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Entegris Inc. (NASDAQ:ENTG)

Q4 2008 Earnings Call

February 12, 2009; 10:00 am ET

Executives

Gideon Argov - President & Chief Executive Officer

Greg Graves - Chief Financial Officer

Bertrand Loy - Chief Operating Officer

Steve Cantor - Vice President of Corporate Relations

Analysts

Brett Hodess - Bank of America

Steve Schwartz - First Analysis

Junaid Ahmed - Citi

Operator

Good day everyone and welcome to Entegris’s fourth quarter 2008 earnings release conference call. Today’s call is being recorded. At this time for opening remarks and introductions, I’d like to turn the call over to Mr. Steve Cantor, Vice President of Corporate Relations. Please go ahead sir.

Steve Cantor

Good morning and thank you everyone for joining our call. Earlier today, we announced our sales results and our operating results for our fourth quarter ended December 31, 2008. You can access a copy of our press release on our website with those results on www.entegris.com.

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. On the call today are Gideon Argov, President and CEO; Greg Graves, Chief Financial Officer and Bertrand Loy, Chief Operating Officer. Gideon will now begin the call.

Gideon Argov

Thanks, Steve. Good morning. As most of you know, the global economic slowdown has contributed to a steep and abrupt downturn in the semiconductor and electronic markets. Not surprisingly, our business like every other supplier of semiconductor components and materials has been adversely impact in the fourth quarter. These trends have thus far continued through February.

While we have historically experienced cyclical downturns in our primary semiconductor market, we have never experienced the level and degree of negative factors we are seeing today, virtually an evaporation of capital spending, which is coincided with historically low fab utilization rates.

In light of these extraordinary macro and micro economic conditions, I’ll focus my comments this morning on what we have done and what we are doing to lower our cash at breakeven point, maximize our cash flow or free cash flow and to protect our balance sheet. These actions will not only allow us to manage effectively through this downturn, but also position us for significantly better profitability when the industry does recover.

First and foremost, we have accelerated steps to fundamentally restructure our business, which will eliminate approximately $28 million in annual fixed operating cost. Many of these steps were initiated several months ago well before the global economic melt down in September. These steps have included the organizational changes we talked about last quarter which led through the elimination of several senior management level positions and a 15% approximate reduction in global headcount compared to a year ago.

In conjunction with these permanent cost reductions, we are consolidating our manufacturing operations by closing our largest manufacturing facility in the U.S., which will provide additional savings when business recovers. In January, we implemented additional headcount reductions as well as a series of temporary cost saving measures, including workflows, global salary reductions for their work weeks and a clamp down in all discretionary expenses.

In light of our current business trends and the near term market uncertainty, we have also restructured the terms and covenants of our revolving credit agreement to provide us with the flexibility we can turn with a sustained downturn. Greg Graves, will have more details on this in his prepared remarks shortly.

While our attention and focus is on taking the necessary actions in the short term to maximize our free cash flow and secure our balance sheet; we’re doing this in a way that balances our key market and product development initiatives. Looking beyond the current business environment, what we do for our customers will continue to grow in importance. The need for contamination control and substrate handling becomes even more important at success in technology generations.

Over the past quarter, even in these difficult times we’ve maintained our leading market positions and even increased our share in some key areas, such as 300 millimeter wafer shipping. In our Contamination Control business, we’ve achieved key qualifications of our new products and subsystems with OEM and device making customers in every area of our business that will benefit us when the market recovers.

These qualifications include five and 10 nanometer advanced filtration products for photochemical and wet etch and clean applications, fluid delivery systems for lithography track in separate tools as well gas purification systems for controlling Airborne Molecular Contamination in critical areas on the fab.

In our microenvironment’s business, sales of our 300 millimeter wafer shippers increased more than three fold in 2008, an indication that we’re taking share in that market. We are recently named by a leading wafer grow as their primary vendor for their 300 millimeter shippers.

In 2008, as you know, we embarked on our diversification initiative to bring material science-based technologies to markets outside of the semiconductor industry. Our specialty materials business, which includes that Poco Graphite, is addressing numerous growth opportunities for advanced graphite, silicon carbide, specialty coatings and performance Polymer products that are built on our proprietary carbon nanotube technology. These products offer growth in a variety of markets, including medical, aerospace and specialty industrial.

