CMC Materials, Inc. (CCMP) 2005 Q4 法說會逐字稿

Good morning. My name is Lisa and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Cabot Microelectronics fourth quarter earnings conference call. [OPERATOR INSTRUCTIONS] Thank you. I would now like to turn the conference over to Barbara Ven Horst, Director of Investor Relations. Ms. Ven Horst, please begin.

Thank you. Good morning, everyone. With me today are Bill Noglows, Chairman and CEO and Bill Johnson, Chief Financial Officer. This morning, we reported results for our fourth quarter and full fiscal year 2005 which ended September 30th. We also announced a new share repurchase program. 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 three weeks via either telephone playback or webcast. The script of this morning's formal comments will also be available on our website. Please remember that our discussion 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 third quarter of fiscal 2005 ended June 30th of 2005 and 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.

Thank you, Barbara. Good morning, everyone. Let me start by welcoming Barbara Ven Horst as our new director of Investor Relations. We're glad to have Barbara join us. Most recently, she was director of Investor Relations at McDonald's Corporation. I know she is eager to work with all of you.

This morning, we announced financial results that reflect an upturn in our business following three relatively soft quarters. Recall that during our last conference call, we cited what we believed was a bottoming of the semiconductor industry's downcycle but at that time, we did not see clear evidence of an upturn. However, stronger sales in August and September resulted in the 13.6% sequential revenue increase in our fourth fiscal quarter. During our fourth fiscal quarter, each of our CMP slurry product lines registered sequential revenue increases. Recently we have made four announcements related to our strategic initiatives I've I'll discuss this greater detail this morning. These include our plan to sell directly to customers in Taiwan rather than through a distributor, our Best In Value supplier award from Samsung, our acquisition of the. assets of Surface Finishes company, which supports our engineered surface finishes or ESF initiative and finally, this morning's announcement of the $40 million share repurchase program authorized by our board of directors. I will also reflect on our accomplishments during the full fiscal year and share my perspective on how I believe we're positioned for the future.

Over the last two years, we have been executing on three principle strategic initiatives, one of which is getting closer to our customers. We want to work more collaboratively and directly with them to jointly develop CMP solutions for their existing and next generation polishing applications. To that end, in August, we announced plans to transition to selling directly to our customers in Taiwan, one of our most important markets rather through our -- rather than through our distributor Market Tech. Currently our largest customer, Market Tech represented almost 35% of our revenue in fiscal 2005. We have had a long and successful relationship with this distributor. However, where we have sufficient business scale to support direct sales and where we see strategic benefit as we do here, we believe it is best to work directly with our customers. Market Tech will continue to serve as our distributor in China where we have a strong position in a small but rapidly growing market.

Given the scale of our business with Market Tech in Taiwan, we announced our plans well ahead of the April 1, 2006, effective date to ensure sufficient time to plan for this important transition. We are committed to making this transition as seamless and invisible to our customers as our transition two years ago from a distributor arrangement to direct sales in southeast Asia and Europe. Later Bill Johnson will comment on the financial implications of this move.

Last week, we made another important announcement that we believe is further evidence of our progress in getting closer to our customers. On October 13th, Samsung electronics honored us with its Best In Value supplier award at its annual supplier appreciation day. This award is the highest honor Samsung grants to its suppliers, and we were one of only five companies and the only CMP provider to receive it at this event. Samsung is a world leader in semiconductor manufacturing and we're delighted with the close and collaborative relationship we have with them.

During our fourth fiscal quarter, we also won a supplier award for outstanding technical service from another important Asian customer. You may recall last quarter I mentioned three supplier awards we received during our third fiscal quarter. We believe that these awards are objective evidence that we're strengthening our partnerships and our credibility with our customers and we expect this recognition will translate into more design wins over time.

Over the past year, I've discussed our engineered surface finishes' initiatives. Through this initiative, we intend to leverage our expertise in CMP formation, materials, and polishing techniques into other high performance polishing applications. We accomplished an important step in this initiative with our recent acquisition of the assets of Surface Finishes, a small privately-owned company that is a leader in precision machining and polishing techniques at the sub nanometer level. We expect this acquisition will provide us with commercial polishing capabilities that will take our internal technology development efforts out of the laboratory to customers beyond the semiconductor industry. It should also provide access to a variety of high performance polishing markets that we do not currently serve. Because Surface Finishes is a small business, we expect its immediate value will be providing us capabilities and market visibility rather than having a material impact on our financial performance. We look forward to pursuing other opportunities that complement our expanding ESF efforts.

