Good day, everyone, and welcome to the Entegris First Quarter 2019 Earnings Call with analysts. Today's call is being recorded. [Operator Instructions] At this time, for opening remarks and introductions, I'd like to turn the call over to Bill Seymour, Entegris 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'd 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 in Regulation G. You can find a reconciliation table in today's press release as well as on our website. Before I hand the call over to Bertrand, I'd like to point out the change we've made to our accounting treatment of inter-segment 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 1 segment and supplied to another before being sold to the ultimate end customer. Our old practice was to transfer the products and components at cost. 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 $6.9 million higher and margins are $2.9 million higher in Q1 with the new practice. And of course, the complementary adjustments were made in the other 2 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 '18 and 2017 quarterly segment financial restatements in 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, Bill. I will make some comments on our first quarter performance, how we see the industry environments and our expectations for the rest of the year. Greg will follow with more details on our financial results and provide guidance for the second quarter of 2019. We'll then open the line for questions. 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 attractive. 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 performance. As you all well know, Entegris operates at the crossroads of materials intensity and materials purity. In other words, our solution set is increasingly critical for our customers to achieve higher yields and targeted levels of true performance and reliability. In addition to executing on our strategic plan and growing our core business, we continue to focus on a broad area of capital allocation options 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 the industry in the quarter. Our first quarter results demonstrated the strength of our execution as well as the resilience of the Entegris…

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 million 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 $0.24. On a non-GAAP basis, EPS was $0.50, up 6% from Q1 of 2018. Moving on to gross margins, GAAP gross margins of 45.4% included the negative impact of an approximately $2 million inventory write-up associated with the SAES Pure Gas and DSC acquisitions. Our non-GAAP gross margins of 46% were flat sequentially. The year-on-year decline in gross margin was driven primarily as expected by the addition of SAES Pure Gas to the portfolio. We expect gross margin to be approximately 46% on a non-GAAP basis in Q2. GAAP operating expenses of $130 million included approximately $19 million of "deal-related" costs associated with the Versum transaction, $19 million of amortization of intangible assets, $3 million of integration costs and $2 million in severance. Non-GAAP operating expenses in Q1 were $88 million, below our guidance reflecting effective cost control. We expect non-GAAP operating expenses to be $89 million to $91 million in the second quarter. Non-GAAP operating income was $92.2 million or 23.6% of revenue, in line with our target model. Our GAAP tax rate was 14.2% for the quarter and included a 3% discrete benefit related to stock-based compensation. Our non-GAAP tax rate was 18.4% and included the same discrete benefit. For 2019, we continue to expect our full year non-GAAP tax rate to be approximately 21%. Adjusted EBITDA for the quarter was $109 million or 28% of revenue. Turning to our performance by division. Q1 sales of $124 million for Specialty Chemicals and Engineered Materials,…

[Operator Instructions] And we'll take our first question from Sidney Ho from Deutsche Bank.

My first question is on you, Bertrand, you made a comment that you have started seeing some positive indicators. I was just hoping that you can explain 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 those process indicators can 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 memory and mainstream 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. 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 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 million of EBITDA. And if you assume EBITDA margins at 30%, it implies revenue of somewhere in the $200 million range. How much of that do you think you can actually recognize in the future and something you can achieve by going alone or is it just a matter of time how long it takes to get those kind of revenues 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. DSC gives us access to new synthesis capabilities that we did not have at Entegris. It's something that we are 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-grade electric materials, hard 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 strategies.

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 this $3 EPS target. Or is it just -- it could be just run rate basis exiting next year. Given the current market conditions, is that still a target that we could think about? And how much we are relying on M&A versus the share repurchases there?

Right. So Sidney, so it's fair to say that on the current industry environment there's 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 the number that -- again, remember, that a $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 and depending on the number of capital allocation decisions that we may make over the next 18 months.

And we'll take our next question from Patrick Ho from Stifel.

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 mix data points that are out there?

So Patrick, for MSI, we expect MSI to be flat year-on-year. But 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 rates will start increasing after that at most of our customers.

Great. 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 were the key levers are? I 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?

Yes. Hi, Patrick. So I would say 2 things. One is, on the gross margin line, I would just say we continue to execute quite well on the operation/manufacturing, 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 to 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 some of the softness coming. We're committed to making our target model. So we really just ask people to sort of to tighten their belts and we trimmed where we could. I noted that we had a couple million dollars of severance in the quarter. So we did make some headcount reductions in the quarter that will result in annualized savings of approximately $5 million. We saw part of that in Q1. We see part of that with the good expense control we talked about for Q2.