I will now turn the call over to Greg, to provide some comments on our financials. Greg.

Greg Graves

Thank you, Gideon. In lieu of the steps that Gideon described, I want to provide some commentary on our current breakeven level and our balance sheet, before discussing the details of the fourth quarter. Given the unprecedented turbulence and uncertainty in our markets, we have focused on reducing our fixed cost and lowering our cash breakeven point. When these actions are fully in place later this year, we would have reduced our quarterly breakeven by $30 million on an EBITDA basis, compared to a year ago.

To achieve this, we have taken steps to eliminate $7 million of quarterly fixed operating costs since February of last year, which includes about $1 million of quarterly fixed costs savings from our manufacturing consolidation. We’ve also imposed short term cost reductions including across the board salary reductions, selective work with shutdowns, four day work weeks, which will save an additional $4 million on a quarterly basis.

Last, in Q1 we expect the breakeven on an EBITDA basis of $110 million and with the completion of our manufacturing consolidation, as well as the previously mentioned structural and short term measures, we should reach a target breakeven below $100 million by the second half of 2009. While these steps will allow us to manage through this downturn, they also position us for improved profitability when the market improves.

The quarterly revenue levels of $160 million, which is comparable to the run rate in 2007, these actions, should enable us to achieve gross margin in the mid 40’s and GAAP operating margins of 10%. With this in perspective, our GAAP operating margin in 2007 was 7% at similar quarterly revenue levels.

Turning to the balance sheet, we ended the year with $115 million in cash and $139 million in borrowings under the revolving credit facility. As Gideon outlined, we have reached an agreement in principal with our bank group to amend the terms and covenants of our credit facility.

Under the initial credit agreement, we had a $230 million dollar borrowing capacity in two primary covenants; a leverage task of debt-to-EBITDA and an interest coverage task of EBIT-to-interest expenses. I want to emphasize that we are in compliance with both covenants at year end 2008. Given the anticipated impact of the current business trends, we initiated a process with our bank group to restructure the facility.

This week, we received a commitment letter or revised agreement, which includes highly flexible covenants in the form of a monthly cumulative EBITDA task that allows for potential losses over the next 12 months.

In exchange we reduced the size of the facility to a $150 million, starting the maturity from February 2013 to November 2011 and agreed to a 400 basis point increase to the interest rate and granted a security interest in certain assets. We believe these amended terms together with our cash balance provide us with ample liquidity to fund our operations until we see a market recovery.

In terms of our fourth quarter results, sales were $112.7 million. Excluding the full quarter impact of Poco, revenues were down 27% from the third quarter. The unit driven capital driven mix of sales was 70:30, reflecting the addition of Poco’s predominately consumable product line and the falling level of capital spending in the semi industry.

Non-GAAP loss for the fourth quarter was $15.4 million or $0.14 per diluted share. We generated $23.4 million in cash from operations, primarily due to decreases in working capital. EBTIDA for the quarter was $2.4 million, adjusted for non-cash accounting charges and stock based compensation expense of $1.5 million.

Our normal annual CapEx spend is roughly $30 million. While we have deferred all non-essential projects to later in the year in an effort to maximize cash flow, we would expect CapEx to run at a maximum of $16 million for 2009.

Our GAAP fourth quarter results included the following non-recurring non-cash item. Goodwill impairment charge of $93.9 million related to FASB 142. This impairment is the result of the continued deterioration in our share price. Purchase accounting adjustments of $7.8 million related to the adjustment of acquired Poco inventory to market value.

We expect these adjustments to wind down in the first quarter as we sell the remaining acquired Poco inventory; the write-off of $10.6 million related to our equity investments in two emerging technology companies and a $12.5 million increase in the deferred tax asset valuation allowance related to U.S. tax credit carry forward. In addition to these non-cash items, we had restructuring charges of $7.2 million in Q4 primarily related to severance.

Reconciliation of our GAAP to non-GAAP results for the fourth quarter and fiscal 2008 is available in today’s press release. Non-GAAP gross margin for the fourth quarter of 35.5% decline from the third quarter due to lower revenues and under absorption in our factories. Operating expenses were $40.1 million on a non-GAAP basis excluding amortization. OpEx benefited from an $8 million reduction in variable compensation accruals.

