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Executives

Gideon Argov - President & Chief Executive Officer

Bertrand Loy - Chief Operating Officer

Greg Graves - Chief Financial Officer

Steve Cantor - Vice President of Corporate Relations

Analysts

Krish Sankar - Bank of America

Paul Thomas - Bank of America

Christian Schwab - Craig-Hallum Capital Group

Steve Schwartz - First Analysis

Entegris Inc. (ENTG) Q2 2009 Earnings Call July 22, 2009 9:00 AM ET

Operator

Good day everyone and welcome to the Entegris second quarter 2009 earnings release conference call. Today’s call is being recorded. At this time for opening remarks and introductions I would like to turn the call over to Steve Cantor, Vice President of Corporate Relations. Please go ahead sir.

Steve Cantor

Good morning everyone and thank you for joining our call. Earlier this morning we announced our financial results for our second quarter ended June 27, 2009. You can access a copy of our press release on our website 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; Bertrand Loy, Chief Operating Officer and Greg Graves, Chief Financial Officer.

Gideon will now begin the call.

Gideon Argov

Thank you, Steve. Good morning and thank you all for joining the call. I’ll provide an overview on the quarter and then Greg will provide some color on the financial results and an update on our breakeven level.

There were several reasons to be encouraged with our second quarter performance. First, we achieved quarterly sales of $82.6 million, which is a 40% sequential increase, driven by steadily improving demand for our unit driven products.

Secondly, we lowered our EBITDA breakeven level to $85 million in Q2, having implemented all the cost reduction steps we described to you in our previous quarterly conference calls. This enabled us to significantly reduce our operating loss and generate positive EBITDA in the month of June. Thirdly, we improved our cash flow and continued to lower our funded debt.

In terms of the revenue trends by market, sales to semiconductor customers represented 69% of Q2 sales and were up 52% from Q1, reflecting increases in fab utilization rates and wafer starts, particularly at our Asian foundry customers. On an industry-wide basis, fab utilization rates rose to around 70% in Q2, from levels around 50% in Q1, when the entire industry was in a virtual shutdown mode during the January and February timeframe.

Similarly, our second quarter sales were boosted by increased demand from wafer growers, who responded to the increased fab production levels. Aside from some technology-driven projects, capital spending among semiconductor customers was still quite soft throughout the quarter.

Our sales to customers outside of the semi industry which represented 31% of total sales reflected a mixed picture. Sales to TFT and flat-panel display market rebounded strongly, driven in-part by the China economic stimulus that included incentives for purchases of new high definition televisions. Sales to the data storage market also improved somewhat.

In contrast, sales to some of the other industrial markets such as EDM, declined in the second quarter, after fairing relatively better in the semiconductor related sales in Q1. This is not surprising since these industrial markets track broader economic trends and tend to lag the semiconductor market by a quarter or two.

The unit-driven, CapEx-driven split in the second quarter was 74% to 26%, compared to a 75% to 25% split in Q1. The pickup in unit-driven sales to semiconductor customers was offset by a decline in sales of unit-driven products to non-semiconductor customers.

In terms of trends by segment, contamination control solution sales of $48 million increased 39% from the first quarter, roughly half of this business relates to our liquid filtration products, which were used in the semiconductor manufacturing process. With the upturn in fab utilization beginning in March, we received some expedited orders for filters as well as for chemical containers from customers who were ramping production.

Sales of CCS capital-driven products such as our photochemical pumps, fluid handling products and gas purification systems, remain soft. While we are seeing some technology buys for some of these systems, sales of most CCS capital-driven products in Q2 remained at levels well below historical mid-cycle volume. On an operating basis, the CCS division rebounded from a loss of $8 million in Q1 to a $3 million profit in Q2.

Sales in our microenvironment segment grew 78% in Q2 to $26 million. After being particularly hard hit in Q1 by both, the slowdown in fab, capital spending as well as reduced wafer starts in the first quarter.

Demand for wafer shippers picked up as the industry worked through wafer inventories and some of the leading wafer growers resumed production after shutting down for most of January and February. In particular, sales growth of 300 millimeter shippers represented continued market share gain.

On the transport side of the ME business, demand for hoops and carriers increased from the extremely low Q1 level, but still reflected depressed industry spending for new equipment and capacity additions.

