CMC Materials, Inc. (CCMP) 2003 Q3 法說會逐字稿

Good morning. My name is Amanda and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Cabot Microelectronics 2003 3rd Fiscal Quarter Conference.

All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer period. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key.

At this time, I would like to turn the conference over to our host, William Johnson. Mr. Johnson, you may begin.

Good morning. I'm Bill Johnson, CFO of Cabot Microelectronics Corporation. With me today is Matthew Neville, our Chairman and CEO. Matthew and I are pleased to host this earnings conference call for the 3rd quarter of fiscal 2003, which ended on June 30th. Matthew and I will take about 25 minutes for our formal comments and, after that, we'll open up the call to questions.

This morning, we reported results for our 3rd quarter of fiscal 2003. A copy of our press release is available in the Investor Relations section of our website at cabotcmp.com, or by calling our Investor Relations office at area code 630-499-2600. Today's conference call is being recorded and access will be available for two weeks via telephone playback. The playback number is area code 800-642-1687, and you'll need access code 7436114. Playback will also be available via webcast for the next two weeks in the Investor Relations section of our website, along with a script of this morning's formal comments.

As we being, I would like to remind you that our conversation today may include statements that constitute forward-looking statements. Such statements 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 reports filed on form 10K for the fiscal year ended September 30th, 2002, and on form 10Q for the quarter ended March 31st, 2003. I'd like to again remind you that we assume no obligation to update any of this forward-looking information.

With that said, I'd like to review our financial performance, then Matthew will provide a broader business review. Afterwards, we will take your questions.

I'll begin the financial review with a brief walk through the income statement, then I'll cover balance sheet and cash flow items.

Let me start by saying that we are pleased with our financial performance this quarter. Total revenue for the quarter was $64.3m, up 3.4% from the $62.2m we reported for the prior quarter. We grew revenue this quarter despite the impact of transitioning from selling through a distributor in Europe and Southeast Asia to selling direct to customers in these two geographies.

As anticipated, during the transition period, we discontinued sales to the distributor while the distributor drew down its inventory of our products, causing a reduction in our revenue this quarter of approximately $3.7m. Our third quarter revenue reflects the impact of this transition. With the transition complete, we are now selling directly to all customers in Europe and Southeast Asia.

In our IT Slurry business, revenue from copper products was up 13.5% versus the prior quarter, and revenue from tungsten and oxide slurries, taken together was up 1.5%.

Our Data Storage Slurry business experience a sequential revenue decrease of 10.5%, and Matthew will discuss this further in his business review.

This quarter saw a continuation of our overall historical trend of increasing sales for CMP applications at the leading edge of technology, such as copper interconnects at the 130 nanometer node for logic devices, as well as memory devices at 130 nanometers. Copper slurries represented 26% of total revenue, up from 23.7% in the prior quarter. We think this trend is evidence of our continued leadership in leading edge technology.

Our average sale price for slurries increased 1.6% versus the prior quarter. Average sales price this quarter benefited from an improved product mix.

On a geographic basis, we saw strong sales growth in the Asia Pacific region, where revenue was up 14.1%. This followed similar sequential growth in the Asia Pacific region that we reported to you last quarter. Again, this quarter, as was last, our strongest growth within Asia was in Taiwan.

Revenue was up by 3.4% in the U.S. this quarter, and revenue for Europe was down, primarily due to the transition from our use of a distributor to selling direct to customers there.

On a year-over-year basis, revenue was down 6% versus the same quarter last year. However, comparing results from this quarter to the year ago quarter is difficult, since last year at this time we saw a 35% sequential increase in revenue. Last year's sales growth was due to a combination of low inventory of IT devices in the channel at the beginning of the quarter, and high expectations on the part of our customers in the industry for a strong recovery in the second half of calendar year 2002.

Recall that the anticipated recovery did not materialize and the industry ended up over building inventory of IT devices. As a result, the strong growth in the third quarter of fiscal 2002 was not sustained. As such, the exceptional results for the year ago quarter represent a difficult comparator.

Despite the overall year-on-year revenue reduction, revenue from our products for leading edge applications continues to increase this quarter. For example, revenue from our copper slurries increased by almost 21% from the same quarter last year.

Gross profit for the quarter was $32.9m, up by 8.3% versus the prior quarter. Gross profit for the quarter represented 51.2% of revenue, which is 2.3 percentage points higher than the last quarter, when gross profit represented 48.9% of revenue.

The primary factors accounting for this 2.3 percentage point improvement are lower manufacturing costs this quarter versus last, an improved product mix, and the benefit of higher capacity utilization on a higher level of sales.