The fourth item I want to discuss is the new $40 million share repurchase program. This program provides continuity with the $25 million share repurchase program we began in August of 2004 and completed during our fourth fiscal quarter. We believe that purchasing stock is an attractive and flexible means of returning cash to shareholders. Given our strong financial model and cash generation capability, we believe we can execute the share repurchase program, meet the capital needs of our core CMP business and fund growth opportunities under our ESF initiative.

Our comments this morning are focused primarily on fourth quarter results. But this is also an opportunity to reflect on what we have accomplished throughout the full fiscal year. Each quarter, I have discussed our progress on our three principle strategic initiatives: technology leadership, operations excellence and getting closer to our customers. Fiscal 2005 was a disappointing year for our Company financially. But I am pleased with the steady progress we've made so far in each of these three areas. Under technology leadership, we've revitalize and refilled our product development pipeline.

Because this pipeline represents the lifeblood of our Company, it is imperative that it be full and robust. As I have previously discussed, we have new and exciting products both in development and commercialization in each of our major application areas. Proper and barrier, Tungsten, dielectric, data storage and polishing pads. The server range of technology notes from 250 to 22 nanometers. By executing on our operations excellence initiative, we made significant productivity gains in fiscal 2005. Through the six signal projects we have discussed with you in the past, we captured productivity improvements of approximately 9% in manufacturing and logistics. These improvements allowed us to maintain gross margins within our guidance range in spite of selectively reducing some selling prices to address competitive situations. During the early years of our Company's short history, we focused heavily on research and development and defined success primarily will in terms of new and higher performing products that we had invented. However, we have improved the functional balance within our Company where we're now achieving operations excellence while also continuing our emphasis on technology leadership.

We also made tremendous progress this year, executing our third principal strategic initiative getting closer to our customers, especially in the Asia Pacific region. Asia is obviously a crucial geographic region for our Company and for the semiconductor industry. I have discussed in previous conference calls the four long-term arrangements executed this year with key customers in that region covering products in all of our application areas and a range of technology notes. Multiyear commitments are unusual in our industry. We believe they highlight the confidence our customers have in us. In addition, this year, we built our Asia Pacific technology center. We're excited about the research and development capabilities this facility can bring to our customers within the region.

Finally, last quarter, we described the move of our data storage business to Singapore. Southeast Asia is an important manufacturing region for a number of our customers in this industry. As a result of our substantial progress on each of these three principal strategic initiatives, Cabot Microelectronics is a very different Company from what it was two years ago. Although there is still much to accomplish to achieve our ultimate goals. As our industry continues to mature and technology becomes more complex, our customers require more reliable CMP solutions. This requirement demands robust technical capability, a bulletproof supply chain and a focus on service excellence, all of which we have worked very hard to build over the last two years. These capabilities combined with our progress in getting closer to our customers give us confidence that we're well-positioned for continued success.

As we look to fiscal 2006, we're encouraged by indicators of improving business trends. Industry expert forecast solid end use demand in a number of key semiconductor market areas such as personal computers, and consumer electronic devices. And our customers appear to be cautiously optimistic about the near term. The biggest uncertainty in the semiconductor industry seems to be what impact higher energy costs may have on disposable income and in turn on consumer demand for electronic devices. We will watch to see how this unfolds quarter by quarter in 2006.

Now, I'll ask Bill Johnson to share a more detailed review of our financial and business performance after which we'll open the call for your questions.

Thanks, Bill. You may recall that our financial results during the second half of fiscal 2004 were very strong. And the subsequent downturn in the semiconductor industry adversely impacted our results through the first three quarters of fiscal 2005. So, the year-over-year financial comparisons that I will mention this morning reflect two very different industry environments.

Our revenue for the fourth quarter of fiscal 2005 was $73.9 million which was up 13.6% sequentially from the $65 million we reported last quarter and down 10.7% from $82.7 million in the same period last year. On a geographic basis, we saw a strong sequential revenue growth this quarter in the Asia Pacific region, with our sales in Korea up nearly 40%, southeast Asia up 33%, Taiwan up 26%, and China up by 24% versus the prior quarter. Our average selling price for the quarter increased by 0.6% compared to last quarter as effects of a higher-priced product mix more than offset modest adverse effects of selected price reductions and the impact of the weaker Japanese Yen versus the U.S. dollar.

