Entegris, Inc. (ENTG) Earnings Call Transcript & Summary

I cover the semiconductor capital equipment and other applied technologies markets in the technology sector. And up next in our fireside chat session today is Entegris, ENTG. They are a leading supplier of specialty materials and chemicals, contamination control and advanced materials handling solutions that serve primarily the semiconductor industry. We have with us today, CEO and President, Bertrand Loy. I'm going to toss it to Bertrand to first give a quick background on Entegris before we start the fireside chat session. So Bertrand, good morning. Thank you again. And I toss it over to you.

Thank you, Patrick, and thank you all for your interest in Entegris. Before we dive into a lot of detailed questions, I thought I would give you some high-level context for who we are. Entegris is a company that was founded about 50 years ago. We are a supplier of process solutions to some of the most advanced manufacturing environments in the world, and Patrick was kind enough to mention some of the process solutions that we are developing and manufacturing. I would argue that Entegris is a very, very exciting story, and I'm glad that you're on the call to learn more about us. The reason why we are exciting is that, number one, we serve primarily the semiconductor industry and its ecosystem, and this is a great place to be. The semiconductor industry will have a lot of strong secular tailwinds for the years to come, and I would argue that those tailwinds will only accelerate as a result of the post-COVID-19 era. Think about the greater automation, the greater digitalization of our lives and the economy. Second reason why we are an exciting story is that we are increasingly important to the semiconductor road map. And as you know, if you're all familiar with the semiconductor industry, the industry road map ultimately defines the winners and the losers. And I would argue that few companies has as many opportunities to contribute to the road map that Entegris has. And I'm sure we will talk about the importance of materials. We'll talk about the importance of purity in the manufacturing processes. And you know that we, at Entegris, operate at a crossroad of materials and purity. And that's one of the reasons why we believe that we should be in a position to outpace and outperform the industry for the years to come. A third point is that we have a very strong balance sheet. Obviously, we were very focused earlier this year on the overall liquidity and the strength of the balance sheet, but more broadly, we have been a very thoughtful of -- a very thoughtful allocator of capital for the past many years. Our framework is very clear, has been very consistent over the years, and we intend to continue to create long-term value for our shareholders by the way we deploy our capital. And then last but not least, we have a very experienced management team. And I think it's particularly important given the prevailing uncertainty around us. So overall, I think that again Entegris is ideally positioned, and we have some very ambitious goals to create value for our customers and to create value for our shareholders. So with that, Patrick, I will turn the call back to you for questions.

Thank you, Bertrand. For our fireside chat session, let's start off with some of the key focus items for investors at this time, maybe first, the COVID-19 impact both internally and operationally for you as well as the demand environment. So based on your March quarter results and your June commentary, it appears you were able to efficiently manage through the COVID-19 situation that presented itself in the March quarter. Maybe first off, can you discuss how [Technical Difficulty] Thanks again. And with this virtual conference, you're always going to get this type of issues. But maybe Bertrand, as I left off about COVID-19, can you discuss how Entegris responded to the crisis as it evolved? First, internally, what steps did you take in order to ensure you could procure the necessary supply and, more importantly for your customers, ensure that they receive their products on time?

Yes. So Patrick, we started actually battling the COVID-19 pandemic really early because of the operations that we have in Hangzhou, China. We, as a management team, came to conclude that there was a very likely scenario that this pandemic could be global in nature and it could create a real risk to our supply chain. So we made a decision very early on in February when the pandemic was still a nonissue in the U.S. We made a decision to increase our safety stocks for all of the critical components across our global supply chains assuming that at some point, the pandemic will imply our European suppliers as well as our U.S. suppliers. So we stocked up about 2 months of additional raw material, and that obviously served us very well. And we could actually then focus our attention to communicate to our teams our strategy, make sure that we could actually safeguard our sites, make our sites some of the safest places to be for our critical employees to come to work, manufacturing employees or lab engineers and technicians. And that actually worked very well. We were not impacted very much with the exception of 2 shelter-in-place ordinances, 1 in California and 1 in Malaysia, that forced us to shut down for a couple of weeks in some of those sites. But broadly, we didn't create any supply chain interruption for any one of our customers on a global basis, and that really goes to -- talk to the strength of the supply chain teams and manufacturing operations teams that we've been able to build at Entegris. So of course, the focus, once you have been able to shore up your business, then I think we've been in a position to actually start playing offense, in my opinion, which means that unlike many other companies, our business remained relatively stable, which did allow us to continue to spend in R&D actually at higher levels than what we've done in the past. And that was by design because we wanted to demonstrate to our customers that not only could they view Entegris as a reliable supplier, but we wanted them to also see that we were, in fact, a strategic partner in good times and in difficult times. And our global organization obviously has helped us tremendously. I mean our global footprint has been a great asset as we face the pandemic.

