CMC Materials, Inc. (CCMP) 2005 Q3 法說會逐字稿

Good morning, my name is Juneeca (ph) and I will be your conference facilitator. At this time, I would like to welcome everyone to the Cabot Microelectronics third quarter earnings 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. [Operator Instructions.] Thank you, I will now turn the call over to Mr. Bill Johnson, Chief Financial Officer. You may begin your conference.

Good morning. With me today is Bill Noglows, Chairman and CEO of the Company, to host this earnings conference call for the third quarter of fiscal 2005, which ended June June 30. This morning we reported results for our third fiscal quarter of 2005. A copy of our press release is available in the Investor Relations Section of our website, www.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. You will need access code 4381279. Playback will also be available via webcast for the next three weeks in the Investor Relations Section of our website, along with the 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-Q for the second quarter of fiscal 2005 ended March 31, 2005, and Form 10-K, for the fiscal year ended September 30, 2004. We assume no obligation to update any of this forward-looking information. This morning Bill and I are conducting this call without David Lee, our Director of Investor Relations, who many of you have interacted with over the last year and a half. David was recently promoted to run one of our business areas. I'd like to thank Dave for his contributions to our investor relations function and wish him success in his new role. We have an ongoing search for Dave's replacement and I hope to announce the new Director of Investor Relations soon. I will now turn the call over to Bill Noglows.

Thanks Bill. Good morning to all of you. This morning we announced financial results for our third quarter of fiscal 2005 that we believe reflect a bottoming of the semiconductor industry downcycle that has affected a significant portion of the semiconductors industry recently, and which has negatively impacted results thus far in fiscal 2005. Our revenue this quarter was up slightly, following two consecutive quarters of sequentially lower revenues during which we saw certain customers reduce production to correct excess inventories of some semiconductor devices. Industry experts indicate that inventory correction appears to be complete, and have predicted that the semiconductor industry will turn up during the second half of the calendar year.

For example, industry analysts have increased forecast growth in semiconductor industry revenue from 2004 to 2005 to between 4% and 8%. Total wafer shipments are now expected to grow 5% in the third calendar quarter. A number of notable semiconductor manufacturers have shown strength in their quarterly financial results. Forecasts for PC shipments in 2005 have increased sharply in the last month.

Finally, foundries are forecasting 8% to 10% growth in wafer shipments for the third calendar quarter, and some product lead times have increased. Since demand for our products is primarily based on wafer starts at subquarter micron technology, an upturn in the semiconductor industry activity should drive growth for us in the coming quarters. Over the past two years we have been executing on our three principal strategies, technology leadership, operations excellence, and getting closer to our customers. During our last conference call, I discussed our progress on our technology leadership initiative, with particular attention paid to our revitalized product development pipeline, as well as our progress on our operations excellent initiative, specifically with regard to productivity and yield improvements we are capturing through our Six Sigma initiative.

We're excited about our progress and ongoing execution in both of these key areas. This morning I'd like to focus our discussion on the substantial progress we are making on our third principal strategy, getting closer to our customers. We have discussed previously that the CMP industry has begun to mature. Technology has begun fragmenting and becoming more complex, and customers are requiring more customized CMP solutions. Shrinking features sizes continue to make slurry product quality, consistency, and performance more important. Given these trends, along with intensifying competition in CMP, it is imperative that we work more closely and collaboratively with our customers to continue to maintain and enhance our leadership in this increasingly demanding technology.

I believe that our customers are enthusiastic about our at execution on this initiative. As we partner with our customers on joint development activities we are openly sharing far more information about our technology and know-how, demonstrating greater commercial flexibility and customer supply arrangements, and making our world-class technical and commercial staffs as accessible to our customers as their needs require. Let me describe several tangible examples of progress we are making in getting closer to our customers. During our third fiscal quarter, we earned supplier quality awards from three important customers. In one case, we're selected number one out of nearly 200 suppliers, and in another we were rated in the top 1% out of 1,500 suppliers. Beyond these three specific awards, we are also consistently earning significantly higher ratings when our customers audit our operations and grade us on their supplier score cards.

In our data storage business, we are moving the portion of our business that serves the rigid disk market to Singapore to be closer to the hard disk drive customer base that is concentrated in Southeast Asia. This will include establishing manufacturing operations there, as well as relocating our related commercial and technical teams. We believe that over 60% of the global manufacturing capacity for the hard disk drive industry is located in Southeast Asia and that we can serve our customers more efficiently, more responsibly, and at lower cost by moving closer to their manufacturing and development centers. During our third fiscal quarter, we reached agreement with two important customers in Asia on long-term supply arrangements for CMP slurries, bringing to four the number of these arrangements we have entered into with significant Asian customers over the past three quarters. The arrangements cover a range of technology nodes and relate to copper, tungsten, and dielectric operations.

