CMC Materials, Inc. (CCMP) 2004 Q4 法說會逐字稿

[OPERATOR INSTRUCTIONS] Mr. Li, you may begin your conference.

Thank you. Good morning. This is David Li, Director of Investor Relations for Cabot Microelectronics Corporation. With me today are Bill Noglows, Chairman and CEO, and Bill Johnson, Chief Financial Officer, to host this earnings conference call, for the fourth quarter and full fiscal year 2004, which ended September 30th.

This morning we reported results for our fourth quarter and full fiscal year 2004. 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 630-499-2600.

Today's conference call is being recorded and access will be available for three weeks via telephone playback. The playback numbers are 800-642-1687 in the United States, or 706-645-9291 internationally, and you will need access code 1609499. Playback will also be available via webcast for the next three weeks in the investor relations section of our website, along with a script of this morning's formal comments.

I would like to remind you that our conversations today may include forward-looking statements that involve a number of risks, uncertainties or 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 10-K for the fiscal year ended September 30th, 2003, and Form 10-Q for the third quarter of fiscal 2004, ended June 30, 2004. We assume no obligation to update any of this forward-looking information.

I will now turn the call over to Bill Johnson who will review our financial and business performance. Bill Noglows will then discuss broader business issues, and Bill Johnson will close with some comments on fiscal 2005. Our formal comments will take about 25 minutes, after which we'll take your questions.

Thanks, Dave. Good morning.

Our revenue for the fourth fiscal quarter was $82.7 million, up 7.5% sequentially from $76.9 million last quarter, and up by 21.8%, from $67.9 million in the same period last year. For the second consecutive quarter, we reported record revenue, and all of our slurry product areas experienced sequential revenue increases this quarter. Revenue for our full fiscal year 2004, was $309.4 million, which is 23% higher than the $251.7 million we reported for the full fiscal year 2003.

This quarter, our average selling price was essentially even with last quarter. This was primarily due to a higher valued product mix this quarter, which offset the impact of selected price reductions. Our average selling price for the full fiscal year 2004, was within a tenth of a percent of our average selling price for fiscal 203.

Gross profit for the quarter was $40.2 million, up 3.1%, versus the prior quarter's $39 million, and up 16.8% from $34.4 million in the year-ago quarter. This represents a gross profit margin of 48.6% of revenue this quarter, compared to the 50.7% of revenue that we reported both last quarter and for the year-ago quarter. Gross profit this quarter was within our current guidance range of 48% of revenue, plus or minus 2%.

But on a sequential basis, gross profit was adversely affected by the impact selected price reductions and higher costs, including one-time transition costs associated with the termination of a distribution arrangement, in our polishing pad business, which we discussed during our conference call last quarter, along with lower yields this quarter in our manufacturing operations. These effects were partially offset by the benefits of higher manufacturing capacity utilization, based on the higher sales level this quarter versus last.

Operating expenses, which include research and development, selling, marketing and general and administrative costs were $20.7 million this quarter, down by 1.9%, from the $21.1 million we reported last quarter, and approximately $200,000, or 1.1% higher than the comparable quarter last year.

Over the last five quarters we have held our operating costs relatively flat, reflecting our successful efforts at moderating the historical growth of cost in this area.

Operating income for the quarter was $19.5 million, up 9% from $17.9 million in the prior quarter, and up 39.7%, from $13.9 million in the same quarter a year ago. Operating income represented 23.6% of revenue this quarter, which was up slightly from the 23.2% of revenue that we reported last quarter, and up from 20.5% in the year ago quarter.

Our effective income tax rate was 32.8% this quarter, and 33.1% for the full fiscal year. Our full year tax rate reflects extra territorial income tax credits related to our export sales, as well as research and development tax credits.

Net income for the quarter was $13.2 million, up 7.5%, from $12.2 million last quarter, and up 36.5%, from $9.6 million in the same quarter last year. For the full fiscal year, we earned net income of $46.7 million, which is 23.8% higher than the $37.7 million we earned in fiscal 2003.

The weighted average number of shares outstanding on a diluted basis was 24.8 million shares this quarter. Down from 24.9 million shares in the prior quarter, primarily due to purchases of stock under our recently approved share repurchase program.

Diluted earnings per share for the quarter was $0.53, up from both the $0.49 per share we reported last quarter, and $0.39 in the year ago quarter. We earned $1.88 per share in the full fiscal year, up by 22.9%, compared to the $1.53 per share we earned in fiscal 2003.

