CMC Materials, Inc. (CCMP) 2006 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Cabot Microelectronics 2006 third quarter earnings conference call. My name is Candice, and I'll be your coordinator for today. [OPERATOR INSTRUCTIONS] I would now like to turn the presentation over to host for today's conference, Ms. Barbara Ven Horst, Director of Investor Relations with Cabot Microelectronics. Please proceed, ma'am

Thank you, Candice. Good morning, everyone. As Candice said, this is Barbara Ven Horst, Director of Investor Relations for Cabot Microelectronics Corporation. With me today are Bill Noglows, Chairman and CEO; and Bill Johnson, Chief Financial Officer.

This morning we reported results for our third quarter of fiscal 2006, which ended June 30th. 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 will be archived for four weeks on our website. The script to this morning's formal comments will also be available there.

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 second quarter of fiscal 2006 ended March 31st, 2005 and Form 10-K for the fiscal year ended September 30th, 2005. We assume no obligation to update any of this forward-looking information.

And now, I will turn the call over to Bill Noglows.

Thanks, Barbara. Good morning, everyone, and thank you for joining us today. This has been a busy three months for Cabot Microelectronics since our second quarter conference call. Since then we reported several significant accomplishments, which I will cover this morning. Most recent, of course, was our announcement this morning of our strong performance in the June quarter.

In addition to this great news, we made a significant acquisition under our engineered surface finishes growth initiative. We continued to make progress in our pads business. We recently reported that we strengthened our competitive position with respect to intellectual property related CMP Slurry, and we were honored to host the President of the United States at our headquarters in Illinois. All in all, we believe it's been a great three months.

Let's take a look at each of these accomplishments, starting with our results for the June quarter. We reported record setting revenue of $84.9 million, our highest quarterly revenue performance ever. We also broke a record in the volume of slurry we shipped to our customers around the world, both in total volume and in each of our RC application areas, including copper. Results were especially strong in Asia, which posted a 44% increase over the June 2005 quarter.

We believe our strong revenues this quarter are evidence of our recent health in the overall semiconductor industry, as well as strength in demand for our products in all of our business areas. Generally, forecasters are predicting that this trend will continue through the end of calendar 2006. Opinion varies about the industry's prospects for calendar 2007, but from our perspective, our business is well-positioned for ongoing success. We believe our strategic initiatives of technology leadership, operations excellence and getting closer to our customers are yielding tangible benefits.

During our last conference call, Bill Johnson and I spoke at length about our recent transition from using a third-party distributor in Taiwan to selling directly to our customers there. We had discussed this planned transition since August of last year, and as you know, we started selling direct on April 1st of this year. We're excited about the long-term benefits this transition affords us, but you will recall the significant short term adverse financial effect it had on our results for the March quarter. With the transition now fully behind us, our customers appear pleased with our execution of this change, and we are satisfied as well.

Demand for CMP slurries appears strong, and Cabot Microelectronics products, both newly introduced and legacy technologies, are participating fully in what has been a healthy market. For example, a major memory player has begun converting from a competitor's products to our newly commercialized tungsten and dielectric slurries across a range of technology nodes. A number of customers have chosen to replace their homebrew solutions with our tungsten slurries. And in addition, we have made initial sales of our new copper barrier slurry for our pre-commercial 45 nanometer application.

We took an important step in pursuing our engineered surface finishes initiative, or ESF as we refer to it. This growth strategy leverages our expertise in CMP technology for the semiconductor industry, including formulations, materials and polishing techniques to address other demanding applications requiring nano scale control of surface shape and finish.

On July 7th, we closed on the acquisition of the assets of QED Technologies Incorporated, a leader in perfecting surfaces for the precision optics industry. We believe the acquisition of QED is a great next step for our ESF initiative. The precision optics industry, estimated by some to be a multibillion-dollar market, is growing quickly. Demand for improved performance is causing manufacturers to move from traditional, manual, artisan-based processing in favor of automated methods that provide predictable, repeatable and consistent results with higher yields.