In the past, long-term supply arrangements have been relatively rare in the CMP industry. We believe our progress in gaining these long-term commitments from our customers underscores the closer relationships we are developing with these customers, as well as the high quality of our products, services, and supply chains.

Our Asia Pacific Technology Center continues on track to open for operation in October of this year. We expect that having this fully capable technology development facility in the Asia-Pacific region will allow us to better extend our strong technical capability and know-how to our customers there, while significantly improving our response time, as well as providing the ability to work closely with our regional customers on unique and customized CMP solutions. Construction is well underway and staffing is progressing as planned. In previous conference calls, we have discussed our efforts in Six Sigma, which have primarily focused on internal improvement activities, mainly in our manufacturing operations and in research and development. We are now extending our Six Sigma initiative to include joint projects with customers. We are currently sharing our Six Sigma capabilities and working on joint projects with two customers to help them improve quality and consistency in their manufacturing operations, which should translate into lower defectivity and higher yields for them. Other customers are expressing interest in this kind of collaboration.

Working with customers on Six Sigma improvement projects represents a great example of how we can address our customers' needs for lower costs through a means other than simply reducing the price of our slurries.

Finally, in April of our third fiscal quarter we held our first CMP technology symposium in Austin, Texas. This event attracted 70 participants from a wide range of customers. We have received terrific feedback from this event and are planning other similar events in Asia and Europe in September of this year. In addition to all of these achievements and activities during our third fiscal quarter, we earned our third process of record, or POR, win for our 65-nanometer copper polishing application. We also earned our first two PORs for 45-nanometer technology, one each for copper and barrier applications, and we earn our third POR for direct shallow trench isolation, or DSTI.

We are delighted with the progress we're making in building ever-stronger relationships with our customers, and earning their greater trust and confidence in us, and we're eager to do more. I believe that no other competitor in the CMP slurry industry has the technical and operational capabilities to work with the broad range of customers that we do, across the full spectrum of applications and technology nodes. Now, I would like to update you on an exciting area of increasing emphasis for Cabot Microelectronics.

You may recall that last October I talked about our emerging efforts in engineered surface finishes, through which we are translating our core technical expertise in CMP technology for the semiconductor industry with which we modify surfaces in an atomic level into a range of demanding surface modifications and polishing applications in other industries, where shaping, enabling, and enhancing the performance of surfaces is as critical to success as it is in the semiconductor industry. We have made real progress on our engineered surface finishes, or ESF, initiative over the past several months, and as it continues to develop and expand we continue to believe that ESF can provide additional growth and diversification opportunities for our Company, while also complementing our leadership position in CMP technology for the semiconductor technology.

A number of the areas we are currently developing have natural adjacencies to our core CMP business and technology, and include applications in fields such as optics, opto-electronics, flat panel displays, and metal finishing. We believe our strong balance sheet and cash flow provide us the flexibility to both acquire business positions in a number of these areas, as well as grow and develop organically as appropriate to create value for our business and our customers. We intend to continue to provide periodic updates on our progress in this exciting area. Now let me 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. Our revenue for the third quarter of fiscal 2005 was $65 million, which was up 0.8% sequentially from the $64.5 million of revenue we reported last quarter, and down 15.5% from $76.9 million in the same period last year. Comparisons of our revenue and other financial metrics to the year-ago quarter reflect the near-record results of our strong third quarter of fiscal 2004 before the subsequent semiconductor industry downturn. This quarter saw combined revenues for our tungsten and dielectric slurries increase by 3.7%. Slurries for copper polishing applications decreased by 9%, and data storage slurries increased by 3.1%.

Our average selling price for the quarter decreased by 2.8% compared to last quarter, primarily due to selected price reductions, along with the effect of the weaker Japanese yen versus the U.S. dollar on the approximately 15% of our revenue that is yen-denominated. Gross profit for the quarter was $31.2 million, up 4.8% versus the prior quarter's $29.8 million, and down 20% from $39 million in the year-ago quarter. Our gross profit, expressed as a percentage of revenue, was 48%, up from the 46.2% of revenue that we reported last quarter, down from 50.7% in the year-ago quarter, and at the midpoint of our guidance range of 48%, plus or minus 2%. Gross profit, as a percentage of revenue, increased largely due to the benefit of a higher valued product mix, partially offset by the effect of selected price reductions that I mentioned earlier.

You are aware that product mix has historically been a significant driver of quarter-to-quarter changes in our gross profit margin, since our three primary CMP applications, copper, tungsten, and dielectrics have differing pricing and margin dynamics. Now let me turn to operating expenses, which include research and development, selling and marketing, and general and administrative costs.