Great. That's helpful. Secondly, and this is always a harder question and I understand the limits that you probably can give, but can you describe the overall demand environment? And what is driving this demand? Do you believe it's actual demand? Or do you believe some of this is inventory replenishment from your customers?

So clearly, in Q1, it was actual demand and only actual demand. In Q2, as we provided some context for the overall state of the industry, we said that we were looking at a very, very strong backlog, and we believe that as part of that backlog, there is certainly some orders to build safety stock by our customers. But that's something that we're going to try to control, and that's an operating objective of ours that we embedded into the Q2 guidance that we provided. In other words, our goal is really to smooth the demand and the production of our products over multiple quarters and try to control and prevent, if possible, the buildup of any significant safety stocks by our customers. And because of what I was saying earlier, I think we have a credible argument to make with our customers given the fact that we were not the cause of any supply chain interruption during the darkest hours of the pandemic.

Great. That's helpful, Bertrand. Let's go to the other big investor topic today, the U.S.-China trade tensions that are ongoing. Although this issue is one that's more directly related to the equipment companies, can you give your thoughts on the U.S. Commerce Department's new trade regulations centered around China? Particularly from your end, are there any specific areas where this may require Entegris to get licensing agreements or permission to sell your products in China? And taking this issue aside, how do you see Entegris' opportunity in China for your businesses overall in the long run?

So as you mentioned, the products that have been the target of the Department of Commerce's new rulings so far have been really equipment and software solutions. So those classifications are really not covering what we do at Entegris. Things could change maybe, but as of right now, that's the case. So that's statement number one. Statement number two, there are a few products still that we develop in Entegris that would fall under those classifications. But in most cases, they are manufactured outside of the U.S. and the IP resides outside of the U.S. So we have not been required to seek export licenses for most of the things that we do. So we don't view that as detrimental to our business short term. Longer term -- first of all, longer term, we, at Entegris, certainly will want to be compliant with all of those new laws and -- but at the same time, we also will work really, really hard to be in a position to be viewed by our Chinese customers as a viable long-term supplier. And the way we will most likely do that is that we were going to continue to invest outside of U.S. in manufacturing and development capabilities to minimize the risk of future adverse rulings. Having said that, I would say that the risk, short term, for us is limited because there are no real Chinese domestic competitor to the solutions that we develop. Most of our competitors are U.S. or I would say non -- again, non-Chinese. So I think that the risk, short term, is limited. And then longer term, again, we're going to try to make the adjustments that we need to make to our business model in order to continue to be relevant to our Chinese customers.

Great. That provides a lot more clarity on your specific business. And let's go to your various businesses and the potential market opportunities for Entegris longer term. I believe one of the key differentiators for Entegris is your participation in the semiconductor and electronics materials and chemicals market. The thesis that I have believed in is that advanced semiconductor manufacturing continues to evolve and become more materials intensive in the manufacturing process. We are seeing it across the board, whether it's NAND, advanced kind of logic and even DRAM. So Bertrand, first, from a broad market opportunity, can you give your thoughts on these industry transitions and if you believe materials engineering is becoming a more critical piece of the overall manufacturing flow?

So first, let me start with the last question. Yes. I absolutely believe that materials will become one of the primary drivers to the semiconductor technology road map, and that's one of the many reasons we are so excited at Entegris. If you go back in time, for the longest time, the primary driver for the semi road map was miniaturization. It was all about shrinking the critical dimensions on the wafer. And what was driving the road map was the lithography steps and the deposition steps. Increasingly, the semiconductor makers are turning to new chip architectures and new materials in order to improve the performance of the next generation of chips. So miniaturization will continue to play a role, obviously, but it will not be the only driver for additional performance. And if you think about all of the new architectures, 3D NAND is one good example of that. Gate-all-around technology is another good example of that on the logic road map. All of that will be driven by the introduction of new molecules. We'll also present all sorts of incredibly complex challenges in terms of etching of those very high aspect ratio structures. And all of that again puts companies like Entegris front and center on the road map, and what we do is becoming increasingly valuable to the road map. And I think that's one of the many reasons why we believe we will be in a position to outpace the market for the years to come.