QED, a technology-driven company with about 12 million in annual revenues, develops and sells unique patented polishing and metrology systems that can achieve these results. The systems enable optics manufacturers to polish large areas with flat, curved or even aspherical geometries to a degree of accuracy and with a level of consistency that was not possible with more traditional manual methods. With more than 100 systems in operations worldwide, QED's technology is widely acknowledged as best in class for final figuring of the highest precision optics.

QED does for precision optics what Cabot Microelectronics does for semiconductors, namely achieving near perfect finishes that enable enhanced performance, and doing so deterministically and repeatedly. Because QED is a leader in the transition to automated manufacturing of precision optics, it offers us both an excellent entry point into the precision optics market and access to important customers who are leading-edge optical systems manufacturers.

We believe combining QED's business with our expertise in CMP forms a strong foundation for growth. We expect the QED business will leverage our expertise in polishing, chemistry and materials to enhance the development of consumables for optical processes and that our global infrastructure will help accelerate QED's entry into new markets.

Our new pad offering is a key growth opportunity within our core CMP business, and we continue to make progress there as well. We have made commercial sales to one customer, eight others are in various stages of qualification, and an even larger number are evaluating samples. We are scheduled to have additional manufacturing capacity online in the US in September, and expect to add additional pad manufacturing capability in Taiwan by early calendar 2007. We believe our pads are a compelling offering in terms of value, performance and pad life. And today, we are excited and pleased with customers' responses.

Our business is based on technology leadership, and as we said in the past, our ability to continue to anticipate and meet our customers' requirements for leading-edge technology is based on the significant investments we make in patent protected research and development. A strong intellectual property portfolio is fundamental to our strategy and success, and we believe provides us with significant competitive advantage.

Continuing to expand our already substantial intellectual property portfolio and protecting our IP against misuse by others are two important elements of this strategy. And in this quarter we made notable achievements in both. First, we acquired a number of patents and associated rights relating to CMP slurry technology from IBM, covering various applications such as copper, copper barrier, tungsten and dielectrics, among others, for $5 million.

While the acquired patents are not likely to make an immediate contribution to revenue, we believe this transaction affords us a competitive edge. We believe the patents add a valuable complement to our existing technology and provide us with future product development opportunities. We are delighted to have completed this transaction with IBM, who is the pioneer in CMP technology, and with whom we have had a productive and collaborative relationship as a valued customer since the early days of CMP.

Our second achievement in the IP arena was our successful protection of our tungsten technology against infringement by Cheil Industries. We had initiated a compliant in this matter before the United States International Trade Commission. The ITC granted our request to prevent this competitor from, among other things, importing infringing products in to US.

Our actions on this issue are consistent with our record of vigorously and proactively pursuing any parties that attempt to compromise our investments in R&D by infringing our intellectual property.

I'll wrap up with a few comments about one more exciting event for our Company, a visit by the President of the United States, George W. Bush, to our headquarters here in Aurora. We were honored and proud to have been chosen by the White House as a company that exemplifies the technology leadership the president is advocating his American competitiveness Initiative.

On July 7th, the President and Speaker of the House Dennis Hastert toured our [cleanroom] facility and research laboratories. And the President made a brief statement to the press on the initiative. We were delighted to have the opportunity to introduce the President and the world to some of our world-class scientists that show off our best-in-class facilities.

Those are some of the highlights of the past three months. Now I'll ask Bill Johnson to review our business results in more detail, and then we will open the call for your questions. Bill?

Thanks, Bill, and good morning everyone. Our revenue for the third quarter of fiscal 2006 was $84.9 million, which as Bill mentioned set a record for our company. Revenue was up by 26% versus the prior quarter. However, because that quarter included the significant impact of the transition to direct sales in Taiwan, sequential comparisons of some financial measures aren't very meaningful this quarter. What is meaningful is that our total revenue increased 30.6% year-over-year.