Our fiscal 2004 EPS, which is a record for our Company, reversed two prior years of decreasing earnings per share. Turning to cash, and balance sheet-related items, capital spending for the quarter was $5.8 million, as we made investments in manufacturing, information technology, and also purchased additional land adjacent to our manufacturing facility in Japan, which we discussed during our third quarter conference call.

Depreciation and amortization expense was $4.6 million for the quarter.

Capital spending for the full fiscal year totaled $14.7 million, including our $3.8 million investment in NanoProducts Corporation, which we also discussed during last quarter's conference call. Depreciation and amortization expense for the full fiscal year was $17.6 million.

We ended the quarter with $157.3 million in cash, $1.4 million higher than last quarter. Our cash balance reflects our use of $8 million, to repurchase approximately 240,000 shares of stock under our share repurchase program, which is authorized for up to $25 million.

Total capital lease obligations were $7.7 million, and we have no long-term debt outstanding.

Now, let me provide additional commentary on the performance of our slurry product areas, beginning with copper. Revenue from our slurries for polishing copper interconnects increased by 14.1% sequentially, and was up by 26.3% compared to the year ago quarter. Our sequential revenue increase this quarter built on the 7.6% sequential increase we reported last quarter.

Revenue from slurries for copper applications represented 23.5% of our total revenue for the quarter, up from the 22.2% we reported last quarter. This growth reflects continued strength of 130 nanometer technology for logic applications where we believe we have a strong position with eight processes of record or PROs. Our eight PROs reflect the loss of one large customer that is transitioning to another slurry supplier, which we discussed last quarter. We expect continued growth in 130 nanometer technology through calender year 2006, as this technology remains the dominant node for copper polishing.

Industry adoption of 90 nanometer copper technology for logic applications appears to be occurring more slowly than originally anticipated. The early adopters of this technology seem to have faced a number of challenges with their 90 nanometer devices, including weak market demand. We believe others are delaying adoption until the cost to performance tradeoff has become more favorable. We continue to work with a number of customers on 90 meter technology, and have now earned 4 PORs, up from the 3 PORs that we reported last quarter.

We believe there are still only 3 semi conductor manufacturers that are at full production with 90 nanometer technology.

We're also beginning to see greater customer interest in our new products for polishing copper barrier, which is an application in which we have not been very visible in the past. We believe that customers are not fully satisfied with barrier polishing solutions available for the most advanced technology nodes.

We are developing a family of tunable barrier slurries that we believe can provide innovations solutions for our customers' specific integration schemes. We continue to work with a number of customers on solutions for polishing copper and barrier for 65 nanometer technology and I have -- and we have earned our first 2 process of record wins for 65 nanometer technology. We expect 65 nanometer copper technology to be first commercialized in calendar year 2006.

Now let me turn to our other slurry products. Revenue from tungsten and dielectrics CMP slurries taken together, was up 6.6% sequentially, and up by 20.9% compared to the year-ago quarter. We believe that this continued strength in our tungsten and dieletric products relates primarily to robust growth and memory applications. We believe we are well positioned in slurries for tungsten applications, both with our existing products as well as with new products in development.

Our new 60,000 series product for 90 nanometer applications is beginning to ramp with 1 customer and a number of others are in evaluation. Our customers have reported significant performance improvement with this product, most notably in reduced erosion.

Another new product, within our 7000 series, is being broadly sampled for use with 65 nanometer technology for advanced memory and logic applications. And we have designed this product to also be extendible to 45 nanometers.

We are confident in our technology leadership in tungsten slurries, and we see a promising future for these products, especially given the growth outlook that we see from memory devices, particularly flash.

Next I would like to discuss our slurries for dielectric applications. Our new dielectronic products within the 6000 series which was developed to provide improved defectivity and also offer a lower cost of ownership, has received positive initial feedback from customers, and is scheduled for commercialization in the next several months. Within our 8000 series, another new dielectronic product, is formulated for advanced ILD applications, and should be commercialized in mid-calendar year 2005.

Finally, in direct shallow trends isolation products, we're the process of record with 2 customers for 90 nanometer applications, and are in evaluations with a number of others.

Revenue from our data storage business increased by 9.1% sequentially, as the data storage market experienced some seasonal strengthening of demand, usually seen in the second half of the calendar year. The data storage industry represents a very competitive arena for our customers. And we find our customers eagerly embrace innovative new products where they see potential for economic advantage.

This concludes our financial and business review. I will new turn the call over to Bill Noglows.