Let me turn now to operating expenses, which are comprised of R&D, selling, marking, and G&A costs.

Operating expenses this quarter were $18.3m, which was $1.5m higher than last quarter, and $1.3m higher than the comparable quarter last year. A significant element of the increase this quarter was due to increased activity in our SMP Polishing and Metrology Clean Room, which is an important aspect of our product development and customer support efforts.

We believe we are a leader among CMP consumable suppliers in that we have a state-of-the-art CMP Polishing and Metrology Clean Room Facility, in which we can replicate the use of our products by our technology leading customers within our own facilities.

Other increased in operating costs were associated with hiring additional staff for R&D and sales and marketing. R&D costs for this quarter reflect our strategy of investing to maintain our technology leadership, and we have continued this investment even through challenging economic conditions.

The increase in sales and marketing costs supports our transition from selling through a distributor to direct sales in Europe and Southeast Asia, as well as our general efforts to further develop relationships with our customers.

Our affected income tax rate remained at 33.5% this quarter.

Net income for the quarter was $9.8m, up approximately $700,000, or nearly 8% versus last quarter, but down roughly 26% from the same quarter last year. As with revenue, the year-on-year comparison of net income reflects the extensive ramp the industry underwent during our third quarter of fiscal 2002, which was not sustained.

The weighted average number of shares outstanding on a diluted basis remained virtually unchanged at 24.6m this quarter. Therefore, diluted earnings per share for the quarter were $0.40. This is up by $0.03 from $0.37 per share last quarter, and down by $0.14 from the year ago quarter.

Now, let me briefly cover cash and balance sheet related items.

Working capital increased by $3.3m this quarter due to three factors. First, receivables increased in line with the higher level of sales this quarter versus last. And in addition, we experienced a temporary increase in receivables in conjunction with the transition from selling to a distributor to direct sales in Europe and Southeast Asia.

Second, prepaid expenses increased due to the payment of the annual renewal premium on our D&O insurance policy. And finally, accrued expenses payable decreased due to a timing adjustment to our accrued income taxes payable in conjunction with the filing of our annual federal income tax return mid-June.

Capital spending for the quarter was $3.3m as we made investments in R&D, manufacturing and information technology. Capital spending for the first three quarters of the fiscal year totals $8m, and we now expect to invest roughly $17m in capital this year. This is down compared to the full-year forecast we provided last quarter. Our updated forecast reflects a staging of capital expenditures to better reflect our current business needs.

The overall reduction in capital investment versus our original expectation for fiscal 2003 also includes the benefit of favorable pricing we've achieved on some capital purchases.

Depreciation and amortization for the quarter was $4m, and it should be around $16m for the full fiscal year.

We ended the quarter with $99.3m in cash, total capital lease obligations were $9.4m, and we have no long-term debt outstanding.

This concludes my financial review. I'll now turn the call over to Matthew for a business update.

Thank you William. I will now provide some highlights of the quarter that demonstrate our progress and accomplishments since our last conference call.

We are proud of the results we achieved in an environment that has been difficult for our industry, our customers and their customers for more than two and a half years. Like other participants in the semiconductor industry, over the last several quarters, we have watched for clear signs of a recovery from the sustained downturn the industry has experienced. While we have achieved modest revenue growth in our business for the last two quarter, and have seen some encouraging signs that the industry is beginning to improve, like others, as of yet we have not seen clear end market drivers for a solid and broad based industry recovery.

One encouraging sign we see is modest revenue growth in the sales of semiconductor devices when viewed on a rolling three-month average basis. We're also encouraged that we do not see signs of building inventory of IT devices as we saw at this time last year. While growth in IT device revenue is modest, production appears to be generally in line with end market demand.

Indications from the foundries also appear encouraging. The foundries have traditionally served as an early indicator of changes in supply and demand. Solid foundry growth and higher capacity utilization, especially at the leading edge, suggest that the industry may be improving.

Growth in worldwide PC shipments for the quarter was reported at 7.6%, which slightly exceeded industry expectation. This is encouraging. However, we are still waiting for a clear, broad upward trend in corporate IT spending, which could drive a strong recover in the PC and Server markets.

Performance in the consumer market segment is also encouraging, where digital video is the main driver. However, two concerning signs we see across the industry landscape are disappointing demand in the wired and wireless communications segment, where cell phones and telecommunication equipment still seem to be languishing. And the lack of recovery in capital equipment orders by semiconductor manufacturers.