Great. Maybe as a follow-up question on that. Now you participate in a lot of different segments within the materials and chemicals side of things, but can you broadly talk about Entegris' market position and where you believe you're best suited to capitalize upon these opportunities? How do you differentiate yourself? And where do you believe some of the areas of share gains that you can drive the most over an extended period of time?

So if you -- I mean this industry is an amazing industry. The technology road map is extremely ambitious in terms of pushing the boundaries of the laws of physics, but it's also very ambitious in terms of the pace at which innovation is expected to take place. And what it means is that our customers really increasingly want to be relying on fewer partners that they deem as relevant, capable, trustworthy. And incumbent advantage in this industry is very significant. We are fortunate enough to have a very, very strong brand, very, very strong reputation. And that actually will allow us to capitalize on that incumbent advantage in many of the applications that we serve. And the way we will continue to maintain that advantage is by investing in the global footprint that we have and the tech centers that we have closed to our customers in Korea, in Taiwan, in Japan, in the U.S. and China. We will invest in the right process capabilities, the right metrology capabilities and the right talent in order to be able to support our customers' engineering teams in their home markets. We will obviously continue to invest not just on the technology but also on our manufacturing capabilities because what our customers expect is not only differentiated solutions but very, very precise manufacturing capabilities where there's absolutely no tolerance for any variation. So I think that the combination of technology leadership, customer engagement capabilities on a global scale and some of the most advanced manufacturing capabilities in the areas that we have in the portfolio really sets Entegris apart.

Great. Let's go to your contamination control business, which, also, I believe, is another area of high growth for the company. First, if you can talk about how overall semiconductor manufacturing requires more purity and better contamination control across, I guess, all customer segments. Can you first discuss the overall market opportunity in this business segment and how Entegris over time has emerged as the market share leader in that segment?

So this is indeed the one part of the portfolio that we expect to enjoy the highest growth rate. We expect this particular division to grow at about 400 basis point over the industry growth. And the reason is that the technology road map, both in memory and logic, will require extremely high levels of purity to yield at acceptable levels. And to achieve those very, very high purity levels, you not only will need to upgrade your filtration solutions within the fab environment, but increasingly, you will need to really engage your entire ecosystem to bring about more purity in bulk chemical manufacturing and upstream in the supply chain of the bulk chemical manufacturer. So what we're seeing is essentially the proliferation of many more filtration points up and down the supply chain. Those filters need to be replaced more frequently, and those filters are becoming more advanced up and down the supply chain. So the SAM is really literally expanding exponentially as a result of all of those factors. That's for the leading edge. There is also another interesting development on the trailing edge, which is actually probably very important for me to mention here. It's that if you think about the trailing-edge fabs, the markets are changing, and increasingly, those fabs are serving another applications around the car industry and as we are all talking about autonomous driving, ADAS systems, and we are all realizing that a very important attribute for those chips will be long-term reliability. And if you think about it, that's something relatively novel for the semiconductor industry. A chip was not expected to last for very, very long. If the phone that you own fails, well, you just get another one. And if your PC stops performing at peak performance, you replace it. If one of the critical sensors in your car fails in the middle of a highway, something pretty dramatic is going to happen and the car manufacturers will have no tolerance for that. So they've been very, very closely looking at understanding what could compromise the long-term reliability of chips. And interestingly enough, they came to conclude that very, very small contaminants can over time answer the reliability of the chip. So purity will become not only very important at the leading edge, but we believe that increasingly, purity will also become essential at the trailing edge. So again, I think there will be many different drivers for our TAM in contamination control to continue to expand at very exciting levels.

Great. Bertrand, maybe I'll follow up with something you kind of briefly mentioned when you talked about the Specialty Materials and Chemicals group. You talked about some of the work you're doing with your customers. Overall, the semiconductor industry continues to evolve. Memory industry is seeing NAND flash move to 3D structures, advanced logic is moving to EUV lithography, and soon, advanced logic will be moving to gate-all-around transistors and 3D structures on their end. From an Entegris perspective, can you discuss your work with customers and the collaborative efforts that allow you to help them and you becoming a more critical part of their overall process technology development process?