Thanks, Bill. Good morning. We are proud of our strong financial performance this quarter during which we delivered another record for sales revenue. In addition, our full-year performance demonstrates what we believe is our continuing ability to deliver solid growth and earnings year after year, as we continue to grow our business.

Strong year-on-year revenue growth combined with the attention to cost management, enabled to us leverage our technology and sales infrastructure and generate the record earnings per share for fiscal year 2004 that we reported this morning. We accomplished this record performance by also strengthening a number of areas within our business, and reinvigorating and refocusing others. I would like to briefly summarize some of these improvements.

First, let me discuss the changes to our Company's leadership team. As you know, I have recruited several new members to my executive team over the course of the year. I have realigned the leadership of our Company, in order to cultivate more disciplined approaches and prophecies that are targeted at capturing quality and efficiency improvements in manufacturing and in the design of experiments in R&D, and also to drive broad organizational development across our Company, and increase our overall leadership capability.

The other improvement initiative I want to discuss this morning relate to the three broad strategies that we have communicated throughout the year, that continue to underpin our accomplishments, technology leadership, operations excellence, and getting closer to our customers.

First, to advance our technology leadership, we continue to invest in our technology infrastructure. Last month we began design work on a new state-of-the-art technology center that will be constructed adjacent to our existing manufacturing facility in Geino,Japan. This technology center is our first development facility to be located outside the United States, and it represents an important step in establishing full technology development capabilities in the Asia Pacific region to support our customers there. This investment, in conjunction with other actions we have taken to strengthen our capabilities in Asia, underscores the importance of Asia Pacific market to our Company, as well as our commitment to reinforce and enhance our strong position and brand in the Asia Pacific region.

Our investment in and our strategic alliance with NanoProducts Corporation, which we discussed during our last conference call, is another example of a longer term investment in our core capability. In this case, to design and engineer nanoscale [indiscernible ] for future CMP slurries at sub 90 nanometer technologies. We believe that a key foundation of our success is our deep understanding of abrasive and particle technology, and our investment in NanoProducts Corporation is intended to expand our capabilities in this area.

Within our technology team, we have reorganized and refocused our efforts to providing excellence in 3 areas, development of fundamental enabling technology to provide new platforms for future generation products, robust development of new products for specific applications, and process development to support rapid and effective commercialization of new products. The efficiencies gained by our disciplined and systemic approach to experimental design and data analysis, as well as our ability to leverage the breadth of business to enhance our collective learning across product lines, markets, and applications, is unmatched by any of our competitors

Next, let me address our efforts under our operations excellence strategy. Over the past six months, we have broadly introduced the concept of six sigma across our Company, and we are seeing intriguing opportunities to both improve the quality of our products and to capture productivity and efficiency gains. Our six sigma activities have created a rallying point for our Company and brought a new focus and excitement to our efforts to continually improve the quality of our services and products, while at the same time driving out costs. This disciplined approach to reducing variation, in all operating parameters is eliminating opportunities that we have previously been unable to see. It has been energizing to see how fast this process has taken hold within our organization, and how quickly opportunities have begun to emerge.

Finally, and most important, let me provide an update on our strategy of enhancing our customer service and support. Over the last year we have focused a great deal of effort around the world, on building a deeper -- on building deeper and richer relationships with our customers. These efforts have involved some significant changes in the operating culture of our Company. We have demonstrated greater willingness to listen to and respond to customer requests, and to work collaboratively with them in many areas. We have made the customer the center of our programs and initiatives.

Our efforts in this area have resulted in some very supportive and complimentary feedback from many of our customers, of which I am pleased and proud, but I am far from satisfied. Our ultimate goal is to achieve ever higher levels of trust and loyalty from all of our customers, and we intend to continue to pursue this initiative relentlessly. Evidence of the positive results of our effort and how these are being viewed by our customers can be found in a long-term supply arrangement we entered into recently with a top five semi conductor manufacturer.

Under this new multi-year arrangement, we expect to provide the vast majority of this customer's copper slurry needs for 130 nanometer technology. We believe this type of arrangement, and the close relationships that tend to evolve as a result, represent the most effective and efficient means of meeting our customers' needs, in terms of CMP product and process development, through providing them direct and complete access to the full range of our organizational capabilities. As we finish what we consider a very successful fiscal 2004, and view the semiconductor industry going forward, we see a continuation of the rapid technical advancement in change that has characterized the industry in the past.

