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Edited Transcript of CCMP earnings conference call or presentation 27-Jul-17 2:00pm GMT

Thomson Reuters StreetEvents

Q3 2017 Cabot Microelectronics Corp Earnings Call

AURORA Aug 13, 2017 (Thomson StreetEvents) -- Edited Transcript of Cabot Microelectronics Corp earnings conference call or presentation Thursday, July 27, 2017 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David H. Li

Cabot Microelectronics Corporation - CEO, President and Director

* Trisha Lee Tuntland

Cabot Microelectronics Corporation - Director of IR

* William S. Johnson

Cabot Microelectronics Corporation - CFO and EVP

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Conference Call Participants

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* Arthur Su

Needham & Company, LLC, Research Division - Research Associate

* Cassandra Silversteyn

* Christopher John Kapsch

Aegis Capital Corporation, Research Division - Research Analyst

* Jacob P. Schowalter

Seaport Global Securities LLC, Research Division - Associate Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the Cabot Microelectronics' Third Quarter Fiscal 2017 Earnings Conference Call. (Operator Instructions). As a reminder this conference call is being recorded. I would now like to turn the conference over to Trisha Tuntland, Director of Investor Relations.

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Trisha Lee Tuntland, Cabot Microelectronics Corporation - Director of IR [2]

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Good morning. With me today are David Li, President and CEO; and Bill Johnson, Executive Vice President and CFO. This morning, we reported results for our third quarter of fiscal 2017, which ended June 30, 2017. A copy of our earnings release is available in the Investor Relations section of our website, cabotcmp.com, or by calling our Investor Relations office at (630) 499-2600. A webcast of today's conference call and the script of this morning's formal comments will also be available on our website.

Please remember that our discussions today may include forward-looking statements that involve a number of risks, uncertainties and other factors that could cause actual results to differ materially from these forward-looking statements. These risk factors are discussed in our SEC filings, including our report filed on Form 10-K for the fiscal year ended September 30, 2016. We assume no obligation to update any of this forward-looking information.

Also, our prepared remarks this morning reference non-GAAP financial measures. Our earnings release includes a reconciliation of GAAP to non-GAAP financial measures.

I will now turn the call over to David.

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David H. Li, Cabot Microelectronics Corporation - CEO, President and Director [3]

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Thanks, Trisha. Good morning, everyone, and thanks for joining us. This morning, we announced strong results for our third quarter of fiscal 2017, reflecting continued healthy semiconductor industry demand as expected and discussed during our Second Quarter Earnings Conference Call in April, as well as the continued successful execution of our strategic initiatives. During the quarter, we experienced sustained robust demand for our tungsten, dielectrics and pad CMP solutions across a wide range of memory and logic applications, including 3D NAND and FinFET technologies. We believe our performance is evidence of our technology leadership, operational excellence and close collaboration with our customers. During the quarter, we achieved record revenue of $128 million, approximately 18% higher than in the same quarter last year. Our gross profit margin was 48.9% of revenue, and we achieved diluted earnings per share of $0.77, reflecting continued strong profitability. In addition, we continued our strong cash generation trend, with cash flow from operations of $32.1 million. Bill will provide more detail on our financial results later in the call.

To provide some context for our third quarter results, let me first offer some perspectives on the global semiconductor industry environment. As forecast by some of our customers and industry analysts, I see demand remaining solid during the June quarter, despite isolated softer conditions in certain smartphone applications, primarily affecting some advanced logic and foundry players, due to mobile product seasonality. Reports suggest that overall semiconductor demand was driven by continued robust memory market, generally due to the growing requirements for storage in a wide range of end-use applications. Due to this and semiconductor device manufacturers inventory management, some of our customers and industry analysts have reported expectations for continued solid conditions during our fourth fiscal quarter, and through July, we are seeing continued healthy demand for our IC CMP consumables products.