Operating expenses totaled $20.6 million this quarter, down by 3.8% from the $21.4 million we reported last quarter and approximately $500,000, or 2.6% lower than in the comparable quarter last year. This quarter's lower operating costs reflect lower staffing-related costs, including lower accruals for the Company's annual bonus plan, partially offset by higher costs of clean room supplies for our research and development activities, and higher professional fees, including fees associated with meeting the requirements of Sarbanes-Oxley, Section 404.

Operating income for the quarter was $10.6 million, up 26.9% from $8.4 million in the prior quarter, and down 40.7% from $17.9 million in the same quarter a year ago. Operating income represented 16.3% of revenue this quarter, up from the 13% of revenue that we reported last quarter, and down from 23.2% in the year-ago quarter. Our effective income tax rate was 27.9% this quarter, and we expect our tax rate for the full fiscal year to be 31%. Net income for the quarter was $8.3 million, up 37.7% from $6.1 million last quarter, and down 31.9% from $12.2 million in the same quarter last year. The weighted average number of shares outstanding on a diluted basis was 24.6 million shares this quarter, slightly lower than in the prior quarter due to purchases of approximately 171,000 shares of stock for roughly $5 million, under our share repurchase program this quarter.

To date, we have purchased approximately 656,000 shares, or roughly $21.5 million at an average price of around $32.85 per share, under the $25 million share repurchase program. Diluted earnings per share for the quarter was $0.34, up from the $0.25 per share we reported last quarter, and down from $0.49 in the year-ago quarter.

Next, I'll address cash and balance sheet related items. Capital spending for the quarter was $4 million, mainly related to construction of the Asia Pacific Technology Center. We also made capital expenses to expand manufacturing capacity, including production capacity for new products. Depreciation and amortization expense was for $4.9 million for the quarter. Our full-year forecast for capital investments is now $30 million, down from our previous forecast of $33 million due to the lower than planned spending on the Asia Pacific Technology Center, and for our quality improvement activities. We expect depreciation and amortization for full fiscal year 2005 to be $19 million.

We ended the quarter with $165.7 million in cash and short-term investments, $2 million higher than last quarter. Cash flow this quarter reflects a $2.1 million increase in working capital, about half of which related to an increase in our inventory of abrasive particle in conjunction with our ongoing raw material supply assurance strategy. Our days of sales outstanding, or DSOs, and accounts receivable remained even with last quarter, and days of sales in inventory increased slightly with the increased raw material inventory. Our cash flow also reflects the $5 million of share repurchases that I mentioned earlier. Total capital lease obligations are $6.8 million and have no long-term debt outstanding.

Let me know provide additional commentary on the performance of our slurry product areas, beginning with copper. Revenue from our slurries for copper polishing applications, including barrier, decreased by 9% sequentially, and was down by 21.4% compared to the year-ago quarter. Copper revenue represented 20.6% of our total revenue for the quarter, down from the 22.8% we reported last quarter. The sequential reduction in copper revenue was due to lower sales to our largest customer, MarkeTech (ph), which is the distributor in Taiwan and China. We believe MarkeTech (ph) increased its slurry inventory in our second fiscal quarter, then returned its slurry inventory to a normal level in our third fiscal quarter, and so, purchased less of our slurry that quarter. In aggregate, sales of copper slurries to all of our other customers during the third fiscal quarter increased by 6% sequentially.

During our third fiscal quarter, we reached agreement with an important customer on an exclusive long-term arrangement to supply copper slurries for 130 and 90-nanometer technologies. This makes three long-term supply arrangements we have entered into with customers for our copper products over the last three quarters, and as Bill mentioned earlier, we believe these arrangements are evidence of the growing confidence and trust in our company by our customers. 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, and believe we have not experienced any material change in our competitive position at this node this quarter. Industry adoption of 90-nanometer technology for logic applications continues to progress. We hold five PORs for copper polishing, and one POR for barrier polishing with 90-nanometer technology, both unchanged from last quarter. We have held our one POR for the 90-nanometer barrier application for several quarters, however last quarter I inadvertently referred to our holding two PORs for 90-nanometer barrier technology.

At 65-nanometer technology, we now have three POR wins for copper polishing, up from two PORs that we reported last quarter, and one POR for barrier polishing, unchanged from last quarter. We recently made our first commercial sale of products for polishing 65-nanometer copper and barrier. Beyond 65-nanometer technology, this quarter we earned our first two PORs for 45-nanometer technology, one each for copper and barrier polishing applications.