Although there are indications that 2005 will be a year of moderating growth in wafer starts, and possibly even a contraction, we believe that there are a number of factors that will allow Cabot Microelectronics to deliver the solid performance, even through a possible downturn in the industry cycle, as we were able to do through the downturns of 1998 and 200-2002.

I would now like to discuss some important macro trends that many believe will reshape the semi conductor industry over the next several years, and then talk about how I believe our Company is positioned to succeed in the future. The emerging digital technologies of today are enabling a new era in which computing, content, and connectivity are becoming all pervasive. Advancements in the technologies that underpin this connectivity and particularly the accelerated penetration of low-cost technologies and developing economies appear to be having a dramatic impact on the semiconductor industry.

In our view, digital mobile phones, digital still and video cameras, digital television, PDAs, and a host of other digital consumer devices and wireless technology, represent the next wave in the industry, versus the traditional focus on personal computers. These advancements in memory technology, broadband and networking capability, and mobile applications, coupled with the capability to personalize features for a diverse consumer market, appear to be underpinning this next wave.

We believe that the new emphasis on memory technology, and the incorporation of advanced memory products and digital consumer devices will drive significant development in CMP slurries, paralleling the ongoing emphasis on development of CMP slurries for microprocessors.

They semi conductor industry has continually found ways to bring higher performing products to the market at lower cost. We expect that as the industry moves to develop and mass produce devices with feature sizes below 130 nanometers and beyond, the technical and materials challenges will escalate, and innovative new materials and process technologies for CMP will need to be developed.

We believe Cabot Microelectronics is uniquely positioned to continue to meet the challenges of the digital consumer market, as well as to continue our leadership, in the leading edge of IC CMP technology. From our perspective, our technical capability, our comprehensive product line, and our supply chain infrastructure are unmatched in our industry. As we see it, we are the only CMP supplier today that offers and supports a full line of CMP products for all applications, serves a broad range of customers and has a proven track record of supplying these products globally in high volume.

These differentiating characteristics all provide a solid platform for continued learning and partnering with our customers. Our goal is to work together to develop the materials and process technologies that will be required to continue the enablement of higher performing devices at lower cost. Our capability and capacity to partner with customers, along with our business scale and CMP slurries represent a competitive advantage that we intend to build on and leverage in the coming years.

New entrants may find it difficult or impossible to match our technical and supply chain excellence and capability, as well as our ability to support the significant up-front costs required to develop and commercialize winning products for customers, as they move to 90, 65, and 45 nanometer feature sizes and beyond. We remain energized and excited by the opportunities to grow and evolve with the semi conductor industry.

We are exploring and developing opportunities to diversify and grow outside of the semi conductor industry. We believe that we have a unique ability to modify surfaces using chemistry in conjunction with mechanical abrasion at an atomic level to provide enhanced and previously unseen performance that can can be applied to a host of different fine finish polishing applications. Further our solid CMP business, combined with our strong balance sheet, provide us the flexibility to pursue these applications.

Our rapid success in earning a strong position in data storage polishing by applying our collective CMP knowledge to a new sub straight, an application, which is an example of what we feel is a significant opportunity to leverage the wealth of knowledge and diverse technical talent that we have assembled and developed inside our Company and translated to other demanding applications.

We have begun to invest in our new business development activities and staff both our market development and technical and scientific support teams. Our focus is on creating value by enabling performance enhancement through engineered service finishing. We will provide periodic updates to you on our progress on this initiative in the future.

Now let me turn the call back to Bill Johnson for some comments on our outlook for fiscal year 2005.

As Bill discussed, whether 2005 represents a short pause in the industry recovery, or the beginning of another downturn, we expect opportunities for growth in fiscal year 2005, will be more modest than what we enjoyed in fiscal 2004. However, we continue to expect gross profit margin in the range of 48% of revenue, plus or minus 2%, so our guidance on gross margin remains unchanged.

We expect that the pricing pressure that we discussed in the past will continue, but that we will be able to maintain gross margin within the guidance range by introducing new, higher margin products, improving manufacturing productivity, and capturing economies of scale that are accessible through our sizable, manufacturing technology and sales infrastructure. We view our operating costs in terms of absolute dollars, rather than as as a percentage of sales. We expect operating costs measured in dollars to increase only modestly in fiscal 2005, from fiscal 2004. We expect our effective tax rate in fiscal 2005, to be 32.8%.

Given our plans to construct our new technology center in Japan, our capital spending program in fiscal 2005, will be significantly higher than our spending in either fiscal 2003, or 2004, during which we invested in equipment but did not add facility space.

