CMC Materials, Inc. (CCMP) 2005 Q1 法說會逐字稿

Good morning. My name is Sylvia, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Cabot Microelectronics first quarter conference call. 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 1, on your telephone keypad. If you would like to withdraw your question, press star, then the number 2, on your telephone keypad. Thank you. 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 first quarter of fiscal 2005, which ended December 31st, 2004. This morning we reported results for our first quarter of fiscal 2005. A copy of our press release is available in the Investor Relations section of our website, 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 3 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 3166676. Playback will be also available via webcast for the next 3 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, and other factors that could cause actual results to differ materially from these forward-looking statements. These risk factors are discussed in our SEC filings, including our report filed on Form 10-K for the fiscal year ended September 30th, 2004. We assume no obligation to update any of this forward-looking information. I will now turn the call over to Bill Noglows.

Thanks, Dave. Good morning. I think it is important that I start the call this morning, and address some issues that I feel are very important in light of our disappointing revenue this quarter. Bill Johnson will then follow with a more detailed summary of our financial and business performance.

We are disappointed with the large sequential reduction in revenue that we reported this morning for our first quarter of this fiscal year. The extent of weakness in our revenues this quarter was greater than we would have expected, given the 2 consecutive quarters of record revenue we experienced at the end of our 2004 fiscal year. We believe the bulk of our revenue reduction is the result of an inventory correction in finished goods at our customers, which resulted in a sharp reduction in wafer starts across the industry during the quarter. We believe this downturn was felt more deeply by the foundries, which as you all know, are a very important part of our business, which is primarily driven by wafer starts at sub-quarter micron technologies. I would like to stress that we are the same Company that we were in Q3 and Q4 of 2004, perhaps stronger. Among companies that supply products to the semiconductor industry, we believe few, if any, match our strong track record of financial performance through industry cycles, by any profitability measure. We believe we are the leader in the very competitive and demanding business of CMP slurries, offering differentiated products and technology across all the business areas in which we participate. We serve a broad range of customers, and have demonstrated a proven track record of supplying our products globally, in high volumes, on time, and on spec, and with the attendant technical support and service. Additionally, we have a very strong balance sheet and an experienced senior management team.

The results this quarter have caused us to pause and take a very hard look at what we see in the market, at our customers, in our Company, and in our people. I come out of this analysis even more convinced that we have the best people in the industry, we are driving the Company in the right direction, and that our focus on technology leadership, operations excellence, and getting closer to our customers is beginning to pay tangible dividends. For example, we have not surrendered any POR positions in copper at any of our customers during the quarter. Our Six Sigma initiatives appear to be taking hold and producing benefits, and our technology leadership initiative is generating a host of new products, and cultivating new technical capabilities. Bill Johnson will discuss these in greater detail following my comments. I would also like to point out that in our short history as a public company, we have experienced similar volatility in our sequential quarterly revenues twice before. As you know, we are a pure play CMP supplier to the semiconductor industry, which certainly has its advantages. But at times like these, the focused nature of our business, market, and technology, leaves us highly exposed to our customers' production adjustments, as well as a lack of forecasting accuracy, down the supply chain. This limited visibility on future sales, combined with our short order-to-ship cycle time, creates a continual challenge.

Notwithstanding the significant revenue reduction we experienced this quarter, we believe the worldwide demand for electronic devices remains healthy. We estimate that projected growth in PC demand, particularly in emerging markets, along with continued growth in consumer devices, including digital cameras, TVs, and mobile phones, supports a positive outlook for semiconductors. Yet, we expect this will be a challenging year for the semiconductor industry, and for material suppliers like Cabot Microelectronics, given the current uncertainty in industry forecasts. It appears, however, from these forecasts, that the industry will not grow at the same rate that it did in 2004. It is also no secret that more competitors have attempted to enter the CMP market, some successfully, and that pricing pressure continues to be intense, as new entrants attempt to win business using low prices as the driving force. This represents classic behavior as a market begins to mature, and we believe we are ready for it. I am very pleased with our activities that are focused on increasing productivity and efficiency, and managing costs. Our business model is strong and getting stronger as a result of our Six Sigma initiatives, our cost management programs, and our customer focused initiatives. Our ability to continue to generate gross margins within our guidance range, as well as our ability to hold our operating costs, are clear indications of successful execution of our strategies.