Later in the call, Bill will provide commentary on our expectations for the September quarter. Considering longer-term expectations for the semiconductor industry, reports indicate that demand for ICs should continue to increase over time, including rapid growth from data creation, analytics and storage. This is being referred to by some as the third wave of the semiconductor industry, with PCs and mobile connectivity having represented the first and second waves. We believe that with this evolution, the industry may see more stability of demand and potentially less pronounced cyclicality and seasonality than in the past.

Related to this, we believe several factors will drive long-term growth in semiconductor industry demand. First, the ongoing transition from traditional planar or 2D memory to advanced 3D memory for mobile, server and PC applications. Next, there is expected continued strong need for advanced semiconductor devices for high-performance computing, virtual and augmented reality and smartphone applications. Third, demand for greater connectivity should drive additional semiconductor growth with wearables, peripherals and The Internet of Things. Finally, automotive applications are also expected to represent a continued strong growth opportunity, as automakers increase semiconductor content related to the driving experience. Some examples of this are improved telematics for end vehicle networking, sensors for safety and autonomous vehicles.

The view from SEMICON West earlier this month in San Francisco appears to reflect this longer-term industry outlook. The overall tone at the conference was generally bullish for the remainder of 2017 and into 2018, with commentary mainly focused on the outlook for 3D memory and semiconductor industry development in China.

China continues to be in the spotlight with a number of fabs under construction, others announced and additional domestic and international investment in both logic and memory capacity expected in the future. Semiconductor industry growth, including within the memory market in China should be a strong driver of demand for our CMP consumables products over the next several years. Based on our global resources, capabilities and infrastructure, which we believe uniquely position us to deliver innovative CMP solutions to our customers around the world, we believe we are well positioned to benefit from these near and longer-term industry demand trends. And we expect our revenue to grow faster than the IC CMP consumables market.

Now let me turn to company-related matters. During the quarter, we experienced strong demand for our tungsten and dielectrics slurries and our pad solutions, across a wide range of applications and technology nodes. This drove approximately 16% year-on-year revenue growth for the quarter from our IC CMP consumables products. Of particular significance, this quarter, we achieved year-on-year revenue growth of approximately 28% in China and 25% in Korea. Our strong positions in these countries are notable, given expectations for long-term overall semiconductor growth in China and continued memory growth in Korea.

You may recall that during our conference call last April, we discussed the recent expansion of our facilities in Korea. We believe this expansion enhances our global infrastructure and our ability to provide local development and manufacturing to support our customers in the region and we look forward to continuing to leverage this facility for future growth.

Now let me provide a brief update on each key product area, beginning with tungsten slurries. During the quarter, we experienced robust demand in this area, driven by our continued support of our customer's ramps of 3D NAND and FinFET technologies as well as our leading supply positions in other applications. As a result, in the third fiscal quarter, we achieved revenue growth in tungsten slurries of approximately 18% compared to last year. The transition from 2D to 3D memory is significant for our business since 3D technology requires roughly twice the number of CMP steps as 2D. We expect the industry transition from 2D to 3D to continue over the next several years.

As we have discussed in the past, a key to maintaining our long-standing leadership within tungsten slurries across all areas: foundry, logic and memory, has been our ability to offer a broad, deep and constantly refreshed portfolio of innovative solutions. Our strategy in this product area is focused on technology leadership, enhancing our supply chain capabilities and quality systems and leveraging our global technical network and infrastructure, to provide unmatched support for our customers. We believe the strength of our brand in tungsten slurries driven by our ongoing delivery of a differentiated, value-added total customer experience will enable us to maintain and grow our business in this important product area.

Moving on to our second key product area, during the quarter, we also experienced strong demand for our dielectric slurries with revenue up approximately 19% compared to the same quarter last year. We're in the midst of a broad transformation of our dielectrics product area, as we promote our family of higher performing, lower cost and higher profitability colloidal silica-based solutions for a wide range of technology nodes and applications to win new opportunities, displace incumbents and replace some of our own legacy solutions. We continue to see robust customer pull for these products as well as for our high-performing Ceria-based solutions. We won a new business opportunity this quarter for a 3D NAND application with one of our new Ceria solutions, which we believe is an example of our ongoing innovation through close collaboration with our technology leading customers to meet their stringent requirements. We expect that the broad transformation underway in this product area will be a driver for continued profitable growth over the next several years and continued evidence of our technology leadership within CMP slurries.