We expect our capital spending in fiscal 2005, to be approximately $33 million. And depreciation and amortization expense should be approximately $19.3 million. You are aware that we did not provide guidance on revenue, but as we look at orders for our products through the month-to-date in October, we see business activity roughly on par with activity we experienced during the comparable period in July, which was the weakest of the three sales months of our fourth fiscal quarter.

However, I would caution that the first four weeks of sales out of a quarter represent a limited window on quarterly results.

This concludes our prepared remarks.

Operator, we'll now open the call to questions.

[OPERATOR INSTRUCTIONS] Your first question comes from Suresh Balaraman with Thinkequity.

Good morning. In terms of the July month, how does that compare with the average month revenues in the September quarter. I have a follow-up after that. Thanks.

The pattern we saw in our fourth quarter was August and September were equal in strength and then July was a bit weaker than either August or September. We don't report on an individual revenue by quarter -- or by month within a quarter. But this kind of a pattern of some variation month-to-month within our quarterly results on revenue, monthly revenue is not unusual.

And is there a way to track growth in 90 nanometer slurries? I'm assuming that since 90 nanometer uses [inaudible - highly accented language] processes to 90 volume growth and can you give us some comments on how big is that of percent of revenue? Any kind of direction would help. Thank you.

Let me comment on that in terms of what we understand is the wafer start capacity in the industry. If you look at information provided by Gartner, they estimate that in the third calendar quarter of '04 that 3.3% of wafer capacity was 90 nanometer and then you'd have to split that between memory and logic. It's still a relatively small part of the industry. I think you'd also have to apply a discount to that then in terms of how much of that 3.3% is being utilized. But that would be one measure of sort of the limited penetration to date of 90 nanometer.

Great. Thank you.

Your next question comes from Gerry Fleming with WR Hambrecht.

That have you entered into this long-term supply agreement with a leading semi conductor company, is that just for the copper slurry or are you also providing the barrier slurry.

I think, Jerry, this is Bill Noglows. We very excited with this development. It's one of our most important customers and I think it represents the tangible evidence that our efforts to get closer to customers is succeeding.

Does it include the barrier.

I think I -- let me first answer the first question. I think we sell a broad range of products to almost every one of our customers, from aisle d to tungsten to barrier, to [indiscernible] and then copper slurries for 130, 90, and, you know, working together on 65 and 45 nanometer. So will I split that out and talk about this company specifically, no? But I think, as we mentioned early this morning under this new arrangement, we will supply the vast majority of this customer's copper needs and 130 nanometer technology, and we are excited about.

And one last question, can you provide us with the geographic mix of sales either for the quarter or for the year?

We report on a quarterly base in our 10-Qs, the portion of our sales that are outside of North America. We haven't reported our 10-K, of course, yet, but through the first three quarters of fiscal '04, sales outside of North America represented 74%. And that's quite an increase from the prior year. The prior year, I think was on the order of 60 or 62%. But I think it underscores the growing importance of Asia. We haven't split out of that 74%, we haven't split out Europe versus Asia but it's generally understood that Asia represents the lion's share of the growth in the industry now.

Thanks and good execution.

Thanks, Jerry.

Your next question comes from Ali Irani with CIBC World Markets.

Two questions for you, gentlemen. One on the 55 nanometer process records that you mentioned. Are these copper selections or are they other segments and I'm thinking in particular of the memory landscape, and I'm also hoping that you could give us a sense looking into next year, what expectations you would have of volume growth for your business, given the significant shift has taken place in the 300 millimeter. I know we have talked a lot in the past about this, but if you could help us quantify what 300 millimeter slurry efficiency entails to your business. Thank you.

I will answer the first question, Ollie and I think I will look to Bill to answer the second question. All of the work we're doing at 65 and 45 nanometers is in copper and copper applications for wire and interconnect technology. Bill, do you have the data that Ollie -- be.

Well, the two -- yes, in the two PRs that we just mentioned were 65 nanometer for copper applications. If you think in terms of the impact of 300 nanometer on our business going forward --

Millimeter.

300 millimeter, I'm sorry. The data we have seen so far looks like quite a bit of that 300 millimeter capacity is going into memory applications. If you see where, you know, the -- where that capacity sits, with which companies. So right now, it seems to be more aimed at the -- at memory applications rather than logic.

But in general, when we think about the efficiencies gained by going to 300 from 200 millimeter wafers, we think in terms of 1.2 to 1.5 times as much slurry per wafer required in going from 200 to 300 millimeter wafers. But there would be further complications around what are the types of devices that are on the wafers? What is the -- what is the area required of a particular dye on a wafer, things like that. But basically the 1. 2 to 1.5 is a multiplier, and so the slurry used per device would generally go down with 300 millimeter.