It is interesting to note that as our customers' technology advances, the costs and risks associated with new product development, and pre and post commercialization support are accelerating. This trend towards higher costs, along with the evolving new dynamic of the CMP industry towards diverging needs of customers for their CMP solutions, create a terrific opportunity for our Company given our scale, experience, and infrastructure. Bill will discuss how we are leveraging our technical capabilities and expertise to bring customized CMP solutions to our customers in the most cost effective means possible to capture this opportunity. He will also discuss the emergence of ECMP technology, and the role our slurries are playing within this new process technology. Over the last 18 months, we have advanced the development of a host of new products and product platforms, while holding our operating costs flat. We continue to recruit and hire the best people, and find ways to enhance the productivity and efficiency of our significant technology and development infrastructure, which we believe provides us with competitive advantage. I will now turn the call over to Bill Johnson for a more detailed review of our financial and business performance, after which, we will open the call for your questions.

Thanks, Bill. Good morning. Our revenue for the first quarter of fiscal 2005 was $67.1 million, which was down 18.9 percent sequentially from the $82.7 million of revenue we reported last quarter, and down 12.1 percent from the $76.3 million in the same period last year. This sequential decline, which followed 2 consecutive quarters of record revenue, was primarily due to 3 factors. First, the impact on demand for our products used in tungsten and dielectric applications, due to a significant downturn of production by the semiconductor industry during the December quarter, to reduce excess inventories of certain IC devices. Second, the remaining impact of the lost 130-nanometer copper business with 1 large customer, which we discussed during the last 2 quarterly conference calls. And third, selected price reductions, including 1 price reduction we granted to an important customer in conjunction with a multi-year supply arrangement for copper slurry for 130-nanometer technology, which we discussed last quarter. For these reasons, all of our slurry product areas, except for data storage, experienced sequential revenue reductions this quarter. Our average selling price for the quarter decreased by 2.9 percent compared to last quarter, primarily due to selected price reductions, which were partially offset by a higher valued product mix.

Gross profit for the quarter was $33.6 million, down 16.4 percent versus the prior quarter's $40.2 million, and down 9.8 percent from $37.3 million in the year-ago quarter. However, within this lower revenue environment this quarter, our gross profit as a percentage of revenue increased to 50.1 percent, up from both the 48.6 percent of revenue that we reported last quarter, and 48.8 percent in the year-ago quarter. Gross margin as a percentage of revenue benefited this quarter from a higher valued product mix, along with higher yield in our manufacturing operations, but partially offset by the impact of selected price reductions, and lower capacity utilization, due to the lower level of sales.

Let me provide a bit more color on this quarter's improvement in manufacturing yield. For our Company, manufacturing yield primarily relates to the ratio of on spec product to total production, and any substandard material relates to unacceptable variability of process or product parameters. Over the past several quarters, we've discussed our Six Sigma initiative, which we have broadly introduced across the Company. Several of our Six Sigma projects have specifically targeted quality improvements in our products and processes by reducing variability. We believe that improvements in manufacturing yields this quarter are indicative of initial success in our Six Sigma initiatives. We are cautious in drawing too many conclusions from this strong quarterly performance, since in the past, we've seen some significant quarter to quarter fluctuations in our manufacturing yield. But we are guardedly optimistic.

Now, let me turn to operating expenses, which include research and development, selling and marketing, and general and administrative costs. Operating expenses totaled $19.4 million this quarter, down by 6.5 percent from the $20.7 million we reported last quarter, and approximately $300,000 or 1.7 percent lower than the comparable quarter last year. Our spending on operating costs this quarter demonstrates continued careful management of costs in this area, consistent with our efforts over the last 6 quarters. Operating income for the quarter was $14.2 million, down 27 percent, from $19.5 million in the prior quarter, and down 18.9 percent from $17.5 million in the same quarter a year ago.

Operating income represented 21.2 percent of revenue this quarter, down from the 23.6 percent of revenue that we reported last quarter, and down from 23 percent in the year-ago quarter. Our effective income tax rate was 33.2 percent this quarter. Net income for the quarter was $9.8 million, down 25.4 percent from $13.2 million last quarter, and down 15.3 percent from $11.6 million in the same quarter last year. The weighted average number of shares outstanding on a diluted basis was 24.7 million shares this quarter, down from 24.8 million in the prior quarter, primarily due to purchases of stock under our share repurchase program. Diluted earnings per share for the quarter was $0.40, down from both the $0.53 per share we reported last quarter, and $0.46 in the year-ago quarter.

Next I will address cash and balance sheet-related items. Capital spending for the quarter was $2.8 million, as we made investments in manufacturing, quality, and research and development. Depreciation and amortization expense was $4.5 million for the quarter. We ended the quarter with $169.8 million in cash, $12.5 million higher than last quarter. Our cash balance reflects our use of $3.7 million to repurchase approximately 95,000 shares of stock this quarter, under our share repurchase program. Total capital lease obligations were $7.3 million, and we have no long-term debt outstanding.