In addition to our total sales record, we achieved record sales in this quarter for both our tungsten and dielectrics slurry businesses. Sales of our slurries for copper polishing, including barrier, were at the second highest level ever. Sales of copper slurries represented 20.8% of our total revenue, and grew 61.3% sequentially and 32% versus the same quarter last year.

Tungsten slurries contributed 37.7% of total quarterly revenue, with revenue up 19.4% sequentially and 30.6% year-over-year. Dielectrics slurries provided 34.6% of revenue this quarter, with sales up 24.1% sequentially and up 37.2% compared with the year ago quarter.

And data storage products represented 6% of our quarterly revenue. This revenue was up 5.5% sequentially, but down 0.6% year-over-year. On a geographic basis, -- excuse me -- as Bill mentioned, we continue to see particularly strong sales growth in Asia. Year-over-year, our sales in China were up 73%, Korea increased 69%, Southeast Asia grew 50%, and Taiwan rose 45%.

Our average selling price for slurry products increased by 4.9% compared with the March quarter. Around 60% of this increase is attributable to higher prices driven by the transition to selling directly to customers in Taiwan, 35% of the increase was due to a higher priced product mix, and the rest was foreign exchange related. Because we now sell directly to customers in Taiwan and provide the value add service that our distributor had previously provided, we keep a portion of the markup that our distributor charged its end customers. However, as we've discussed in the past, we are now responsible for some logistics costs that largely offset the higher prices.

Gross profit this quarter represented 47.6% of revenue, up 80 basis points from 46.8% last quarter, but down 40 basis points from 48% in the year-ago quarter. Gross profit is a percentage of revenue increase this quarter primarily due to the benefits of higher manufacturing capacity utilization on the higher level of sales and higher pricing, largely offset, though, by higher costs including logistics costs associated with selling direct in Taiwan.

Now, I'll turn to operating expenses, which include research, development and technical, selling and marketing and general and administrative cost. Operating expenses of $26.7 million increased by $2.1 million sequentially, and were $6.1 million higher than in the same quarter last year. The sequential increase was mainly due to higher estimated accruals for our annual incentive program, greater usage of wafers and other laboratories supplies for our research and development efforts, and higher professional fees including cost to enforce the company's intellectual property portfolio.

The year-over-year increase in operating expense was primarily due to higher staffing costs. And these include cost to support a number of the company's strategic initiatives such as the Asia-Pacific Technology Center, the Singapore Data Storage Facility, and the Taiwan Technical Service Center. It also includes stock option expense.

As you know, we began expensing stock options in the current fiscal year as required by new accounting rules. Pre-tax stock option expense was $2.6 million this quarter, of which $2.5 million was classified in operating expenses. Net income for the quarter was $9.8 million, up by nearly 80% from the $5.4 million last quarter. Net income this quarter was 17.3% higher than the $8.3 million we reported in the same quarter last year, even with the $1.6 million after-tax effect of stock option expense.

The weighted average number of shares outstanding on a diluted basis this quarter was 24.2 million, and this was essentially unchanged from the prior quarter. We did not purchase any stock in the June quarter under our share repurchase program because of our pending acquisition of QED. Diluted earnings per share were $0.40 this quarter, including a $0.07 adverse effect of stock option expense.

EPS was $0.18 higher than the previous quarter, and $0.06 higher than we reported in the same quarter last year. Remember, we are not required to report stock option expense in the June quarter of 2005, so on a comparable basis we achieved significant EPS growth year-over-year.

Turning now to cash and balance sheet related items, capital additions for the quarter were $3.5 million, and this included investments to commercialize our new pad product as well as tools and equipment for our clean rooms and laboratories facilities worldwide. In addition, as Bill mentioned, we invested $5 million to acquire the collection of CMP slurry patents from IBM.

Depreciation and amortization expense was $5.2 million for the quarter. We ended the quarter with $169.5 million in cash and short-term investments, which was $4.2 million lower than last quarter. Cash flow reflects an $11.6 million increase in working capital, mainly due to a higher level of accounts receivable associated with our higher revenue this quarter.