Now let me turn to our other slurry products. Revenue from our tungsten and dielectric CMP slurries taken together was up 3.7% sequentially, and down 15.6% compared to the year-ago quarter. We continue to have confidence in our technology leadership in slurries for tungsten applications, both with respect our existing products, as well as with new products in development. The two long-term supply arrangements that we entered into with customers during our third fiscal quarter both include our tungsten slurries. Our new 6000 Series product is now fully commercial and several customers are in advanced evaluations, and our new 7000 Series products, still in development, are being broadly sampled for use with 65-nanometer technology, and should also be extendable to 45 nanometers. We see a promising future for our tungsten slurry products given the growth outlook that we see for memory devices, as well as the opportunity to convert a number of home brew slurry users to our commercial slurry products.

We're working with a number of customers that currently provide their own tungsten slurry who are now evaluating our products as potential replacements for their home brew slurries. We believe that the strength of our technology and our outstanding product performance can provide compelling advantages to current home brewers. Turning now to dielectric polishing applications, the two new long-term supply arrangements we have discussed this morning also cover our dielectric slurry products. Our new 6000 Series slurry was commercially launched in April after extensive customer evaluation. Ongoing evaluations by a number of customers could lead to sales over the next several quarters. This product provides improved defectivity at a lower cost of ownership than our Legacy products. Our new 8000 Series slurry, which is still in development and targeted for advanced ILD applications, should be commercialized during the second half of the calendar year.

We're also developing new products for advanced applications for 45-nanometer and 22-nanometer technologies. Also, within dielectrics sales of our slurries for direct shallow trench isolation applications continue with our customers' ramp of 90-nanometer technology. We earned our third POR this quarter, up from the two we have reported previously, and our products are in evaluations with a number of other customers. Finally, revenue from our data storage business increased by 3.1% sequentially. The data storage industry has demonstrated continued strength due to growing demand for hard disk drives and PCs, and consumer electronic devices, even through an historically seasonally weak period. This concludes our financial and business review.

Now, let me offer a few comments on our near-term outlook. You are aware that we do not provide guidance on revenue, but as we look at business activity through the month to date and July, orders for products that we expect to ship by the end of the month are approximately even with orders during the same period in each of the three months of the June quarter. I would caution that the first four weeks of orders out of a quarter represent a limited window on quarterly results. With respect to guidance on gross margin, our guidance remains unchanged at 48% of revenue, plus or minus 2%. This concludes our formal comments. Operator, we can now take the first question.

Your first question comes from the line of Steve O'Rourke, Deutsche Bank..

Good morning. Were the two long-term supply agreements with existing or new customers, and how long is a long-term supply agreement?

Steve, these cover, as we talked about this morning, all of our products, tungsten, dielectric and copper variously. Since we're serving essentially the entire market it covers existing customers.

Okay, and you mentioned that your largest customer, the Taiwan distributor drew down inventory, could you help us understand the dynamic here? It seems an inventory draw down on copper slurry ahead of a ramp may be a bit unusual?

I think Steve what we said an our formal comments was that our distributor in Taiwan increased inventories in Q2 and now is bringing down inventories to a normal level for Q3.

Okay.

Is that correct?

Fair enough, and just one on your new efforts. In your prepared remarks, you also alluded to this potential acquisition efforts in your engineered surface finishes. Do you see potential candidates out there now or is this really a longer-term anticipation?

Steve, I think in past calls, back in October we introduced the engineered surface finishes initiative and over time we have been staffing two groups of capabilities within the Company. One is a technically-oriented group to develop applications and explore new technologies. The others is what I would describe as a kind of classic corporate/market development group of people that has expertise in identifying opportunities. We have been building that capability and developing in-house, and we've looked at a number of, I would say, we're in the process of looking at a number of different opportunities within different market sectors and segments, but we will be more forthcoming as time goes on, Steve.

Okay, and one last question, if I may. You mentioned that in your efforts to move closer to the customer, you're demonstrating greater commercial flexibility. Can you help us understand what this means, and whether there is some anticipated cost impact associated with that?

I think last quarter we talked about our willingness to be more aggressive with pricing on Legacy products, and some of that -- some of that leads to the resulting long-term arrangements that we talked about this morning. I think, as it relates to pricing, we might see some effects, but we believe our activities around Six Sigma and operational efficiency and productivity can offset those price, those price concessions to, in some cases where we've used price to attain long-term agreements.

Thank you.

You're welcome.

Thanks, Steve.

Your next question comes from the line of Dmitry Silversteyn, Longbow Research.

Good morning, gentlemen. A couple of questions. Number one, you talked about moving some of the hard disk design and development and manufacturing to Singapore. Given your pretty large footprint in Japan, I was just curious why Japan wasn't picked as a site for your Eastern operations?

Dmitry, this is Bill Noglows. We think the bulk of that data storage industry is in and around Singapore an Malaysia, and we just felt, if you, I'm sure you know the industry, it's a highly competitive fast-moving industry. It's very different than the IC industry, for instance, and the data storage customer's willingness to change CMP slurries and go to new technology is far different. They're way more aggressive, and we just feel that it's important that we're on the ground very close to the manufacturing and development centers of our customers in the data storage industry.