Let me now provide additional commentary on the performance of our is slurry product areas, beginning with copper. Revenue from our slurries for copper polishing applications, including barrier, decreased by 25.8 percent sequentially, and was down by 11.3 percent compared to the year-ago quarter. Our sequential revenue decrease in copper this quarter followed 2 very strong quarters, during which we recorded consecutive sequential revenue increases of 7.6 percent and 14.1 percent. Revenue from copper slurries was adversely affected this quarter by the remaining impact of the lost business with 1 customer, as well as the impact of price reductions, both of which I mentioned earlier. Absent the impact of the lost business, our copper sales volume would have increased this quarter, compared to the prior quarter. Revenue from slurries for copper applications represented 21.5 percent of our total revenue for the quarter, down from the 23.5 percent we reported last quarter. We continue -- we believe that we continue to have a solid position in copper slurries for 130-nanometer technology, which remains the dominant node for copper polishing. We hold 8 processes of record, or PORs, at this technology node, unchanged from what we reported to you last quarter. And we expect continued growth in 130-nanometer technology into calendar year 2006.

Industry adoption of 90-nanometer copper technology for logic applications, continues to progress. We believe that 90-nanometer applications represented between 3 and 5 percent of overall wafer starts during our first fiscal quarter, whereas 130-nanometer technology represented between 17 and 20 percent. We hold 4 PORs in copper polishing for 90-nanometer technology, also unchanged from last quarter. And we are continuing to work with a number of other customers, as they prepare to adopt this new and demanding technology. Beyond 130 and 90-nanometer technologies, we continue to work with a number of customers on solutions for polishing copper using 65-nanometer technology, which we expect will be generally first commercialized in calendar year 2006.

As we discussed last quarter, we have earned our first 2 65-nanometer process of record wins, both in conjunction with planned ECMP applications. As we've discussed in the past, we believe ECMP is an interesting technology with the potential to gain traction at the 65 and 45-nanometer nodes. We have been working closely with a large OEM on this technology, and we believe that our products will play an important role when, and if, ECMP is adopted broadly by the industry. ECMP could replace the first of what is becoming a 3-step copper polished process. First, bulk copper removal. Second, the soft landing polish before the barrier. And third, barrier polishing. In the future, we believe that the bulk copper polish step will become commoditized, but higher valued solutions will still be required for the soft landing and barrier steps.

Last quarter, we talked about greater customer interest in our new products for polishing copper barrier. We believe that customers are not fully satisfied with barrier polishing solutions available for the most advanced technology nodes. And we are developing a family of tunable barrier slurries that we believe can provide innovative solutions for our customers' specific integration schemes. With our new developmental barrier slurry platforms, we can tailor, or tune, various performance attributes to meet a specific customer's needs, by altering the respective amounts of a number of trace chemical additives. So our new developmental barrier slurries can be independently and selectively tuned for either the copper polish rate, to remove remaining residual copper on top of the barrier layer, the barrier polish rate, or the rate of polish of the insulator layer after we polish through the barrier layer. With this approach, we can offer customers a range of products and application solutions within a single product platform, and therefore, cost effectively develop and commercialize custom products, since they are built off of the same product platform. We have earned 2 PORs for copper barrier polishing applications for 65-nanometer technology, and we hold 1 each at the 90 and 130-nanometer nodes. We are encouraged by our customers' responses to our barrier products, and we believe that barrier polishing represents an important growth opportunity for our Company.

Now, let me turn to our other slurry products. Tungsten and dielectric CMP slurries are broadly used in a wide range of memory applications, as well as in logic devices of the more mature 180 and 250-nanometer technologies, where aluminum wiring is used rather than copper. Revenue from our tungsten dielectric CMP slurries taken together, was down 19.4 percent sequentially, and down 14.7 percent compared to the year-ago quarter. Over the last few quarters, the semiconductor industry has seen an increase in inventories of semiconductor devices within the supply chain, particularly logic devices for communications applications. During the December quarter, a number of our customers appeared to have scaled back production of these devices, in order to draw down finished goods inventories. We believe that the production turn-down was relatively broad-based, but likely more profoundly experienced by the foundries than the integrated device manufacturers. You are aware that the foundries represent a very important part of our business. Aggressive growth among the foundries last year was a significant contributor to the 23 percent year-on-year overall revenue growth we recorded for our Company in fiscal 2004. But during the December quarter, the foundries significantly reduced production of certain IC devices, and we believe that most of the production turn-down related to logic devices of more mature technologies, that utilize aluminum wiring rather than copper.

