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spk07: Your conference is about to begin. Should you require operator assistance, please press star and zero. Good day, everyone, and welcome to the INTEGRIS second quarter 2024 earnings conference call. At this time, all participants have been placed in a listen-only mode, and the floor will be open for your questions following our presentation. If you would like to ask a question at that time, please press star and one on your telephone keypad. If at any point your question has been answered, you may remove yourself from the queue simply by pressing star and two. So others can hear your questions clearly, we ask that you pick up your handset for best sound quality. Lastly, if you should require operator assistance, a reminder, please press star and zero. I would now like to turn the call over to Bill Seymour, Vice President of Investor Relations. Please go ahead, sir.
spk18: Good morning, everyone. Earlier today, we announced the financial results for our second quarter of 2024. Before we begin, I would like to remind listeners that our comments today 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 the reconciliation tables in today's news release as well as on our IR page of our website at integris.com. And finally, as a reminder, we have included in the earnings slide presentation for your reference consolidated and divisional P&Ls that exclude divestitures for Q1 and Q2 of 2024 and all four quarters of 2023. On the call today are Bertrand Lawat, our CEO, and Linda LaGorga, our CFO. With that, I'll hand the call over to Bertrand.
spk05: Thank you, Bill, and good morning. I am pleased with another strong performance in the second quarter. With a semi-industry that continues to be in transition, The Integris team delivered results that were in line or better than our guidance. Sales of $813 million were above our guidance, and excluding divestitures were up sequentially in all three divisions. Gross margin increased sequentially and was up over 300 basis points year on year, in line with expectations, showing strong execution and the benefit of our recent divestitures. and EBITDA and non-GAAP EPS were within our guidance range. Looking more closely at our sales performance, second quarter sales increased 10% sequentially and 6% year-over-year, excluding divestitures. Sales were up across most product areas. For our unit-driven revenues, sales were particularly strong in CMP slurries and pads, liquid filtration, and etching chemistries. Our capex-driven revenue also rebounded sequentially in the quarter. This was true for facilities-based capex products, like gas purification and fluid handling, as well as for WFE-related capex products, like FOOPS and gas filtration. Let me cover a few other business highlights. Last month, we announced a preliminary award of up to $75 million and proposed direct funding under the Chips and Science Act to support our new manufacturing facility we are building in Colorado. We are honored to be the first materials supplier to be awarded funding through this federal initiative, validating the importance of what we do as a key enabler of the semiconductor industry and its ecosystem. We expect to receive the funding and installments tied to the achievement of several milestones over the next four years. The first phase of this project will include the production of FOOPS and proprietary membrane used in our photoresist liquid filters. Initial sales from this facility are expected to be generated in the second half of 2025. I am also pleased to report that our new facility in Kaohsiung, Taiwan continues to be on track to ramp up production. We generated our first revenue from this new facility in late Q2, a great milestone for our local team, and we continue to expect to generate approximately $40 million in revenue from this facility for the full year 2024. Our investments in both Taiwan and Colorado will provide manufacturing capacity to support the significant growth we expect in the coming years. On that note, We are continuing to make significant R&D investments that are critical to capturing the many growth opportunities ahead of us. In support of this, we expect our R&D spending will increase 15% in 2024. Our customers' technology roadmaps are calling for new materials innovation and ever greater process purity to achieve optimal yields and incremental device performance. The compounding process complexity of these roadmaps is making our expertise in material science and materials purity increasingly valuable to our customers. Investments we are making in fundamental research and new product platforms are expected to translate into key wins in the new nodes, further solidifying us as a critical enabler of our customers' technology roadmaps. providing us with excellent growth opportunities going forward. Moving on to our outlook for the balance of the year, 2024 continues to be a transition year for the semiconductor market. Industry inventories are normalizing and fab utilization rates are broadly improving. These recent trends validate that the industry reached the bottom of the cycle in the first quarter of this year. We expect the market will continue to gradually recover in the second half of this year and will accelerate entering 2025. For 2024, including two months of the PIM business, which we divested in March, we now expect our sales will be approximately $3.3 billion. This modest reduction in our 2024 sales outlook primarily reflects slightly slower than expected market recovery in the back half of the year and the negative impact of foreign exchange versus our original assumptions. Excluding divestitures from both 2023 and 2024, our full year guidance amounts to approximately 7% top line growth versus 2023 and approximately 11% growth in the second half versus the first half of this year. Continue to expect EBITDA to be approximately 29% of revenue in 2024, and we now expect non-GAAP EPS to be approximately $3.15. Let me now turn the call over to Linda. Linda?
spk12: Good morning, and thank you, Bertrand. Our sales in the second quarter were above our guidance at $813 million, up 6% year-over-year, and up 10% sequentially, including the impact of divestitures from prior periods. On an as reported basis, our sales were down 10% year over year and up 5% sequentially. Foreign exchange negatively impacted revenue by $10 million year over year and by $4 million sequentially in Q2. Gross margin on a GAAP and non-GAAP basis was 46.2% in the second quarter within our guidance range. The higher margin compared to Q1 primarily reflects improved plant utilization, focused execution, and the PIM divestiture. Operating expenses on a GAAP basis were $246 million in Q2. Operating expenses on a non-GAAP basis in Q2 were $197 million. Adjusted EBITDA in Q2 was $226 million, or 27.8% of revenue within our guidance range. Net interest expense was $53 million in Q2. The GAAP tax rate in Q2 was 9%. and the non-GAAP tax rate was approximately 14%. GAAP diluted EPS was 45 cents per share in the second quarter. Non-GAAP EPS was 71 cents per share and within our guidance range. Sales for our MS division in Q2 were $342 million. Sales were up 8% sequentially, excluding the impact of divestitures. The largest contributors to the sales increase were CMP slurries and pads as we benefited from improving trends in memory, specialty coatings, and etching chemistries. On an as-reported basis, sales were down 2% sequentially. Adjusted operating margin for MS was 20.7% for the quarter. MS adjusted operating margin was up slightly sequentially, excluding divestitures. The modest increase in margin was driven by higher sales volumes, partially offset by increased R&D spending. Our AMH division sales in Q2 of $188 million were up 16% sequentially. The largest driver of the sequential sales increase in AMH was the rebound in our CapEx solutions, led by FOOPS, sensing and control, and fluid handling products. Adjusted operating margin for AMH was 15.4% for the quarter. The modest sequential increase in margin was primarily driven by higher sales volumes. Our MC division had record sales in Q2 of $294 million, up 10% sequentially. Revenue was up across most product lines, including gas purification, liquid filtration, and gas filtration. Adjusted operating margin for MC was 31.9% for the quarter. The modest sequential decline in margin was primarily driven by increased investment in R&D. Moving on to cash flow. Second quarter free cash flow was $52 million. CapEx for the quarter was $59 million. We continue to expect to spend approximately $350 million in total CapEx in 2024. A significant portion of the incremental spending in the second half will be related to our new facility in Colorado. During the second quarter, we paid down $55 million in debt from cash on hand, which means to date we have paid down approximately $1.9 billion of total debt since the close of the CMC acquisition. The blended interest rate on the debt portfolio is approximately 4.9%. And since the term loan is fully hedged, currently 100% of our debt is fixed. At the end of Q2, our gross debt was approximately $4.2 billion, and our net debt was approximately $3.9 billion. Gross leverage was 4.7 times, and net leverage was 4.3 times. We remain committed to maximizing free cash flow and debt repayment. Based on the pace of the market recovery, we now expect gross leverage to be slightly above four times at the end of 2024. Moving on to our Q3 outlook, we expect sales to range from $820 million to $840 million. We expect the EBITDA margin to range from 28.5% to 29.5%. and we expect GAAP EPS to be 51 to 56 cents per share and non-GAAP EPS to be 75 to 80 cents per share. Let me provide additional modeling information for Q3. We expect gross margin of 46 to 47% both on a GAAP and non-GAAP basis. gap operating expenses of $238 million to $242 million, and non-gap operating expenses of $191 million to $195 million. We also expect depreciation of approximately $47 million, net interest expense of approximately $53 million, and a non-gap tax rate of approximately 15%. I'll now hand it back over to Bertrand for some closing remarks.