Summarizing then, we see some encouraging signs, but somewhat mixed signals of the beginning of an industry recovery, but still failed to see broad-based market drivers that would provide the means for a robust recovery. Despite the mixed outlook for the overall industry, we are encouraged by our recent results, which we think demonstrate the unique growth drivers specific to the demand for CMP consumables within the broader IT industry.

I'd now like to discuss specific progress in a number of key business areas, beginning with our slurry product for copper. Our early technical efforts earned us what we believe to be the leading position in copper slurries. We believe that we still hold this leadership position today, despite the competitive nature and challenging technology of CMP for copper inner tags.

Copper CMP remains a very high priority for our company. We continue our efforts to work closely with our customers to develop and product products to meet their evolving requirements. We continue to improve the performance of our commercial products in the overall Copper CMP process.

Our progress in this business are is reflected by the 13.5% sequential growth in sales of our Copper Slurry products this quarter, building on the 16.8% sequential growth we reported to your last quarter.

Our R&D resources for Copper Slurries are focused on each of the 130, 90, and 65 nanometer nodes. Most of our current commercial production is the products for 130 nanometer feature size. Recent efforts have focused on facilitating our customers' ramp at this node. We are improving performance of our products in our customers' processes to help increase their overall yields and efficiency.

We've also been active at several customers who are in pre-commercial ramp of their 90 nanometer products. We expect several technology leaders to begin ramping commercial production at the 90 nanometer node later this year.

In tandem with our customers' development and commercialization efforts, we have continued to advance our manufacturing technology for production of these leading edge products and have made additional investments in our manufacturing facility to support production of our new 90 nanometer copper products.

Looking forward, we see three growth drivers for continued ramp of copper CMP. First, our existing customers are expected to continue ramping their manufacturing of 130 nanometer devices. Second, we expect to field a second wave of customers to commercialize and ramp copper inner tags for 130 nanometer devices. And third, technology leaders should begin commercial production of 90 nanometer devices within the near term. This growth may be mitigated somewhat as our customers continue to increase process efficiency and yields in their operations.

In addition to increases in our copper revenue, tungsten and oxide revenues taken together increased sequentially this quarter by 1.5%, building on the 7.5% increase we reported to you last quarter.

We expect continued growth opportunities in tungsten in high-end areas, such as leading edge memory devices, front end layers and ear transistors for logic devices using copper interconnects, and potential new applications such as metal gates [ph].

We continue to improve to maintain our leadership in this business area. To that end, we are developing a new product which we believe should offer our customers significant improvement and performance in terms of planarity and defectivity. We have received positive feedback form a key customer based on our preliminary data and are beginning to work with other customers as well.

In oxide, we continue to work on improving our existing products to maintain our position in this competitive business area. In addition, this quarter we continued the development of a new product which we think will provide an attractive value proposition for our customers. We are encouraged with the progress to date.

We also continue to make progress in our new products for direct shall trench isolation application, or known as Direct STI. Our Direct STI technology, called SiLECT, has the potential to eliminate the need for most of the conventional processing steps used today in reverse mass STI, a process which isolates transistors on a semiconductor device.

SiLECT technology has the potential for broad usage for all device types. Initially targeted at the 90 nanometer node, the economics of this new product may be compelling enough for customers to back integrate for use with devices of larger feature sizes. We have qualified with our first customer, who is transitioning to commercial production. Several more customers are developing their production processes with our product, and we are in early stage evaluations with still more customers.

Let me now move to our data storage business. As Bill mentioned earlier, revenue from our data storage business decreased this quarter by 10.5%. We believe that general industry activity declined this quarter among data storage manufacturers due to some planned production shutdown and efforts by some manufacturers to reduce inventories that they had built in the first and second quarter of calendar 2003.

Our historical strength in data storage has been in the second polish step where we brought IC CMP slurry capabilities to this new market for us, and helped increase our customers' yield by approximately 20%. We are currently selling slurries for second step polishing for 40, 60 and 80 gigabit applications.

We are now successfully earning business in first polish step applications as well. We have developed a first step slurry product intended for 120 gigabit technology. Our first customer has backing integrated and is beginning to use the product commercially for 80 gigabit technology now, and has been qualified for our first step slurry for 120 gigabyte disk drive.

Evaluations are now in progress with a number of other customers and we expect an additional qualification over the next several quarters.

In addition, we continue development of second polish step technology for 120 gigabyte disk technology, and our first customer evaluation is underway.

Next, let me update you on our polishing pad business. We continue to make progress with our pad business via our two-prong strategy, acting as value added reseller of pads supplied through a commercial relationship with another pad producer, and separately developing pads with our own technology.