As such, this slow-down of IC manufacturing significantly affected our sales of tungsten and dielectric slurries this quarter. We believe we continue to be well positioned in slurries for tungsten applications, both with our existing products, as well as with new products in development. Our new 6000 series product for 90-nanometer applications is in advanced evaluation with a number of customers, several of whom 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. We expect this product will also be extendable to 45-nanometers. We're confident in our technology position in tungsten slurries, and we see a promising future for these products, especially given the growth outlook that we see for memory devices. For dielectric polishing applications, our new CMP slurry within the 6000 series, which was developed to provide improved defectivity and also a lower cost of ownership, has received positive initial feedback from customers. Within our 8000 series, another new dielectric product is formulated for advanced ILD applications. Both of these new products should be commercialized in the third quarter of this calendar year.

Finally, revenue from our slurry for direct shallow trench isolation applications grew sequentially by nearly 50 percent this quarter, although from a small base. We believe that growth this quarter was driven by our customers' ramp of 90-nanometer technology, where we are the process of record with 2 customers and are in evaluations with a number of others. Revenue from our data storage business increased by 21.3 percent sequentially, as the data storage market experienced some continued seasonal strengthening of demand, customarily seen in the second half of the calendar year. This concludes our financial and business review.

Now, let me close with some comments on share-based compensation expense, as well as our near-term outlook. Recently, the FASB issued a final pronouncement on share-based compensation expense, which will require public companies to record the calculated fair value of stock options as compensation expense in their income statements. In the past, we have just disclosed this information in the footnotes of our financial statements. Based on the current rule, our Company will first record this share-based compensation expense in our fourth fiscal quarter of 2005, which will end on September 30th. The share-based compensation expense we expect to record for our fourth fiscal quarter of this year, will primarily reflect expense related to the approximately 1.3 million stock options, the vesting of which we accelerated to September 1, 2005, plus a pro-rated portion of annual expense related to approximately 1 million options that were granted to our employees in December, 2004, as a normal annual grant under our equity incentive plan. We currently estimate our pre-tax share-based compensation expense for the fourth fiscal quarter will be approximately $11 million.

Looking forward, under the new FASB rule, we would expect to recognize pre-tax share-based compensation expense for the full fiscal year 2006 of approximately $11 million, based primarily on the expense associated with our annual option grants, made in December 2004, and a pro-rated portion of annual expense associated with our normal annual grant that we would expect to award in December 2005, assuming we don't materially change our Company's historical approach to long-term incentive compensation. The 1.3 million options that are scheduled to vest on September 1st, 2005, will not trigger any further compensation expense after fiscal 2005. Of course, all of this share-based compensation expense will be non-cash, and therefore, will not impact our cash flow. We intend to provide periodic updates on expected share-based compensation expense, as appropriate.

You're aware that we do not provide guidance on revenue, but as we look at orders for our products through the month to date and January, we see business activity roughly on par with activity we experienced during the comparable period in December of our fiscal first quarter. And sales for the month of December represented approximately 30 percent of total revenue for the quarter. However, as we have stated on previous quarterly conference calls, I would caution that the first 4 weeks of sales out of a quarter represent a limited window on quarterly results. During the fiscal first quarter, we slightly exceeded the high end of our guidance range for gross margin of 48 percent of revenue, plus or minus 2 percent, with a gross margin of 50.1 percent. Notwithstanding this performance slightly above guidance, we maintain our gross margin guidance at 48 percent, plus or minus 2 percent. We expect that the competitive pricing environment that we have discussed in the past will continue. And I would point out that our March quarter is the first quarter of the new calendar year, and historically we have seen increased pricing pressure around this period, as customers attempt to negotiate new pricing for the new calendar year. But we expect that we will be able to maintain gross margin within the guidance range by introducing new, higher margin products and improving manufacturing productivity. This concludes our prepared remarks.

Operator, we will now open the call to questions.

(OPERATOR INSTRUCTIONS) Gerry Fleming, WR Hambrecht.

A couple of questions. One, you talked about the impact of the lost customer on the copper business. Does that customer still do business with you in tungsten or oxide?

Yes. The answer is yes. We, as you know, we sell broadly across all the customers at all applications, and that customer, we continue to sell tungsten products, as well as oxide products. And perhaps more importantly, we are working currently at both 65 and 45-nanometer nodes with this very important customer.

In copper?

In copper.

Okay. You mentioned there were no process of record losses in copper. Were there any in either tungsten or oxide?

It is interesting that we -- we don't tend to focus on tungsten and oxide, and we probably should. My answer to that question is, there were no losses, POR losses, in tungsten and oxide. Fortunately, or unfortunately, we tend to be focused on copper, and people tend to focus us on copper. Certainly, no material losses, no POR losses, and I think as Bill discussed, when he was talking about our individual product lines, we are very excited about some new products in the pipeline in both of those applications.

Okay. And the last question, your inventories were up fairly substantially in the quarter. Are you cutting back on your production rates? And what did you see from your customers in terms of their adjustments to their own inventories?