Q4 income tax benefit on a non-GAAP basis was $500,000 reflecting the increase in allowance for deferred tax assets. Despite the current lack of visibility, we believe we have a head start in taking the steps that will enable us to not only withstand, but could be an extended downturn or to emerge on the other side with a stronger and more profitable business model.

As I told our bank group, Entegris is here to stay. We have a diverse mix of customers and products, strong market share positions and what we do will only become more critical to semiconductor manufacturing processes as technology advances and consumer trends improve.

With that we’ll now take you questions. Operator

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions) Your first question comes from Brett Hodess of Bank of America.

Brett Hodess - Bank of America

Good morning guys. I know that you’re probably not given any outlook, but I wanted to ask a couple of questions about how we should be thinking about the process of the business. First, I was wondering if you could give us a little bit of break down between, what was semi and non-semiconductor and how the semiconductors versus the non-semiconductor parts of the business might be performing?

Then secondly I was wondering, a lot of the other consumables companies have talked about maybe declines in the 25% to 35% range. Is that something that might be reasonable if we think about your consumable part of your business?

Gideon Argov

This is Gideon here. Good morning. So, on the first part of your question, the non-semi portion of our business was about just about 31% of our business in the fourth quarter and 70% obviously semiconductor. So that is a higher number than we’ve seen before and that’s largely because of the Poco and its inclusion in the numbers.

As we said before, Poco is about 40% semi historically and 60% non-semi, so that changes the mix and you’ll expect to see that continued to be a higher mix of non-semi and both, that business, as well as our semi are being affected by the downturn. I would say that within our Poco business, certainly the non-semi, it’s not as dramatic Brett, but we’re still seeing a falloff in revenue that’s substantial in a number of areas within Poco, again not as dramatic as it is in semi.

For the second part of your question, let me turn it over to Bertrand.

Bertrand Loy

Hi Brett. Well, we are not providing guidance for Q1 2009; however, I think it’s reasonable for you to expect that our overall consumable revenues will be trending pretty much inline with some of the guidance provided by our major IDM and foundry customers.

Brett Hodess - Bank of America

Okay and at this stage of the game, if we look at the major IDM and foundry customers, there’s a spread of actual decline. The foundry is being down more in 1Q than the IDMs. Would it be appropriate to be in between those or could you give us some idea about the mixes between foundry and IDM?

Bertrand Loy

We typically don’t provide a lot of details on the mix between IDM and foundries, but again I would say that, yes I think that’s a good approximation for you to probably see us being impacted somewhere in the middle of the trends reported between those different types of customers.

Greg Graves

This is Greg. That was a similar trend to what we saw in Q4 as well, where our business declined to steepest in Asia, which is a heavily driven foundry type market for us.

Brett Hodess - Bank of America

Final one for you Greg, can you give us a little thought on what kind of tax benefit you might be seeing? Do you have a range on some of your percentage or something like that that we might see this year?

Greg Graves

Yes Brett, we will because we’ve written our deferred tax assets off and we’re carrying an allowance against them. So, from a book accounting purpose, we will not show a tax benefit. So, as we think about the tax rate in 2009, domestically we think about a rate of zero and then it’s outside the U.S. depending on our income or loss in other jurisdictions, we could have $1million or $2 million a quarter of actually tax expense, as a result of earnings in places like Japan or other places outside the United States, but we will not book significant tax benefits because of our book accounting position.

Brett Hodess - Bank of America

Got it. Thanks so much.

Operator

(Operator Instructions) We’ll take our next question from Steven Schwartz of First Analysis.

Steve Schwartz - First Analysis

I’d like to talk just a little bit about the revolver if I could. I think coming out of the third quarter you had just over $100 million available and it looks like this revised agreement trimmed about $80 million. Am I right in thinking you’ve got about $20 million available under that?

Gideon Argov

They were drawn to $139 million; the total available is $150 million.

Steve Schwartz - First Analysis

Okay and is it still expandable by another 20?

Gideon Argov

In the third quarter, we were drawn more as to like the $105 range as we saw increasing declines in the industry environment. We did through the fourth quarter make a number of small draws just to increase our liquidity position.