We'll take our next question from Toshiya Hari from Goldman Sachs.

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, I think, within MC as well, especially post the SAES acquisition. A meaningful part of your business is tied to CapEx. But what's -- 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 are 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 into investment. So examples of that would be the steadiness of our gas purification business, which continues to grow, and we expect that business 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 standards for advanced memory and advanced logic fabs. So those fabs require very pure fabs and tubes and subfabs 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, the sales of our on-tool solutions, so products like gas filters, dispense pumps, liquid flow controllers, so the products that we sell to the equipment makers, those product lines were down sequentially in line with the decline that we experienced as an industry in wafer fab equipment.

Great. 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 SCEM, I think this was the third consecutive quarter of margin declines. Can you kind of talk about that? What's driven that? And then what's the go forward within SCEM? 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 plan? And then finally, AMH, you had a nice sequential uptick in margins. Is there more to come in terms of some of the benefits post the restructuring there?

Yes. So let's start with SCEM. As you pointed out, down pretty significantly 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. You had a relatively weak product mix. We have higher -- 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 2 areas -- we're starting to depreciate that capacity and pay for it, but the volumes have not increased to the level to absorb that. So that business is a little bit capacity laden at this point. So, we do expect -- in both cases, we expect improvement in a sense via the absorption in the volumes in deposition materials and engineering 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 -- we 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 mix/pricing, which have had a favorable impact. So that business -- it 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 in the capital cycle. And then MC, we expect the margins to improve as we move through the year primarily driven by improvements in the business head base. We started 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 potential EBITDA contribution are you assuming for Q2 and the full year?

So that business is order of magnitude $15 million to $20 million. The EBITDA contribution this year is, I'll just say, low single digit. So we said it's essentially earnings neutral this year. As we move out, it will be accretive next year. And as we get into 2020 and 2021, it will start to see 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% CAGR for the next 5 years. And as Greg mentioned, we expect EBITDA margins to become pretty much in line with the SCEM margins. 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 to the P&L.

We'll take our next question from Paretosh Misra from Berenberg Bank.

Great. My first question is on you mix, the units driven versus CapEx driven. So when it comes to M&A, are you pleased with where your mix is currently? Or maybe you could use the M&A to move it a bit more towards unit-driven business?

Yes. I mean, that's not necessarily a major criteria for selection. I mean recall, for instance, that we acquired a pure equipment business when we acquired SAES last year. But this was a very high-quality business, the 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. I think said all of that, if I look forward and if I look at our M&A pipeline, I indeed, see mostly unit-driven businesses in the pipeline. So assuming success on the M&A front, you should expect 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, and in other words have you -- if you have given any dollar impact for 2019 from -- due to tariffs?

Right. So we have always cited the U.S. China tariff 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 $1 million annually. And actually, the actual impact is significantly below that.

We'll take our next question from Christian Schwab from Craig-Hallum Capital Group.

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 flatten out. But when you guys talked about the second half being greater than the first half last quarter, you said it will be driven by CapEx improvement in memory as well as foundry and logic, only due to node transitions at the NAND level at 64 and 96, and then the 10, 7 node transitions, and you thought that the company was in position to outgrow the wafer front-end market in 2018, which it seems you still believe it will be down mid- to high-teens. Is that still accurate as we look to the second half? Or is there anything changed regarding that as well?

Yes. So, Christian, I mean, this is a very difficult environment to predict indeed. And I think that that's what you're saying in your own 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 are suggesting in our annual guidance of $1.6 billion, and if I want to deconstruct that guidance for you, I would say that we expect the industry to be down 5% 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 2019. And how do we get there? Well, we capitalized on improving utilization rates. We capitalized on new node transitions, both in logic and memory in the back end of the year. And we capitalized 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 million to $5 million positive impact quarterly in the back end of the year. I mean, that capacity is already totally permitted, 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 help you?

And we'll take our last question from Chris Kapsch from Loop Capital Markets.

I just had a question about your geographic mix 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 now you see that playing out sort of over the , I guess, the balance of '19 to the extent you have visibility?

Yes. So Japan, we suffered from continuous decline in our OEM business. So sales to the equipment makers in Japan was down significantly, sequentially. And then we also saw some negative impact from the soft economic 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.

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.