Turning to CMP pads, our third key product area, this quarter we achieved record revenue for the seventh consecutive quarter and year-over-year revenue growth of approximately 25%. On a year-to-date basis, our pad revenues up approximately 40%. This growth has largely been driven by continued strong and broad customer pull for our products across the logic, memory and foundry segments. We continue to leverage our global sales channel, technical resources and infrastructure to speed the qualification and adoption of our pad offerings, based on our NexPlanar acquisition.

During the quarter, we advanced several initiatives in conjunction with driving growth in our pads product area. First, to position our company for sustained growth in China, we continue to make progress with our collaboration with Konfoong Materials International or KFMI. This collaboration emphasizes our commitment to provide our customers in China with reliable, local manufacturer of advanced CMP pad technology. Based on the progress of our combined teams and consistent with our previously discussed expectations, we began customer sampling during the June quarter. We continue to expect our first KFMI-related revenue in fiscal 2018. Second, as we mentioned several quarters ago, to support expected robust growth of our CMP pad solutions, we are expanding our manufacturing capacity in Hillsboro, Oregon. And we expect production from this additional capacity to begin during the first half of our fiscal 2018.

Finally, during the quarter, we expanded our product offerings with a commercialization of a family of new polishing pad configurations, focused on improving both performance and profitability in this product area. We continue to view CMP pads as the greatest growth opportunity for our company. Based on the strong growth performance and momentum we have achieved in this product area to date and consistent with what we previously discussed, we are confident that we'll be able to grow our pad revenue to over $100 million in fiscal 2019. Across our CMP slurry and pads product areas, we have a strong pipeline of active new business opportunities around the world covering foundry, logic and memory customers, including CMP slurry and pad consumable sets. We believe that given our broad product portfolio on CMP slurries, along with our technology and capabilities in CMP pads with the NexPlanar acquisition, we are uniquely positioned to deliver best-in-class slurry and pad CMP solutions.

To summarize, we have demonstrated continued momentum in 3 key product areas: CMP tungsten slurries, dielectric slurries and CMP pads. And we believe these will be drivers for continued profitable growth for the company over the next several years. In addition, our focused business model along with our global resources, capabilities and infrastructure, differentiates our company as a leader among suppliers to the semiconductor industry. Based on all of this and our results through 9 months of fiscal 2017, we believe we are well positioned to achieve record revenue and profit for the full fiscal year. With that, I'll turn the call over to Bill, for more detail on our financial results.

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William S. Johnson, Cabot Microelectronics Corporation - CFO and EVP [4]

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Thanks, Dave, and good morning, to everyone. Revenue for the third quarter of fiscal 2017 was a record $128 million, which represents an 18.3% increase from the same quarter last year. The increase reflects continued strong global semiconductor industry demand that we've seen over the last 5 quarters as well as the continued successful execution of our strategic initiatives. Year-to-date, revenue of $370.4 million represents a 20.3% increase from last year. Drilling down into revenue by product area, tungsten slurries contributed 42.8% of total quarterly revenue. With revenue we continue to see strong demand for our tungsten slurries for advanced applications, including 3D memory and FinFET. And as Dave discussed earlier, this is a key product area that we expect will drive future profitable growth for our company.

Dielectric slurries representing a second key product area, provided 23.7% of our revenue this quarter, with sales up 19.4% from the same quarter a year ago. Our dielectrics growth was primarily driven by strong demand for our colloidal, silica and Ceria-based solutions. We look forward to winning more business in this area with our higher performing, lower cost and higher profitability products. Sales of our polishing pads, our third key product area, represented 13.8% of our total revenue for the quarter, and increased 25.1% compared to the same quarter last year. Our pads product area achieved record revenue for the seventh consecutive quarter. Sales of slurries for polishing metals other than tungsten, including copper, aluminum and barrier represented 12.6% of our total revenue and increased 0.3% from the same quarter last year. Finally, revenue from our Engineered Surface Finishes area represented 6.1% of our quarterly revenue and data storage products represented 1.1%.