Gross profit expressed as a percentage of revenue was 46.9%, down from the 48% of revenue that we reported last quarter and down from 48.6% in the year ago quarter. Gross profit as a percentage of revenue decreased this quarter largely due to the adverse effects of a lower margin product mix and higher manufacturing costs in certain areas. These effects were partially offset by the benefits of higher utilization of manufacturing capacity on the higher level of sales this quarter.

Now, let me turn to operating expenses which include research and development, selling and marketing and general and administrative costs. Operating expenses totaled $24 million this quarter, up by $3.4 million or 16.7% from the $20.6 million we reported last quarter and $3.3 million or 16% higher than in the comparable quarter last year. Approximately two-thirds of the sequential operating expense increase was attributable to staffing-related costs including costs to support our activities in Asia. Higher operating expenses this quarter also reflect start-up costs for our new Asia Pacific technology center. Operating income represented 14.3% of revenue this quarter, down from the 16.3% that we reported last quarter and down from 23.6% in the year-ago quarter. Our affected income tax rate was 27.8% this quarter.

Net income for the quarter was $8.3 million, down 1% from last quarter and down 37.3% from $13.2 million in the same quarter last year. The weighted average number of shares outstanding on a diluted basis was 24.5 million shares this quarter. This was slightly lower than in the prior quarter due to purchases of approximately 118,000 shares of stock for roughly $3.5 million under our previous share repurchase program which we completed during our fourth fiscal quarter. Diluted earnings per share for the quarter was $0.34 equal to last quarter and down from $0.53 in the year-ago quarter.

Turning now to cash and balance sheet-related items. Capital spending for the quarter was $16.1 million, the vast majority of this related to our Asia Pacific technologies center. We also made capital investments to expand manufacturing capacity including production capacity for new products as well as to move our data storage business to Singapore. Depreciation and amortization expense was $4.7 million for the quarter. We ended the quarter with $171 million in cash and short-term investments. $5.3 million higher than last quarter.

Cash flow this quarter reflects a $13.2 million decrease in working capital, largely due to an $11 million increase in accrued payables related to the Asia Pacific technology center. Accounts receivable increased in line with our sequential increase in revenue and inventory of raw materials decreased by $3.9 million. Our cash flow also reflects the $3.5 million of share repurchases that I mentioned earlier.

I'll now comment on our performance by product line. Beginning with slurries for copper and barrier polishing which are used in advanced logic devices. Revenue from our slurries for copper polishing applications including barrier increased by 12% sequentially. And was down by 22.9% compared to the year-ago quarter. Copper revenue represented 20.3% of our total revenue for the quarter down slightly from the 20.6% we reported last quarter. We believe we continue to have a solid position in copper slurries for 130 nanometer technology which remains the dominant node for copper polishing and we believe our competitive position at this node did not change materially this quarter.

In 90 nanometer technology for logic applications, we believe we continue to hold five process of record positions or PORs for copper polishing and one POR for barrier polishing. Both unchanged from last quarter. 65 nanometer technology for logic devices represents the new competitive arena for copper and barrier. And a limited number of semiconductor manufacturers are in various stages of development and ramp of this technology. We believe we continue to have hold three POR wins at this node for copper polishing and one POR for barrier polishing, unchanged from last quarter. Beyond 65 nanometer technology, we continue to develop products and work with a number of customers on copper and barrier solutions for 45 nanometer technology. We're excited about our copper and barrier slurries. We believe our copper and tunable barrier slurry platforms which we've described in detail in the past, provide an innovative and economic approach to customizing products for our customers' most advanced applications.

Turning to our other slurry products, revenue from our Tungsten and dielectric CMP slurries taken together was up 15.4% sequentially and down 8.6% compared to the year-ago quarter. Tungsten and dielectric slurries are most heavily used in a range of memory devices and older generation logic devices that use aluminum rather than copper wiring. We continue to have confidence in our technology leadership in slurries for Tungsten applications. We see a promising future for our Tungsten slurry products given the growth outlook for memory devices as well as the opportunity to convert a number of home brew slurry users to our commercial slurry products. During our fourth fiscal quarter, we achieved an important win as we converted one of the more significant of these players to one of our Tungsten products for a 90 nanometer application. We hope that this win will create broader acceptance of our commercial products with this important customer as well as with others in this category.