I think just for completeness, Alil, one thing we should have mentioned is -- and I think Bill mentioned it during our talk, is our new 7000 series product which is being broadly sampled for use in 65 nanometer technology for advanced memory applications and then we also designed the same product and are working with some customers on 45 nanometer applications in tungsten. Okay? So your question, and I probably didn't answer it as completely as possible. But we are doing some work in tungsten with our memory customers as well as 65 and 45 nanometers.

Okay. Thank you.

Your next question comes from Chris Cap [ph] with Black Diamond Research.

Yes, I had a question about the sequential growth in copper slurry sales which I think you mentioned was 14%. That's clearly being driven by a ramp, I guess in this quarter by 130 -- capacity at 130 nanometers. I'm just curious whether you could break that out, whether it's in the leading logic producers that are ramping their 130 nanometer capacity or if we're finally starting to see second tier producers ramp their capacity as well.

Yeah, thanks, Chris. I think what we have seen -- well, we've talked about the last couple of quarters was where our sequential copper revenue growth was not keeping up with overall wafer start growth, and we talked over the last couple of quarters about kind of a lag in capacity expansion, and 130 nanometer for copper application, and we had concluded that there was currently ongoing spending, but we were waiting for that spending to be -- the equipment to be put in place, and for that capacity to become operational. And it looks like in this quarter, like you say, more of that capacity became operational and was being utilized.

I -- we talk about our position in 130 nanometer copper we have 8 processes of record and so, clearly, those go beyond just the top 2 or 3 or 4 semi conductor manufacturers in copper. So I think we are seeing adoption of more semiconductor manufacturers of 130 nanometer technology. But clearly, the big volume is still with the larger players.

Just as a follow-up, as -- it sounds like the bulk of it is still the leading logic makers but as they ramp up additional capacity and/or as the second tier ramp up their -- their 130 nanometer production, is -- initially when 130 ramped, there was pretty low yields in the fabs by these producers. As this further ramps, is there any sense in how the yield is running in those fabs at 130 nanometer. In other words, are the late adopters having the kind of challenges with their yields that the early adopters were, or have they benchmarked off the leading producers? And thus having better yields early on?

Chris, I think first I would say we have somewhat limited visibility into yield data at our customers' fabs. I think as we would sort of suggest, the second tier customers perhaps have the advantage of learning from the first tier customers as they implement new technology nodes, both through their relationship with equipment suppliers and consumable suppliers, and their ability to share our learnings and the equipment company's learnings along the way. So I would -- and some of this is sort of speculating on my own but I would guess that the second tier suppliers moving from 180 to 130 nanometer technology don't have as many of the fundamental challenges in materials and equipment that the first tier suppliers would have.

Okay. Fair enough. And then I just had a follow-up. Also you mentioned a new product for barrier layer. I assume that's sort of on an looking forward basis. Just curious if the -- the abrasive that is deployed in that product is from the NanoProducts acquisition and if you could just maybe talk more generally on where you see those particular particles finding traction in terms of your different slurry applications.

Well, I think we should think of the NanoProducts relationship and our investment and strategic alliance with that company as a long-term development opportunity for Cabot Microelectronics. We have been working on a number of projects with them and have made very good progress. As yet, I would tell you that many of the slurries that we have made from NanoProducts' abrasives are what I would describe as purely experimental for future nodes way down the road, Chris.

Thanks.

Thanks, Chris.

Your next question comes from Dimitri Silverstien with Lambeau Research.

Good morning, Dimitri.

Good morning gentlemen. Congratulations on the third quarter in a very difficult environment, judging by other people's releases. I have a couple of questions. On the six sigma effort that you have launched, I was encouraged to hear the effect it had on invigorating your organization and making you look at things a little bit differently. Can you give us a little bit more detail on whether or not we're -- where these efforts are being directed? Is it revenue growth or cost reduction or R&D improvements and do you have any metrics or goals that you can share with us? What is your expectations for this program are?

Sure. Let me start by explaining where we are focusing our activities. We focused our activities on primarily in three areas. Our manufacturing operations, our supply chain operation, and our research and development community. There is a process called design for six sigma, which involves cradle to grave product development thinking which is a cross functional approach to thinking about new products which involves every aspect or every step along the path to developing new products, which we think is very important as we think of -- you know as many people sort of think of new products in the labs, it's not always as easy as they think it might be to commercialize those products so we tend to get the people that do product commercialization involved early on in the new product conception phase.