Gross profit for the quarter was 48.9% of revenue, compared to 48.1% that we reported in the same quarter a year ago. This includes $1.2 million of amortization expense related to our NexPlanar acquisition. Excluding this, non-GAAP gross profit was 49.8% of revenue. Factors impacting gross profit this quarter compared to last year include higher sales volume and a higher valued product mix, partially offset by higher fixed manufacturing cost, including higher incentive compensation expense. Year-to-date, gross profit was 49.7% of revenue compared to 48.5% last year. This includes $3.6 million of amortization expense related to NexPlanar. Excluding this, non-GAAP gross profit was 50.7% of revenue. Taking into account our results through 9 months, we currently expect our GAAP gross profit margin for the full fiscal year to be between 49% and 50% of revenue. Our prior full year guidance range was 49% to 51% of revenue. This includes an adverse effect of approximately 100 basis points related to NexPlanar amortization expense.

Now I'll turn to operating expenses, which include research, development and technical, selling and marketing, and general and administrative costs. Operating expenses this quarter were $35.6 million, including $0.5 million of NexPlanar amortization expense. Operating expenses were $5.7 million higher than the $29.9 million reported in the same quarter a year ago. This mainly reflects higher staffing-related expenses, primarily incentive compensation expense. Year-to-date, total operating expenses were $105.1 million, which includes $1.4 million of NexPlanar amortization expense. We currently expect our GAAP operating expenses for the full fiscal year to be between $140 million and $142 million. Our prior guidance range was $137 million to $142 million. This includes approximately $2 million of NexPlanar amortization expense. Our effective tax rate for the third fiscal quarter was 22.4% compared to 9.6% in the same quarter last year. The increase is primarily related to changes in the jurisdictional mix of our earnings and a tax benefit recognized in the same quarter last year. Year-to-date, our effective tax rate was 21.1%. We currently expect our effective tax rate for the full fiscal year to be within the range of 21% to 22%. Previously, we had estimated 19% to 22% for the full fiscal year.

Our net income for the quarter was $19.9 million or $21 million on a non-GAAP basis, excluding amortization expense related to NexPlanar. This is 6.6% higher than the $18.7 million reported in the same quarter last year. The increase was primarily due to higher revenue and a higher gross profit margin, partially offset by higher operating expenses and a higher tax rate. Year-to-date, our net income was $60.4 million or $63.7 million on a non-GAAP basis, excluding the referenced amortization expense. This is 54.4% higher than the $39.1 million reported last year. Diluted earnings per share were $0.77 this quarter or $0.81 on a non-GAAP basis, excluding the NexPlanar amortization expense, compared to $0.76 we reported in the third quarter of fiscal 2016. Year-to-date, diluted earnings per share were $2.37 or $2.49 on a non-GAAP basis, which is 49.1% higher than the $1.59 reported last year.

Turning now to cash and balance sheet-related items. Capital investments for the quarter were $4.2 million, bringing our year-to-date capital spending to $15.9 million. For the full fiscal year, we now expect capital spending to be within the range of $21 million to $23 million. Our product guidance range was $20 million to $25 million. As previously discussed, our capital spending this year includes our facility expansion in South Korea, which we completed during the second fiscal quarter and expansion of our polishing pads manufacturing capacity to support anticipated growth. Depreciation and amortization expense for the quarter was $6.3 million, and we generated cash flow from operations of $32.1 million. We ended the quarter with a cash balance of $363.9 million and $147.2 million of debt outstanding.