Our goals are to, first, provide customers with an alternative to pads currently available in the market; second, to offer a portfolio of pads to our customers suitable for a range of different applications; and the ultimate goal is to also provide integrated CMP consumable sets that are optimized for each application.

In the role of value added reseller where our products are intended to satisfy the needs of customers' existing applications, we currently have commercial sales to several customers. We believe our pad demonstrates a performance advantage in our customers' process in terms of improved consistency and lower defectivity, and are now beginning to broaden our rollout to additional customers, some of which have begun evaluations of our product.

In addition this quarter, we reached a significant milestone in our pad business which should benefit both prongs of our strategy. We entered into a technology licensing and co-marketing arrangement with Applied Materials. Under our agreement with Applied Materials, we have access to innovating window technology for polishing pads. In a number of leading edge CMP applications, optical endpoint technology is used to measure the surface of wafer while it is being polished on a tool to determine when to stop polishing. This technology requires an optically clear section on the clear, a window that allows the sensor to see the wafer surface.

Under our new arrangement with Applied Materials, we plan to develop, manufacturer and sell window pads for use on Applied's tools, and intend to work closely with Applied to optimize our pad on their tools to provide the best possible solution for our customers. We believe that combining our efforts as the leader in CMP slurries with Applied Material, the leader in CMP equipment, to provide technically optimized pads for use on Applied's tools will further energize our polishing pad business.

The last business area I would like to address is operation excellence. Last quarter, I discussed in some depth our multi-step initiative to improve our manufacturing capabilities to meet the ever increasing performance requirements of our customers. As the complexity of IC technology advances through shrinking feature sizes and new manufacturing processes utilizing CMP, customers demand increasingly higher product performance form us in their pursuit of improved yields and device performance.

As these customer demands tighten control of product consistency and reproducibility, our manufacturing capabilities must keep pace. Recall that in our second quarter of this fiscal year we experienced a reduction in our manufacturing yield due to these increased customer requirements. This translated into higher manufacturing costs for us and an overall lower gross margin.

This quarter saw a near term improvement in our manufacturing yields and resulting in higher margins than last quarter. Despite this short-term improvement, we have more work ahead. The long-term trend is clear. We need to continue to invest to improve our manufacturing capabilities to deliver higher quality, finer tolerances, and tighter controls quarter after quarter as our customers requirements keep advancing.

Now I'd like to offer some conclusion remarks before we open up the call for your questions. As I discussed earlier, we believe the near term outlook for the broad semiconductor industry shows mixed signals at present. As a result, forecasting visibility remains low for our customers and for us.

Last quarter, we provided near term guidance on gross profit margins in the range of 50% plus or minus 2%. Given our caution on the industry outlook, ongoing costs and investments required in manufacturing, and pursuit of our Operations Excellence initiative, and continuing pricing pressure that we have discussed in the past, we are holding to this guidance on gross profit margins.

As we believe competitive advantage lies in technology, we plan to continue to invest in R&D consistent with our long-standing strategy of maintaining our technology leadership. We believe that these investments in R&D along with investments in Operations Excellence will generate attractive returns in terms of enhancing our ability to provide optimized CMP slurry solutions to our customers.

Further, with continued progress, we believe our polishing pads business will provide a valuable compliment to our CMP slurry business. We believe that there are four compelling growth drivers that collectively point to a strong, long-term outlook for CMP consumable markets, with growth expected to be in excess of general growth rates in wafer starts.

The first is expected further penetration of CMP into the IC manufacturing base. Currently, CMP is used in less than half of all semiconductor devices produced, those with feature sizes smaller than quarter micron. As technology progresses, we expect CMP will be required in an increasing portion of overall semiconductor device manufacturing.

Second, we expect to see further shrinks in feature sizes, which should constitute more wiring layers and require more polishing steps. This should drive greater CMP usage in the future.

Third, we anticipate new materials to be introduced in the semiconductor manufacturing process that will require CMP, and will require new and more technically challenging CMP solutions.

Finally, new manufacturing processes that can only be enabled through the adoption of CMP are also expected to drive growth in the CMP market.

For these reasons, we remain encouraged about the long-term outlook for CMP consumables. As a pioneer in CMP slurry technology, our company has built an enviable position based on our technology and customer relationships that is attracting interest from competitors.

As technology requirements in the industry advance, and the market becomes more complex, existing and prospective competitors will continue to vie with us to fill market niches. We believe we have a competitive advantage with our broad base of technology, service and support. We expect to derive further advantage from our continued implementation of our Operations Excellence initiative and our polishing pad strategy.

I would now like to open up the call to questions.