Well, in fact, maybe the proof point of the fact that we are becoming so critical to our customers' road map is that we couldn't talk about it as much as we used to. A lot of what we do is, in fact, becoming increasingly customized and you need to in a particular customer's road map. The molecules that we're developing for one customer will ultimately differ from what we're developing from another customer. And there, integration schemes are increasingly bifurcating. So it's becoming very, very difficult for us to talk about specific molecules. But at the highest level, I would just simply say that we see a lot of opportunities in deposition materials around hard mask materials, new dielectric materials in particular. We see a lot of opportunities in selective etch solutions from the chemistry side, and we continue to be very, very invested in our coating solutions as well for chamber components. So again, I think we have a well-rounded portfolio of opportunity. If I think about the single biggest reason why we are excited about our growth prospects, it doesn't have to do with any one product in particular. It has really to do with the quality and the breadth of the opportunity pipeline. We are a technology company. We know that not all of those initiatives will ultimately work. But given the quality and the breadth of the opportunities that we have in the pipeline, we feel very, very comfortable about our objective of outpacing the industry by 200 to 300 basis points for the years to come.

Great. Let's go to the operating model for a bit. Over the past few years, even as you've made acquisitions to grow the company, you've seen the model itself actually narrow its margin ranges but drive higher earnings leverage. There's clearly a greater resiliency in your operating model today despite the volatility and cyclicality inherent in the semiconductor business. From an operating model perspective, what are some of the key levers that has helped you narrow that margin range while at the same time drive higher operating margins and EBITDA?

This -- well, first of all, thank you for noticing. Because our management team, we had -- we made it a priority for us to not just focus on top line growth but really to expand the bottom line at least at the same rate, if not higher rate than the top line growth. And if you go back and look at our historical performance for the last 4 or 5 years, I believe that our bottom line has essentially expanded at close to twice the rate of the top line growth. And the top line growth was actually very attractive. So how did we do that? Well, focus and no silver bullet. But first, it starts with being a lot more deliberate today than we were maybe 20 years ago in the way we allocate our R&D and really focus on the hardest process challenges that our customers are facing, areas where we can really truly bring some unique solutions to the party so that we can actually capture enough value. I think we brought a lot more discipline to our pricing strategies as well. We are fortunate enough that the mix is playing to our favor with the highest growth coming from the most profitable part of the business, contamination control, not to name it. We have also made very significant investments in new capacity for the materials that I was describing, and we are now starting to see the leverage on those investments as some of those new molecules and products are hitting the market. So again -- and then a lot of just operational discipline. I mean we are constantly looking at ways to run our business in a more effective way. I think that the organization or reorganization of our customer-facing organization last year is a good example of that. I mean the company was performing really, really well, but we decided that we needed to try something different and, yes, better. So that mindset I think is ultimately what is allowing us to deliver those very exciting results.

Great. And maybe as a follow-up to the questions on the operating model. You stated a long-term goal of $3 in EPS. How confident do you remain on that longer-term target? And is M&A the largest variable that gets you there? Because you've made a lot of strides on EPS even without the acquisitions, but is M&A the fastest way to get to that $3?

Well, first, we -- so I mean first, we are very, very committed to that objective, and we have actually many different ways to get there. M&A is certainly a big accelerator. But as I mentioned earlier, our organic growth rate will also be very, very exciting. So it's all a question of time frame but if -- and to bring that horizon closer to us, obviously, M&A will have to be a factor, but we will get there on an organic basis as well given time.

Great. And speaking of M&A specifically, obviously, Entegris has been very active on the acquisitions front, making big acquisitions as well as smaller acquisitions that have broadened your portfolio. How do you evaluate potential deals for Entegris? And what are the key operating metrics you use to determine whether a company is a potential core fit for Entegris?

So in terms of the fit, we start really with just making sure that we get exposure to the most exciting areas of the road map or reinforcing what we already do. So expect us to add to our microcontamination platform, expect us to continue to add to our materials platform and, in a more selective way, to our sensing and control capabilities around certain modules of the fab. In terms of the financial metrics, it -- we want those acquisitions to be growth-enabling. In other words, we want them to help us achieve that 200 to 300 basis point over the industry growth rate. We want our acquisitions to be accretive year 2, and we compare accretion against just buying back our shares. So that's the benchmark that you need to hit. And then every acquisition usually has some level of hockey stick when it comes to ROIC, but we want to see a minimum threshold year 3, and we want the ROIC year 3 to be in the high single digit. So that's how -- broadly how we're thinking about fit, both strategically and financially.

Great. Bertrand, I think with that and if not any more technologies message, I think this is the end of our fireside chat session. Bertrand, thank you very much again for your time. And as you mentioned, Entegris has evolved greatly over the last several years. And now I believe you're over an $8 billion market cap. So congrats and kudos to you for those efforts and keep up the good work.

Thank you, Patrick, and thank you all for your attention.