I'll now turn to dielectric polishing application. These include legacy, interlayer dielectric or ILD applications which represent the more mature and commodity-oriented part of the business and advanced dielectric applications which require much higher performing solutions for premetal dielectric or PMD and direct shallow trench isolation or direct STI applications. We continue the introduction of our new dielectric slurries which utilize a Syria based abrasive particle and rely more heavily on chemical action, rather than on abrasion compared to our legacy products. We believe our new 6600 solution can replace older slurry products for legacy ILD applications at a lower cost and with higher performance. And our new 8800 product is targeted for advanced dielectric applications. It's tuneable for selectivity and removal rate and is multifunctional since it can polish advanced ILD, PMD and direct STI applications. Sales of our slurry product for direct STI applications, select 6,000, continue with our customers' ramp of their 90 nanometer technology. We believe that we have three PORs in direct STI unchanged from last quarter and a number of other customers are evaluating our product.

We also captured our first two advanced polysilicon PORs for contact and floating gate polishing applications with one customer. Polysilicon at polishing is a new dielectric application area for us and we hope this win is the first of many to come.

Finally, revenue from slurries for our data storage business increased by 2.5% sequentially. The data storage industry continues to demonstrate strength due to demand for hard disk drives and PCs and consumer electronic devices.

I'll conclude my remarks with comments on our outlook for fiscal year 2006. As Bill discussed, industry experts generally appear to be cautiously optimistic about the near-term outlook for the semiconductor industry. However, keep in mind that in fiscal 2006, during our transition to selling directly to customers in Taiwan, we anticipate an adverse impact on our revenue in our second fiscal quarter which ends on March 31st, 2006. During the transition period, our distributor will sell its remaining inventory of our products to our customers and we will begin building inventory required to begin servicing these customers directly. Therefore, we expect a short-term interruption in our sales attributable to these end-use customers. Which we continue to anticipate will reduce our second quarter revenue by approximately $11.5 million. Following this transition period, we believe sales volumes should return to the prior level.

Our guidance on gross margin remains unchanged at 48% of revenue plus or minus 2%. This reflects our expectation that we will continue to offset ongoing pricing pressure with additional productivity improvements and sales of new higher margin products. We generally review our operating expenses in terms of absolute dollars rather than as a percentage of sales. We expect the run rate we saw for operating expenses in our fourth fiscal quarter to continue through fiscal 2006 with some incremental growth. We expect operating expenses for the full fiscal year 2006 to be higher than in 2005, primarily due to three factors. Reporting of options expense which we estimate at $10 million, incremental costs of our Asia Pacific technologies center, and additional cost associated with selling directly to customers in Taiwan. We expect our effective tax rate in fiscal 2006 will be 31.2%.

We plan to spend approximately $20 million on capital expenditures in fiscal 2006, down from $29.3 million in fiscal 2005 which included construction of our new Asia Pacific technology center. We expect depreciation and amortization expense to be roughly $21.8 million. You are aware that we do not provide guidance on revenue but as we look at business activity through the month to date in October, orders for our products that we expect to ship by the end of the month are roughly equal to orders during the comparable period in August and September which were both stronger sales months than July. However, again, I would caution that first four weeks of orders out of a quarter represent a limited window on quarterly results.

Thank you, Bill. And Lisa, we will now open the call for questions.

[OPERATOR INSTRUCTIONS] Your first question comes from Steve O'Rourke of Deutsche Bank.

Thank you for taking my call. A quick question on your OpEx forecast going out into 2006, should you actually see a benefit in the gross margin line from this transition over to direct sales as well and what kind of a trend should we expect for gross margin going out through the next several quarters?

Steve, Bill Noglows. What we're doing in Taiwan is a strategic initiative to position ourselves much more closely with our customers and through that transition, we are adding our own logistics support and service infrastructure which comes with a cost and we don't assume or we're not anticipating that we will see a lift in our gross margins in Taiwan. We are anticipating a lift in revenue, of course, which Bill can describe in more detail. But that's the approach we've taken and it is purely a strategic move to make sure that we are the face in front of our customers and that our customers view us as the ultimate supplier.

Okay. Can you provide some insight on higher manufacturing costs? I mean what is that? How should this trend? How should we be looking at this?

Steve, it is Bill Johnson. If we look at manufacturing costs, our variable manufacturing costs continue to show the progress that we described in the past in terms of improvement in our manufacturing yields and we also experienced lower logistics costs but we did see some increases in certain fixed manufacturing costs which we think was a unique circumstance for this quarter. This is included in areas such as maintenance, utilities, we had a bump in fringe benefits and also an increase versus the prior quarter in our bonus accrual. You may remember last quarter, our third fiscal quarter, we talked about a reduction in operating expenses related to a lower accrual for our bonus incentive accrual. This quarter tax returned to a more normal level and that impacted fixed manufacturing costs but we think this is a quarter phenomenon. It wasn't a huge impact. So, our guidance going forth continues to be gross margin at 48% plus or minus 2%.