At this time, I would like to remind everyone, in order to ask a question, please press star, then the number one on your telephone keypad. Now we will pause for just a moment to compile the Q&A roster.

And your first question comes from Ali Irani with CIBC World Markets.

Yes, good morning. Thank you. Looking at your revenue this quarter, including the absorption of the inventories at your distributor, it seems you're running about at a $68-$69m run rate. And I'm trying to do a little bit of the math in my head and look at the third quarter to your guidance of sales exceeding wafer starts into an improving mix. And should I conclude from that, Matthew, that if we're looking for somewhere in the mid to high single digits wafer starts in the third quarter, that we could see Cabot revenues exceed that number?

Ali, at this point we only have insight into the first three weeks. And so it's really too early for us to make any comments. We don't normally give guidance on the upcoming quarter. And so, at this point what we see for the first three weeks are in line with the last quarter.

So continuing kind of on the trend with the second quarter.

Correct.

Would it be fair to say that your second quarter was as you went through them month-over-month, back-end loaded or was it fairly well balanced as you went through the quarter?

It was fairly well balanced as we went through the quarter.

And then one follow-up. On the data storage side, it seems that there were some one time inventory issues. Would it be fair to expect between the market itself on the seasonality, but also your market share penetration, that that segment of your business would recover sequentially?

You are correct. This is--they take advantage of this time. We did have some customers who were shut down for longer periods as they go into the next several quarters and as we capture more business.

Terrific. I'll come back for some follow-ups.

Okay.

Your next question comes from Suresh Balaraman with ThinkEquity.

Hi. Good morning, guys. Could you comment on how the mix would be in Q3 if you were to enter the business from the division agreement? I was wondering how we should be looking at the margins. It looked like Q2 was pretty nice. And also, can you give us any thoughts on how the CMP market is at this point? I know it's pretty tiny, but I was even wondering if it's a meaningful factor in your revenues. Thanks.

Let me just comment. The mix is pretty even between our business and what the distributor sells, so you really won't see much mix change due to going direct. In terms of [low k], and let me just elaborate on your question, and please correct me if I'm not hitting the right point. But I think what you're trying to get at is, is there--[low k] is being introduced at 90 nanometer with copper interconnect technology. As we've said, we have several customers who are in pre-commercial ramp, so we do have sales but they are small.

And Matthew, any thoughts on the gross margins in Q3? If the mix is the same, should we expect the gross margins to be flat with Q2?

Suresh, it's Bill. We're continuing with our guidance within the range that we gave last time, 50% plus or minus 2%. When you look at the drivers of our gross margin, it's kind of volume price and cost. From a price standpoint, we've talked about some pricing pressure in the past and some mix improvements we've seen here and there. But, we continue to see, expect and until you see a strong industry recovery, we're probably continuing the base pricing pressure.

On the manufacturing cost side, the last quarter, our second fiscal quarter, we experienced lower manufacturing yields and higher manufacturing costs, which impacted margins. We saw some recovery of this in the third fiscal quarter, but I would tell you that, as customers increase their requirements for our product performance and our manufacturing capabilities have to improve, that's not turning a switch on and it's not an improvement that you see--fixed, that you see from one quarter to another.

So, I think you ought to expect going forward kind of a continued volatility in manufacturing costs. We saw an improvement this time. It may slip back and forth over the next several quarters as we implement Operations Excellence. So, if you layer all those factors in , we think that it'll be within the 50% plus or minus 2, and wouldn't be surprised to see it flip up and down a bit.

Okay, let me skip--one more question. Regarding the pad thing that you're doing with Applied Materials, are you the only one that Applied is working with on this window pad technology?

That's a question that you'll have to ask Applied. We prefer not to comment on their business.

Okay, thank you.

Your next question comes from John Roberts with Buckingham Research.

Hello. Can you hear me okay?

We can hear you. You're a little faint, but we can hear you.

Matthew your Asia Pacific sales were up 14% sequentially. Is it fair to say that your distributorships significantly impacted Asia so that it would've been up significantly above 14% if you didn't have that shift?

It probably--it would've been up some, but the distributor was active in both Europe and Singapore and Malaysia. Probably more of the distributor sales were in Europe. So, there was some impact in Asia, but more pronounced in Europe.

And do you know what the wafer start number was for Asia Pacific? I know you gave us 7.5% industry wide.

We didn't make any comments about wafer start on this call.

The reference was PC growth at around that number.

Okay. Sorry.

And that was global PC.

Secondly, the SiLECT Direct STI product that you're now qualified with one customer, is the market opportunity there more similar to the tungsten market, or is it more similar to what dielectric was and what copper may ramp to be?