Among the positive in the quarter, was the speed with which we restructured the microenvironments business to lower our breakeven, while maintaining our focus and growing market share. As we told you in our last call, the closure of our largest manufacturing facility in North America and the move of a majority of that production to our facility in Malaysia, is part of a plan that lowered the breakeven point of this business by half since last year.

All the tooling is now in place in Malaysia and we are up to speed with production on a number of products. The full benefit of this move will be realized when we achieve higher sales volumes, but for now, we narrowed the operating loss in the segment from $10 million to almost breakeven in Q2, as a result of permanent and temporary reductions in operating expenses.

Sales in our specialty materials segment fell 12% to $9 million. A majority of these products including Poco’s specialized graphite and silicon carbide are heavily weighted to customers outside of the semi industry, such as the EDM segment. As I indicated earlier, these markets typically lag the semiconductor market, which they did in Q2, after holding up relatively better early in the downturn.

In short, Q2 represented a huge improvement from Q1 and we were pleased with the upturn in the unit driven side of our business. While we’re pleased with the progress, we believe the industry and economy have a long way to go before turning to a level that we would characterize as normal. Certainly, reaching such a level will require meaningful improvement in capital equipment spending.

Although, the timing and trajectory of that improvement is unclear, our breakeven level does not require extensive recovery in the capital side of the business, in order for us to generate positive EBITDA and to operate comfortably within our bank covenants.

We’re controlling what we can control and we are reaping the early results of a lower cost structure, manufacturing footprint that is better aligned with the needs of our customers, and a streamlined and more focused organization. Above all, we’re managing our balance sheet and cash flow effectively. When the broader recovery does occur, these steps give us significant operating leverage and earnings power. We look forward to reporting to you on further progress in Q3.

Before turning the call to Greg, for some comments on the financials, I want to acknowledge and thank Entegris’s employees around the world for their hard work and dedication during these past several months. This has not been an easy period to say the least, but the result of our employees during a period of incredible change has been truly inspiring. Greg.

Greg Graves

Thank you, Gideon. I’ll provide some detail on the financials for the quarter and then provide an update on our breakeven model for the third quarter. We were pleased with the financial progress in the second quarter in every respect. Sales increased in each successive month since March and while we had a small EBITDA loss for the quarter, we were EBITDA positive in the month of June.

Our Q2 sales growth reflected strong increases in Asia and Japan, which grew 89% and 55% respectively. As Gideon mentioned, we continued to take share in key areas, including 300 millimeter FASB wafer shippers and PVA post-CMP roller brushes.

We successfully implemented all of the cost reduction steps we announced last quarter to achieve an $85 million EBITDA breakeven level for Q2, excluding restructuring expense. These actions led to a reduction in our operating loss to $14.2 million in Q2, excluding $5.5 million in restructuring costs related to cost reduction programs and manufacturing consolidation. This compared to an operating loss of $34.5 million in Q1.

Gross margin for the second quarter was 29%, up from 15% in Q1, excluding the first quarter purchase accounting adjustment. The higher margin was the result of both higher sales volumes as well as continued reductions in both fixed and variable cost at our manufacturing facilities.

Operating expenses were $33.5 million, down from $38.6 million in Q1 and $47.5 million in the prior year, excluding amortization and restructuring charges. Second quarter SG&A of $25.7 million and ER&D of $7.8 million declined sequentially due to a combination of permanent headcount reductions and temporary cost savings programs such as work furloughs. Depreciation and amortization was $12.8 million in Q2.

EBITDA for the quarter, as measured by the terms of our amended credit agreement, was a loss of $4.3 million. For the first six months, the EBITDA loss on this basis was $20.2 million, well within the $45 million cumulative loss under our debt covenants. CapEx was $2.5 million in Q2 and $10.4 million through the first half of the year. We expect CapEx to run at around $6 million for the second half of 2009.

Turning to the balance sheet, we reduced our borrowings by $14 million and ended the quarter with $151.7 million of funded debt, including $130 million under the revolving credit facility. The cash balance was $84 million, as we generated $3.1 million in cash from operations, primarily due to reductions in inventories. Inventory turns improved to $2.7 from $2.2 in Q1, and DSOs declined to 65 days in Q2, from 80 days in the first quarter.

Looking to the third quarter, we expect to be above break even on an EBITDA basis, excluding restructuring expenses. The EBITDA break even level will be $85 million to $87 million, similar to the level we experienced in Q2. This reflects a slight upward bias from Q1, given the discontinuation of work furloughs as our plant utilization continues to ramp.