I'll conclude my remarks with a few comments on our near-term outlook, starting with revenue. As you know, we don't provide guidance on revenue, but in terms of order pattern we have experienced a month-to-date in July, we see generally steady demand for CMP slurries comparable to what we experienced during our June quarter.

As we caution on every earnings call, the first four weeks of orders out of the quarter represent only a limited window on full quarter results. In addition to revenue from our CMP business, in our September quarter, we will begin recognizing revenue from our QED acquisition. In the last 12 months, QED generated approximately $12 million of revenue. Our expectation is that by working together, QED will become a growth vehicle for our company.

Our guidance on gross margin for our fourth fiscal quarter remains at 48% of revenue plus or minus two percentage points. Considering near-term operating expenses, again, research, development and technical, selling and marketing, and general and administrative costs, we expect three factors will increase these costs in our September quarter and the first two relate to the QED acquisition.

In accordance with accounting rules, we expect to write off approximately $1 million in value associated with in-process research and development efforts related to an as yet un-commercialized research project. We had previously disclosed an estimate of this one-time cost of approximately $2 million.

Second, we expect the run rate of QED's operating expenses to be approximately $2.5 million per quarter. And third, we expect to recognize approximately $0.5 million per quarter as we amortize the value of the IBM patents that we purchased.

So going forward, we expect in aggregate operating expenses will increase by approximately $3 million per quarter on an ongoing basis with an incremental $1 million one-time expense in the September quarter. Finally, our balance of cash and short-term investments, which totaled nearly $170 million at June 30, should be lower in our September quarter due to the QED acquisition.

We purchased the assets of QED in early July and paid $19 million in cash. As we previously reported, the total price could ultimately be up to $23.5 million ,depending upon future performance under an earn out arrangement.

Now, I'll turn the call back to Barbara, so we may prepare to take your questions.

Thanks, Bill. Candace, we're ready to take questions.

[OPERATOR INSTRUCTIONS] Our first question comes from the line of Suresh Balaraman of Think Equity. Please proceed.

Good morning, Suresh.

Good morning, Barbara. What is your current capacity on pads in terms of revenues and how much additional capacity will you bring on through your initiative in the US and also in Taiwan?

Good morning, Suresh. This is Bill Noglows. Suresh, we are in the process of installing enough capacity to meet the targets we've set internally for growth for our pad business. I think as we've discussed, our technology allows us to make these installations for what we think is a very competitive cost, and we can also do it in a modular fashion.

So our initial investments in the US are what I would describe as our upstream substrate manufacturing process. And then, we intend to install the backend processes close to our customers so we can customize the ultimate pad for specific customer needs. The targets we've set for ourselves internally, I would describe as aggressive, and we're making sure we have enough capacity to meet those targets and beyond.

The other thing that we're making sure that we do, and we've learned this from experience, is we're making sure that we can clearly manufacture the pads in a quality way that we would manufacture any CMP slurry as well as make sure that we have a robust supply chain to continue to manufacture those pads in the way our customers expect us to.

Thanks, Suresh. Next question, please.

Our next question comes from the line of Chris Blansett of JP Morgan. Please proceed.

Hi, guys. Just a kind of quantify, you did recognize revenue this quarter for some of your pads products?

What I said in my comments is was we had commercial sales for one customers, and we had -- I think the number was seven in -- in some seven or eight in some aspects of qualification. I think what we've said in the last call, Chris, was that we expected to recognize revenue before the end of this fiscal year, and I would guess that next quarter, we will have more to say on recognized revenue for pads sales.

Overall, then, going forward on the pads, I mean, do you expected to be positive, negative, or neutral influence on corporate gross margins?

Well, here is our challenge. We've spent -- we're in the process of spending the money to install the capacity to meet the requirements of our targets for pad growth. And we're bearing --we're bearing those cost today in our gross margin calculations. And we will continue to invest in our pad business.