Just to explain, it's a one-step process that is on the front-end of the device a very high value proposition and opportunity. It's a one-step polishing that will occur on all device tops. So, you might think as it penetrates into the market, it will grow with wafer starts, but it's only a one-step process. But, it's high value for our customers and, therefore, it's an attractive business to us.

Okay. And then lastly, Microsoft this past quarter had everybody thinking about how to deal with options and dividends. You've got a lot of cash in the balance sheet and so forth, and you've got a fair amount of option related expense that's not in the earnings. Any updated thoughts or is it just your plan to wait to see what Intel and some of your customers do?

Our plan is to watch and see what the general trends are. As we understand the process, they're still trying to decide how they're going to value options. So we're going to wait and see what the overall industry and what the government requirements are going to be, and we will follow what's best for the shareholders and the law.

And since you're a September fiscal year, so it's safe to say there's nothing coming in this fiscal year. Will it be sometime in fiscal '04 before we know?

We're always watching and monitoring. And if things proceed more quickly, then we'll heed to make adjustments more quickly. If they don't, we're not going to be a leader in this area.

John Roberts. Got it. Thank you.

Your next question comes from Jeffrey Cianci with UBS Warburg.

Hey, guys. I guess first just on the margin issue, operating margins going forward. I noticed in the first quarter you did like 24%. Expenses have come up since then. You commented that the distributor won't affect the margin going forward, but is it a straight volume ramp? I mean, is it still a case where incremental margins are not going to be higher than the operating margins. So if we get volume, we can see the current margin go back where it was?

One of the things that we've talked about over time is the importance of continuing to invest in R&D. This quarter, we saw an increase in R&D costs and that's likely to continue. So, I think you can expect going forward continued spending on R&D in line with our historical strategy to invest in maintaining technology leadership. There could be some volume leverage around that, but you should map R&D spending increasing over time.

Well, right now it's about 15--maybe 15% of sales. Is that good guidance going forward for R&D? It's a big number.

Well, I think you ought to think in terms of dollar amount. That next quarter, for our fourth fiscal quarter, we would expect R&D costs to increase in the range of $1m to $1.5m. But, we really fund R&D on a basis of needs, the business needs, and not really targeted to any specific percentage of revenue.

Okay. And then the other question was on the pad. It's a very big market. To my knowledge, pushing hard in the market. Can you quantify timing on any upsize? I mean, is this like flurries, you know, a long qualification process? Would we see something in fiscal '04?

It's fiscal '04 is when we start expecting to see substantive sales in pads.

And is it a different technology than what's on the market? Can you elaborate on the advantages?

It has--the first pad technology that we're going to market with a pad technology that has manufactured in a very controlled way, so it has very good consistence and it also has much lower defectifvity. So it has real advantages for our customers. And we see a lot of excitement and interest in it. Applied has done a lot of work with the pad and they're very encourage with the performance as well.

Would they be bundling to sell their pad with their equipment?

No, we're going direct with the pad to the market. We're just collaborating around technical and taking our pad along with their tool to the market. It's providing a broader collaboration to ensure that we've really optimized the pad with the tool set.

Thanks. And my last question is the cap spending because it jumps out. You cut it half it looks like this year. And what's the run rate in fiscal '04? Can we run it at $20m a year and spend depreciation, or does that go back up?

The reduction in CAPEX, there are a couple of things at work there. One, last year's capital spending included significant spending still on building real estate, bricks and mortar. This year, fiscal 2003, we're not adding building space and so capital spending came down. Further, with the current business environment, we've staged our capital spending according to business need and so our forecast now has come down to around $17m from a higher number before.

As rolling forward, I think the spending's going to depend on when we have to make the next expansion in bricks and mortar and that would drive a higher level of spending.

That's not '04, right?

Right now, we're in the middle of our annual planning process and we haven't finished that. So, it's a little early for us to start sharing what we think our capital budgets are. As we've said, we always invest ahead of the needs. We feel that we've properly invested to make sure that we've got the best state-of-the-art capabilities in our applications area, as well as our manufacturing and IT systems. Depending on how broad and strong the recovery happens would drive our timing of what kind of investments we'd need to make in the future and how quickly.

Okay, this brings the last point, that it would draw $30m to $40m in free cash flow with the cap spending coming down. You guys want to comment on what you might do with that money?

Well, it's a great problem to have. What I would say is, as we've talked about before, we came out of the ITO three years ago with little to no cash. And so our initial focus has been really to build our cash position and make sure that we can proper invest in the company to make sure that we're well positioned to maintain our leadership position.