The inventory increase that we experienced, you're right, was significant. I think our inventories were up by about $6 million. But it was mainly in raw materials and particle inventories, not finished goods. We're primarily a make-to-order business, and so we did not see a significant increase in finished goods inventory. The increase in particle inventory was really on purpose. I think we found that with the strong year we had in 2004, and the increasing demands we're seeing for our products, we maintained a lower level of particle inventory, due to the high demand, than we really might feel is comfortable over time. So we are increasing particle inventory on purpose, to try to bring that back to sort of a normal target level. In terms of our -- .

And I have 1 last question. And that relates to the foundries. I assume you're not going to give us the percentage of the business that they represent, but could you give us a rough idea of how much of the foundry business is copper and how much of it is in aluminum and oxide?

The best indication of that, Gerry, might be from what we disclosed in the 10-K, where we pointed out for 2004, our largest customer was Marketech.

Right.

Which is our distributor and logistic service provider that serves Taiwan and China. The big foundries are located there. That business -- that represents 32 percent of our business, and so you can probably draw some conclusions from that. But you're right, we wouldn't give specific numbers by customer or by foundry.

What about by copper versus tungsten?

We couldn't give that split, either, but the foundries are more active in logic devices than memory certainly. So for the newer technologies, you would expect more copper than tungsten and oxide.

John Roberts, Buckingham Research.

Normally, you've experienced most of your average selling price decline in the March quarter, after the year-end discussions. So, with the decline you just had in the December quarter, should we expect it to worsen in the March quarter?

The 2.9 percent ASP reduction was a bit unusual. I guess 1 of the things that we pointed out was 1 significant price reduction or concession, in conjunction with a multi-year supply agreement that we've talked about in the past. There were other modest price concessions, but that was the most significant one that we reported this quarter.

Okay. So we didn't have year-end negotiations, as we've had in the past, and the March quarter is not going to be typical of the last couple of March quarters?

No, I didn't say that. I think, we wouldn't be able to comment on that. But I would just point out that the last 2 March quarters, we have seen continued pressure, as we think customers try to negotiate better prices for the beginning of the calendar year. But I didn't say anything further about how we might expect that to behave in the March quarter of 2005.

Was the lost copper customer, 130-nanometer copper customer, completely out of the September quarter? So the December quarter had zero compared to nothing in the September quarter, as well? Or was there partial -- if you would just remind me exactly the timing of that, and when we anniversary it.

Right, I think we talked about that first in our July conference call. And we saw some of the effect of that in the September quarter, and what we think is the remaining effect of that in the December quarter.

Okay. So March will be a comparable quarter to the December quarter, with respect to the 130-nanometer copper?

That's correct.

Steve O'Rourke, Deutsche Bank.

A couple of questions to start off. I want to make sure I understand this. Could you give us a bit more detail on the revenue decline, and how much was due to the loss of the customer, and how much was due to a fall-off in older technology wafer starts? It just seems like there was a fairly significant decline percentage-wise in copper revenue.

I'm sorry. Could you repeat the last part of your question?

It just seemed there was a rather significant decline percentage-wise in just copper revenue.

Yes, on a percentage basis. Let me take a different approach to that. If you look at our revenue last quarter of $82.7 million, going to 67.1 million this quarter, there is a reduction of around $15.5 million. Around two-thirds of that was in tungsten and oxide, which we think was an industry impact as our customers turned down production. And the remaining impact was really in copper. And I would split the copper impact in terms of 2 portions. 1 would be the pricing impact, and the second would be the lost business. And both of those were significant. That might be kind of a high level way of looking at the revenue variance, quarter-to-quarter.

Okay. Just a follow-up. You mentioned particular weakness at the foundries this past quarter, and that is probably where a fair amount of the tungsten and oxide kind of lost, potentially. TSMC just reported wafer starts down 8 percent quarter-over-quarter, and indicated wafer starts should be down single-digit percentage in calendar Q1. So if we kind of assume the 3 components of the revenue decline, where the loss of share is pretty much out of the picture now, we do have some incremental price reductions, and we still have wafer starts going down, if TSMC is an indication. Should we see a meaningful revenue decline in the March quarter? Is that how we should be looking at this?

We are a wafer start-based business at sub-quarter micron technology. So to the extent that wafer starts continue to decline, we would have a continued impact on our business. One of the things that makes it a little more complex to look at, in terms of the wafer start impact on our business, relative to the broad industry data, is you have to wait a while to get good wafer start data by technology node. And so the broad industry might go 1 way, but a particular technology might go another, and you wouldn't be able to see that until sort of the industry data was all in. So we will -- our business will move with wafer starts at sub-quarter micron technologies, but I think you have to look at how do those specific wafer starts move.