spk05: Thank you, Linda. In closing, I am pleased with our strong performance and the team's execution in the first half of this year. Our performance to date and the double-digit growth we expect in the second half of the year will drive integracies above market growth for all of 2024. And the setup for next year is looking very promising. We feel good about the improving fundamentals of the semi-market, and we expect growth to accelerate into 2025. More importantly, our investments and customer engagements are positioning us very well to earn new wins in new nodes. All of this translates into significant growth opportunities for Integris, expanding our content per wafer, and ultimately driving significant market outperformance. With that, Operator, Let's open the line for questions.
spk07: Mr. Loy, thank you. And now to our phone audience. The floor is now open for your questions. At this time, if you have a question or comment, please press star and 1 on your telephone keypad. If at any point your question is answered and you may remove yourself from the queue by pressing star and 2. Again, we ask that you pick up your handset when posing your question to provide optimal sound quality. Thank you. Once again, ladies and gentlemen, that is star and 1. We'll take our first question today from Toshia Hari at Goldman Sachs. Please go ahead.
spk16: Hi, thank you. Good morning, team. Bertrand, maybe my first question is on the market outlook. You talked about a slower market recovery in the back half. You also talked about FX being a bit of a headwind. On your first point about the market recovering at a slower rate, I was hoping you could expand on that. is it both CapEx and wafer starts, or is it more wafer starts? And then by end application, based on what your customers have said and what your peers have said, it seems like leading edge is, if anything, a little bit stronger. And sort of the commentary and the data points from the memory and storage space seem quite constructive. So I'm curious what's driving the the slightly weaker outlook into the second half. And again, if you can contextualize the FX impact, that would be helpful too.
spk05: Sure, sure. So let's start with the industry. So, you know, a little bit lower assumptions on wafer starts. Right now we're expecting wafer starts to be up about 3%, so a little bit less than our original assumption when we started the year. We expect, on the other hand, CAPEX to be a little bit stronger in the low to mid single digit. That's the blend that gets you to about 3% industry growth. I think that what is driving that revised outlook in terms of wafer starts? As you mentioned, a lot of strength in advanced logic. driven by AI primarily, and that translates into our business, our advanced foundry business is growing very rapidly this year as a result of the strength that we are seeing in advanced logic. Memory, certainly in a better state than last year. We are seeing strength in high bandwidth memory, obviously, but NAN is still suffering from elevated inventories and then demand for NAN is still relatively soft in most applications. So if you think about wafer starts in memory, both in DRAM and NAN, in fact, we're not back to the levels of wafer start of pre-COVID. So recovery, yes, but, you know, slow recovery in terms of wafer starts. And that's really what is driving NAN. our business, as you know. And then, of course, you have mainstream, and we're seeing industrial and automotive in particular. The demand there has been declining in Q2, and the deterioration is certainly worse than our original forecast. And we expect many of our customers to cut production in the second half of the year. So that's really the blend that gets you to that 3% wafer start outlook for the year. So more broadly, I think you were asking me to provide a bit more color on the reduction in the annual guidance. There are three buckets, two that I cited in my preliminary remarks. So that's the slower market recovery. That accounts for about $25 million or so of the reduction for the annual outlook. foreign exchange accounts for about 15 roughly and the last one is specific to SIC. So what's behind those numbers? I mean the slower market recovery I think I talked about that again the broad-based recovery we originally expected in the second half is being delayed and that accounts for those 25 million dollars. We've seen on the foreign exchange we've seen a lot of movements in the first half of the year and the rates today are very different from what we used early in the year to set the original guidance. Then SIC is still a growth area for us. We expect our SIC business to grow 30% this year, which is very good, but it is less than the original 50% growth expectation that we had for this business starting the year. So that's the overall context for the reduction in our annual guidance.
spk16: Yeah, thank you for all the details, Bertrand. And then as my follow-up, maybe on your rate of outperformance versus the broader market, I think you've been saying, you know, four to five percentage points of outperformance for 24. Given your SIC comment there at the very end, maybe that's come in a little bit, but curious where you stand in terms of your outperformance in 24. And then for 25, I know it's really early, but in the past you've talked about things like gate all around and potential adoption of MOLLE and 3D NAND. What's kind of your confidence level as it pertains to your ability to outperform the broader market into 25? Thank you.
spk05: Yeah, so I think that you understand all of those numbers pretty well, Toshia. So when it comes to the outperformance in 24, right now we expect to outperform by four points. I mean, you know that no transitions are a major driver for our outperformance. And you also know that these transitions have been very limited this year. We expect that to change significantly in 2025 and a lot of reasons to be excited in terms of what we expect in advanced logic with the transition to N2, transition to gate or around architectures, and as you mentioned, 3D NAN, a lot of expectations in terms of the adoption of MOLLE and high-volume manufacturing in 2025. Again, we have always said that it's harder for us to outperform the industry when you are in a state of transition, and that's exactly the type of year that we're facing. in 2024. So in that context, an outperformance of 4% is, in my opinion, at least a good outcome.
spk16: Great. Thank you so much.
spk07: John Roberts at Mizuho, you have our next question.
spk17: Thank you. We had some restrictions on exports into China of products for leading-edge applications over a year ago, and things have been relatively stable since then. Do you see further restrictions as a potential risk or maybe just tariff risk here but not outright restrictions? Any thoughts on that topic?