Much closer to the blocking and tackling of this Company, we've applied the tools and concepts of six sigma in our manufacturing operation. We see significant opportunities which I -- I am not in a position to disclose you're goals and targets at this point, and as this comes together, I would hope to be more visible and tell you what we think our targets for cost savings and efficiency gains would be.

Okay. Fair enough. Can you give us a little bit better idea of what the impact of costs of terminating the supply agreements and pads was on your gross margin, so we can kind of get an idea of what we can expect going forward.

Sure. You recall the last quarter we talked about the termination of a distribution arrangement in conjunction with our pad business.

Mm-hmm.

Which we were pursuing as part of a value-added reseller approach. In terminating that, we needed to work with our customers and provide transitional pad material and transition pads. Therefore, we built some inventory, in anticipation of that transition. Now, several months later into that transition, we took -- we expensed about $900,000 worth of pads, took them out of inventory and now we'll hold them for use in our laboratory facilities to the extent we can use those. But that extra $900,000 probably impacted us by about 1% on our gross margin. So where we reported gross margin of 48.6%, that $900,000 was probably worth about 1%.

Okay. Great and finally a longer term question, or a question about longer term prospects. There's been a lot of recent -- recently written and talked about the ECMP process, using electrical current to help or prepare the wafers before you start polishing them with the mechanical chemical. Do you see this as an impactful technology going forward and when do you think it will start having this impact and how are you prepared to respond to that?

That's a great question, Dimitri. Let me try to answer it. We think ECMP is an interesting technology that may have the potential to gain traction at the 65 and 45 nanometer nodes. We have been working closely with large OEM on this technology and that we believe our products will play an important role. When and if ECMP is broadly adopted by the industry. Basically -- and I think this helps us, we think we are starting to see the fragmentation of copper polishing into three significant steps, as the technology emerges. There's the first step which is kind of the bulk removal for that, and then there's the second step which has been called the soft landing before the barrier and then the third and final step which is barrier polishing.

In the future we believe that less value may be placed on the bulk removal step where the ECMP process has been applied. But we still believe that higher value CMP solutions will be required for the soft landing and barrier step, which we think will be more challenging. I think as many of you know, we have always been strong in soft landing and as we mentioned this morning, we are seeing an increased interest by our customers and our barrier slurries so we feel that this may represent an opportunity for growth in the future, but we see the timing out when people begin to commercialize 65 and 45 nanometer technologies.

Thank you very much, gentlemen.

Thank you.

Your next question comes from Steve O'Rourke [ph] with Deutsche Bank.

Good morning, Steve.

How are you. A couple of questions here. First, with competition a bit more pronounced and kind of noting the strength in memory going forward, should we expect pricing declines to be a bit more severe. That is not offset by mix going out into 2005.

We continue to see competition in the CMP slurry market, especially in copper, but also in more mature technologies like dielectrics. And it's not surprising to us that competitors have entered the market given the strong desire for growth and the visible success of our Company. We talked a lot today and the previous calls about the capabilities of our Company. We believe that over time many potential competitors will learn or may learn how complex and demanding the slurry market and it's customers can be, especially as the industry advances to even smaller feature sizes.

You know, product development has become more challenging and extremely expensive, while the demands on product quality supply assurance and technical support continue to be extremely intensive and escalate. So would I sort of forecast or guide on pricing, no. I think I would remind everyone that our core business is developing, producing and supporting CMP slurries and I truly believe that the breadth of our business, the depth of our resources makes our Company unique with a position to continue to be successful in the industry. But there are competitors out there and we fight competitive battles every day and we expect to win them. That's how I would answer your question.

Okay. And you mentioned also lower manufacturing yields as an impact on gross margin. You may have commented on some of this already and I apologize if you have. Can you tell us why and whether or not we should expect some of that to continue.

Yes, this is Bill Johnson. We've talked about yield and our manufacturing facilities and given the high quality and consistency requirements of our customers, we have to screen very, very carefully, incoming raw material that it will meet customer requirements and also test extensively within our manufacturing process at various steps to assure that the products we're producing will meet the quality and consistency requirements of our customers. And in the past there have been periods or quarters where we have reported a spike in costs related to yields, where we have, you know, screened out off quality raw material or off quality production. In this case I think we had an impact of around -- I think it is similar to the impact of the pads expense, around the $1 million.