Okay. And just 1 last question. In the past, you've commented on competitor copper slurry POR status in technology nodes, of course not mentioning names. Could you give us an update on that? Have there been any changes in POR wins by your competition, in say 90 or 65-nanometers?

Steve, this is Bill Noglows. We have, in my understanding, we have never talked about competitive PORs or competitors.

Okay. Not so much competitors, but I thought in the past you said there had been 4 decisions made, and you got 2 of them, and 2 looks like they went to competitors.

The approach we've -- we've really -- the last several quarters, our approach has to been to talk in terms of our PORs in absolute numbers. Historically, we tried to do some of that in terms of PORs among a select group of customers, but we weren't comfortable in naming customers. And to do that, created a lot of confusion, because our numbers that we were thinking of, weren't necessarily the same numbers that our customers and others were thinking of. So to be clear, we have been talking over the past several quarters, just in terms of absolute numbers of PORs, rather than so many PORs out of a subset of overall customers.

Ted Berg, Lehman Brothers.

Historically, you guys have done a really good job, versus the competition, given your service and support organization, your big R&D budget, and the new products that you continually rolled out. And I was wondering at the 130 node in particular, where you were able to get a lot of process of records early on, versus competition. Has that market become more of a mature market for copper slurry today, and are the switching costs much lower in that particular technology node versus the prior? Or are the competitors -- are the competitors, to the extent that the 1 big customer that you mentioned, are they winning that solely on price? Or how much of it is due to very compelling product offerings at 130?

Hi, Ted, this is Bill. We continue to believe that the switching costs are high, once a supplier has selected, and is at HVM, high volume manufacturing. But however, at the big -- let's describe them as the big leading edge companies, they're always evaluating, testing, and looking at alternative slurry products, processes, and pad technologies, and tool technologies. They have the resources and the people to do it. And that's what they do. But we think once a CMP supplier is spec'd in and is POR, and at high volume manufacturing, the customers are very reticent to switch, unless there is such a significant performance advantage or cost advantage, which may provide a driving force to cause them to take a much harder look than they would normally look. Did that answer your question, Ted?

Yes. So you don't really think a lot has changed then, from a year ago in terms of the barriers at 130? They're still pretty much the same?

That's my belief, yes.

And would you suspect that -- do you think you can hold on to the 8 PORs that you have you at 130 today, a year from now? Do you think you will be able to maintain those PORs, or do you see the competitors rolling out better products today to compete at 130 with you?

Well, we certainly see more competitors, as you all know. However, our goal is to not maintain the 8 PORs we have today. Our goal is to have 10 or 12 next year. And so we are not sitting still with our current offerings at 130-nanometer technology. We are developing products that we think will provide a significant performance advantage at a lower cost at the 130-nanometer node for our customers. That's what we do, and that's what our Company is based on. So, your question is one that we hope to have more PORs at 130.

Okay. All right. Great. I had 1 question on the gross margin. Despite the revenue being weaker than expected, the gross margin was a lot better, and I understood, Bill, your explanation of that. Was there anything else at all or was it just due to those items? Were there any accounting issues in terms of reserves that were lowered, or anything that helped gross margin? It just seems a lot higher than it was possible, given the revenue number.

No, that's right. There were no -- there were no new accounting approaches, anything like that. The -- we saw 2 benefits. 1 was a mix benefit that I mentioned. The second was the higher manufacturing yields. And we talked some about that. We're cautious about tying too much improvement to that, because we want to see how it persists. But we are very encouraged by the increase in manufacturing yield, which helped drive gross margin. The Six Sigma projects, we think are driving that. We'd just like to see a bit more history before we -- before we really declare victory on that one. But it looks like it was higher yields, and driven by Six Sigma efforts.

Ali Irani, CIBC World Markets.

I'm hoping you could help us understand a little bit what the inventory of slurries are at your customers at this point, and whether you see those as normal or over corrected at year-end? And just shifting a little bit from that, on to the nodes.,Your 90-nanometer market share is obviously, at present, a lot lower than your 130-nanometer. Could you try to qualify for us your 65-nanometer market share, Bill? And I'm wondering if there are some of these efforts on yield management, product quality control, and of course the technology, are helping reverse that trend going into 2006. Thank you.

Well, Ali, we have never commented on market share, as such. I think if you look at the PORs as we described them, I think your conclusion is correct, that our position at 90-nanometers is not as strong as our position at 130-nanometers. Our work at 65, I would describe as pre-HVM work with the customers and OEM that we're working with, it is very developmental. I would also like to perhaps point to sort of our early success at 65-nanometers. I think we talked earlier about our view of the 3-step copper removal process at that future nodes, particularly 65 and 45-nanometer, where the bulk removal step is becoming, or at least we believe, is becoming sort of a commoditized part of the process. And this is where we believe ECMP excels at that first step of sort of blasting off the bulk of the copper. But the soft landing, if you will, and the barrier polish, still remains very, what I would describe as a very technical application of CMP technology. And at that 65-nanometer nodes in the 2 cases Bill talked about, where we're POR, we're excited about where we are positioned today with the introduction of that new technology.

