Good day, everyone, and welcome to the Entegris First Quarter 2019 Earnings Call with analysts. Today's call is being At this time, for opening remarks and introductions, I would like to turn the call over to Bill Seymour and Tyra's VP of Investor Relations. Please go ahead, sir.
Good morning, everyone. Earlier today, we announced the financial results for our first quarter of 2019. Before we begin, I would like to remind listeners that our comments today will include some forward looking statements. These statements involve a number of risks and uncertainties, which are outlined in detail in our reports and filings with the SEC. Please refer to the information on the disclaimer slide in the presentation.
On this call, we will also refer to non GAAP financial measures as defined by the SEC And Regulation G You can find a reconciliation table on today's press release as well as on our website. Before I hand the call over to Bertrand, I'd like to point out change we've made to our accounting treatment of intersegment product sales, which started in the first quarter of this year. Our new practice recognizes the revenue and profit associated with products and components produced in one segment and supplied to another before being sold to the ultimate end customer. This change does not impact our consolidated financials, but it does impact the segment financials. The segment with the most impact is AMH, AMH segment sales are $6,900,000 higher and margins are $2,900,000 higher in Q1 with the new practice.
And of course, the complimentary adjustments were made in the other two segments. You can find restated segment financials for the prior year and sequential quarters in today's earnings release, and we've also provided all of 20182017 quarterly segment financial restatements and our earnings slide deck. On the call today are Bertrand Loy, our CEO and Greg Graves, our CFO, I'll hand over to Bertrand.
Thank you, Mir. I will make some comments on our first quarter performance. I will see industry environment and our expectations for the rest of the year. Greg will follow with more details on our financial results, and provide guidance for Before I get started, I would like to address the termination of the Versum transaction. While we are disappointed that the merger did not happen nothing changes for Entegris.
We feel very confident in our competitive position, world class technical capabilities, operational excellence and overall growth prospects. It is also worth repeating that we believe the secular semiconductor demand will continue to be attracted, enabled by technologies like IoT, 5G, and AI, our society will continue to need more and better chips. Greater materials intensity and greater materials purity will be the 2 defining factors of the next generation of semiconductor and the crossroads of materials intensity and materials purity. In other words, our solution set is increasingly critical for our to achieve higher yields and targeted levels of trip performance and reliability. In addition to executing on that will lead to additional long term value creation for our shareholders.
We will provide more details on that shortly. But for now, let me cover Q1. During the first quarter, we delivered solid results that were essentially in line with our guidance. I am particularly pleased with this performance in light of the incremental softness that impacted industry in the quarter. Our first quarter results demonstrated the strength of our execution as well as the resilience of the Integris platform.
We grew our sales 6% year over year in first quarter, once again outpacing our markets, Sequentially, sales were down modestly, reflecting the impact of the softer industry environment. In spite of this, our operating margins were flat sequentially, and we generated $109,000,000 of EBITDA. Demonstrating the organization's strong execution and ongoing focus on cost control and productivity enhancements. In addition, non GAAP EPS was up 6%, both year over year and sequentially. Finally, in March, we acquired digital specialty chemicals.
I will now provide some color on the market and how it impacted us in the first quarter. As I said, the market was softer than expected in memory related wafer production, where customers lowered utilization rates and focused on working down inventory levels. As a result, our sales to memory customers were down significantly in the first quarter. In contrast, in logic and foundry, despite the soft end market, all sales grew both year on year and sequentially, as we started to benefit from a number of new node transitions. And with the growers and chemical customers, Entegris sales were up significantly year over year and up modestly sequentially.
And finally, as you would expect, our sales to equipment customers, which is more tied to industry CapEx, was down in the quarter both year over year and sequentially. In mid March, we acquired digital specialty chemicals, or DSC, a provider of advanced materials to the semiconductor, specialty chemical and pharmaceutical industries. In semiconductor manufacturing, increasing complexity of device architectures and leading edge nodes requires more advanced and highly engineered materials. DSC is a market leader in designing and synthesizing these new generations of films and deposition materials. DXC, chemical synthesis capabilities expands our ability to serve our from in between $15,520,000,000 in sales for the full year of 2019 and be essentially neutral to earnings this year.