Our Q3 breakeven level is based on manufacturing fixed costs of about $27 million to $29 million, variable manufacturing costs of about 36% to 38% of revenue, and operating expenses exclusive of amortization of approximately $35 million to $37 million. We expect operating expense to be modestly higher than in Q2, as we reverse the portion of the temporary cost cuts that were put in place in Q1, namely the furloughs and salary reductions for non-executive employees.

We intend to reinstate the remaining temporary cost reductions as revenues continue to recover to levels that support sustained and growing profitability. On a GAAP basis, we expect the breakeven to be approximately $110 million in Q3.

In summary, our revenue trajectory is positive, even without the benefit of a full recovery in the capital driven side of the business. We delivered on our cost reduction initiatives and have positioned the company to realize significant operating leverage when the business fully recovers.

We continue to invest in new products and markets and to take share in key areas and finally, we’ve improved our cash flow and our balance sheet and are operating well within the requirements of our bank covenants.

With that, we’ll now take your questions. Operator.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question today comes from Krish Shankar.

Paul Thomas – Bank of America

Good morning. This is Paul Thomas for Krish Shankar. Hey guys. So on the units related business, obviously things recovered pretty well in foundry and at this point, do you guys think the restocking is mostly done now or are we going to see a return to more normalized wafer start type growth or is it still going to be faster than that in the next couple of quarters?

Bertrand Loy

Hello Paul, this is Bertrand. I think most of the restructuring activity took place probably in Q2 and we don’t expect to see any significant impact going in the second half of this year.

Paul Thomas – Bank of America

Okay and then CapEx; Gideon, you said that CapEx-related sales were still pretty soft during the quarter. We’re starting to hear about orders from your OEM customers are going to be up in Q3, it seems pretty significantly? Are you seeing any activity that indicates you guys are going to see something similar to that anytime soon or is that going to come later?

Gideon Argov

I think we haven’t seen that so far and as you know, we tend to have limited visibility in our business. The way to think about that is that we can do quite well and we’ve done quite well on a relative basis without that so far and we’ll be happy to see any impact of that in the future; let me put it that way. That will be a good thing and to some extent, icing on the cake.

Paul Thomas – Bank of America

Okay. Thank you.

Operator

And we’ll take our next question today from Christian Schwab - Craig-Hallum Capital Group.

Christian Schwab - Craig-Hallum Capital Group

Great, thank you. Greg could you give us a little bit more color on positive EBITDA? Is that $1 million to $2 million in positive EBITDA? Is that $3 million to $7 million? Can you give us any directional help there?

Greg Graves

Christian, we’re not giving revenue guidance and essentially if I were to give you an EBITDA point, I’d be giving revenue guidance. I think sufficed to say, it’ll be positive we’ll continue to see positive revenue trends as I said. Each month in the quarter was better than the prior month and so we feel like we’ve got good momentum in the business, but we’re not going to give a specific revenue number.

Christian Schwab - Craig-Hallum Capital Group

Okay. As we look at the recovery scenario, can you give us some color on how you see the recovery playing out over the next two to three quarters as your best estimate at this time?

Bertrand Loy

Christian, this is Bertrand. I would just start with some considerations at the micro level, and I think it is safe to say that first there is a general consensus for a recovery in global GDP in the second half of the year.

From an industry standpoint, we also expect the cell phone and PC shipments to see some seasonal strength going into the second half of 2009. So, all of that bodes well for continued strength in our unit-driven business, really, again led by a recovery in fab capacity utilization.

Now as it relates to CapEx, as Gideon said, that’s the big question mark that we all have. Right now, on an aggregate level, fab capacity utilization is still relatively low and we would need fab capacity utilization to probably exceed 80% to 90% for any meaningful capacity addition to take place and as of right now, I don’t think anybody in the industry would be capable to tell you when that would take place.

Christian Schwab - Craig-Hallum Capital Group

So when you look at fab utilization, it was 50% in Q1, 70% in Q2, what are your leading customers telling you that they expect the utilization rates to be at in the second half or exiting this year, calendar?

Bertrand Loy

I think that if we look at Q3, there is a fair degree of certainty that fab capacity utilization will get closer to mid 70%, maybe getting as high as 80%; after that it’s really, we don’t have enough visibility to comment on that.