spk05: Well, we won't speculate on potential new rules and regulations around trade with China. We obviously have been complying with the existing rules. We have quantified the impact to our business. which is about $20 million of lost revenue per quarter. So about $80 million on an annual basis. We have seen that reduction in late 2022, early 2023. And since then, I'm pleased to say that our China business has been actually performing really well. We have a lot of international customers in China. There are a lot of mainstream fabs in China, and our business with these customers have been actually growing very steadily. Again, I'm not going to speculate on potential new restrictions, but as of right now, we're very pleased with the performance of our business in China.
spk07: Thank you. Our next question will come from Bhavesh Lidaya at BMO Capital Markets.
spk20: Hi, good morning, Batron. Thanks for taking my question. If I look at your third quarter EBITDA guide and then the full year guide, which was slightly reduced, but not that much, you're implying a very strong fourth quarter, almost 25-30% higher sequentially versus the third. Can you touch on what's driving that? Are you seeing that in your order books? Or in general, what's the confidence level for the fourth quarter ramp?
spk12: Hey, Bethesda, it's Linda. Thanks for the question. Let me frame the answer for you. So first of all, the full year guide of the approximately 29%, we haven't changed. As we go through the year, we're balancing the investing in the business with the cost control. And so we took that into the account as we thought about EBITDA margin for the full year. Yeah, as we go into the fourth quarter and you think about how that EBITDA margin might progress, some of the keys are with our expectation on the overall guidance and the continued gradual recovery and growth in sales as we go into the fourth quarter, we're going to get the benefit from both volume and operating leverage. So those two things combined are going to allow us to have a stronger EBITDA margin as we go into the fourth quarter and therefore give us confidence in approximately 29% for the year.
spk13: Got it.
spk20: And then with respect to your third quarter guide, can you talk about the factors driving the low end and the high end of the guide? The low end in particular shows not much growth sequentially. So just trying to understand the factors as we head into the third quarter.
spk06: Yeah, Bhavesh.
spk05: I mean, look, I mean, I think right now what makes it very difficult to forecast is the fact that various segments in the industry are recovering at very different times and rates. And when we were putting our guidance together and our outlook for Q3 and the balance of the year, I mean, you really almost have to go to a customer-specific discussion. It's really hard to generalize. And I can't really give you customer-specific details on this call. But at high level, I would say that it really has to do with the level of reduction in production in mainstream i mean it's it's again it's very different customer by customer we know that some customers are expected to manage their output manager inventory a lot more aggressively than um than than originally expected and then the other thing is is memory again there's a lot of nice recovery but when you look at wafer starts as I mentioned earlier, they are still below pre-COVID. I think we are seeing a gradual recovery, which is encouraging, but we know that HBM capacity is limited. I know that the industry is obviously feverishly working to expand that, but the question is how much of that will we be able to see in Q3 as opposed to going into Q4 and in 2025. So, I think we feel good about the guidance for Q3. And again, what will sway us one way or another is really very much customs specific.
spk11: Thank you.
spk07: Our next question will come from the line of Melissa Weathers at Deutsche Bank.
spk01: Hi there. Thank you for taking my question. I wanted to double click on your CAPEX, your industry CAPEX commentary. I understand the wafer start forecast is coming down a little bit, but you did say that CAPEX is coming up a little bit. So can you talk about what's driving that? If there are any particular areas of strength that give you more confidence in that growing faster this year?
spk05: Yeah, so what we're seeing is we're seeing WFE actually growing in the mid to high single digit. We expect FAB construction to remain relatively flattish this year. So my comment is really the net effect of those two parts of the CAPEX number. Remember that our business is more exposed to FAB construction. About two-thirds of our CAPEX revenue ties to FAB construction. One-third ties to WFE.
spk01: Got it. Thank you. Kind of along those lines, could you talk more specifically about your FOOP business? I think last quarter you talked about that business having troughed in the first quarter. So how should we think about the more unit-driven FOOP business throughout 2024 and into 2025?
spk05: So FOOP is a CapEx business for us. And the reason it's a CapEx business is our customers usually would use those products for about four to five years. So they get eventually replaced but not frequently enough for us to deem them a consumable product. But I'm glad you're asking the question because, in fact, the food platform did really well sequentially in Q2. It was up nearly 30% sequentially, Q1 to Q2. And frankly, one of the reasons why Q3 guidance sequentially is more modest is that we expect our full business to contract in Q3. That business has been notoriously lumpy, especially in periods of transition like we are facing this year. So that business is going to contract a little bit in Q3. We expect that business to expand rapidly in Q4 and then continue to grow in 2025 on the strength of the overall industry.
spk07: Very helpful. Thank you. Charles Shi at Needham, you have our next question.
spk25: Hi, good morning. So Bertrand, you provided a little bit of color on the product details into Q3. I just want to ask if you could give a little bit more color across the three divisions, how things are trending from Q2 to Q3 on a sequential basis. Your comment on FOOBs. It makes me wonder maybe AMH is going to be down a little bit in Q3, but I wonder if you can provide a little bit more color for all three divisions. Thanks.
spk05: Sure. I prefer to look at our Q3 guidance in the context of a year-on-year comparison. In that context, at the midpoint of the range, you're looking at a 10% up quarter in Q3. And you will see actually strength across all three divisions compared to last year. We expect MC to be up in the mid-single digits. We expect MS to be up in the mid-teens, and that's excluding divestitures.
spk06: And we expect AMH to be up in the mid-single digits.
spk10: Thanks.
spk25: Maybe a question about KSP. I think you guys mentioned that it's on track. Congrats on the initial revenue in Q2. But just wonder, can you remind us what's the total revenue potential for that facility? And let's say compared with the time you started building this facility, the ramp in 2024, How does it compare? Is it a little bit lighter or is it rather consistent or actually above? I want to get a little bit of color on that. Additionally, I did get questions on how to think about KSP versus the advanced node business. that you're getting from the leading foundries in Taiwan. Is it really tied to that or the demand from the leading foundry is still largely supported by facilities from elsewhere? Thank you.
spk05: Yeah. So today, obviously, all of the needs of our leading Taiwanese customer and its ecosystem is supported from Taiwan. other factories. This is going to change, especially when it comes to advanced filters. We expect the bulk of the advanced filters used by our Taiwanese foundry customers and their ecosystem to come from Taiwan. Not all of it, but the bulk of it over time. So the full potential, the full capacity for our Kaohsiung site will be around $500 million. at maturity, at scale. And this year, really, the focus is on product qualifications. And we are making good progress, but there's a lot of work that needs to happen. We want to be ready for the N2 transition next year. It's important for our Foundry customers. It's also very important for their ecosystem. So the focus for us this year is is really about product qualifications as opposed to revenue maximization. Having said that, as I said, very pleased. I think we generated about $2 million in Q2. We expect to generate about $40 million on a full-year basis out of this facility. But again, the bulk of the efforts right now by the team is product qualifications ahead of the N2 conversion.
spk11: Thanks.
spk10: Thank you.
spk07: Our next question today comes from the line of Tim R. Curry at UBS.