DSC will be part of our SCEM business. And then we just said that we are very excited to have DSC join the integrys team. Looking ahead at the rest of 2019, let me first comment on the market. As I just referenced, memory related wafer starts declined during the first quarter as the memory makers confronted high inventory levels. We expect this softness to extend into the second quarter as customers continue to lower their inventory levels.
However, looking to the second half, there are reasons to be cautiously optimistic. As we see some positive indicators for both the broader industry and our business. In particular we are a recovery in leading edge logic in the later part of the year. However, I want to be clear that we are not counting on any meaningful recovery in industry CapEx for the balance of the year. As it relates to our own business in 2019, we remain very confident On a macro level, we expect to benefit from technology node transitions at a number of foundry, logic and memory customers.
Several new products will benefit from these advanced node transitions, including in our microcontamination division, the Torrento X wet agent clean filter and our SAES bulk gas purification systems, in our AMH division, our EUV reticle parts and high purity drums. And finally, an SCM, a number of new deposition materials, advanced coatings, and selective etch chemistries. In addition, we continue to look at ways to use Historically, M and A has been a very effective way to create shareholder value. As an aside, the acquisitions completed in 2018, namely PSS, Flex Concepts And SAES, all performing well above our expectation. In spite of the soft industry environment.
Looking forward, expect us to be focused on additional M and A in the areas of high performance materials, filtration and purification. Sales and DSC are perfect examples of the type of We expect our sales in 2019 to be approximately SEK 1,600,000,000, and we expect our non GAAP EPS to exceed $1.90. I will now turn the call to Greg for the financial detail, Greg.
Thank you, Bertrand. As Bertrand said, our first quarter performance and execution was solid, especially in light of the industry environment. Q1 sales of $391,000,000 grew 6% from a year ago. Sales were down 2.6% sequentially, driven primarily by the slower wafer starts that Bertrand referenced. Q1 GAAP diluted earnings per share was 0 point 2 $4.
On a non GAAP basis, Moving on to $2,000,000 inventory write up associated with the SAES Pure Gas And DSC acquisitions. Our non GAAP gross margins of 46 percent were flat sequentially. The year on year decline in gross margin was driven primarily as expected by the addition in Q2. GAAP operating expenses of $130,000,000 included approximately $19,000,000 of deal related costs associated with the Versum transaction, $19,000,000 of amortization of intangible assets, $3,000,000 of integration costs and $2,000,000 in severance. Non GAAP operating expenses in Q1 were 88,000,000 below our guidance, reflecting effective cost control.
We expect non GAAP operating expenses to be 89000000 to 91000000 in the second quarter. Non GAAP operating income was $92,200,000 or 23.6 percent of revenue, in line with our discrete benefit related to stock based compensation. Fit. For 2019, we continue to expect our full year non GAAP tax rate to be approximately 21%. Adjusted EBITDA for Turning to our performance by division.
Q1 sales of $124,000,000 for specialty chemicals and engineered materials or SCEM declined 5% from a year ago. As a reminder, our SCEM business is the most exposed to the memory decline and the decrease in wafer starts. Adjusted operating margin for SCEM was 20.1%, down over 300 basis points from the same period last year. The decline in operating margin was driven primarily by lower sales volume, and investments in manufacturing capacity $8,000,000 for microcontamination control, or MC, were up 33% from last year. The strong growth in the quarter was driven by Adjusted operating margin for MC of 31.8 percent was down over 200 basis points from last year but was flat sequentially.