Okay, fair enough. When you talked about possibly getting some share in tungsten versus the home brews, could you give us an idea of how big is the home brew market compared to the [inaudible] market, or what percentage of the overall tungsten market is available to you via the home brew competitors, if you will?

Well, you're aware that we have very strong position in tungsten, and so, really, from our standpoint there are two growth opportunities. One, is to grow our business with application growth and we cite memory, and the strong outlook for memory as an application, or an opportunity. And the second is to expand the market, the commercial market, by capturing some of these home brew customers. There are several significant customers out there that are using home brew. I don't have a real good sense of exactly what percentage of the market, but that represents an opportunity, I think, roughly in line with the kind of growth we would expect in memory and our share of that going forward.

Okay, and then the final question, if I may. Your revenues are down versus last year, and your working capital and, particular, inventory has been creeping up every quarter over the first three quarters of this year. Can you address that? Are you building inventory for something in particular? Is this price inflation of the raw materials, or are you doing some finished goods stocking in the preparation for the recovery in the industry?

The vast majority of the increase in inventory that you've seen over the last several quarters has been in raw materials, and, more specifically, abrasive particles. If you look at how we've operated the business over the last several years, we've always had something of a discomfort with the level of particle inventory that we maintained, and as we look at supply assurance and the need to assure customers of continued supply, we made the decision to increase our inventories of raw material particles, and that's, the incremental increase that you saw this quarter was all around raw materials and particles. The portion of our inventory that represents finished goods is very small, and you're aware that we're a make-to-order business. So basically, our finished goods would represent anything that's in transit that we sell on title, and in some cases some consignment inventory, but finished goods inventory is a small part of our total.

So the increase in raw material inventory reflects your comfort level rather than your responsibility to your supplier to take certain volume of product every year?

That's right. We share a forecast with our key suppliers, and we are obligated to buy a portion, a percentage of that forecast, but that forecast is updated periodically. So, really, the reason behind our increase in particle was more around supply assurance comfort level.

Okay, thank you very much. I'll get back in queue.

Your next question comes from the line of Suresh Balaraman.

Thanks. Regarding the 9% sequential drop to MarkeTech (ph). Is that business appearing to be reversing based on the first four weeks of data, and a follow-up to that is, just like as they over estimated the demand for copper in fiscal Q2, did they also do the same kind of overestimation for tungsten and dielectric? Thanks.

Yes. This is Bill Johnson. Let me provide a little more background on the MarkeTech (ph) situation. MarkeTech (ph) is our largest customer, and last year represented about 32% of our revenue. They are our distributor in Taiwan and China, and so to the extent, they're our customer, but they're not an end user of our materials. They, in turn, sell to semiconductor manufacturers, again in Taiwan and China. What we understand is, during our March quarter, our second fiscal quarter, MarkeTech (ph) increased inventory, and this is an incremental increase of around one week's worth of inventory, so not a not a huge amount. But given the size of MarkeTech (ph) to our business that was significant, especially with respect to our copper business. Then in the June quarter, which is our third fiscal quarter, they reduced the slurry inventory back to a normal level, and so they bought less of our slurry that quarter. Again, it's only an incremental week of inventory, but had a dramatic impact on our copper business, and I think, specifically, with your question we saw it most profoundly with respect to copper. I don't know offhand if we also saw that with respect to tungsten dielectric.

Great, thanks.

Again, if you'd like to ask a question, press star then the number one on your telephone keypad. Your next question comes from the line of John Roberts, Buckingham Research.

Can you hear me?

Barely. Go ahead and try.

Most of your pricing, price decline came in the first or second quarter, and the calendar quarters the past couple years. Should we expect further price declines in the back end of this calendar year given the new contract approach you're taking?

In the past, John, we had talked about more significant price erosion during the first calendar quarter of the year, but as you recall, in the first calendar quarter of 2005, we didn't see as much of that. Our pricing, our ASP was down 1.1% for our fiscal quarter one to quarter two, which is low relative to the prior first calendar quarter. And the pricing ASP reductions that we've seen in the last three quarters, I think, are consistent with what Bill described as our effort to be more aggressive on pricing Legacy products to maintain position. I would not want to forecast pricing, any further pricing erosion in the coming quarter. Some of the erosion that we've seen in the last couple of quarters has been in conjunction with those long-term agreements. I think we would continue to be interested in executing other long-term supply agreements, and given the competitive nature of the business, I think we can expect future price reductions and future pricing pressure. One thing I would point out, and Bill mentioned this earlier, in parallel with this more aggressive approach on pricing, we've also have our Six Sigma program that's identifying and capturing opportunities for productivity improvements within our operations, and if I look at the sequential price reductions we've seen in the first three quarters of fiscal 2003, and look at the revenue impact on that, we're confident that our Six Sigma program has captured a like amount of cost savings in our operations through higher yields, reduced cycle times, better utilization of logistics and things like that.