spk24: Hi, thanks. Sorry, I got kicked out of the call for a moment, so I apologize if this has been asked. But, Bertrand, I'm sure you've seen the news reports, and even there was one today about expanding the use of the FDPR to further restrict, well, I mean, we can debate what they're trying to do, but they're certainly trying to expand the use of the FDPR and potentially even go after some of the Chinese equipment companies. And it seems like this is extending into the subsystem world, too. I mean, it's not materials per se, but it's subsystems. So I know that I ask you about this a lot, but, I mean, you're in pretty close contact with the Department of Commerce. Do you see any potential that materials and just the subsystems world that you sort of generally live in as being – swept into the restrictions?
spk05: So Tim, it's a fair question and as you know we've been very very involved working with the Commerce Department working also as part of the semi consortia but we don't have any specific knowledge around that right and we certainly don't control the outcome of those decisions so I'm sure you understand, but we won't speculate on what may happen in the future.
spk24: Okay, yeah, I get that. And then I guess just relative, and I don't know if this question was asked, but I mean, certainly we're seeing N3 is certainly, at least from an equipment perspective, there are shipments being dropped into the end of the year. TSMC sounds more bullish about N3 toward the end of the year and certainly more optimistic about N2 next year. The capacity forecasts keep on going up. So can you speak, there was a question before that was sort of trying to get at why you're down taking a bit when your largest customer from a consumption perspective seems to be upticking on these key nodes. Can you sort of try to square that for us again?
spk05: Yeah, so our business with Our largest customer is going really well this year. This is actually, as you would expect, the fastest part of our business. We certainly expect Q2 to be a very successful node and a big node transition in 2025. And we know that the entire ecosystem is getting ready for that. We expect to see the bulk of that impact in 2025, but frankly, we expect to see some of it at the end of this year in Q4, and that's what is reflected in the implied guidance for Q4.
spk24: Okay, Bertrand, so then just to make sure I understand, so Q4 being taken down, if that's being taken up in Q4, so what is offsetting that in Q4?
spk05: Well, I think, again, as I mentioned, the SIC business is going to be growing at 30% year-on-year, but the original expectation was for it to grow at about 50%. So that's one headwind that we're facing. We are also obviously witnessing a significant contraction in mainstream FAB activity. both because demand from their automotive and industrial applications is coming down, because a lot of their customers are really focusing on reducing inventory levels, and our customers are adjusting their fab production schedules accordingly. So that's something that we're taking into account as we revise the overall, I mean, the second half industry outlook. I mean, those are the two main drivers.
spk23: Understood, okay. Thank you so much.
spk05: Sure.
spk07: Our next question comes from Alexey Yefremov at KeyBank Capital Markets.
spk15: Thanks and good morning everyone. This is Ryan on for Alexey. Just one from me. Wanted to kind of drill into margins a little bit sequentially from 2Q to 3Q. Obviously you guys are kind of guiding margins to be up. Just wondering on a segment basis, Kind of where you expect that strength to come from and you know what's giving you confidence there. Thanks.
spk12: Thanks Ryan. So to me it's really an overall strength. So there is some uptick in revenue as you can see and as we continue to see that uptick we will continue to see volume leverage. As you think about Q2 to Q3 also we have the OpEx number coming down a bit so we're getting that OpEx leverage. and the OpEx as a percent of revenue will be coming down as we go through Q3 and into Q4. So that general recovery as it happens, we're going to see that benefit in our margins. Obviously, we have a little bit of pressure throughout the year that offsets some of that benefit as we go from Q3 to Q4 as we continue to ramp KSP as Bertrand referenced and focus on the qualifications.
spk10: Anything further, Mr. Efremov?
spk14: Nope. All set here. Thank you.
spk07: Thank you, sir. And our final question today comes from the line of Chris Parkinson at Wolf Research.
spk21: Great. Thank you so much. Can you just talk a little bit more about how we should be thinking about and modeling the ramps, not only about, you know, in Taiwan more near term, but any preliminary thoughts on Colorado as well? Just, you know, any color would be greatly appreciated. Thank you so much.
spk12: Sure. So in our industry, as we all know, as we're building capacity, we're going to have plants that we're building the capacity, focusing on the qualifications and therefore, you know, in advance of the revenue. So on KSP, the way I would think about 2024 is the gross margin headwind year over year is about 80 basis points. This year, the Colorado facility is not in service yet. We're building it. As we go into 25 and speak about 25, we will have some margin pressure as we ramp up into the revenues. As we mentioned earlier, revenues for Colorado will come in the second half of the year. So that's how I think about the two facilities at this point in time.
spk21: Great. And just a real quick follow-up, just on the balance sheet, the deleveraging process, obviously it's been a bit of a journey the last few years. Can you just remind us, you know, just given your free cash flow outlook for the second half as well as your projected conversion for 25, just any preliminary update on, you know, uses of cash and how you're thinking about the balance sheet, what you're hearing from shareholders, so on and so forth. Thank you.
spk12: So with the balance sheet, you know, I'm very pleased with us controlling what we could control. And what we've done to date is we've used proceeds from divestitures to pay down debt, and we're using our free cash flow to pay down debt. we will continue to stay focused on using that free cash flow to pay down debt. We are absolutely committed to continuing to reduce our leverage. Since the acquisition of CMC, we have paid down $1.9 billion of debt. But as we go through this year, we still want to make sure we're balancing investing in the business with the debt pay down. So as I mentioned earlier, that all comes together We expect leverage to be slightly north of the 4.0 times based on the timing of the recovery this year and the timing of cash flow coming in. But we still remain very committed to getting that leverage down further.
spk05: To add to that, I would say, look, we're very focused, obviously, on honoring the commitment we made to bring down the leverage as quickly as we could. Having said that, I'm very, very proud of what the team has been doing this year. This is, again, a transition year for the industry, and we've been able, in spite of that, to make all of the required strategic investments that would be critical to our future success, investing significantly in CapEx this year and last year, continuing to invest in R&D. I think I mentioned the increase in R&D of about 15% year-on-year. And all of that is really, really important to set us up for our future success. So those investments in technology and capacity and redundant manufacturing capabilities, all of that will ultimately translate into significant competitive advantage for Integris. So I'm glad that we're able actually to do all of that and operate within our target model or the target model that we presented during the Analyst Day in January of this year. A tough year to navigate overall, but I think the team is performing really well.
spk22: Thank you for the caller.
spk07: And that was our final question in the queue today. I'd like to turn the floor back to Mr. Bill Seymour for any additional or closing remarks.
spk18: All right. Thank you for joining our call today. Please reach out to me directly if you have any follow-ups. Have a good day. Thank you very much.
spk07: Ladies and gentlemen, this does conclude today's Integra's Q4 conference call. We thank you for your participation. You may now disconnect your lines.