I would make one addition. Bill commented on gross profit with the transition of going direct in Taiwan remain the same. That's remain the same on a percentage of sales basis. We will have higher logistics costs that will take on -- that our distributor had taken on in the past so that will hold gross margins roughly equal on a percentage of sales basis.

Steve, I would add one more thing. We, like a lot of other companies in the United States and around the world today are paying very close attention to higher commodity prices and what that might do to our ultimate gross margins. We're seeing what I would describe as fairly significant increases for some of our raw materials and packaging materials as well as the higher logistics costs associated with fuel prices. But we're -- our first thing guys and gals are on top of it and working hard at it. As soon as we get more visibility into the impact on '06, we'll communicate that.

Okay. One other question. Your POR positioning in copper didn't change. If I remember the numbers correctly. Are you aware of any POR decisions in copper that were made in the quarter that may have gone elsewhere?

We don't have a lot of visibility on that. We focus more on our own positions which were unchanged. We continue to work with a number of customers continuing at 90, at 65 and 45 but in terms of what we would consider official POR positions, those didn't change for us and I don't think we really have much visibility on decisions in terms of other competitors.

Thank you.

Thank you.

Our next question comes from Robert Maire of Needham and Company.

Yes, were there any shifts in terms of market share given that it appears the memory side of the industry is doing better than the foundry side? What impact has that had on your business?

Robert, Bill Noglows. Robert, we don't talk about market share but I think if Bill reported some fairly significant gains in Korea, Taiwan, southeast Asia and China in his discussion this morning; we enjoy what we believe is a very strong position at the memory manufacturers as well as the foundries. And I would suggest that our sales increase Q on Q are indicative of our performance and position in that market.

If I were to compare your memory positioning versus generic logic or foundry positioning, you should have a higher percentage share overall in the memory market, would that be accurate?

I'm not sure -- we haven't commented on that, Robert. I'm not sure I can give you an answer that's meaningful at this time.

Although, as the leader in CMP slurries by a significant margin, we do have strong positions, we think in all major applications. We have talked in the past about a strong outlook for our dielectric and Tungsten slurries given the strong growth in memory and I think of some the performance you saw this quarter relates to that.

And any further update in terms of Memory devices going to copper and requiring more slurry products?

I think our view is that the development and introduction of copper into the memory market is still a ways out. We would expect it to show up in norflash first where people are trying to implement copper wiring at 90 nanometer technology. We have not yet see it in nanflash or Dram. We're watching it very closely to see where we end up on copper in the memory market.

I think our view is that in norflash in particular where processing speed is more important that, that likely guess to copper first but we think that there's still quite a long run of aluminum wiring in nanflash and Dram such that that would continue strong demand for our Tungsten and dielectric slurries going forward.

Ok. Very good. Thank you.

Thank you, Robert.

Your next question comes from John Roberts of Buckingham Research.

Good morning, John.

After tax?

Sorry, can we try it again? We got half your question.

Is the $10 million option expense after tax?

No. That's a pretax number.

That's pretax so you've lowered that pretty substantially from the original estimates.

No, actually -- well, before, we said $11 million pretax.

Ok. And are you going to formally adopt option expensing in the December quarter or are you going to just still footnote it?

Oh, no. We're required under accounting policy and regulations to start reporting that as an expense in the income statement in the December quarter.

So, that will be across all of the line items if it is somebody in sales, it will be in the sales line item, et cetera.

That's correct. We expect a bigger impact in operating expenses: Research and development, selling marketing, general administrative rather than manufacturing but it will be spread based on where the recipient would work.

Secondly, those were pretty impressive gains you cited for Korea, southeast Asia, Taiwan, China and that was versus the June quarter obviously. So, you obviously had declines sequentially in U.S. and Europe combined that dampened that down.

Could you comment about -- I know you had the two customers that you talked -- that you had two accounts that you had dropped down in. That you talked about earlier. Could you comment on the rest of the business? Was there anything that's declined away from those previously-disclosed losses?

Well, there was -- back in July of '04, we disclosed one significant loss in copper. But I don't recall having disclosed another loss. Is there another one that you're --- ?