Again very frankly, it really depends heavily on what customer you’re talking to. If you talk to some of the DRAM customers, their fab utilization is not even at those levels as of today and I don’t expect them to reach 70% fab utilization anytime soon.

Now, if you talk to some of the leading edge fabs, some of them have already exceeded 70% capacity utilization, so we have a mixed picture here.

Christian Schwab - Craig-Hallum Capital Group

Right. As we look at the recovery over the next few quarters and peak revenue, a few quarters ago being roughly $160 million, do you see the recovery scenario returning to a more normalized rate at about 75% of that, give or take?

Greg Graves

That is the question. We certainly don’t see the industry returning to what existed in 2007, early part of 2008. In my opinion, that is unlikely to happen in the next year to two.

What we do see is a company, in our case that even if we are operating at 20%, 25% less than those kinds of levels, we’ll be delivering fairly healthy profits, because the fact is we have a far more streamlined cost structure; we have executed on the product transfers; we have now for the first time a majority of our manufacturing operations in Asia and outside the United States, in the second half of this year and you’re going to see us at levels that are even 25% less than what you would call prior normalized levels, operating at a very healthy and profitable clip.

Bertrand Loy

Color around that Chris, I mean our operating margins at 125 in quarterly revenue will be as good or better than they were at 150 in earlier cycles.

Christian Schwab - Craig-Hallum Capital Group

Right, exactly. Great, and then lastly, my last question, the 300 millimeter, what do you think your market share is there? Where do you see that going in the next two to three quarters?

Bertrand Loy

Christian, this is Bertrand again. I’m assuming that your question relates to our 300 millimeter FOSB shippers. I’m actually very pleased with the results recorded in Q2. In Q2, we are back to levels we enjoyed in Q3 and Q4 of last year, which is in itself suggesting that we are continuing to gain share, but you’ll remember, our long term plan, our two to three year plan is to get to 25% to 30% market share.

We have continued to execute on that strategy. We have continued to make very good progress at all of the major wafer growers, and we’re now currently working with some major IDMs to qualify their incoming wafer shipping lanes. So I feel pretty good about how the team has executed in Q2 and I think we are well positioned to be on par with those long term objectives.

Christian Schwab - Craig-Hallum Capital Group

Great. Thank you.

Operator

(Operator Instructions) We will go next to Steve Schwartz with First Analysis.

Steve Schwartz - First Analysis

Good morning, everyone.

Gideon Argov

Good morning, Steve.

Greg Graves

Good morning, Steve.

Steve Schwartz - First Analysis

I guess the first thing is, it looks like inventory continues to generate cash, even though you had an upturn in business and I’m just wondering, how many quarters you think that will continue?

Gideon Argov

We have done a very good job really in both inventory and receivables, in terms of managing the balance sheet and that’s a function of the fact that we’re much more focused on that today.

In terms of, can inventory continue to decline on a sustainable basis? I would say not at the rate that it has, but I don’t think you’ll see inventory move up significantly over the next quarter or two. Although we would expect that if revenue continues to increase, we will see some modest increases in inventory as what we’re planning for.

Steve Schwartz - First Analysis

Okay, so just modest cash consumption there as things continue to improve?

Gideon Argov

Right, I mean we will consume more cash as the business grows as a percentage, we’ll consume considerably more cash in the accounts receivable than in the inventory area. Receivables are going to grow inline with revenue, we would not expect inventory to grow inline with revenue on a percentage basis.

Steve Schwartz - First Analysis

Greg, was there a tax valuation allowance in this second quarter like you had in the first?

Greg Graves

Well, there was. I mean we’re not taking any benefit with regard to the losses for U.S. purposes.

Steve Schwartz - First Analysis

Okay. What was that amount?

Greg Graves

So, the answer is yes. So as we generate the operating or the taxable losses, we’re putting an allowance against them and not showing the benefit. Other than that there was a slight benefit this quarter and that related to Japan, where we’re not putting valuation allowances on them.

Steve Schwartz - First Analysis

That amount in the second quarter?

Greg Graves

I don’t have that right off the top of my head Steve; I’ll have to get back to you with that.

Steve Schwartz - First Analysis

It will be in the Q right?

Greg Graves

Yes.

Steve Schwartz - First Analysis

Okay, I’ll get it there. Then last question is you actually had a much stronger percentage improvement sequentially in your CapEx. Even though we know that there is still weakness there, is there some replacement business in there that’s helping to drive that?