spk08: © transcript Emily Beynon Thank you. Hello. Thank you. you
spk07: Good day everyone and welcome to the INTEGRIS second quarter 2024 earnings conference call. At this time all participants have been placed in a listen only mode and the floor will be open for your questions following our presentation. If you would like to ask a question at that time, please press star and one on your telephone keypad. If at any point your question has been answered, you may remove yourself from the queue simply by pressing star and two. So others can hear your questions clearly, we ask that you pick up your handset for best sound quality. Lastly, if you should require operator assistance, a reminder, please press star and zero. I would now like to turn the call over to Bill Seymour, Vice President of Investor Relations. Please go ahead, sir.
spk18: Good morning, everyone. Earlier today, we announced the financial results for our second quarter of 2024. Before we begin, I would like to remind listeners that our comments today 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 the reconciliation tables in today's news release as well as on our IR page of our website at integris.com. And finally, as a reminder, we have included in the earnings slide presentation for your reference consolidated and divisional P&Ls that exclude divestitures for Q1 and Q2 of 2024 and all four quarters of 2023. On the call today are Bertrand Lawat, our CEO, and Linda LaGorga, our CFO. With that, I'll hand the call over to Bertrand.
spk05: Thank you, Bill, and good morning. I am pleased with another strong performance in the second quarter. With a semi-industry that continues to be in transition, the Integris team delivered results that were in line or better than our guidance. Sales of $813 million were above our guidance, and excluding divestitures were up sequentially in all three divisions. Gross margin increased sequentially and was up over 300 basis points year on year, in line with expectations, showing strong execution and the benefit of our recent divestitures. EBITDA and non-GAAP EPS were within our guidance range. Looking more closely at our sales performance, second quarter sales increased 10% sequentially and 6% year-over-year, excluding divestitures. Sales were up across most product areas. For our unit-driven revenues, sales were particularly strong in CMP slurries and pads, liquid filtration, and etching chemistries. Our capex-driven revenue also rebounded sequentially in the quarter. This was true for facilities-based capex products, like gas purification and fluid handling, as well as for WFE-related CAPEX products like FOOPS and gas filtration. Let me cover a few other business highlights. Last month, we announced a preliminary award of up to $75 million in proposed direct funding under the Chips and Science Act to support our new manufacturing facility we are building in Colorado. We are honored to be the first material supplier to be awarded funding through this federal initiative, validating the importance of what we do as a key enabler of the semiconductor industry and its ecosystem. We expect to receive the funding and installments tied to the achievement of several milestones over the next four years. The first phase of this project will include the production of FOOPS, and proprietary membrane used in our photoresist liquid filters. Initial sales from this facility are expected to be generated in the second half of 2025. I am also pleased to report that our new facility in Kaohsiung, Taiwan, continues to be on track to ramp up production. We generated our first revenue from this new facility in late Q2, a great milestone for our local team. and we continue to expect to generate approximately $40 million in revenue from this facility for the full year 2024. Our investments in both Taiwan and Colorado will provide manufacturing capacity to support the significant growth we expect in the coming years. On that note, we are continuing to make significant R&D investments that are critical to capturing the many growth opportunities ahead of us. In support of this, we expect our R&D spending will increase 15% in 2024. Our customers' technology roadmaps are calling for new materials innovation and ever greater process purity to achieve optimal yields and incremental device performance. The compounding process complexity of these roadmaps is making our expertise in materials science and materials purity increasingly valuable to our customers. Investments we are making in fundamental research and new product platforms are expected to translate into key wins in the new nodes, further solidifying us as a critical enabler of our customers' technology roadmaps, providing us with excellent growth opportunities going forward. Moving on to our outlook for the balance of the year, 2024 continues to be a transition year for the semiconductor market. Industry inventories are normalizing and fab utilization rates are broadly improving. These recent trends validate that the industry reached the bottom of the cycle in the first quarter of this year. We expect the market will continue to gradually recover in the second half of this year and will accelerate entering 2025. for 2024, including two months of the PIM business, which we divested in March, we now expect our sales will be approximately $3.3 billion. This modest reduction in our 2024 sales outlook primarily reflects slightly slower than expected market recovery in the back half of the year and the negative impact of foreign exchange versus our original assumptions. Excluding divestitures from both 2023 and 2024, our full-year guidance amounts to approximately 7% top-line growth versus 2023, and approximately 11% growth in the second half versus the first half of this year. Continue to expect EBITDA to be approximately 29% of revenue in 2024, and we now expect non-GAAP EPS to be approximately $3.15. Let me now turn the call over to Linda. Linda?
spk12: Good morning and thank you, Bertrand. Our sales in the second quarter were above our guidance at $813 million, up 6% year-over-year and up 10% sequentially, including the impact of divestitures from prior periods. On an as-reported basis, our sales were down 10% year-over-year and up 5% sequentially. Foreign exchange negatively impacted revenue by $10 million year-over-year and by $4 million sequentially in Q2. Gross margin on a GAAP and non-GAAP basis was 46.2% in the second quarter within our guidance range. The higher margin compared to Q1 primarily reflects improved plant utilization, focused execution, and the PIM divestiture. Operating expenses on a GAAP basis were $246 million in Q2. Operating expenses on a non-GAAP basis in Q2 were $197 million. Adjusted EBITDA in Q2 was $226 million, or 27.8% of revenue, within our guidance range. Net interest expense was $53 million in Q2. The gap tax rate in Q2 was 9%, and the non-gap tax rate was approximately 14%. Gap diluted EPS was $0.45 per share in the second quarter. Non-gap EPS was $0.71 per share and within our guidance range. Sales for our MS division in Q2 were $342 million. Sales were up 8% sequentially, excluding the impact of divestitures. The largest contributors to the sales increase were CMP slurries and pads as we benefited from improving trends in memory, specialty coatings, and etching chemistries. On an as-reported basis, sales were down 2% sequentially. Adjusted operating margin for MS was 20.7% for the quarter. MS adjusted operating margin was up slightly sequentially, excluding divestitures. The modest increase in margin was driven by higher sales volumes, partially offset by increased R&D spending. Our AMH division sales in Q2 of $188 million were up 16% sequentially. The largest driver of the sequential sales increase in AMH was the rebound in our CapEx solutions, led by FOOPS, sensing and control, and fluid handling products. Adjusted operating margin for AMH was 15.4% for the quarter. The modest sequential increase in margin was primarily driven by higher sales volumes. Our MC division had record sales in Q2 of $294 million, up 10% sequentially. Revenue was up across most product lines, including gas purification, liquid filtration, and gas filtration. Adjusted operating margin for MC was 31.9% for the quarter. The modest sequential decline in margin was primarily driven by increased investment in R&D. Moving on to cash flow. Second quarter free cash flow was $52 million. CapEx for the quarter was $59 million. We continue to expect to spend approximately $350 million in total CapEx in 2024. A significant portion of the incremental spending in the second half will be related to our new facility in Colorado. During the second quarter, we paid down $55 million in debt from cash on hand, which means to date, We have paid down approximately $1.9 billion of total debt since the close of the CMC acquisition. The blended interest rate on the debt portfolio is approximately 4.9%. And since the term loan is fully hedged, currently 100% of our debt is fixed. At the end of Q2, our gross debt was approximately $4.2 billion. and our net debt was approximately $3.9 billion. Gross leverage was 4.7 times and net leverage was 4.3 times. We remain committed to maximizing free cash flow and debt repayment. Based on the pace of the market recovery, we now expect gross leverage to be slightly above four times at the end of 2024. Moving on to our Q3 outlook, we expect sales to range from $820 million to $840 million. We expect the EBITDA margin to range from 28.5% to 29.5%. And we expect GAAP EPS to be 51 to 56 cents per share and non-GAAP EPS to be 75 to 80 cents per share. Let me provide additional modeling information for Q3. We expect gross margin of 46% to 47%, both on a GAAP and non-GAAP basis. GAAP operating expenses of $238 million to $242 million, and non-GAAP operating expenses of $191 million to $195 million. We also expect depreciation of approximately $47 million, net interest expense of approximately $53 million, and a non-GAAP tax rate of approximately 15%. I'll now hand it back over to Bertrand for some closing remarks.