Because of the nature of the technology, it's continuous process technology, and you need to be - there's a point where your sales, you begin to get operating leverage on the costs that you've invested in the business. And so there is a break-even point for us in pad sales. It's a relatively low number of pads. But we have to get to that breakeven point. But I would say today that those costs are part of our business today, and any sales we make will contribute to our gross margin dollars.

All right. Thanks, guys. Appreciate it.

Thanks, Chris. Next question, please.

Our next question comes from the line of Steven O'Rourke of Deutsche Bank. Please proceed.

Hi, Steve.

Thank you. Good morning. Bill, you had a good June quarter and you mentioned these trends should continue. This morning we heard from TSMC that said we're in an inventory correction that will likely extend through yearend. [inaudible] for this morning also said some similar things that there had been significant changes in customer sentiment in the past few weeks. ATMI said wafer starts would be flat in Q3 yesterday. Are you seeing the impact of this, and how should we be thinking about the September quarter in light of this?

Well, Steve, I think we've been pretty clear in past calls that we have very limited visibility into what we see, and we look at order patterns, and as Bill explained, the first sort of month to date, our sales continue to be on the same level as we had in the June quarter. We don't like to and don't think we're qualified to comment on wafer starts and some of the future looking metrics. However, we have heard concerns -- clearly, there is some concern --

I think it first originated in the flat panel industry where there was clear evidence that there was an oversupply of flat panels and as a result, people talked about the [old comp]. And at SEMICON West last week, in walking around and visiting with customers, there's -- in this industry there is always a healthy paranoia about when the shoe is going to drop.

And we always hear that at places like SEMICON West. We just saw the release this morning of TSMC as well. And I guess, what I'd tell you is I don't think we have any more visibility than anybody else in that we just look at our sales on hand, and we continue to see relatively strong market pull for our CMP slurries, at least at this point in July.

Okay. Fair enough.

Thanks, Steve. Candice, next question please.

Our next question comes from the line of Robert Maire from Needham & Company. Please proceed.

Yes. I'd like to drill down a little bit more. You mentioned that copper was up 60% quarter-over-quarter. Can you give us a little more granularity or detail on that? Are you starting to see an acceptance or use of copper in memory devices and thus seeing copper-related slurry there or what's driving such a sharp sequential increase in copper related slurries?

Robert, it's Bill Johnson. This is an example. I think where the quarter-over-quarter -- the sequential quarter comparisons are a little misleading because of the impact we had last quarter of the direct sales transition in Taiwan. If you remember, last quarter, in the March quarter, our copper revenue was down by about 32% because copper was a big part of the business we do in Taiwan. And with the transition to direct sales there, the copper revenues were heavily impacted.

So now we see an absence of that effect in this quarter. So the sequential growth was around 60%, but it was recovering from the 32% sequential reduction last time. So there's a more normalized growth that's probably something significantly less than the 60%. But I think the growth that we're seeing is mainly in advanced logic applications. There is a little bit of copper that -- that's starting talked about in memory. But it's very small at this point. So we think it's advanced logic that's really driving this for us.

Okay. And a follow-on question. In terms of legal expenses in protecting your IP, any other potential infringing companies that you're seeing on the horizon? And I would direct that question particularly to Asian-based companies or Chinese companies or others where intellectual property may not be the same as in the States. Any indication or has your -- has the fact that you've prevailed recently kind of dissuaded people from doing that?

Robert, I -- we -- as I said in my comments, we will defend our technology anywhere in the world. In most cases, I would say there is a different aspect to this. Our customers that we deal with in the Asia-Pacific region are very concerned about quality, supply chain robustness and I think most importantly, they like to have access to our technological capability.

So in most cases, the customers we deal with are our best advocate in terms of our own intellectual property and help us defend our position. So I want to get that on the table first. But there are always, let's call it, skirmishes with some of our competitors that we find overlap into our technical areas. And in those cases, we're going to do what we always do and we're going to aggressively and proactively go after them. So that's how I answer the question.

Okay. But any near-term things that you see on the horizon that may change that? Any new incidences of incursion to your IP?