Our strong cash generation model has enabled us to implement a balanced capital deployment strategy over the years, for which our priorities continue to be funding organic investments to improve our global capabilities and our core CMP consumables business, dividends, acquisitions in closely related areas and share repurchases. We believe we are well positioned for continued profitable growth and delivery has significant value to our shareholders.

I'll conclude my remarks with a few comments on demand for our IC CMP consumables products. During the third fiscal quarter, we saw a 6% increase in revenue from our IC CMP consumables products compared to the second quarter of fiscal 2017. This is stronger than the expected 3% increase for the third quarter that we referenced during our conference call in April. Earlier, Dave talked about general industry expectations for continued solid demand during our fourth fiscal quarter. Consistent with that outlook, we expect demand for our IC CMP consumables products in the September quarter to be around 2% higher than the record level of revenue we achieved in our third fiscal quarter.

To summarize, from a financial standpoint, we have now delivered strong financial performance over 5 consecutive quarters. As we think about the remainder of fiscal 2017, we expect continued solid semiconductor industry demand and we expect our full fiscal year gross profit margin to be between 49% and 50% of revenue. Based on our revenue growth and profitability through 9 months of fiscal 2017 and expected continued momentum in tungsten and dielectric slurries and polishing pads, we believe we're on track to deliver record revenue and profit this year. Now I'll turn the call back to the operator as we prepare to take your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question is from Dmitry Silversteyn of Longbow Research.

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Cassandra Silversteyn, [2]

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This is Cassandra Silversteyn on for Dmitry. So the first question is kind of into the detail of the tungsten demand. About how much of that is kind of attributed to the newer technologies like FinTech? And how much of that is more towards the already incumbent market demand?

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William S. Johnson, Cabot Microelectronics Corporation - CFO and EVP [3]

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Hi Cassandra, thanks for your question. With regards to tungsten, you're right. So we're really excited about the opportunity for the advanced technologies for both FinFET and 3D. And exiting fiscal 2016, we talked about 20% of our tungsten revenue, which driven by sales into these advanced technologies with memory on a faster, stronger trajectory. And we'll update that advanced tungsten sales -- sales into advanced technologies next quarter. But as you probably have been following, there is a lot of investment going into memory, and we think that offers a significant growth opportunity for us for both tungsten, dielectrics and pads. But for now, what we've talked about is 20% of our tungsten sales exiting FY '16 and we'll update that, again, at the end of this next quarter.

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Cassandra Silversteyn, [4]

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Great. And then for the second question, you had mentioned a 25% growth in your polishing pads for the quarter, which is great, but it kind of seems that it's a bit lower than the growth from the previous 2 quarters and lower than our modeling. So could you just kind of tell us how we should think about the factors that are attributing to the decrease in growth? Or we should kind of consider that 25% a new normal?

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David H. Li, Cabot Microelectronics Corporation - CEO, President and Director [5]

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Right. So what we talked about is continued growth in pads, as we mentioned, our seventh consecutive record quarter for pads revenue. And we also talked about our strong expectations for growth in the next several years. So we kind of measure it by how we're doing over time, not just quarters. And we talked about our confidence in growing this business to over $100 million for our fiscal '19. So that would be considerable growth versus certainly the timing of our NexPlanar acquisition. But we continue to see strong customer pull. We also talked about continued investments in capacity. So we're investing ahead of demand there. So we see strong growth potential in pads and expectations to grow 100 -- more than $100 million by fiscal '19.

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Operator [6]

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The next question is from Edwin Mok of Needham & Company.

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Arthur Su, Needham & Company, LLC, Research Division - Research Associate [7]

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First question is just on your pads business. In the past you talked about how you've penetrated 8 out of 10 leading semi customers. Are there any new customers that you would like to share during the quarter? And then if not, then what are the state of engagements with some of these -- the remaining 2 customers?