spk05: Thank you, Linda. In closing, I am pleased with our strong performance and the team's execution in the first half of this year. Our performance to date and the double digit growth we expect in the second half of the year will drive integracies above market growth for all of 2024. And the setup for next year is looking very promising. We feel good about the improving fundamentals of the semi-market and we expect growth to accelerate into 2025. More importantly, Our investments and customer engagements are positioning us very well to earn new wins in new nodes. All of this translates into significant growth opportunities for Integris, expanding our content per wafer, and ultimately driving significant market outperformance. With that, operator, let's open the line for questions.
spk07: Mr. Loy, thank you. And now to our phone audience. The floor is now open for your questions. At this time, if you have a question or comment, please press star and 1 on your telephone keypad. If at any point your question is answered, then you may remove yourself from the queue by pressing star and 2. Again, we ask that you pick up your handset when posing your question to provide optimal sound quality. Thank you. Once again, ladies and gentlemen, that is star and 1. We'll take our first question today from Toshia Hari at Goldman Sachs. Please go ahead.
spk16: Hi, thank you. Good morning, team. Bertrand, maybe my first question is on the market outlook. You talked about a slower market recovery in the back half. You also talked about FX being a bit of a headwind. On your first point about the market recovering at a slower rate, I was hoping you could, you know, expand on that. Is it both CapEx and wafer starts, or is it more wafer starts? And then by end application, based on what your customers have said and what your peers have said, it seems like leading edge is, if anything, a little bit stronger. And sort of the commentary and the data points from the memory and storage space seem quite constructive. So I'm curious what's driving the slightly weaker outlook into the second half. And again, if you can contextualize the FX impact, that would be helpful too.
spk05: Sure, sure. Let's start with the industry. A little bit lower assumptions on wafer starts. Right now, we're expecting wafer starts to be up about 3%, so a little bit less than our original assumption when we started the year. We expect, on the other hand, CapEx to be a little bit stronger in the low to mid single digit. That's the blend of that gets you to about 3% industry, um, growth. I think that, um, you know, what, what is driving that revised outlook in terms of way for starts? Uh, so as you mentioned, uh, a lot of strength in, in advanced logic, um, driven by AI primarily, and that translates into our, um, you know, business, our advanced foundry business is going very rapidly this year. as a result of the strength that we are seeing in advanced logic. Memory, certainly in a better state than last year. We are seeing strength in high bandwidth memory, obviously, but NAND is still suffering from elevated inventories, and then demand for NAND is still relatively soft in most applications. So if you think about wafer starts in memory, both in DRAM and NAN. In fact, we're not back to the levels of wafer start of pre-COVID. So recovery, yes, but, you know, slow recovery in terms of wafer starts. And that's really what is driving our business, as you know. And then, of course, you have mainstream, and we're seeing Industrial and automotive in particular, the demand there has been declining in Q2, and the deterioration is certainly worse than our original forecast. And we expect many of our customers to cut production in the second half of the year. So that's really the blend that gets you to that 3% wafer start outlook for the year. So more broadly, I think you're asking me to provide a bit more color on the reduction in the annual guidance. There are three buckets, two that I cited in my preliminary remarks. So that's the slower market recovery. That accounts for about $25 million or so of the reduction for the annual outlook. Foreign exchange accounts for about 15 roughly, and the last one is specific to SIC. So what's behind those numbers? I mean, the slower market recovery, I think I talked about that. Again, the broad-based recovery we originally expected in the second half is being delayed, and that accounts for those $25 million. We've seen on the foreign exchange, we've seen a lot of movements in the first half of the year. and the rates today are very different from what we used early in the year to set the original guidance. Then SIC is still a growth area for us. We expect our SIC business to grow 30% this year, which is very good, but it is less than the original 50% growth expectation that we had for this business starting the year. So that's the overall context for the reduction in our annual guidance.
spk16: Yeah, thank you for all the details, Bertrand. And then as my follow-up, maybe on your rate of outperformance versus the broader market, I think you've been saying, you know, four to five percentage points of outperformance for 24. Given your SIC comment there at the very end, maybe that's come in a little bit, but curious where you stand in terms of your outperformance in 24. And then for 25, I know it's really early, but in the past you've talked about things like gate all around and potential adoption of MOLLE and 3D NAND. What's kind of your confidence level as it pertains to your ability to outperform the broader market into 25? Thank you.
spk05: Yeah, so I think that you understand all of those numbers pretty well, Toshia. So when it comes to the outperformance in 24, right now we expect to outperform by four points. I mean, you know that no transitions are a major driver for our outperformance. And you also know that these transitions have been very limited this year. We expect that to change significantly in 2025 and a lot of reasons to be excited in terms of what we expect in advanced logic with the transition to N2, transition to gate-all-around architectures, and as you mentioned, 3D NAN, a lot of expectations in terms of the adoption of MOLLE and high-volume manufacturing in 2025. Again, we have always said that it's harder for us to outperform the industry when you are in a state of transition, and that's exactly the type of year that we're facing. in 2024. So in that context, an outperformance of 4% is, in my opinion, at least a good outcome.
spk10: Great.
spk16: Thank you so much.
spk07: John Roberts at Mizuho, you have our next question.
spk17: Thank you. We had some restrictions on exports into China of products for leading-edge applications over a year ago, and things have been relatively stable since then. Do you see further restrictions as a potential risk or maybe just tariff risk here but not outright restrictions? Any thoughts on that topic?