Robert, if I would guess it, I probably wouldn't disclose that if there were and -- because we might compromise our position in any of those kind of battles. So I'd rather not comment on that.

Okay, great. Thank you.

Thanks, Robert. Next question, please.

Our next question comes from the line of Dmitry Silversteyn of Longbow Research. Please proceed.

Good morning and congratulations on a very good quarter. Questions, if I may, a couple of -- first of all, I'd like to get a clarification on the SG&A guidance that you provided for the third quarter.

Namely, if you look at the run rate that you've got in the second quarter or - I'm sorry -- yes, in the second quarter and you exclude the IBM -- not IBM, but the litigation expense and the accruals, which should not be repeated in the September quarter, the 4 million or so of incremental revenues - a incremental expenses and should be off of a lower base. Is that the right way of thinking about it?

Dmitry, it's Bill Johnson. Yes, that's correct. I guess if you looked at the company in the past, though, occasionally we've seen a situation where we'll have spike of operating expenses in our fourth quarter for one reason or another. And as we look going forward, I think we'd see an incremental, as we described, $4 million in September quarter and then an incremental 3, down from 4 in the subsequent quarters.

But I think you're right. The two items you mentioned would not be recurring, but they're -- we've got a history of seeing some higher -- some spikiness in our costs in the fourth quarter. And so it's just a caution about that that I think is -- that we ought to keep in mind.

Okay. That's fine. Secondly, you talked about QED having revenues of about 12 million over the past 12 months. But I think Bill also talked about being -- there being some marketing and sales synergies and infrastructure synergies when you make the acquisition. Should we expect the growth rate of the business to be single digits, double digits? Can you give us an idea of how fast this business should be growing within Cabot Micro?

Boy. Dmitry, I prefer to kind of hold back on that one for subsequent quarters and talk about -- we just closed last month and we're in the process of working very closely with QED. We see plenty of opportunities going forward. Let me just talk about a couple of high level ones. From a precision and finish point of view, QED and Cabot Microelectronics are very similar in that we're both, let's call it, high technology, high-end suppliers and we both focus very carefully on very precise needs of different industries.

The second area is an area where we think we can benefit QED, and that's our experience with materials like silicon and gallium arsenide, aluminum, nickel and copper. We think it'll definitely benefit the QED applications where they're working on mirrors or lenses for applications like photolithography and lasers and metrology instruments.

And then, finally, our infrastructure around the globe supports and provides service to many of the customers that would either directly or indirectly purchase technologies from QED. So we think there's a lot of overlap and we think there's a lot of opportunities, both technically and commercially. And we're in the middle of exploring those and investigating those. And when we get more clarity, we will certainly share that with everyone.

Okay, Bill. Thanks. And then final question on share repurchases. Can you update us on how much is left under your $40 million authorization and now that QE is closed and done with, can we expect you to be in the market a little bit more aggressively in the September quarter?

Through the first two quarters of the fiscal year we've used about $8 million of this new $40 million share repurchase program, and you'll recall that this $40 million program follows a $25 million program that we executed through the fourth quarter of fiscal '05. During this quarter, we mentioned we didn't purchase any stock due to the material nonpublic information that we had, to the extent that we had - we're in that situation again that would drive some of our action and we have - we've been careful not to sort of signal what we're doing with this in the market. But I think we'll just report that on an ongoing basis sort of after the quarter.

Okay, thank you.

Thanks Dmitry.

Thanks Dmitry. Next question, please.

Our next question is a follow-up question from the line of Chris Blansett of JP Morgan. Please proceed.

Yes. I wanted to kind of understand the linearity of sales throughout the quarter. I believe when you guys kind of gave quantitative guidance last quarter, you mentioned that the first month was looking kind of weak. So I just wanted to see how things trended throughout the quarter.

Chris, that's right. If you remember on our April conference call, we cited kind of a weak start to April, but obviously given how the quarter turned out, it's strengthened through the quarter and we did see that. April to May to June got progressively stronger, and what we mentioned this morning was that July month to date we're seeing sales or order comparable to the overall quarter. So that would imply a little bit softer than the strong June that we ended the quarter with, but on average running kind of at a comparable basis, again four weeks into July.