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David H. Li, Cabot Microelectronics Corporation - CEO, President and Director [8]

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Right. So for pads, we've talked about in the past 8 of 10. And the one thing -- the interesting dynamic and what we're really encouraged by is once you start selling pads into a customer, we're seeing continued really short qualification time. So a customer may bring in our pad for certain application, and what we've seen is rapid proliferation across different applications and different locations within the same customer. So what we're seeing primarily now is increased proliferation within existing customers. That is also being complemented with a very strong pipeline of new opportunities with both existing and new customers. We also commented on a new pad configuration, which is really our launch of a new series called the ultra-series, building off, innovating off that NexPlanar platform. What we're doing there is providing our customers with better performance and also taking some cost out of our process. So we're excited about that new series. We're excited about the growth in pads and we see a strong trajectory going forward.

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Arthur Su, Needham & Company, LLC, Research Division - Research Associate [9]

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Great. I think, David, you mentioned that you've had a new win for your higher-performing ceria dielectric slurries for 3D NAND application, was that with a new customer?

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David H. Li, Cabot Microelectronics Corporation - CEO, President and Director [10]

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We didn't mention about the new customer or not, but as you know, the number of customers in high-volume in 3D is pretty limited and we sell to just about everyone today. But one of the things we've talked about a lot in the past is our new family of colloidal silica products and we also have continued innovation in the ceria area. So this was just an example of continued innovation, working closely with our customers to hit a really stringent requirement in the ceria area. We've seen tremendous growth in both colloidal and ceria and we're excited about that new family. I think this area for dielectrics in general is an area where we're really taking strong technology leadership, continued innovation to an area where there has not been a lot of innovation in the past. So whether it's our new family of colloidal silica-based products or our building off our family of ceria-based products, we feel we are really well positioned for both memory and foundry and logic. But this was an example of blend in 3D NAND.

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Arthur Su, Needham & Company, LLC, Research Division - Research Associate [11]

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Got it. And then during the call, you also talked about how you're seeing this demand for your CMP consumables coming from these non-leading edge applications. And obviously leading-edge is a strong driver for your business due to the higher CMP intensity. But when you think about the trailing edge, do you see this as an accelerating growth driver for Cabot and could you see a broadening of your business that could potentially offset some typical seasonality?

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David H. Li, Cabot Microelectronics Corporation - CEO, President and Director [12]

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Thanks for the question. What we've seen, and following the industry, I'm sure you're seeing the same, are that some of the traditional drivers are still certainly there, like smartphone, mobile, those types of applications and also, of course, memory. But some of the other applications that are continuing to increase and grow significantly, are what's being referred to as this third wave which includes segments like automotive and industrial and for example, we announced several months ago, we won an award from TI. We're honored to win that award. And TI recently announced they are seeing tremendous growth in automotive area as well. So we feel like we're well positioned to grow with those segments of the market and certainly we're serving those already but as those continue to grow, we do see the potential for less cyclicality and seasonality than we see in the past.

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Arthur Su, Needham & Company, LLC, Research Division - Research Associate [13]

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Great. If I could just squeeze in 1 more question. Bill, I just had a question on gross margins. You guys reported a strong revenue quarter, but non-GAAP gross margin declined by 160 basis points quarter-over-quarter. I know in the past you've highlighted the swing factors for gross margins, but was moderation in this quarter mostly due to the stronger growth in the pads business?

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William S. Johnson, Cabot Microelectronics Corporation - CFO and EVP [14]

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It's actually -- yes, we did see benefit of higher revenue, but we did see 1 significant factor this quarter, was higher fixed manufacturing cost. We talked over the past several quarters about expanding our facility in Korea, and expanding our pad manufacturing capacity in Hillsboro and that's been to fuel significant growth. We've talked about a lot of growth in Korea, and strong growth in pads and that's meant more staff. So we've added people in a number of areas. And including in the pads area beyond just sort of keeping up and staying ahead of strong demand and pull from customers, we've also added engineering capability to capture more productivity improvements. We've talked about our pad business as having gross margins below the company average. We think there are opportunities to improve those gross margins over time with productivity improvements, more efficiency, more automation. That takes engineers, and so we've added some staff there. And you can see that in higher fixed manufacturing costs. In addition, we've talked over the year -- we mentioned about higher incentive compensation cost and that hits cost of goods sold also as well as operating expense. We've been performing quite well throughout the year, our performance versus our corporate goals, and so incentive compensation has been higher as well. But what we saw this quarter was higher fixed manufacturing cost. That was kind of the key factor. We did see stable ASPs. So this wasn't a factor of ASP erosion or anything like that. It was just -- it was higher cost.