It came in two pieces though, I thought.

No, that's the only one -- material one that we've disclosed. You recall in the June quarter, we also talked about an inventory of slurry inventory correction in Taiwan. That impacted business in the June quarter. But the only significant business that we feel like we've lost was the one customer that we disclosed in July of 2004.

So, what was the trend in the rest of the U.S./ European business adjusting for that customer?

Well, if I look at sequentially, you're right. Given the strong -- the strength and growth in Asia Pacific, there was modest reduction in the other geographies but it wasn't -- I don't think it's anything we can attribute to any particular customer.

Ok. And then were there any changes in your 10% customers when you file your 10-K, you're going to have to disclose 10% customers. Are there any new additions to that list and did any of the previously above 10% customers drop off or change materially?

We mentioned --

--- the one that you lost.

We mentioned the Market Tech would be about a 35% of our revenue in '05. That was the only greater than 10% customer we disclosed last year and we'll issue the 10-K on or around December 7th and we would disclose any other 10% customers at that point.

Okay, thank you.

Thank you.

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

Hi. I just wanted to see if I interpreted some of your earlier comments correctly. I believe the sales benefited from what you said was sort of more growth, I guess, and higher-priced products and yet the gross margin was hurt by lower margin --- lower margin products. So, I guess what I'm getting at is are your -- I assume the higher price were related to copper slurries. Are those products lower margin than say the corporate average at this point?

Chris, this is Bill Johnson. When you think about product mix, you have to think about several different levels. There's first the product mix effect on price, then there's also a product mix effect on margin. And usually when we talk about product mix, it is in terms of application area, either copper, Tungsten or dielectric but you actually have to drill further into that. Because within an application area, we have a family of products that may have different prices and margins that differ pretty considerably within that application. So, in this case, we talked about a higher price product mix which actually increased average selling prices but a slightly lower valued product mix in terms of gross margin. We've had that phenomenon in a couple of quarters, as I recall in the past. But it does come down to the fact that we have different price and cost dynamics in different products both within applications and across applications.

Right. But it sounds like some of these higher-priced products are more costly to manufacture. They might be more customized rather than say of some the legacy ILD slurries. So, I'm just wondering if I'm sort of characterizing that properly.

Well, we've never give a lot of visibility to margin by product line and I think for competitive reasons, we prefer not to do that. But a lot of times, the cost of a product may have more to do with the intensity of mechanical abrasion that it utilizes versus chemical action because the abrasive particle is more expensive than the chemistry and so I think it is not a simple thing to draw a conclusion about our price and margin and cost dynamic on any particular product.

Okay. And then one other question about the sequential growth. If you look at your sequential growth from your IC application, I was just wondering if the growth was more skewed toward products into 130 nanometer application or 90 nanometer node.

We haven't broken that out, Chris. I think what we see is we saw -- we sell our products into all nodes and all applications. We think the growth was kind of across the board this quarter, Q on Q sequentially.

So, you can't directionally say whether 130 was stronger than 90 in terms of sequential growth?

No. We haven't disclosed that.

Okay. Thanks.

Thank you.

Your next question comes from Jay Harris of Goldsmith and Harris.

Good morning, Jay.

What are your higher-priced products that affected the average selling price?

Jay, we have never disclosed the pricing of our products.

I'm not asking the unit prices of your products. I just want to know on a relative scale which products sell for higher prices.

Copper and Tungsten have traditionally or historically been the higher-priced CMP products in the market place.

Okay. What happened to the mix of copper versus Tungsten in the quarter?

We indicated that Tungsten and dielectrics together increased by slightly over 15%. Copper increased by 12%. But we haven't split out the difference between Tungsten and dielectric. Since they're both -- Tungsten and dielectric are both used in memory applications and older logic legacies --- logic applications, they tend to move in parallel so we tend to look at them together. So, there was slightly higher growth in Tungsten oxide versus copper.

When you -- when you go into the share buyback program, do you anticipate this will result in a net share shrink? I notice in the last program, there was a very minor share shrink. In other words, as you spend this $40 million, do you anticipate a very significant share shrink?

No. I mean it is a $40 million program which is larger than our previous program but still, relatively modest. And the intent there is we think that that's an appropriate and prudent use of a portion of our cash but we'll monitor that carefully and to the extent that we see other competing needs for the cash, we can suspend that program at any time. But overall impact on our share count on a diluted basis will also depend upon what our stock price does.

Well, do you anticipate issuing shares and options in the same magnitude that did you the last time you had a share shrink?