Greg Graves

Steve, I think part of it is we are just coming off such a low base on the capital side; that explains part of it. Then we have seen some very modest improvement in our shipments during the quarter to some of the OEMs, but like I said, the primary reason is that capital business has gotten so low in Q1. So when you look at it on a percentage basis, you’re right, the improvement is about the same, but it was a really low base.

Steve Schwartz - First Analysis

Okay. Very good, thank you much.

Bertrand Loy

Just to add to that Steve, if you look at our CapEx business right now, peak to trough, our overall CapEx business is still at about 30% of peak levels of a year ago. So, I think that just gives you an order of magnitude of how depressed the levels were in Q1.

Steve Schwartz - First Analysis

Yes. Okay.

Operator

Next we’ll take a follow-up from Krish Sankar, Bank of America.

Krish Sankar - Bank of America

Hey guys, this is Krish. Sorry I got in a little late. A couple of questions, I know you’re not giving any revenue guidance, but it seems like the semi business is picking up, but if you flat line non-semi from here, how do we think of the margins profile going forward?

Gideon Argov

So number one, the non-semi business, we don’t necessarily see that business flat lining. I would say we see that business as growing over the balance of the year.

Even in the specialty materials division, which we saw a decrease in revenue in the second quarter for reasons that we talked about, part of that’s tied to the broader economy, there’s a segment in there that’s impacted to some extent by automotive, but we actually see that business growing, and we have seen a rebound in the level of activity in that business as we get into the current quarter.

The margin profile is not dramatically different between the semi and the non-semi. The way to think about the margin profile is on a product-line by product-line basis. So within CCS, within ME, and within ESMD, all of which are outlined clearly in the financial reports, we see different product lines with different margins, but there’s no consistent and systematic bias, either better or worse in terms of margin by segment is the way I would describe it.

Krish Sankar - Bank of America

Got it, thank you. Then one other question or two more actually; the upside in Q2 came from the unit driven side, both the filtration and wafer shippers. Was the filtration business pickup mainly driven by the foundry guys? The second part to that was on the wafer shipper side, is there anyway of setting up what percentage came from share gains versus the wafer start improvement?

Gideon Argov

So, you’re correct in your first assumption that a lot of the improvement that we recorded in the U.S., in the unit driven business was coming from liquid filters, wafer shippers, as well as our container business, which did very well with obviously some increase in materials, in the chemicals consumptions by the fabs as well. So we needed to provide some drums and other containers to the chemical companies.

So, back to your question about share gains versus just benefiting from the industry trend, I would just say that if I look at the wafer shipper business itself, we enjoyed a growth rate in excess of 100% in the quarter; I mean quarter-over-quarter, which suggests that a portion of that is related to just benefited from the industry trend and a portion of that is leading to market share gains.

Krish Sankar - Bank of America

Thank you very much.

Operator

We will take a follow-up from Christian Schwab of Craig-Hallum Capital Group.

Christian Schwab - Craig-Hallum Capital Group

You would expect all business segments to be up sequentially, did I understand that right in Q3 contamination control microenvironment and specialty materials.

Gideon Argov

Yes.

Christian Schwab - Craig-Hallum Capital Group

Mid cycle, as we look out and we can all guess when that mid cycle will occur, but what do you think the quarterly revenue run rates for your company would be at a mid cycle?

Gideon Argov

We don’t have an answer for that, is the short answer. I mean that depends on overall level of activity and fab utilization. I think, again, my personal view is that it is not unreasonable to assume that that will be somewhere around 25% lower than what we sort of assumed to be mid cycle a year or two ago.

On a pro forma basis in the third quarter of 2008, with all of our SMB business, we did $165 million range. That was the revenue on a pro forma basis in that quarter. If you take 25% lower than that, 20% lower than that, I mean is that a reasonable assumption? Potentially, yes. That would put us at around $125 million a quarter.

So I am not suggesting that we are forecasting that. I am suggesting that that is not an unreasonable thought and the only question is, when and at what rate it’ll recover and when do we get there.

Christian Schwab - Craig-Hallum Capital Group

Great, thank you.

Operator

And with no further questions, I would like to turn the conference back over to Gideon Argov for any additional or closing remarks.

Gideon Argov

Thank you very much for joining our call and we look forward to updating you in the future.

Operator

And that does conclude today’s conference ladies and gentlemen. We appreciate everyone’s participation today.

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