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Operator [15]

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The next caller is Chris Kapsch of Aegis Capital Corp.

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Christopher John Kapsch, Aegis Capital Corporation, Research Division - Research Analyst [16]

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Just a follow-up on the gross margin. So that was pretty good explanation. But the -- IC comp accruals -- was there like a catch-up accrual in this quarter that disproportionately affected the gross margin because, otherwise you would have expected some of these other costs that you've been investing in, the people, and the fixed manufacturing cost presumably flow-through a little bit in the fiscal second quarter as well? So just trying to get a little more color on that.

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William S. Johnson, Cabot Microelectronics Corporation - CFO and EVP [17]

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Sure. That's a bigger factor year-over-year. We did see some sequential increase. But yes, that was not the biggest part of it. It was kind of broader fixed manufacturing cost. But if you look at other profitability metrics, gross profit decreased sequentially but our operating income, EBITDA margin, net income margin all expanded sequentially. So I think we're comfortable with the overall model but we did see some higher cost in Q3 in manufacturing.

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Christopher John Kapsch, Aegis Capital Corporation, Research Division - Research Analyst [18]

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Was there -- on the IC comp expense that you called out, was there a catch-up accrual there? Or is it just more being added, given the performance that you guys put up sequentially?

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William S. Johnson, Cabot Microelectronics Corporation - CFO and EVP [19]

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Yes. There was -- we true-up that accrual every quarter and we did have a classification between manufacturing cost and operating expense that caused a bit of that tick upward in fixed manufacturing cost.

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David H. Li, Cabot Microelectronics Corporation - CEO, President and Director [20]

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But Chris, as Bill mentioned earlier it's really us what you're seeing this quarter is investing ahead of demand for pads and timing of hires, especially in Hillsboro, we referenced capacity expansion and we're investing there. We believe that capacity will be online in early FY '18 first half. And so that's really what you're seeing this quarter.

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Christopher John Kapsch, Aegis Capital Corporation, Research Division - Research Analyst [21]

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Okay. So it's more people than fixed capacity-related cost, correct? In terms of the -- that part of the higher manufacturing cost that you quoted.

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William S. Johnson, Cabot Microelectronics Corporation - CFO and EVP [22]

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I think it is a combination of the two. We're adding manufacturing capacity in pads in particular and people and then people to support the strong growth in Korea. So it's a combination of the two I think.

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Christopher John Kapsch, Aegis Capital Corporation, Research Division - Research Analyst [23]

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Okay. Is there new capacity that was being ramped up in the process of being qualified that was flowing through the P&L?

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William S. Johnson, Cabot Microelectronics Corporation - CFO and EVP [24]

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When you look at our -- we have added staff. And you can see that in our press release when we talk about -- we've always given approximate number of employees and you can see an increase in that number. So yes, we've added people to help support the growth in pads, in particular, but also in Korea. It is...

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Christopher John Kapsch, Aegis Capital Corporation, Research Division - Research Analyst [25]

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No. But I was asking about new capacity in the form of hard capacity assets?

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William S. Johnson, Cabot Microelectronics Corporation - CFO and EVP [26]

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Right. So we've added -- we expanded our Korea facility. That was $8 million capital investment. And then we're in the process of adding new hard assets in pads but also you add people as you ramp up production from the existing assets. So it's a combination of those 2 things.

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Christopher John Kapsch, Aegis Capital Corporation, Research Division - Research Analyst [27]

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Okay. That's helpful. I don't mean to be too nitpicky. Just given the strength in some of your -- the sales strength in some of your highest margin products, just trying to understand why that wouldn't have flowed through more and it sounds like it relates to just the transient aspect of ramping up your capacity in pads and to a lesser extent in, I guess, Korea specifically to address the growth that you can see looking forward, if that's one way.

