to plan and evolve, as you mentioned, we’re always going to be looking at cost controls across our P&L.

And we have done that as another offset, and we will continue to do that. But you’re thinking about it right, with that balance between the divestitures and some of the key initiatives that we’re driving right now is a bit of headwind.

Toshiya Hari: And Linda, sorry, the inventory reductions, is it fair to assume that you’ll be done exiting this calendar year? Or could that continue into 24′?

Linda LaGorga: Well, to me, working cap is always important. And we’re going to always maintain a focus on working cap. We have a bigger opportunity this year because we started with a higher level of inventory, but definitely, things aren’t going to stop on that focus when we head into ’24. So it will continue. But I think you’ll see the numbers come down. $80 million is an incredibly big number. As we go into Q4, what we’re targeting to try to see is another $40 million to $50 million inventory reduction. And then as Bertrand said, we’ll be giving more color as we go into 2024 with our Analyst Day, but it’s a continuing effort.