I think, as you know, we issue options in our -- at the end of our first fiscal quarter to our employees for incentive compensation. We'll continue to do that again this year. I won't comment on the magnitude of that program today because we don't really know what the numbers are, Jay.

All right.

We'll continue to do that as part of our total compensation.

All right. When talking about operating expenses, you said that that included start-up expenses in Japan. Normally, when I think of start-up expenses, they are things that, after a short period of time, disappear. But then when you talked about your operating expenses for next year, you didn't seem to reflect any benefit from passing -- getting past the start-up expense period. I was a little confused on that.

I think through 2006, we'll see continued incremental cost in research and development associated with the Asia Pacific technology center. The start-up expense that I mentioned in the fourth quarter was mainly related to hiring people for the facility buying wafers for the facility, things like that. In 2006, we're going to see run rate kind of expenses there over time, I think we've described our research and development activity in Japan will represent sort of a shift of focus from the U.S. to Japan but that would occur over more than a quarter or so. In 2006, we'll have some redundant costs and research in development because we'll run both facilities relatively the same.

What were the level of start-up expenses in the September quarter?

In total, the sequential increase in operating cost was $3.4 million and the start-up cost associated with APTC would represent a few hundred thousand dollars of that. It wasn't huge.

All right. On your productivity improvement program, the 9% reduction in manufacturing and logistics costs, is there a carryover effect of that into the December quarter or was that a number that was fully realized in the September quarter?

That was a productivity improvement that we had accomplished for the entire year. It was 9% in fiscal year '05 compared to full year fiscal '04.

All right. Is there a carryover effect as we go forward, in other words, when you looked at your costs in the September quarter, relative to earlier in the year, without any further productivity improvement, should we look for some benefit to show up in the December quarter?

Jay, I think on previous calls we've talked about a number of projects under our six sigma initiative that we had targeted at reduced variability and improved quality and lower cost. We're on our second wave of six sigma projects that we fully intend to continue this march to increased productivity and reduced cost. So, we would expect what we started in fiscal year '05 to continue into '06 and '07 and then just keep driving for reduced variability, higher quality and lower costs.

Thank you. I think we need to move on to the next questioner.

Thanks, Jay.

our next question comes from John Roy of WR Hambrecht.

Hi, guys. Your $11.5 million projected hit in the second quarter, that would be March, you going to build up your own inventory in response to that? And eventually that will play out through your sales hopefully but actually you're never recover that, right?

It will be a shift of inventory that our distributor is holding now.

Through inventory that you hold?

That we'll have to hold.

All right. We'll take the hit in the second quarter and probably shouldn't model anything coming back in the rest of the year.

You would have a return to the prior kind of level of sales volume, I think.

Got it.

Right, not a recovery of that.

Not a recovery, a return. Perfect. Thank you.

Thank you.

Operator, I think we have time for one more question.

Your next question comes from Dmitry Silversteyn of Longbow Research.

Good morning. A lot of my questions have been answered. I want to clarify a couple of things. Number one, can you give us an idea of what the run rate for R & D and SG&A expense is going to be in 2006? Is it going to be similar to what we're seeing in the fourth quarter or is it going to be a little bit less as of some the start-up expenses abate but still higher than in 2005?

Let me take the first shot at this one, Dmitry then I'll ask Bill to provide a little more color. I think through '05, we worked very hard to manage and control our operating costs. We look at the numbers, I think our costs were up about 3%, FY '04 to FY '05. The initiatives we've started and we have ongoing, the Asia Pacific technology center, our move of the data storage business to Singapore, some increased capability in Taiwan, are things that we see are all necessary and important to make sure that we're doing what we need to do to support our customers in that part of the world. So, we anticipate I guess the way Bill described it, I would describe it as a high level. I think the quarter we just finished, our fourth quarter fiscal '05 would probably represent the run rate for operating cost for the next four quarters. That accurate, Bill?

With some additional growth. That would include stock option expensing.

Okay. So, the stock option expenses would be incremental to the $24 million you did in the September quarter more or less.

No, it would be included in the run rate.

Oh, it would be included in the run rate.

Look at the $24 million as a run rate with some modest incremental growth and that would include the stock option expensing.

Got it. Thanks. And then the second question, over the past several quarters, you talked about new products, series, 6,000, 8,000, 7,000 and now you've got 66 and 88,000 --- 8800, I should say. Can you give us an idea of where they are in terms of commercialization are being sampled by customers and when you expect to see some impact on the P & L in terms of gross margins as my understanding, a lot of these products or some of these products are designed to not only improve your performance but also improve your financial performance.