We expect that MC margins will benefit as SAES synergies are more fully realized in the back half of 2019. Q1 sales for Advanced Materials Handling or AMH of $116,000,000 was down 6% from last year. The year over year decline in sales was driven ensure of a small noncore cleaning services business. Adjusted operating margin for AMH of 9 teen 0.8 percent was down year over year, but up almost 300 basis points sequentially. AMH margins benefited from cost reductions, favorable product mix and other margin enhancement programs implemented in Q4 of last year.
Cash flow from operations for the first quarter was a negative 3,000,000 and free cash flow was a negative $37,000,000. As a reminder, Q1 typically has the lowest cash flow of the year primarily due to the variable compensation payment We collected the $140,000,000 termination fee from the Versen transaction, and we received a $31,000,000 tax refund. Us of cash during the quarter included $50,000,000 for the purchase of DSC. CapEx in the 1st quarter totaled $34,000,000, We expect to spend approximately $110,000,000 on CapEx in 2019 to support our new product introductions improved technical capabilities and growth in filtration and liquid packaging. Consistent with our capital allocation strategy, we used $9,500,000 for our quarterly dividend.
For share repurchases, in the 4th quarter and through the end of January, we repurchased a total of 600,000 shares for approximately $179,000,000 at an average price of approximately $27. This includes 1,000,000 shares purchased in January prior to the announcement of the MOE transaction. We expect our share count Turning to our outlook for Q2, we expect sales to range from $375,000,000 and we expect non GAAP with revenue improving in the back half. In summary, we are pleased with our operating and financial performance in the first quarter. We once again demonstrated the resilience of our model with revenue declining modestly sequentially, despite softness in wafer start, a weak CapEx environment.
Even with the modest decline in revenue, we delivered an operating profit in line with our expectations and the target model. Achieve a higher level of earnings in 2019.
Thank you. And we'll take our first question from Sidney Ho from Deutsche Bank. Please go ahead.
Good morning and thanks for taking my question. My first question is on your Bertrand, you made a comment that you're starting some positive indicators. I was just hoping that you can expand that a little bit more. Is that mostly related just to leading edge logic or is it some signs on the memory side as well? And in terms of timing, how are those positive indicators that could play out?
So, Sidney, I think that the second quarter industry environment will remain challenging. We expect to see low level of utilization rates at both our memory and main stream fab customers. But we expect those utilization rates for those customers to improve in the back end of the year. And that's really what led us to be more optimistic for the back end of the year. That's on the one hand.
On the other factor is indeed the number of node transition and the intensity of those node transitions in the back end of the year, both in logic and in memory. And as you know, that should benefit both our filtration and our SCEM business in the back end of the year.
Okay, great. Maybe a question on the Versum Merger. Clearly, it was not a it's a different outcome that you would prefer. But curious on the revenue synergy side that you guys identified during the process, I think you mentioned $50,000,000 of EBITDA. And if you assume EBITDA margin is like 30%, it implies revenue somewhere around 2 $200,000,000 range.
How much of that do you think you can actually recognize in the future? Something you can achieve by going alone or is it just a matter of time, how long it takes to get those kind of revenue for yourself?
Look, I think that the Versum merger is now old history for us. So I don't want to spend too much time talking about that. Instead, what I would say is that, we have the opportunity to selectively grab, technologies that could be enhancing our portfolio in such a way that we could be in a position to unlock some of those positive revenue synergies. DSC is a good example of that. You know, DSC gives us access to new synthesis capabilities that we did not have.
At Entegris, something that we were hoping to get as part of a combination with Versum. Ultimately, we didn't get it, but I'm glad that we found it through the acquisition of DSC. So DSC gives us access to a number of new materials that cobalt precursor, high k, dielectric materials, hot mask materials, also allows us to expand our served market into pharmaceutical applications and other industrial applications. So again, we will find other ways to create, positive revenue synergies as we continue to be active on our acquisition strategy.
Okay. Maybe one last one for me. I'll hop back in the queue. I know the management team has been very focused on getting to the $3 EPS target for, or is it just a it could be just a run rate basis exiting next year. Given the current marketing positions, is that still a target that we should think about and how much are we relying on M and A versus share repurchase there?