Steve Schwartz - First Analysis

Yes, I saw that your cash balance went up nicely on the balance sheet. If I remember from reading the details of the former agreement, you could exclude certain non-cash items from EBITDA, it looked almost like it read like cash from operations, is that about right Greg?

Greg Graves

No, the primarily things, I mean for instant these big one time charges we have this quarter are obviously excluded. The primary item we can exclude, though that is non-cash is the stock based compensation. Clearly it’s primarily depreciation, amortization and stock based comp.

Steve Schwartz - First Analysis

Okay and then from that I would imagine in going through these discussions, you guys have looked at what cash from operations might look like over the next twelve months. Can you share that with us, what your thinking is there?

Greg Graves

Steve, at this point we’re not providing forward guidance. What I would say is that I believe this credit agreement combined with the existing liquidity that we have on the balance sheet, puts us in a position to weather a pretty unattractive scenario in the industry over the next twelve months. We focused on a relatively pessimistic scenario in setting the covenants under the credit agreement and then we’re becoming much more aggressive about how we manage cash and just thinking about every penny if you will.

Steve Schwartz - First Analysis

Okay and then just one last one, before I get back in queue and this relates to the $28 million in fixed cost savings. How do you expect that to split out between cost of sales and SG&A?

Greg Graves

It’s $6 million in SG&A and $1 million in cost of sales.

Steve Schwartz - First Analysis

$6 million and then $1 million per quarter?

Greg Graves

Per quarter, yes.

Steve Schwartz - First Analysis

Okay. All right, very good. Okay, thank you.

Operator

(Operator Instructions) We’ll take our next question from Timothy Arcuri of Citi

Junaid Ahmed - Citi

Hi, this is This Junaid Ahmed calling in for Tim. Good morning. Could you talk about any progress on Poco within Japan region?

Gideon Argov

Yes, I didn’t catch that question; I think you’re asking about progress with Poco in Japan.

Junaid Ahmed - Citi

Yes.

Gideon Argov

Okay, the answer to that is the Poco business is performing reasonably well. It is profitable overall and has not had the kind of declines that we’ve seen in some of the core semi business, because it’s not limited to semiconductor. We have actually introduced that business through Japan and we have actually seen some pretty good traction with new applications.

I would say that those are technology buys and they will not result in substantial revenues until we have an upturn in the business, because in Japan, Poco is directed at the semiconductor part of the marketplace, but we have seen some interest and we have introduced that group to Japan and have had actually meetings with customers over there.

Junaid Ahmed - Citi

Thanks you for that. Do you see your non-semi business percentage; like it was at 31% this quarter, growing for 2009 given the semiconductor environment?

Greg Graves

We can’t give guidance and so it all depends on the marketplace and obviously the market that’s most down is the core semi market. In general, I would expect that the percentage you see is likely to remain roughly constant in 2009, but it’s very difficult to say. Bertrand.

Bertrand Loy

Yes Gideon, I would just simply add that we are also aggressively pursuing applications of I would say CCS and any products outside of semi and I would expect to see some tangible results of those ventures to be recorded in 2009. It’s a little early for us to really give you a lot of details around that, but this is definitely a new strategic avenue for us.

Greg Graves

Our CCS business is a contamination control solution, so that’s a part of our business that comprises liquid filtration and fluid handling, Emy [Ph] is microenvironments, which consists of all our wafer handling and some straight handling products.

Junaid Ahmed - Citi

Right, thanks. Just one last one, the new products that you spoke about and I know in previous calls you said a lot of them are targeted at 45 nanometers. Given that the foundries or maybe delaying that towards the end of ’09, would it be right to assume that revenue potential from those new products would be not much at best in ’09?

Bertrand Loy

Yes, so I think you’re right. I mean it’s very difficult right now to ascertain market share and market penetration. We are really living through very unique market conditions and so it’s hard for us to really give tangible targets for new product introductions at this very moment. Once the industry starts settling down a little bit more, we’ll be happy to provide a little more clarity around those hopes.

Junaid Ahmed – Citi

Okay, great. Thank you.

Operator

(Operator Instructions) And we’ll take a follow-up from Steve Schwartz of First Analysis.

Steve Schwartz - First Analysis

Yes, just one question about the industry really and related to your restructuring actions, plant closures in North America; how do you think your competitors are handling this? Do you think you’re taking a lot of capacity out as well, on par with what you guys are doing?