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William S. Johnson, Cabot Microelectronics Corporation - CFO and EVP [28]

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I think that's a fair characterization. In our history, we've seen some fluctuations in gross margin quarter-to-quarter and there is an element of that, but I think your characterization is fair.

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Christopher John Kapsch, Aegis Capital Corporation, Research Division - Research Analyst [29]

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And just to be clear, currency didn't influence the margins whatsoever, it sounds like.

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William S. Johnson, Cabot Microelectronics Corporation - CFO and EVP [30]

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No, really. There was really no significant currency effect.

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Christopher John Kapsch, Aegis Capital Corporation, Research Division - Research Analyst [31]

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And then my follow-up unrelated was just on your commentary about the fiscal fourth quarter. The way you describe it as a little different than the way you used to about the trend, you don't necessarily call out the order trends, I guess, thus far into July. But the 2% higher sequential revenues that you expect in the September quarter vis-à-vis the June quarter, are the demand trends that you see so far in June consistent with that? Are they above that? Or do you need further sequential seasonal strengthening to hit that sort of -- that bogey or metric?

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William S. Johnson, Cabot Microelectronics Corporation - CFO and EVP [32]

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Yes. If you remember last quarter, we kind of departed from our traditional approach of just referring to orders to date in the month where we were at the time of the earnings call. And then we used kind of more judgment and based on our internal forecast, last quarter we said we expected a 3% increase in IC CMP consumables from Q2 to Q3 and we're carrying on that practice this time. We take into account what the orders are to date in July but also our view of August and September. And so, yes, we've seen continued strong orders in July, and for the quarter, the expectation is some growth approximately 2% Q3 to Q4. So it's a different approach that we started last quarter and now we are continuing this quarter.

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Operator [33]

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(Operator Instructions) The next question is from Michael Harrison of Seaport.

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Jacob P. Schowalter, Seaport Global Securities LLC, Research Division - Associate Analyst [34]

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This is Jacob on for Mike. In your prepared remarks, you kind of talked about the softness in smartphones. So I'd be curious of your take on how you think that market will shape up in the back half of the calendar year? And sticking with the order theme, have you been seeing any order activity pick up in regards to customers' more levered to the smartphone market?

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David H. Li, Cabot Microelectronics Corporation - CEO, President and Director [35]

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Right, Jacob. So consistent with what some of the releases have been recently including TSMC, they actually had a down quarter this quarter and are expecting a strong quarter going forward. And we believe that is related to smartphone launches, whether it's the iPhone 8 or other devices that are in preparation for launch. For us, for those advanced logic and foundry applications, we're well positioned to grow with those ramps, especially because in the FinFET there is a tungsten gate requirement, that's very challenging. We obviously have the leadership position in tungsten. So we would -- we feel we're well positioned to grow with that growth in advanced logic. I do think you pointed out correctly what the industry analysts would say is that this quarter that we're currently reporting on, the only soft spot in the industry, memory continued to be strong, the legacy logic and foundry continue to be strong and the only kind of soft spot was that advanced logic which seems to be ramping up in preparation for those new launches. And as Bill, referenced, we have some expectations of about 2% growth. That's broad-based industry strength and, of course, we'd be well positioned to grow with advanced logic.

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Trisha Lee Tuntland, Cabot Microelectronics Corporation - Director of IR [36]

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Thank you, Jacob. Those are all the questions we have this morning. As a reminder, we hosted a virtual investor and analyst event on May 23, and we are happy that many of you were able to join. The virtual environment, including a wealth of video content on our company will be available until September 23. You can access that material through a link in the Events and Presentations area of the Investor Relations section of our website cabotcmp.com. Thank you for your time this morning, and your interest in Cabot Microelectronics. We look forward to talking with you again soon.