Right. So Sydney, so it's fair to say that, the current industry environment is a little bit of a setback for us. There were a number of industry growth assumptions obviously built into that model. Having said that, Given where we stand today and with the acquisition of DSC, we believe that we should be able to reach close to $2.50, on an organic basis. And that's a number that, Again, remember that the $3 number was a run rate number as we exit 2020.
So we expect that we would be in a position to improve that number further as we continue to be active on the acquisition front. Depending on a number of capital allocation decisions that we may make over the next 18 months.
Great. Thank you very much.
And we'll take our next question from Patrick Ho from Stifel. Please go ahead.
Thank you very much. Maybe Bertrand first, in terms of the market environment, can you give us your updated view of the MSI or the industry wafer starts data and where you think that's tracking to for 2019? And maybe as a follow-up to that, Obviously, you're getting feedback from your memory customers regarding a potential second half recovery. We've heard comments from Hynix and Micron about that recovery. What gives you confidence that, I guess, that recovery will ensue giving a lot of the mixed data points that are out there?
So, Patrick, for EBITDA, we expect EBITDA to be flat year on year. I think MSI is a misleading indicator in 2019 simply because as you know, a lot of the wafer growers instituted take or pay contracts in the past few years. So instead what we've been trying to do is to really assess what wafer starts truly was, which is really the primary driver for our business. And wafer starts, you can infer wafer starts based on, utilization rates and levels of inventory. And as we know, our customers have been working their inventory levels down in Q1.
We expect that to continue to be the case in the second quarter, as well. We expect inventory levels to be at sound levels as we exit Q2. And that's really the reason why we believe utilization rate will start increasing, after that at most of our customers.
Great. And maybe as a follow-up question for Greg, in terms of the execution, you did execute quite well. Despite the soft industry environment and the lower revenues. Can you just give us a little bit of color in terms of where the key levers are mean, gross margins came in at 46% despite the lower revenue. Are you getting more leverage and I guess more ability to make, I guess, flexible moves on the gross margin line?
Or are additional moves necessary on the OpEx line to keep the operating margins at these relatively elevated levels?
Hi, Patrick. So I would say 2 things. One is on the gross margin line, I would just say we continue to acute quite well on the operations slash manufacturing side and I've said it before. We continue to mature as an organization and get better there. And so as things slow down, that team is managing their variable costs very well.
It used to be from time to time. We'd see surprises on the op side. We see a lot less of that today. So I would just say a lot more consistency and a lot more discipline on the gross margin side of the house and specifically the manufacturing and supply chain organizations. With regard to OpEx, I mean, as we came into the quarter, we saw the softness coming.
We're committed to making our target model. So we really just asked people to sort of to tighten their belts and we trimmed where we could. We did, I noted that we had a couple of $1,000,000 of severance in the quarter. So we did make some headcount in the quarter that will result in annualized savings of approximately $5,000,000 you saw part of that in Q1. You see part of that with the good expense control we talked about for Q2.
Great. Thank you very much.
We'll take our next question from Toshiya Hari from Goldman Sachs. Please go ahead.
Hey guys, good morning. I had a couple of questions. Bertrand, I was hoping you could provide a little bit more color on your CapEx business. We know AMH, there's a significant CapEx component, and I think within MC as well, especially post the SAES acquisition. A meaningful part of your business is tied to CapEx.
But was how meaningful was the decline in your overall CapEx business in Q1, on a sequential or year over year basis? And is it fair to say that business has troughed or is there further downside into Q2 and the second half in your view?
So the unit CapEx ratio was 70:30 in Q1. That was essentially the same ratio as last quarter. So in other words, the decline in unit or CapEx was about the same in that 2% to 3% range for us. So the way to think about it is that, overall, we're very pleased obviously with the performance of our CapEx business. Especially in the context of a declining industry CapEx.