I think now that we've built up our cash position, we are starting to look at broader ways to strengthen our business. And I think with that building cash position, it gives us more flexibility and capability to take advantage of opportunities as they arise.

On the deal front you mean?

Yes.

All right, thanks for all the help.

Your next question comes from Jay Harris with Goldsmith & Harris.

William, what was the cash flow in the quarter?

We carried cash of $11.4m.

Okay. Matthew, if one assumes that wafer starts are flat forever, what's the inherent growth rate of the slurry marketplace that you're serving, looking out three or four years as a result of new technology adoptions?

It's fairly compelling. I can't give you hard number, but I can just walk through a couple of things as we look out over the next three to four years.

As the big driver, should wafers start to stay flat, you're still going to see more and more of those wafers using CMP and that's due to the shrink. So, there'll be growth just due to that, as I said.

The second factor is, as the devices shrink, there are more polishing layers. And just to give you the magnitude of the leverage there, in a quarter micron devise there are 10 polishing steps. In a 90 nanometer devise there are about 23 polishing steps. So you almost see a doubling. And so you'll see that same type of effect as the industry goes from 130 to 65 or 45 nanometers. So there's good growth opportunity there. And then you'll see a third factor which is, as the devises shrink, the technology of the fabrication becomes more and more complicated and they'll bring in new types of materials and new manufacturing processes that can only be enabled through CMP. And so, just one way of looking at it, you know, in '95 there was one main application oxide polishing. Tungsten became an important-started to grow as an important application. In 2001, you saw the introduction of copper and we've all seen the impact that's had. In 2005, we expect to see probably five, six other applications emerge where new materials or new processes are used. So there's some pretty compelling growth drivers there.

Is there any way of saying that the marketplace is going to double in-onto these assumptions in three years, four years, five years? You guys must have certain assumptions in your long-term business planning.

I-I think--.

--And that's not--you know, that doesn't mean that you're going to get the same market share, I'm just-I wonder if you could share with us some overall marketplace growth prospects.

Yeah. I think based on what the industry is projecting, I think what we've said, over the next five years, if the industry does everything that they plan to do from a technology roadmap perspective, and you look at all of those drivers, there is a potential for a five-fold growth. But, that's dependant on what the industry does, how fast the technology advances, and that they follow all of the paths that are laid out in the SIA roadmap. So that's just a ballpark number. It is dependent on wafer growth and it is dependent on technology advancement, which we do see--.

--Well, how much would you cut that if it was no wafer growth?

I don't have a firm number, but the wafer growth is not the main driver.

Okay. Thank you.

Your next question comes from Robert Tango with William Blair.

Thank you and good morning, guys.

Good morning.

Matthew, you made some comments that I thought were very candid about some signs that the industry is obviously improving and we've seen it in recent months. We've heard it from other business, including other equipment and tool businesses that have released results. And you know, we obviously know demand is getting a little bit better in general.

I guess my question is, as you look at your customers and you're dealing with them on a daily basis, what's your level of conviction that their ability to predict future end user demand is going to be there, is going to be high in the future?

I guess I'm trying to get a sense as to how confident you are in the ability of your customers to predict, you know, future trends and forecasts, you know, beyond just a two or three month period. And maybe one way to answer that is if they were, you know, your business obviously picked up this summer, and if six or nine months ago they were correct in their forecast and assumptions.

Yeah, that's a very tough question to answer and I think--I don't think anyone has an answer. I'm going to stay very high level. I think everybody's right now seeing some growth. There are some encouraging signs. We still feel the data's mixed. We still feel that there are not solid, strong drivers out there in the end market. And so you're not hearing anyone being bullish about there's a solid recovery underway in the semiconductor industry or in the global economy as a whole.

And so I think as we've said before, and I think as most of our customers say, you know, visibility is limited and I think it's driven by the fact that everybody's trying to sort out what's going to happen with the global economies around the world. There are some encouraging signs, but no one's willing to make a call or a prediction. So that it's tough our customers' customers to make any quantitative statement, and therefore it's tough for our customers and tough for us.

But in general, do you think that your customers have been fairly accurate in their communications with you?

In the dialogue between us and our customers are very good, in the sense of--what they want to make sure is that we know as much as they know, that we're well positioned so we can supply and meet their needs. And so, from that perspective, there's always been good communication on their expectations, their demands.

We've got an excellent customer support organization that has very good relationships with their counterparts in staying on top of that. And then we have pretty in depth meetings once a quarter with our customers to go over the forecasts for the coming year.