spk05: Well, we won't speculate on potential new rules and regulations around trade with China. We obviously have been complying with the existing rules. We have quantified the impact to our business. which is about $20 million of lost revenue per quarter. So about $80 million on an annual basis. We have seen that reduction in late 2022, early 2023. And since then, I'm pleased to say that our China business has been actually performing really well. We have a lot of international customers in China. There are a lot of mainstream fabs in China, and our business with these customers have been actually growing very steadily. Again, I'm not going to speculate on potential new restrictions, but as of right now, we're very pleased with the performance of our business in China.
spk07: Thank you. Our next question will come from Bhavesh Lidaya at BMO Capital Markets.
spk20: Hi, good morning, Batran. Thanks for taking my question. If I look at your third quarter EBITDA guide and then the full year guide, which was slightly reduced, but not that much, you're implying a very strong fourth quarter, almost 25-30% higher sequentially versus the third. Can you touch on what's driving that? Are you seeing that in your order books? Or in general, what's the confidence level for the fourth quarter ramp?
spk12: Hey Bethesh, it's Linda. Thanks for the question. Let me like frame the answer for you. So first of all, the full year guide of the approximately 29%, we haven't changed. You know, as we go through the year, we're balancing the investing in the business with the cost control. And so we took that into the account as we thought about EBITDA margin for the full year. Yeah, as we go into the fourth quarter and you think about how that EBITDA margin might progress, some of the keys are with our expectation on the overall guidance and the continued gradual recovery and growth in sales as we go into the fourth quarter, we're going to get the benefit from both volume and operating leverage. So those two things combined are going to allow us to have a stronger EBITDA margin as we go into the fourth quarter and therefore give us confidence in the approximately 29% for the year.
spk13: Got it.
spk20: And then with respect to your third quarter guide, can you talk about the factors driving the low end and the high end of the guide? The low end in particular shows not much growth sequentially. So just trying to understand the factors as we head into the third quarter.
spk06: Yeah, Bhavesh.
spk05: I mean, look, I mean, I think right now what makes it very difficult to forecast is the fact that various segments in the industry are recovering at very different times and rates. And when we were putting our guidance together and our outlook for Q3 and the balance of the year, I mean, you really almost have to go to a customer-specific discussion. It's really hard to generalize. And I can't really give you customer-specific details on this call. But at high level, I would say that it really has to do with, you know, the the level of reduction in production in mainstream. I mean, it's, it's, again, it's very different customer by customer. We know that some customers are expected to manage their output manager inventory a lot more aggressively than, um, then, then originally expected. Um, and then the other thing is, is memory. Again, there's a lot of nice recovery, but when you look at wafer starts, as I mentioned earlier, they are still below pre-COVID. I think we are seeing a gradual recovery, which is encouraging, but we know that HBM capacity is limited. I know that the industry is obviously feverishly working to expand that, but the question is how much of that will we be able to see in Q3 as opposed to going into Q4 and in 2025. So, I think we feel good about the guidance for Q3. And again, what will sway us one way or another is really very much customs specific.
spk11: Thank you.
spk07: Our next question will come from the line of Melissa Weathers at Deutsche Bank.
spk01: Hi there. Thank you for taking my question. I wanted to double-click on your CAPEX, your industry CAPEX commentary. I understand the wafer start forecast is coming down a little bit, but you did say that CAPEX is coming up a little bit. So can you talk about what's driving that? Are there any particular areas of strength that give you more confidence in that growing faster this year?
spk05: Yeah, so what we're seeing is we're seeing WFE actually growing in the mid to high single digit. We expect FAB construction to remain relatively flattish this year. So my comment is really the net effect of those two parts of the CAPEX number. Remember that our business is more exposed to FAB construction. About two-thirds of our CAPEX revenue ties to FAB construction. One-third ties to WFE.
spk01: Got it. Thank you. Kind of along those lines, could you talk more specifically about your FOOP business? I think last quarter you talked about that business having troughed in the first quarter. So how should we think about the more unit-driven FOOP business throughout 2024 and into 2025?
spk05: So FOOP is a CapEx business for us. And the reason it's a CapEx business is our customers usually would use those products for about four to five years. So they get eventually replaced but not frequently enough for us to deem them a consumable product. But I'm glad you're asking the question because, in fact, the food platform did really well sequentially in Q2. It was up nearly 30% sequentially, Q1 to Q2. And frankly, one of the reasons why Q3 guidance sequentially is more modest is that we expect our full business to contract in Q3. That business has been notoriously lumpy, especially in periods of transition like we are facing this year. So that business is going to contract a little bit in Q3. We expect that business to expand rapidly in Q4 and then continue to grow in 2025 on the strength of the overall industry.
spk07: Very helpful. Thank you. Charles Shi at Needham, you have our next question.
spk25: Hi, good morning. So Bertrand, you provided a little bit of color on the product details into Q3. I just want to ask if you could give a little bit more color across the three divisions, how things are trending from Q2 to Q3 on a sequential basis. Your comment on FOOBS makes me wonder, maybe AMH is going to be down a little bit in Q3, but I wonder if you can provide a little bit more color for all three divisions. Thanks.
spk05: Sure. I prefer to look at our Q3 guidance in the context of a year-on-year comparison. In that context, at the midpoint of the range, you're looking at a 10% up quarter in Q3. And you will see actually strength across all three divisions compared to last year. We expect MC to be up in the mid-single digits. We expect MS to be up in the mid-teens, and that's excluding divestitures.
spk06: And we expect AMH to be up in the mid-single digits.
spk25: Thanks. Maybe a question about KSP. I think you guys mentioned that it's on track. Congrats on the initial revenue in Q2. But just wonder, can you remind us what's the total revenue potential for that facility? And let's say compared with the time you started building this facility, the ramp in 2021 how does it compare? Is it a little bit lighter or is it rather consistent or actually above? I want to get a little bit of color on that. And additionally, I did get questions on how to think about KSP versus the advanced node business that you're getting from the leading foundries in Taiwan. Is it really tied to that or the demand from the leading foundry is still largely supported by facilities from elsewhere? Thank you.
spk05: Yeah. So today, obviously, all of the needs of our leading Taiwanese customer and its ecosystem is supported from Taiwan. you know, other factories, right? This is going to change, especially when it comes to advanced filters. We expect the bulk of the advanced filters used by our Taiwanese foundry customers and their ecosystem to come from Taiwan. Not all of it, but the bulk of it over time, right? So the full potential, the full capacity for our Kaohsiung site will be around $500 million. at maturity, at scale. And this year, really, the focus is on product qualifications. And we are making good progress, but there's a lot of work that needs to happen. We want to be ready for the N2 transition next year. It's important for our foundry customers. It's also very important for their ecosystem. So the focus for us this year is is really about product qualifications as opposed to revenue maximization. Having said that, as I said, very pleased. I think we generated about $2 million in Q2. We expect to generate about $40 million on a full-year basis out of this facility. But again, the bulk of the efforts right now by the team is product qualifications ahead of the N2 conversion.
spk11: Thanks.