And the way to think about it is we have been taking share on a number of new fab projects in advanced logic and advanced memory. And that was really a nice offset to the otherwise industry wide decline in new investment. So examples of that would be the steadiness of our gas purification business, which continues to grow. And we expect that this to actually grow year on year this year. Another example of that would be the continued success of our fluid handling business.
Which is a business unit residing in our AMH platform. That business actually grew sequentially. And those products are increasingly becoming the industry standard for advanced memory and advanced logic fabs. So those fabs require a very pure, valves and tubes and sub fabs that can withstand higher temperatures and very harsh chemistries. And we've been actually picking up share for those new fabs and those applications.
So that part of the business actually behaved well. And as you would expect, are the sales of our on tool solutions for products like gas filters, dispensed pumps, liquid flow controllers. So products that we sell to the equipment makers those, those product lines were down sequentially, in line with the decline that we experienced as an industry in wafer fab equipment.
Great. Thanks so much for the color. And then Greg, On operating margins, for the individual segments, and I apologize if I missed some of the, some of your prepared remarks, But for FEM, I think this was the 3rd consecutive quarter, of margin declines. Can you kind of talk about that? What's driven that?
And then what's the go forward within SCM? MC, you talked about some of the synergies with SAES materializing in the back half. Are the synergies on track, or are you tracking ahead of a plan? And then finally, AMH, you had a nice sequential uptick in margins. Is there more on the come in terms of some of the benefits post your restructuring there?
Yes. So let's start with SCEM, as you pointed out, down pretty significantly, year over year year over year and then sequentially down again. So, a couple of things. One is in the quarter, you really had 3 things going on. 1, you had a relatively weak product mix.
We had higher or abnormally high logistics costs. And then the thing that is impacting that business from a trend perspective is we've invested very heavily in deposition materials as well as engineered materials, I. E. Graphite. And the capacity in those two areas.
And we're starting to depreciate that capacity and pay for it, but the volumes have not, increase to the level to absorb that. So that business is a little bit capacity laden at this point. So we do expect, I mean, in both cases, we expect improvement in essentially the absorption and the volumes in-depth position materials and engineered materials, which should help the overall margins in SCEM as we move through the year. AMH, as you pointed out, relatively Excuse me. Up sequentially, pretty good performance.
That business is a business where they are We've made lots of change, from a cost structure perspective. We've done a number of things to improve the margin. Around, I'll call it, product mixpricing, which have had a favorable impact So that business continues to be our lumpiest business because of the capital nature of it, but from a, if I said overall, how do I feel about the margin trends I feel we should have an upward bias, but I would say I expect that there to be some lumpiness as we go forward until we see improvement capital cycle. And then MC, we expect the margins to improve, as we move through the year, primarily driven by improvements in the business space.
Okay. Got it.
And then As we start to realize the, more of the synergies And frankly, we have a better backlog today than we had a year ago in terms of the quality of the backlog from a margin perspective.
Okay, got it. And then one housekeeping question, if I could. For DSC, what sort of revenue and potentially EBITDA contribution are you assuming for Q2 and the full year? Thank you.
So for the so that business is order of magnitude $15,000,000 to $20,000,000. The EBITDA contribution this year is, I'll just say low single digits. So we said it's essentially earnings neutral this year. As we move out, it'll be accretive next year. And as we get into 2020 2020 1, it'll search the accretion levels in kind of the $0.04 range.
Yes, if I could add to that, I would say this is a business that we expect to grow at 10 to 15 percent CAGR for the next 5 years. And as Greg mentioned, we expect EBITDA margins to become pretty much in line with the SCEM margins over time. So not a meaningful contributor this year, by any stretch, but as you get into late 2020, 2021, the contribution of that business will start actually to show very nicely. Through the P and L.
Great. Thanks so much.
We'll take our next question from Fritash Mishra from Berenberg Bank. Please go ahead.