Higher this quarter than last, in raw material and work in process, that we screened out for quality and consistency purposes. But as we have seen in the past, these have been kind of periodic expenses and so not surprising in fact, I think we have -- we have warned people this can occur from time to time and that's one of the reasons that we give a guidance range of 48%, plus or minus 2, to account for these kind of periodic spikes in costs.

As Bill talked about the six sigma effort, one of the big areas of focus is on, you know, how do we improve yields in our products? And our expectation is that as we get better traction on that, we'll see some positive impact of those efforts.

And just a follow on to that, it seems that as this technology advances, as we get more variance in slurry, you seem to have more of them, it seems like the R&D and manufacturing would become a bit more difficult. Should random events become more frequent? Is that possible?

I think -- this is Chris, right?

Steve.

I'm sorry, Steve. I think as we spoke on previous calls, that -- that technology is beginning to fragment at more advanced nodes of technology. And that represents a challenge for the CMP slurry providers in that the -- the numbers of slurries and the number CMP solutions are starting to go to the same as the number customers we support and sell to at the different nodes. We see that as -- quite frankly, we see that as an opportunity given the scale of our Company and the manufacturing infrastructure we have around the world, as well as the unique nature of our manufacturing process that allows us to make discrete formulations and products.

I think the other thing that I would add to your question is that our move into Asia Pacific with our technology center is sort of our first move to did he centralize our R&D activities and put scientists and engineers in the region to support and help our customers there. As Bill mentioned earlier, some 74% of our sales are outside of the United States. Which I should mention includes Europe as well. But we are very much focused on making sure that we provide the ability our customers to access our capabilities, and facilitate their process of designing and commercializing unique CMP solutions for specific applications and their devices.

Steve, it's Bill Johnson. Let me just add a comment there, one of the things that I talked about, in my comments on our performance in the copper business is our progress in barrier slurries and what we are finding at the advanced nodes and barrier slurries is different customers with different integration schemes require different products. And like you say, that could result in a proliferation of products, but what we are doing in our barrier case is developing a family of products where you can tweak different additives, different aspects, on a relatively minor basis and maintain a family of products, rather than specific customized products for every customer and that's one way that I think we can manage that proliferation going forward.

All right, thank you.

Thank you.

Operator, we'll have time for one more question.

Okay. Your next question comes from John Roberts with Buckingham Research.

Good morning. In under the wire, guys.

Good morning.

I just wanted to recall when you reported last quarter, I think you said July was the strongest or stronger than any month in the June quarter. So if October is running like July, you are kind of running somewhere in between the June and the September quarter run rate?

When we talked about July in the prior conference call, right, we talked about July being on par with June -- of the June quarter and June was the strongest month within the June quarter. So, right, July is paralleling -- October is paralleling July, which paralleled June, which was the strongest month our June quarter.

Got it. Secondly, when your 10-K comes out, you're going to give us your customer breakdown or at least your significant customers that are [indiscernible]. I don't expect you to give us that detail today, but do you expect any changes in the names, the number of customers, could your Asian customer in memory move up into a 10% kind of reporting position? Any qualitative feel you can give to what that disclosure will look like?

You're right, we will disclose that in the 10-K, which will be out about mid-December. If you look at what we've reported, through 2004 on a quarterly basis, we track the percent of our sales that relate to the top five customers, and through three-quarters of fiscal '04, our top five customers represented about 54% of our total sales and we only call out greater than 10% customers on annual base in the K. Last year on the 10-K, Market Tech [ph] was at 28% and Intel was at 15%. We'll disclose those greater than 10% customers in our K, 10-K in December, but given the small number, any kind of discussion we could have around that, would probably disclose more than I'd want to right now.

Lastly, is there a broad breakdown between memory versus logic for technology node that you can tell us today? Total sales that are, say, 130 and under, and total sales that are over 130, let's say.

That's a great question and we don't track our revenue by technology nodes to that degree at this point. So nothing we can comment. But I would think in general, we've tried to emphasize that we feel like memory is playing a more important role in the business going forward, based on those trends that Bill described. So I couldn't give you a particular percentage breakout, but I -- but I think it will become more important, certainly as more growth in memory, we think, going forward over the next several years, than there may be in the traditional microprocessors.

Okay. Thanks. Great quarter, guys.

Thank you all for your interest in Cabot Microelectronics, and we look forward to speaking with you again.

Thank you for participating in today's Cabot Microelectronics call. [OPERATOR INSTRUCTIONS] This conclude's today's call, you may now disconnect.