Gideon Argov

Yes, this is Gideon. I don’t think we’re really in a position to comment on that. I think every company handle this in their own way and all I can direct you to is to the scripts of other conference calls. I think, certainly I’m seeing some of the same things happening in other places.

I think that I can’t really speak for other companies; I can tell you that we saw this coming relatively early. We took action going back to the middle of last year, so we started these steps early and we’ve intensified our cost reduction and our structural cost reduction efforts and so we had a running start as the year progress.

Steve Schwartz - First Analysis

Okay, the reason I’m asking Gideon is, I think in the last conference call you mentioned that the restructuring would get your capacity utilization up to reasonable levels, at 60% or 70% and just given the amplitude of these cycles, it just leaves me wonder, what happens when the turnaround comes? Do you find yourself capacity constrained and I guess if your competitors are in a similar situation, that’s less of a concern, so that’s the nature of the question?

Gideon Argov

It’s a fair concern. Obviously that has been something we’ve been watching very, very carefully as we were taking some of those cost reduction measures and to a great extent that’s why we started migrating away from this headcount reductions into reduced work weeks, furloughs and other solutions that allows us to preserve institutional knowledge and allow us to be able to ramp up when the industry recovers.

Steve Schwartz - First Analysis

Okay, that’s helpful. Thanks for taking the question.

Operator

And we’ll take another follow-up question from Mr. Arcuri’s line.

Junaid Ahmed – Citi

Yes, just a quick follow-up, could you just confirm that you said for a non-GAAP basis your income tax benefit was $500,000 this quarter, was that right?

Greg Graves

Could you repeat that?

Junaid Ahmed – Citi

The income tax benefit, could you just repeat. You stated in your comments, what that was on a non-GAAP basis for this quarter?

Gideon Argov

The tax benefit yes on a non-GAAP basis was $500,000. There was a significant charge related to additional deferred tax adjustments on a GAAP basis.

Junaid Ahmed – Citi

Okay and just one more thing lastly; the $28 million of cost reductions you said it should be done by second half. Is that exiting the second quarter or how should we think about when those costs would all kind of kick in?

Gideon Argov

I mean the $6 million of operating expense reductions will all have taken place as we go into the second half of the year, so going into the third quarter. The cost related to manufacturing moves, is as we move sort of between the third and fourth quarter, those costs will be gone and they relate primarily to our building four initiative, which we’ve talked about being completed by the end of the third quarter as the manufacturing cost.

Junaid Ahmed – Citi

Okay and this $28 million, the reduction would be relative to beginning of ’08? What would be it relative to?

Gideon Argov

I’m sorry; your connection is just not very good.

Junaid Ahmed – Citi

No I’m saying the $28 million annual cost reduction, that’s relative to the beginning of ’08, the $28 million?

Greg Graves

If you look back to 12 months, our operating expenses were running in the low 50’s. So say $50 million, $52 million; between $50 million and $53 million depending on the quarter. I would expect those operating expenses in Q2 or actually in Q1 to run somewhere in the low 40s. So we’ll have taken out much of $6 million in costs as well as the impact of some of the short term initiative.

We would expect our operating expenses in Q1, to run about $9 million less than they ran in the similar quarter last year and by the time we get to Q2, where we’re getting the full benefit of the short term initiatives, we should be running on an operating expense basis, about $10 million lower than a year earlier. Like expected, the Q1 operating expense excluding amortization to be somewhere in the 42, 43 range and I’d expect it’ll be in the 41 range in Q2.

Junaid Ahmed – Citi

Okay thank you very much. That’s very helpful.

Operator

And it appears there are no further questions at this time. Mr. Argov, I’d like to turn the conference back over to you for any additional or closing remarks.

Gideon Argov

To summarize, we’ve taken action to protect our balance sheet and give us sufficient flexibility and liquidity through what is obviously a horrendous downturn of the business. Number two, we’ve reduced our prominent cost structure in a significant way, as well as taken temporary measures, both of which will provide us with better profitability when things do improve and number three, the company is here to stay.

This is an important company that provides critical products; it has a strong market position in critical technologies and a product pipeline that will service us well when the industry recovers. Thank you for participating and we’ll talk to you later.

Operator

That does conclude today’s conference. We thank for your participation. Have a great day.

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