Great. Thank you. My first question is on your mix, the units driven versus CapEx driven. So when it comes to M and A, are you pleased with where your mixes currently, or maybe you could use the M and A to move it a bit more towards units driven business?
Yes, I mean, that's not necessarily a major criteria for for selection. I mean, recall, for instance, that we acquired a pure equipment business when we acquired sales last year. But this was a very high quality business, a CapEx business that is really not behaving the way your usual CapEx business would so again, so it's not necessarily a criteria for selection. As it said, all of that, if I look forward and if I look at our M and A pipeline. I indeed see mostly, unit driven businesses and enterprise So assuming success on the M and A front, you should expect that, that ratio to trend more towards units, going forward.
Got it. Very clear. And then second one, just if you could please remind me, How are you impacted by the U. S.-China trade issues? In other words, if you have given any dollar impact for 2019 from due to tariffs?
Right. So we have always cited the U. S, China carry tensions as relatively immaterial to our business. And now that we have actually a few quarters of, actual experience behind us, the numbers are confirming the range that we gave externally, which is an impact of less than a $1,000,000 annually. And actually, the actual impact is significantly below that.
Got it. Thanks guys.
We'll take our next question from Krishna Swab from Craig Hallum Capital Group. Please go ahead.
Hey, good morning guys. I understand the memory weakness that you're seeing today. I just want an update from when you guys reported the last quarter we've taken MSI from being up modestly to flat now. But when you guys talked about the second half being greater than the first half, last quarter. You said it would be driven by CapEx Improvement in Memory as well as Foundry And Logic only due to node transitions.
At the NAND level at 64 96 and then the 107 node transitions. And you thought that the company was in position to outgrow, the wafer front end market in 2019 teen, which it seems you still believe will be down mid to high teens. Is that still accurate as we look to the second half, or is anything changed regarding that well.
Yes. So question, I mean, this is a very difficult environment to predict indeed. And I think that that's what you're saying in your long question. Having said that, we believe that 2019 will be a great opportunity for us to demonstrate the resilience of our model. And that's what we're suggesting in our annual guidance of 1,000,000,006.
And if I want to deconstruct that guidance for you, I would say that we expect the industry to be down 5% to 6%. And that's how do we get to that number? That's CapEx down in the mid teens wafer starts, not MSI, but wafer starts down in the low single digits. But we expect our organic revenue to be flat in 20 19. And how do we get there?
Where we capitalize on improving utilization rates. We could capitalize on new node transitions, both in logic and memory in the back end of the year. And we capitalize on access to new graphite capacity. As Greg was mentioning, we have invested a lot in new capacity. That capacity is going to come online at the end of Q2.
So no impact to Q2, but we expect a $4,000,000 to $5,000,000 positive impact quarterly in the back end of the year. I mean, that capacity is already totally committed And, and so we should see a nice pickup from there. So, and then, the additional revenue on top of that organic performance is really the net effect of the recent acquisition minus the divestiture of the, cleaning business that we had in France last year. Does that happen?
That's extremely helpful. Thank you. I don't have any other questions. Sure.
And we'll take our last question from Chris Kapsch from Loop Capital Markets. Please go ahead.
Yes, good morning. I just had a question about, your geographic mix and as depicted on I guess, Slide 7. And clearly, the strength in Taiwan and softness in Korea is consistent with your narrative around foundry logic and memory end markets specifically. But could you just elaborate on the trends in Japan? What's driving that and how you see that playing out sort of over the, I guess, the balance of 'nineteen to the extent you have visibility?
Yes. So Japan, we suffered from continuous decline in our OEM business sales to the equipment makers in Japan was down significantly sequentially. And then we also saw some negative impact from the soft economy environment in Japan that, led most of our fab customers to operate at fairly low levels of utilization in Japan. So that's why we saw a decline, a sequential decline of about 9% in Japan.
And we have no
further questions. I think that's all for
the call operator. Thank you again for joining the call and have a great day.
And that concludes today's presentation. Thank you for your participation. You may now disconnect.