The dielectric product, the 6600 is a product that could replace legacy applications so, it could be utilized in older technologies up through 90 nanometers and potentially smaller technologies. That's commercial now. It is available for sale. So, the revenue on that depends on adoption by customers in ramp but that's fully commercial.

The 8800 product that I mentioned is another advanced dielectric product. That is still in development and it is being sampled by customers but it is not fully commercial yet. We would expect to see that in 65 nanometer technology and going forward potentially at 90. That's a pretty advanced product.

Several of the -- we have two products in Tungsten, I don't recall offhand the series' numbers, but both are -- one is available in commercial and applicable for 90 nanometer technology and forward and then there is a second one that's near commercial that would also be for advanced technologies like 65 and forward. So, it will depend on the pace of adoption of those new technologies. The further ramp of 90 nanometers and then the adoption of 65. I think we expect 65 to start to be commercialized later. Second half of 2006 in general but there are only a few semiconductor manufacturers that are really active at that right now.

Did I also remember that there was a product or two for the copper slurry market as well, the barrier slurries, perhaps?

Yes, our tunable barrier slurries are available for 65 nanometer application and beyond. That's where we think we can get some traction in barrier which is an area where we haven't been as successful in the past as our other applications. So, we're excited about all of these new products. The issue is how quickly will customers ramp these new technologies that will require them?

You talked about getting a process of record when in the barrier slurry market. Do you actually have commercial sales in the barrier slurry or barrier polishing?

Yes. We have -- we have, I think one POR at 130 and one POR at 90. Both of those, of course, are commercial sales. We have one POR at 65 and barrier. Which is not commercial yet.

Okay. So, if you kind of take a look at everything you're doing in terms of new product launches and you talked about that being one of your key initiatives, do you have a target for percentage of revenues coming from new products or -- and where you are currently versus the target? And also, what kind of an impact you expect this to have on the gross margin line? Is it just going to be enough to offset the price declines that are seen through the market or are you actually hoping to start growing gross margins as these businesses gain traction and the products gain traction?

We have -- this is Bill Noglows. We have internal goals and objectives around new product introductions, product demos and revenue targets from new products in terms of the revitalization kind of index. Just to back up a little, I think in previous quarters, we've talked to you about our approach in terms of new products and offering to the market, tunable products that are very sophisticated in nature but very elegant in their applicability at our customers' fabs in that. they span a broad range of materials, integration schemes and films as well as technology notes. We continue to believe that that is the right approach in what is becoming a more and more perplexed technology where our customers are definitely demanding more and more predictability and reliability and consistency. So, we continue to go down that path.

The other thing that I think is very important that we make sure that we communicate is that we no longer -- we no longer bring what I would describe as experimental samples to our customers. We bring samples that are fully vetted from a supply chain point of view meaning we can manufacture them and we have a sub supplier supply chain that can produce the raw materials we need for them.

On the gross margin question, you asked, our focus has been to look for ways to drive costs out of the ultimate CMP formulation either in the sense of providing an option or solution to our customers that allows them to produce wafers at lower costs of use of our CMP slurries. And in some cases, that involves what I would describe more sophisticated CMP slurries that may cost more money but result in higher yields and better performance for the customer or slurries that are of a lower price but the formulation is such that the gross margins are higher for our Company.

Bill talked earlier about the nature of our slurries. We have an abrasive component as well as a chemical component and we're looking for ways to reduce the abrasive nature of our CMP slurries which tends to reduce the cost. So, that was a long answer to your question but I think it is the focus of what we're trying to do.

Okay. So, would you care to share with us what the internal goals are for revitalization index or however else you call it?

We're not planning to share the goals outside of the Company.

Okay. Thank you.

Thanks, Dmitry. I think that's all of the time we have today. I want to thank you all for your interest in Cabot Microelectronics. I look forward to speaking to you again.

I just would close by saying we're excited by this last quarter of our fiscal year. We've been waiting a long time for an upturn and it appears to be here. We're very pleased with the sales pickup we saw this quarter. As you know, it is an exciting time in Chicago right now. It has been -- the city is celebrating a win, a sweep of the world series. We're equally excited about that, too.

We look forward to seeing you next quarter. Have a good day. Thank you, operator.

Thank you. This concludes today's Microelectronics conference call. You may now disconnect.