And in general, I mean any kind of color relative to the types of customers you're seeing, strength in memory, strength in logic or -- ?

Chris, Bill Noglows. I think we've seen significant strength in the foundries. And we've actually seen significant strength. I mean in general we've seen strength in all areas in all applications across the board, quite frankly. And -- but the foundries have been roaring, and many of the IDMs have been doing very well as well. So I think -- I can't point to any one area other than say we're up in all areas and we've been enjoying a very robust market.

And I guess -- kind of last question tied back to your purchase of the IBM patents. Was there a certain area where you think that by purchasing these patents you can then shut out some competitors? I mean, were there specific targets or that we might see material lawsuits against in the near future?

Chris, there were several areas actually that we found ourselves interested in this particular portfolio of patents that covered some tungsten applications, some copper applications, some dielectric applications. And we see them as both defensive and offensive . They complement our already -- what we think is an already very strong patent portfolio of intellectual property. And we will continue to -- we will continue to look for opportunities like the one we just completed with IBM because we think they're valuable and we think they provide a competitive edge for us in product -- as well as product development opportunities going forward.

I guess kind of what I was trying to get at is I just wasn't sure if maybe there was some competitors infringing on the patents that were maybe too small for IBM to really pursue?

No, that wasn't the case here, Chris.

All right, thanks a lot, guys.

I would say there was a fair bit of interest in those patents and we're quite happy that Cabot Microelectronics owns them today.

Was there any licensing you paid to IBM that goes away?

No.

All right. Thanks.

Thanks Chris. Next question, please.

Our next question is a follow-up question from the line of Suresh Balaraman of Think Equity. Please proceed.

Thanks. The memory supplier that you said had started to switch from a competitor's slurry to your studies, is that related to the ITC ruling on Shield.

No, no. Not even -- No connection, Suresh.

Okay great. Thanks.

It has to do with a long -- a relatively long product development engagement and joint development engagement with that customer where, as I said in the past, where we worked together to develop a very specialized and customized solution for that particular customer and their particular needs at each of the nodes that they're working at.

Okay great. Thanks.

Thanks Suresh. Next question, please.

Our next question comes from the line of Robert Tango of [Bart Moor]. Please proceed.

Thank you. Hey Bill, how are you?

Good, how are you Rob?

The profitability performance this quarter, just gross margin wise was very good. The - I'm just trying to get an understanding maybe looking out over the next two or three quarters. If there's -- from a pricing standpoint and volume standpoint and assuming some of the comments out of the foundries are any indication of what they may be expecting in terms of utilization rates and production in the next three or four months, is there any sense on what impacts the profitability? Are you guys anticipating any sort of changing impact to profitability in the coming months after -- coming off a quarter where things were obviously very, very healthy? Or is it sort of a tough read?

Yes, one of the things -- we did give guidance for the next quarter in terms of gross margin at 48% plus or minus 2%. I don't think we've ever talked recently about any sort of expectations that gross margin percentages return to sort of the 50% type level plus.

Given the expectation of customers for lower cost, our focus is on continuing to bring out higher-margin products that can offset some anticipated erosion in pricing or efficiency usage, that sort of thing. And that's why our margin guidance stays at 48%, plus or minus 2. And we've had quite a bit of success at this in the recent past. You may recall last year we reported that we had improved productivity by about 9%, and we have comparable targets in place this year, and we will going forward.

There's one thing, a couple of things ongoing now that are hurting margin a bit, and Bill mentioned the pads business. We are incurring costs now ahead of revenue, and so that has had a slightly adverse impact on pads or on gross margin percentage. In addition, our data storage business, which we moved to Singapore, there was a transitional period where we ramp up manufacturing there as we ramp down our traditional manufacturing sources, and for a period of time there are some redundant costs.