Now if you look at the first, if you look at the March and June quarters combined, the first half calendar quarters for both this year and last year, the combined price erosion is about the same, doesn't seem to be any acceleration downward in pricing from last year, at least through the first calendar six months of both years.

The thing that might distort that a little bit, I guess, is we had in our second quarter of 2004, we had a pretty significant price erosion, 5.3% you may remember, and about half of that was mix and half of it was related to price reductions. So if that's part of your data point for 2004 that might impact the analysis that you're doing. But I think we've said for quite some time that this is a price competitive market, and in the last couple of quarters we talked about being more aggressive, particularly with respect to Legacy products and copper, and I think your are seeing that.

You've had a lower profile at Semicon West, both this year and, I think, maybe last year as well. Could you comment on your strategy around that event?

Sure, John. This is Bill. John, both last year and this year we did not have a booth at the Semicon West trade show in San Francisco. We find the trade show is a wonderful venue to schedule a number of meetings and forums with our customers and suppliers, and co-suppliers to the industry. But we have found in the past that the traffic through the show tends to be more analysts and co-suppliers than customers. I would also add that in North America we know all our customers and all of our customers know as, and we find more value in that trade show by just using it as a venue to schedule meetings and forums with our customers and co-suppliers. I would add that we find the trade shows in Shanghai and Taipei and Tokyo far more valuable, in terms of developing customers and making our products more visible and supporting our brand in those parts of the world.

And so you've had booths at those other conferences?

We have booths and we have a significant contingent of our scientists and associates from Aurora that travel there for that, for all those forums.

Lastly, Bill, could you maybe put some parameters on a typical long-term contract would be? The duration, any min/max requirements? I know you don't want to talk about specific customers, but are there any general rules you could give us?

John, we haven't disclosed the terms and conditions of those arrangements, and we don't plan to.

Thank you.

I would tell you, though, just to reinforce what we said earlier that, whereas, in our past discussions we've talked mainly about copper. The two that we entered into this period talked, covered all three of our products, ILD, tungsten, and copper variously. And so I think it's something we want to continue to explore with customers, the idea of procuring commitments over an extended period of time, I think, is valuable for our business and for our customers.

Thank you.

Thank you.

Your next question comes from the line of Robert Maire, Needham & Co.

Getting back to the question about home brew companies. You said you didn't have quite an idea of the size of the market. Is there any way of putting some boundaries on that? Is 10% of the slurry market served by home brew, 5%, 20%? Any way of putting some parameters around that?

It varies by application, but I think what we found is tungsten is an area where there's more concentration of home brew, and your 10% number is probably within the ballpark.

Okay, so 10% primarily in tungsten. And if I look at the other market segments, copper and such, I would assume home brew is a relatively small piece there. In terms of competitive positioning, where do you think you are now, and have there been any changes, given that we've gone through sort of a weak period in the market?

Bob, are you asking about particular technology, or can you be more specific with your question?

Well, in terms of your percentage of the overall slurry market in the three general applications in the semiconductor world, do you think that there has been any change in your share of the market? Any guesstimate as to where your current share is and what are your opportunities to gain share , that was sort of what my question about the home brew was targeted at, what additional upside there versus where you are currently?

Let me try to address your question without going back over the entire POR discussion that we had this morning.

Right.

I think it's clear that we continue to seek competition in the CMP slurry industry, especially in copper, but also in the more mature technologies like dielectrics. It is not surprising to any of us here at Cabot Microelectronics that many different competitors see this as an attractive industry given our growth rate and are very strong financial model. We're doing the things that, without disclosing market share, we're doing the things that we discussed on many of these calls are around technology leadership, operational excellence, and getting closer to our customers, as well as reestablishing our position, or not reestablishing our position, quite frankly, strengthening our position in Asia Pacific and our brand there.

The last year-and-a-half I feel very confident that through those three strategies, as we talked on our last call, we feel we have a very robust product pipeline that's very competitive, and we talk about our POR positions often, and where we think we've gained business at specific accounts, specific nodes, and specific technologies. We've talked openly about what we see as a maturing industry, and a maturing technology, and, I think, our activities and I believe activities around operational excellence and Six Sigma have brought the kind of discipline we need in a maturing environment to drive costs out of our business, improve the quality of our offerings, and just make our supply chain as robust as it can be to supply this very demanding and difficult industry. And then, finally, what we talked about this morning in that our activities to get closer to our customers and engage them at a far different level, far more broadly and deeply, I believe that we are in great shape to continue to maintain and enhance our leadership in this industry and this technology.