Okay. And one follow-up, just on the financial side. You know, you're company has done--always done a great job with its working capital since really you were private, and even subsequent to the IPO. And, you know, your balance sheet obviously continues to get stronger quarter after quarter.

You know, going forward with the uncertainties in the market, it's almost like an ongoing job to balance and manage receivables and inventory, depending on when you think demand may be there, when it may not be there, and whether or not your customers' forecasts are correct. Can you talk a little bit about how Cabot is able to manage its working capital, assuming that customers are still a little unclear in terms of what they may need in the future, maybe six or nine months from now?

A couple of things. One, in terms of inventory we are essentially a make to order business. So we can respond rapidly to increasing customer demands, and we've shown an ability to ramp up production in a relatively short period of time to meet pretty large swings in demand in the near term. Like Matthew said, we don't have a lot of visibility on long-term forecast, but what we do is try to maintain the flexibility to respond quickly when the orders come in.

In terms of receivables, we've managed those pretty carefully. We supply a critical material for our customers' operations, and so we've had pretty good collection results as a result of that I think.

Okay. Good. Thank you guys and nice job during the quarter.

Thank you.

We'll take one last question.

Your next question comes from David Duley with Wells Fargo.

Good morning. Listen, I'm sure I have a somewhat easy question, but probably with a complex answer. We listened to TSMC's conference call this morning and their .13 and below business was up, I think, 97% sequentially. Those are copper processes. So I'm just wondering if you could help us understand the difference in that kind of growth at TSMC and your copper slurry growth in the quarter.

We can't talk--we have to be very careful. One, I didn't hear the call so I can't make a lot of comments on it. I think when you're starting--the only way you could draw connections or parallels to growth rates--you know, growth rate numbers are really dependent on the size of the manufacturing that's being done. So, if you're doing little manufacturing and you do a little more, you get huge increases. So it's scale.

So I think you need to probably look a little more closely at what their production levels were before this growth pick-up, and then look at where it is now in terms of wafer starts and determine whether that's a big number or small number relative to all copper wafer starts. And that's what I'd suggest you do.

Well, I think it's like up to 17% of their overall business, so it's a pretty healthy number.

I'm sorry. Could you repeat that?

Yeah. I think that [sub-.13] business at TSMC is now up to 17%, up from 11% sequentially. So, it's a pretty big number. So is it-I'm just trying-okay, maybe if we look at it this way, a slightly different twist to it.

Your overall revenue I think was down 6% year over year. Overall units in that same time frame, I'm guessing, were up 5% or 10%. Maybe help us understand the difference between those two.

Yeah. Let me just come back to get a clarification. You said that their wafer starts below 130 nanometer represented 17% of their business?

I think that was actually their revenue levels.

Okay. Well, I just would like to inform you that no one is doing commercial production as we understand it at the 90-nanometer node.

I meant .13 and below.

Okay. Well, without seeing the data I can't make comments.

Okay. And just to get-just to clarify kind of what you said about the outlook, kind of picking up the commentaries throughout the conference call, it sounds like you think revenue will be flat, gross margins 50% plus or minus with operating expenses up slightly. That would-if we waded through all of that information, are you saying that our EPS numbers might be down a little bit sequentially?

We haven't given-the only guidance that we've really given is of how to look at the gross margin, plus or minus two. We're not giving guidance on revenue and we're giving an indication that we will be continuing to invest in R&D. And you'll have to draw your own conclusions on how that will impact our business based on what's happening overall.

Okay. And the mix. This quarter the gross margins were up substantially. Could you just help us understand inside the mix why the margins were up? Which pieces of business drove the higher margins versus last quarter?

We haven't really talked about margin by product line, but the margin, you know, clearly benefited from two things. One was the increase in average selling price, and that was clearly mix related. The second was the improvement in yields and manufacturing kind of overall, based on our ability to meet customer requirements.

So that would imply, since the copper grew faster than oxide and tungsten, that they have the higher ASP and the higher margins?

We have never commented on margin by product line, but the two factors impacting are the increase in average selling price and the overall improvement of the manufacturing costs.

Okay. Thank you.

Thank you David.

That was our last call, our last question, so I'd like to thank you all for your time this morning and your interest in Cabot Microelectronics. I look forward to speaking with you again soon.

Thank you for participating in today's Cabot Microelectronics 2003 3rd Fiscal Quarter Conference. This call will be available for replay beginning at 11:30 a.m. EST today through midnight EST on Thursday, August 7th, 2003. The conference ID number for the replay is 7436114. Again, the conference ID number for the replay is 7436114. The number to dial in for the replay is 1-800-642-1687, or 706-645-9291.

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