And so I think in both those two cases we saw some impact in our gross margin this quarter. So going forward to the extent that we were successful in growing pad revenue and to the extent that we ramp up our data storage manufacturing and don't have that redundant cost, then that could help gross margin a bit. But those are two small factors. And the pricing and demand and product mix are also big factors. So the short answer to your question then is that guidance remains the same at 48% plus or minus 2. And I don't think we're signaling any major changes one way or another going forward. But thanks.

Thanks Rob. Next question, please.

Our next question comes from the line of Steven O'Rourke of Deutsche Bank. Please proceed.

Thank you. Just two quick follow-up questions. Does the acquisition of the IBM intellectual property come with potentially more IBM or IBM partner-related business for Cabot? And secondly, is there a potential positive revenue impact on the Cheil litigation resolution?

Okay. Two questions there, Steve. Let me try to answer them both. My first -- in regards to IBM, although, we don't like to talk about customers, in this case, we've had a very long and collaborative relationship with IBM going all the way back to when this company was still part of the parent company, Cabot Corporation and we enjoy that today. And we would hope to enjoy that into the future.

I wouldn't suggest and wouldn't even think that it would -- as a result of our purchasing this portfolio with patents, it would lead to more business with IBM. IBM makes their decisions like every other customer in this industry. They're based on the technology we provide, the performance of the product, our ability to meet the requirements from a quality and supply chain perspective, and they're going to make those decisions regardless of this transaction.

The second question on the Cheil issue is potentially yes. Potentially yes. Can I put a number to that? No. But I would say, potentially, yes, that it might result in additional incremental revenue going forward.

Thank you. Very helpful.

Candace, we'll take one more question please.

Our final question comes from the line of Dmitry Silversteyn of Longbow Research.

Great. Thanks for taking my call here at the end. A couple of questions having to do with different end-markets. One, in the memory storage device market, it's been kind of bouncing along in the flat trajectory for you over the past several quarters. Is there anything going on in the industry that would lead you to believe that this business is about to either experience a period of a little bit more rapid growth or, conversely, perhaps some reduction in revenue?

Dmitry, are you talking about memory or data storage?

I'm talking about data storage, I'm sorry.

Okay.

My apologies

You had me a little confused there, Dmitry because it hasn't been bouncing along for memory.

Yes.

The data storage industry is -- it's been a wonderful example for us of our ability to pursue the ESF strategy going forward in just taking the existing technology and moving it into a totally new market. However, that - well, it's a better industry to be a supplier to than actually be in the industry I think unless you're a Comag or Seagate in that, they continue to find ways to increase the density of the memory capacity on the devices and shrink them.

So from a slurry provider point of view, the market does not grow like the IC market does. In fact, it remains relatively flat as they innovate and they find ways to get more -- higher density on their devices. So the growth perspectives for the CMP slurry providers are not nearly as good as they are in the IC industry. Did you follow all that?

Yes, I do. So that would basically mean that it's business as usual there with perhaps unit growth being offset by slower or less usage per unit. Would that be the right way of looking at it?

I think that's a good way to think about it.

And there is pretty strong demand. I mean there are new consumer devices, DVRs and the like that are driving demand for more storage capacity, but there seems to be efficiencies gained about as fastest those to come out.

Right. Okay. Then the second question maybe a little bit out of left field, but I think at some point over the past years, you were looking as a company into the MEMS market, into MEMS market as a possible opportunity for slurry applications. Is that still the case and given that the market really seems to be taking off here at least projected to take off over next couple of years. Is this going to become an opportunity for you?

I would say two years ago we had a fairly low level activity in the pursuit of -- at least understanding the MEMS market and where CMP might or could be applied, Dmitri.

Today we're focused on other areas as we spoke and these have optics, health care, some of the other things we talked about previously, and we stay -- I would say we stay up to speed on what's happening in MEMS. But we don't really have a focused activity target at it.

Thank you.

Thank you all for your time this morning and for your interest in Cabot Microelectronics. We look forward to our next opportunity to speak with you. Goodbye.

Thank you for your participation, ladies and gentleman. You may now disconnect. Have a great day.