One last thing, in terms of the price erosion, or relatively little price erosion that we're seeing, would you suggest that part of that is reaction to competitive pressures, or are you trying to be proactive and develop a better relationship by lowering prices ahead of time to get into longer-term agreements and such, or, what -- I guess what are the pricing actions more related to?

I would describe the actions in actually several ways. The first is when we introduce a new product to the market and to our customers, we do the best job we think we can do at capturing the value we bring to those customers and we price those products appropriately. In cases where we have what we describe as Legacy products that have been in production and manufacturing for say a year, or a number of years, our customers and rightly so, expect regular price decreases. If you look of their industry and what happens to their ASPs over time, their expectation is their supplier should be no different and we've responded to that ,and we're doing what we think we need to do in terms of what I describe this price ramps in many of these arrangements. So that's the second one, and the third one is just in general in the competitive environment, we're going to compete, and if we have to compete with price we're going to compete, and we're going to do all we can to maintain our position in the CMP technology and the CMP market today.

Okay, great thank you.

You're welcome.

Thanks.

Your next question comes from the line of Robert Tango, Lazard Frères & Co.

Thank you. Good morning. Bill, the long-term arrangements that you talked about and you've highlighted, do you think, if I made the assumption you'll enter more of these, will it -- do you think two or three quarters out it will materially alter the gross margin assumptions that you have typically handed out in the last few quarters?

Rob, our guidance an gross margin at 48% of revenue, plus or minus 2%, takes into account the sort of pricing environment that we're operating in and that we expect to operate in. Again, there have been some ASP erosion over the last several quarters, and some of that is in conjunction with some of these long-term arrangements and to the extent that there's value to us and to our customers in having more of these then we would certainly be interested in exploring that. At the same time, we have Six Sigma activities that are capturing tangible benefits in our operations and our strategy has been to guide the 48%, plus or minus two, gross margin with the understanding there's continued pricing pressure but with the expectation that activities like Six Sigma and new product introductions with higher margin products can help to offset some of that. So our guidance would reflect possibly future of these long-term agreements, but we'll report on those quarter-by- quarter.

So actually some of the effect of these long-term arrangements, the effects, to some degree, have already been recognized in some of your financial results in this quarter and last quarter? In other words, the partial effect has already been reflected in historical results?

Well, to the extent that we've announced long-term agreements over the last three quarters and if there's pricing adjustments in those they would be reflective in our operations over the past three quarters.

Okay, okay. Does in general demand trends too, you mentioned that the current quarter is sort of tracking on par with the first three months or the months in fiscal Q2, and given there is always a little bit of seasonality in the month of August, but are you getting indications that -- I am not sure where you can and can't say here, but are you getting indications from customers considering rising utilization, wafer shipments, what's coming out of Taiwan, and what they're claiming is going to happen or the next four to six months, that the month of July could be the most conservative over the course of this quarter? Do you expect -- do you anticipate some rising shipments?

Well, we don't guide to revenue, but I guess the two messages that we talked about this morning. One is is that there's a number of indications out through external industry experts that are looking toward a second half calendar year recovery of the industry, and strong PC shipments, the right kind of message is coming from a number of customers to the extent that we look at our orders through yesterday, the 27th of July, we saw our order patter on par with the three months of the prior quarter. We hope that the industry turns up like people are saying, but we haven't seen it in our orders to date in July, yet. I don't think we can provide any other color. Can we go into the next question, operator? Thanks Rob.

Your next question comes from the line of Chris Kapsch, Black Diamond Research.

Yes, hi. I had a follow-up question on the pricing variance. Could you just provide a little bit more color on that negative pricing variance? Was that more accentuated, or severe, in ILD slurries, or copper slurries, and also are you seeing negative pricing in tungsten slurries?

I believe as we look at the ASP change there were some effects in all three product areas. We talked in the past about being more aggressive on the copper side -- I'm sorry I think there may even more of it in the copper area. There was also a foreign-exchange element of this, as well. As I look at the overall 2.8% ASP change, around 20% of that was related to foreign-exchange and with the fluctuations in the U.S. dollar versus Japanese yen.

So you are seeing a little bit of pricing pressure in tungsten?

I think there's pressure pricing pressure across the entire industry. It tends to be different in different business areas. We have a very strong position in tungsten, so we tend to see less competition there but there's pricing pressure and competition in all areas.

Okay, and then a follow-up on the long-term supply agreements. I don't know if you can characterize this as being put into place, but are you actually maintaining share, or actually gaining share at these particular customers by establishing these long-term supply agreements?

I think it's a little of both. In some cases were maintaining share, in other cases were growing at specific accounts, or specific nodes.