And with respect to the inventory at the customers?

Ali, it is Bill Johnson. We believe that our customers maintain relatively low levels of inventory of slurries. And in the past, we've said on the order of 4 to 6 weeks of inventory is what we think. In terms of what -- did any of the customers run down inventories in the year-end, we don't have a lot of visibility on that. And we don't think there was a huge opportunity for that. The 1 area where there is a bit more inventory is between here and Taiwan and China, since we use logistic service provider and distributor there, they maintain some amount of inventory, and the customers then would maintain some inventory. So there is a bit of a longer supply chain there. But as we look at our results, it wasn't -- it didn't look like there had been any kind of a change in inventory of slurries outside of our gates.

Okay. And 1 follow-up question for you. Given the impact of the loss of that 1 significant customer in this quarter, and the fact that your PORs at 90-nanometer are now 4 out of 7, should we expect any subsequent quarters in which the reduction of POR share at 90 versus 130, would again give an impact to your revenues? And in particular, I'm wondering what happens here in the first quarter, in addition to the seasonal output declines, whether we see some impact of that, again, by some measure.

Sorry, Ali, it is Bill Johnson. We've expressed our PORs of 4 in absolute terms, not 4 out of 7. But then, you have to repeat your question. I'm not sure I followed the rest of it.

Okay. When I look at your December quarter, you had a pretty significant impact from the loss of that 1 major logic customer. And I'm wondering, if given the relative market share -- the relative -- I'm going to use Bill's terminology here, the relative PORs at 90-nanometer, that are now lower than the relative PORs at 130, whether there is a similar impact, albeit it in smaller magnitude, that is still ahead to your revenues, as the 90-nanometer ramp takes place at other chip makers?

Our view is that we will have continued growth in 130-nanometer technology into calendar year 2006. The ramp in 90-nanometer is taking place, and we do -- we have 4 PORs at 90 versus 8 in 130. But we're continuing to work with other customers at 90. I think -- you can't draw a simple analysis of just -- of pure PORs, meaning weaker market position, it really kind of depends on who those PORs are with. But we continue to work to strengthen our position at 90. I think we will have to watch as 90 ramps more robustly, can we grab a larger position in that.

Chris Kapsch, Black Diamond Research.

Yes, just had a question about copper in general. When copper was first being adopted, it is obviously a 2-step process, and that the leading edge 90 and 65 obviously, the 3-step. But I'm just curious if you could give us an indication, at 130, how many of the IC device makers are currently running 3 steps versus 2 steps in copper? In other words, the bulk removal, the soft landing, and the barrier?

I don't think we have a great deal of visibility in that. We understand that some customers would tend to treat it as 3 separate steps. Others treat it as 2. But I don't think we have a good count on who does which.

Okay. Then just to follow up on your PORs at 90 and 65. I'm just curious if any of those PORs include some qualification of your products for the middle step. In other words, the soft landing step, specifically.

Let me just -- let me define what we use when we talk process of record. That may help. And then I will try to answer your question. We define process of record as sort of as the following. For technologies that are in high volume manufacturing, such as 130 and in some cases 90, we consider that we are POR when we have the majority of that customer's business for copper polishing. Although this is somewhat ambiguous, we feel that it is the best way for us to characterize our position, since there are many different process schemes out there for copper polishing today. Some customers use 1 step, some use 2 steps, so that it would be difficult and inefficient to go into greater detail I think at this time. I think it is a good question, though, Chris, and we will dig in a little further, and see what we can determine and communicate.

But in terms of at 65, we mentioned a couple of different PORs, 2 PORs in copper polishing at 65, and then we also talked about 2 PORs at -- in barrier, at 65. We mentioned that the ones at 65 for copper are in conjunction with ECMP, and so that would sort of define those as sort of a second step in that case.

Okay. That's helpful. Where ECMP is more the first step, right, bulk removal?

Right, ECMP, if it is adopted, would replace kind of the bulk gross commodity type copper removal, the first step.

Got you.

And then we think there are higher valued steps, the soft landing and the barrier that would follow.

Got you. Thank you very much.

Operator, I think we've got time for 2 more questions.

Dmitry Silversteyn, Longbow Research.

A couple of questions. A lot of them have already been answered. When you -- your R&D center in Japan that is currently under development and that you are going to begin construction sometime this year, once it is operational, and staffed, can you give us an idea, or is too soon to talk about the delta in terms of R&D, higher R&D costs, or facility depreciation, or anything like that, so we can see what this is going to look like in 2006?