spk10: Thank you.
spk07: Our next question today comes from the line of Tim R. Curry at UBS.
spk24: Hi, thanks. Sorry, I got kicked out of the call for a moment, so I apologize if this has been asked. But, Bertrand, I'm sure you've seen the news reports, and even there was one today about expanding the use of the FDPR to further restrict, well, I mean, we can debate what they're trying to do, but they're certainly trying to expand the use of the FDPR and potentially even go after some of the, you know, Chinese equipment companies. So, and it seems like this is extending into the subsystem world too. I mean, it's not materials per se, but it's subsystems. So I know that I ask you about this a lot, but I mean, you're in pretty close contact with the Department of Commerce. Do you see any potential that materials and just the subsystems world that you sort of generally live in as being swept into the restrictions?
spk05: So Tim, it's a fair question. I mean, as you know, we've been very, very involved working with the Commerce Department, working also as part of the SEMI consortia, but we don't have any specific knowledge around that, right? And we certainly don't control the outcome of those decisions. So I'm sure you understand, but we won't speculate on what may happen in the future.
spk24: Okay, yeah, I get that. And then I guess just relative, and I don't know if this question was asked, but I mean, certainly we're seeing N3 is certainly, at least from an equipment perspective, there are shipments being dropped into the end of the year. TSMC sounds more bullish about N3 toward the end of the year and certainly more optimistic about N2 next year. The capacity forecasts keep on going up. So can you speak, there was a question before that was sort of trying to get at why you're down taking a bit when your largest customer from a consumption perspective seems to be up ticking on these key nodes. Can you sort of try to square that for us again?
spk05: Yeah, so our business with Our largest customer is going really well this year. This is actually, as you would expect, the fastest part of our business. We certainly expect Q2 to be a very successful node and a big node transition in 2025. And we know that the entire ecosystem is getting ready for that. We expect to see the bulk of that impact in 2025, but frankly, we expect to see some of it at the end of this year in Q4, and that's what is reflected in the implied guidance for Q4.
spk24: Okay, Bertrand, so then just to make sure I understand, so Q4 being taken down, if that's being taken up in Q4, so what is offsetting that in Q4?
spk05: Well, I think, again, as I mentioned, the SIC business is going to be growing at 30% year-on-year, but the original expectation was for it to grow at about 50%. So that's one headwind that we're facing. We are also obviously witnessing a significant contraction in mainstream FAB activity. both because demand from their automotive and industrial applications is coming down, because a lot of their customers are really focusing on reducing inventory levels, and our customers are adjusting their fab production schedules accordingly. So that's something that we're taking into account as we revise the overall, I mean, the second half industry outlook. I mean, those are the two main drivers.
spk23: Understood, okay. Thank you so much.
spk05: Sure.
spk07: Our next question comes from Alexey Yefremov at KeyBank Capital Markets.
spk15: Thanks and good morning everyone. This is Ryan on for Alexey. Just one from me. Wanted to kind of drill into margins a little bit sequentially from 2Q to 3Q. Obviously you guys are kind of guiding margins to be up. Just wondering on a segment basis, Kind of where you expect that strength to come from and you know what's giving you confidence there. Thanks.
spk12: Thanks Ryan. So to me it's really an overall strength. So there is some uptick in revenue as you can see and as we continue to see that uptick we will continue to see volume leverage. As you think about Q2 to Q3 also we have the OpEx number coming down a bit so we're getting that OpEx leverage. and the OPEX as a percent of revenue will be coming down as we go through Q3 and into Q4. So that general recovery as it happens, we're going to see that benefit in our margins. Obviously, we have a little bit of pressure throughout the year that offsets some of that benefit as we go from Q3 to Q4 as we continue to ramp KSP, as Bertrand referenced, and focus on the qualifications.
spk07: Anything further, Mr. Yeffermoff?
spk14: No, all set here. Thank you.
spk07: Thank you, sir. And our final question today comes from the line of Chris Parkinson at Wolf Research.
spk21: Great. Thank you so much. Can you just talk a little bit more about how we should be thinking about and modeling the ramps, not only in Taiwan more near term, but any preliminary thoughts on Colorado as well? Any color would be greatly appreciated. Thank you so much.
spk12: Sure. In our industry, as we all know, as we're building capacity, we're going to have plants that we're building the capacity, focusing on the qualifications, and therefore in advance of the revenue. So on KSP, the way I would think about 2024 is the gross margin headwind year over year is about 80 basis points. This year, the Colorado facility is not in service yet. We're building it. As we go into 25 and speak about 25, we will have some margin pressure as we ramp up into the revenues. As we mentioned earlier, revenues for Colorado will come in the second half of the year. So that's how I think about the two facilities at this point in time.
spk21: Great. And just a real quick follow-up, just on the balance sheet, the deleveraging process, obviously it's been a bit of a journey the last few years. Can you just remind us, just given your free cash flow outlook for the second half as well as your projected conversion for 25, just any preliminary update on uses of cash and how you're thinking about the balance sheet, what you're hearing from shareholders, so on and so forth? Thank you.
spk12: So with the balance sheet, I'm very pleased with us controlling what we could control. And what we've done to date is we've used proceeds from divestitures to pay down debt, and we're using our free cash flow to pay down debt we will continue to stay focused on using that free cash flow to pay down debt. We are absolutely committed to continuing to reduce our leverage. Since the acquisition of CMC, we have paid down $1.9 billion of debt. But as we go through this year, we still want to make sure we're balancing investing in the business with the debt pay down. So as I mentioned earlier, that all comes together We expect leverage to be slightly north of the 4.0 times based on the timing of the recovery this year and the timing of cash flow coming in. But we still remain very committed to getting that leverage down further.
spk05: To add to that, I would say we're very focused, obviously, on honoring the commitment we made to bring down the leverage as quickly as we could. Having said that, I'm very, very proud of what the team has been doing this year. This is, again, a transition year for the industry, and we've been able, in spite of that, to make all of the required strategic investments that would be critical to our future success, investing significantly in CapEx this year and last year, continuing to invest in R&D. I think I mentioned the increase in R&D of about 15% year-on-year. And all of that is really, really important to set us up for our future success. So those investments in technology and capacity and redundant manufacturing capabilities, all of that will ultimately translate into significant competitive advantage for Integris. So I'm glad that we're able actually to do all of that and operate within our target model or the target model that we presented during the Analyst Day in January of this year. A tough year to navigate overall, but I think the team is performing really well.
spk22: Thank you for the caller.
spk07: And that was our final question in the queue today. I'd like to turn the floor back to Mr. Bill Seymour for any additional or closing remarks.
spk18: All right. Thank you for joining our call today. Please reach out to me directly if you have any follow-ups. Have a good day. Thank you very much.
spk07: Ladies and gentlemen, this does conclude today's Integra's Q4 conference call. We thank you for your participation. You may now disconnect your lines.
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