Okay, and then, finally, just on the PORs that you have for copper polishing, not the barrier-layer copper, but the copper polishing, are those all for bulk removal or are there any PORs for soft-landing copper?

We have not differentiated between those, but as we've talked about how we view copper and copper-barrier polishing, we are focusing a lot of our effort on the soft landing in the barrier steps because we think that's where the value resides now and will in the future, particularly with respect to the possible emergence of ECMP we talked about something of a commoditization (ph) of the bulk copper removal, so our development efforts and efforts in the market are focused more on soft landing and barrier. Operator, I think we have time for one more question.

And our final question comes from the line of Jay Harris, Goldsmith & Harris.

I didn't think I was going to make it. Good morning.

Good morning Jay.

On copper, what do you think MarkeTech's (ph) motivations were by increasing copper slurries in the March quarter and then decreasing it in the June quarter since everybody is expecting a pickup in wafer starts in the last half of the calendar year?

Sorry.

Well, MarkeTech, (ph) we can speculate. MarkeTech (ph) is an independent company and a customer of ours, even though they're not a semiconductor manufacturer, and, therefor, they manage their inventory, but what we understand is that in the first calendar quarter, our March quarter, they increased inventory for several possible reasons. One, and in anticipation of Chinese New Year, I think there's a minor kind of a seasonal upturn in inventory that they might maintain, but in addition to that, there was a protracted dockworkers' strike, for instance, in the area that I think they wanted to increase their comfort around supply assurance, so that may have been a driver for a bit more inventory. It's the typhoon season, that may have driven it some, and possibly, it could of been in anticipation of a run-up in industry, but then they decided to back off on. But they're an independent company, it's their inventory, so we don't manage it.

So you wouldn't assume then that it had to do anything with their outlook for demand in the coming months?

What we believe is they returned their inventory to what they would consider a normal level, but again, this wasn't a wild swing in inventory, it was an additional week, but because they represent, last time 32%.

Right.

32% of our business, a week of inventory for a large customer impacts our copper revenue significantly but, I guess, I'd really point back to the supply assurance issue here to the extent that -- it's imperative that our customers have slurry when they need slurry, and so to the extent that we add particle inventory to improve supply assurance for our distributor increases inventory to have a higher comfort level that slurry is there when customers need it, that's a small price to pay. We absolutely cannot cause our customers to shut down for lack of slurry.

I appreciate that. The only reason I ask the question was other consumable suppliers to fabs generally have shown increases in shipments in the June quarter and have given as a reason the demand for copper-related activities.

Well, as well look at MarkeTech (ph) at the consumption of our slurries by their customers we don't see a significant change, we did not see a significant change in consumption of our slurries by their customers from Q2 to Q3.

On the tax rate, is the reason for the adjustment downward of the tax rate just a geographic distribution of business or is there some other reason?

There's two things that impacted our tax rate. One, is increasing interest rates, to the extent that we have our short-term investments invested in tax exempt instruments, to a large extent, that tax-exempt interest tends to impact the tax rate, or decrease it because that's not taxable. Second thing is we saw an adjustment in extra-territorial income tax credits in our third quarter related to a true up following the filing of our 2004 return in June. That was the second factor, and for the full year we expected 31%.

All right, so pretty much in line with the nine-month number.

Yes, correct.

Okay. One other thing. A year ago there were some industry studies which suggested that the growth in slurry demand looking out over five, '05, '06, '07 would be dominated by copper and that tungsten demand would start to slide and '06 and '07, I guess I'm assuming because of the adoption of copper interconnects by memory manufacturers. Are your comments meant to suggest that there's a change in that outlook, generally?

Not to speak specifically to the outlook that you're discussing. We continue to see the same compelling growth drivers that we have seen for our tungsten slurries, and particularly the adoption and growth in proliferation of DRAM devices in consumer applications where we sell a significant portion of tungsten slurries for the general memory market, cause us to believe that our tungsten, the growth available to us in our tungsten slurries is robust and will continue to be for some time. We see limited development work on copper in the memory side of our business, although customers are exploring it and we have made some sales, but that's how I would answer the question, Jay.

Okay, thank you very much.

Thanks, Jay. Operator, I think that's all the time we have for questions.

I want to thank you for all your interest in Cabot Microelectronics and look I forward to seeing you in future quarters.

Thank you for participating in today's Cabot Microelectronics third quarter earnings conference call. This call will be available for replay beginning at 1:00 o'clock p.m. Eastern Standard Time today through 11:00 o'clock p.m. Eastern Standard Time, Thursday, August 18. The Conference ID number for the replay is 4381279. Again, the Conference ID number for the replay is 4381279. The number to dial for the replay is (800) 642-1687, or (706) 645-9291. Thank you. You may now disconnect.