Yes, the only visibility we've given on that, is in terms of our capital spending for the year. We expect to be at $33 million, which is roughly double what we've spent the last 2 years. I think we also guided to a higher depreciation expense, on the order of $19 million for the year, and a portion of that would be based on -- a small portion of that would be based on the Asia Pacific Technology Center. I think it is something we will manage over time, to see how do we -- how do we handle the respective resources in our North American effort versus our Asia-Pacific effort. But I think it is something I think we will have to manage and watch over time. We're excited about the Asia Pacific Technology Center. We think that's going to give us a great additional capabilities, in an important part of the world. And clearly the semiconductor market is growing aggressively in the Asia-Pacific region, and so we're delighted we're going to be there. We think that will be operational in October of this year. So it is a relatively near-term project.

Okay. All right. The next question I have is you provided some information on the impact, on the gross margin of improving mix versus lower price of productivity improvement. Can you give us an idea of what these moving pieces are? For the first quarter, for the December quarter? In terms of magnitude.

Yes, there were 4 -- we mentioned 4 impacts, and each of the 4 are significant. 1 was an improved product mix. The other was the improvement in yields in our manufacturing process. But this was partially offset by 2 other significant impacts. 1 was price reductions, and we talked a bit about a single 1 that was impactful this quarter. And the other is lower capacity utilization. Since we had a lower level of sales, there was lower utilization. But those were the 4 impacts, and each of them were significant. I don't think I could quantify that beyond that comment, though.

Okay. Fair enough. And the final question then, a little bit more of a strategic question. You're going through your $25 million share repurchase authorization here pretty quickly. You've got $170 million in cash on hand. Has there been any clarity added, or anything you care to share with us, as far as your plans for using this cash?

Dmitry, nothing more than we've communicated on past calls. As you are aware, we're upping our capital expenditures for this year, with the new facility in Japan. We still have that buyback program in place, and we're looking -- we're looking carefully at attempts and efforts to extend our technology into other applications. So we will be prepared to talk more about that in future calls.

Okay. And just as a point of clarification, the impact of the lost customer at 130-nanometer is going to anniversary, you basically -- we basically have this whole year to anniversary it, correct? Because you just began to see it in the September quarter and the major impact was in this first quarter of the fiscal year?

No, we said that we began to see the effect in the September quarter, and we saw the remaining effect in the December quarter.

Okay. So -- but in terms of year-over-year comparisons, it's going to be December of next year before it anniversaries, is that correct?

That's correct. Because we saw the final effect in the December quarter.

Operator, we've got time for one more question.

Suresh Balaraman, Thinkequity Partners.

Yes, when we look at the foundry, such as TSMC, the wafer starts are down 8.4 percent for December. Any reason why your wafer starts, your slurries to them could be worse than that? Is it because they're drawing down on their own inventory? Or is it anything else? Thanks.

I think you have to look at the mix that might make up their reduction. We've only seen their announcement this morning, so I haven't examined it in detail. But if they represent the foundries, their turn-down of production of wafer starts would be comprised of different elements. We would expect that their leading technology would continue to ramp, and so there is probably less of a reduction, and perhaps growth at the leading technologies. We think that the bigger impact was on some of the more mature technologies, say 180-nanometer to 250-nanometer, and so they could have a larger than 8 or 10 percent reduction in wafer starts at those technologies. That's where we think the inventory was largest in the channel. So we believe that there is a disproportionate turn-down of production by some customers of those more mature technologies. But that would be 1 reason to expect that the overall wafer start reduction of the foundries might be different than our overall revenue turn-down.

Okay. And in terms of your gross margins, the ninth sequential increase, did the loss of the big customer have any impact on your gross margins in a positive sense?

The forward effects -- there was a negative effect of gross margin on price that was mainly related to price reductions. I don't think -- I don't think there is -- I haven't analyzed it that way. I don't think there is anything that we could -- any conclusion you could draw about that 1 lost customer.

Ladies and gentlemen, we have reached the end of the allotted time for questions and answers. Mr. Li, are there any closing remarks?

I will hand it over to Bill.

No. I just want to thank you all for your support and your interest in our Company. And we look forward to talking to you again next quarter. Thank you.

Thank you for participating in today's Cabot Microelectronics first quarter conference call. This call will be available for replay beginning at 11:30 a.m. Eastern Standard time today, through 11:59 p.m. Eastern Standard time February 17th, 2005. The conference ID for the replay is 3166676. Again, the conference ID number for the replay is 3166676. The number to dial for the replay is 1-800-642-1687, or 706-645-9291. Thank you. You may now disconnect.