CMC Materials, Inc. (CCMP) 2008 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second quarter 2008 Cabot Microelectronics earnings conference call. My name is Stacy and I will be your moderator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of the conference. (OPERATOR INSTRUCTIONS)

I would now like to turn the presentation over to your host for today's call, Ms. Amy Ford, Director of Investor Relations. Please proceed.

Good morning. With me are today are Bill Noglows, Chairman and CEO, and Bill Johnson, Chief Financial Officer. This morning we reported results for our second quarter of fiscal year 2008 which ended on March 31st. A copy of our press release is available on 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 of this morning's formal comments will also be available there.

Please remember that our discussions today may include forward-looking statements that involve a number of risk, 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 first quarter of fiscal 2008 ended December 31st, 2007 and Form 10-K for the fiscal year ended September 30th, 2007. We assume no obligation to update any of this forward-looking information.

Before we deliver our prepared comments, I'd like to remind you about our upcoming investor day which will be held the afternoon of Thursday, June 5th at the Millennium U.N. Plaza Hotel in New York. For more information, please send an e-mail to me at ir@cabotcmp.com. I will now turn the call over to Bill Noglows.

Thanks Amy, good morning, everyone. And thanks for joining us. This morning we announced solid financial results for our second quarter of fiscal 2008. We reported our fourth consecutive quarter of record revenue totaling $94.5 million. This record is particularly noteworthy as the March quarter has historically been seasonally soft for both the industry and our Company. Additionally, our diluted EPS of $0.34 was up 79% compared to the same quarter last year and excluding share-based compensation expense represents the highest second fiscal quarter EPS in our history as a public Company. Our EPS was down 34% compared to the previous quarter reflecting what we believe are two short-term Company-specific factors that adversely affected results, which we previously discussed at our annual meeting on March 4th. These are lower manufacturing yields in our rapidly expanding polishing pad business and higher legal fees associated with our ongoing intellectual property enforcement litigation against DuPont Air Products NanoMaterials. I will discuss both of these items in more detail in a few minutes.

From a broad semiconductor industry standpoint, it appears that despite the uncertain global economic environment, semiconductor unit production remained relatively in line with seasonal trends in the March quarter, and forecast for wafer starts growth calendar 2008 are relatively robust. A number of industry analysts have recently reduced their semiconductor revenue growth forecast for 2008, but it is our understanding that these reductions were primarily driven by lower than expected average selling prices for memory devices during the first calendar quarter rather than lower expectations for unit sales. Unit growth predictions continue to be strong for 2008 which we view as a positive sign for our business, since we sell CMP consumables and demand for our products is driven by wafer starts.

Industry experts also expect 2008 to be a down year for semiconductor capital equipment investments. This seems to have put a cloud over near-term prospects for much of the industry. Capital investment by our customers is relevant to our business over the long-term, but of greater interest to us in the near-term are wafer starts. And again the industry outlook for wafer start growth this year appears relatively strong. Although some semiconductor manufacturers have recently reduced their planned spending on capital equipment, we believe that total wafer start capacity is continuing to grow. Chip manufacturers have been placing greater emphasis on improving productivity in their existing operations, enabling them to produce more devices from the production capacity that they already have in place.

Regardless of how the semiconductor industry performs for the rest of calendar 2008, we continue to believe we are well positioned to operate successfully over a range of future industry and economic environments. We have a proven track record of weathering industry cycles and have historically generated solid cash flow even during market environments of moderating growth. We also continue to believe that our business results reflect a consistent and successful execution of our three strategic initiatives within our core CMP business, technology, leadership, operations excellence in connecting with customers. I would like to update you on our progress in these areas.

We are pleased with the advancements we have made on our technology leadership initiative. We continue to innovate with a priority on providing high-performing low cost of ownership products for our customers. By creating products that increase yields or throughput for our customers, we can improve their cost of ownership. A great example of progress in this area is our D100 polishing pad, which we believe delivers significant value on multiple levels.

First, our continuous pad manufacturing process coupled with the innovative thermal plastic material from which our pads are formed, has resulted in a differentiated pad product that clearly demonstrates a significant advantage in longer-- in terms of longer pad life. The longer pad life has been shown to effectively reduce our customers' total spending on pads. Second, a longer pad life increases our customers' throughput by reducing tool time since the frequency with which the pads must be replaced and conditioned for polishing is reduced. And third in a number of cases, our customers have seen higher yields in their manufacturing operations in terms of lower defectivity using our D100 pad.

Given the huge capital investment and equipment for a leading edge fab and the high volume of useable chips that need to be produced to make it profitable, even a small increase in yields can have a dramatic effect on our customers' total cost of ownership and ultimate profitability. This is the type of innovation that motivates semiconductor manufacturers to test and adopt our products resulting in additional business for our Company.

Like most companies that invest in research and development and are leaders in their fields, legal proceedings to protect our technology are part of the ordinary course of our business. The discovery phase of our litigation to enforce certain of our CMP slurry technology patents against infringement by DuPont Air Products NanoMaterials has ramped and continues. As expected, we have incurred increased external legal fees and you can see the effect of this increase in our operating expenses. While we can't predict with certainty the timing and outcome of this legal matter, we remain confident in our legal claims and defenses and we intend to continue to pursue and defend them vigorously.

As we have discussed previously, some of the patents related to this litigation are associated with our tungsten CMP slurry products, which are mainly used in mature logic and advanced memory devices. Although advanced memory devices are slowly migrating from aluminum to copper wiring, the market for tungsten C.M.P. slurry is alive and strong and we expect the tungsten slurry market to continue to grow in both the short and long-term. There are several design changes anticipated for next generation memory devices such as replacing certain poly plugs with tungsten plugs which we believe will be one of the factors driving growth for tungsten CMP slurry applications in the future. We plan to discuss our views on these technologies and the general market at our upcoming investor day on June 5th in New York.

Another exciting slurry application we have been placing greater emphasis is the copper barrier business. As competition has increased for copper CMP slurries, the bulk copper and soft landing polishing steps have become more commoditized and there seem to be fewer opportunities for differentiation. However the barrier polish step requires significantly higher performance which in our view falls right in our sweet spot. Our B6600 barrier solution is on the market today and is designed to provide customers with enhanced customization flexibility, superior electrical performance and an attractive cost of ownership. We are pleased with this success that we have seen with this product and continue to look for innovative ways to improve and expand our product offerings.

Across our Company, we are executing on our operations excellence initiative to drive our variation in our products and processes to increase quality, productivity and efficiency. One clear and immediate opportunity for productivity improvement is in our rapidly growing polishing pad business. As is common with a new product production ramp, we have been experiencing lower than optimal manufacturing yields in this new business area. This yield issue has not impacted our ability to meet our customers' demand for our products with the high level of consistency and product support that is required in this industry and for which we are known. However, we did see an impact on our profitability again this quarter. Excluding our polishing pad operations as a percent of revenue, gross profit this quarter would have been 3.6 percentage points higher.

At this time, we have intensive efforts ongoing in a number of areas to improve yields in our pad manufacturing operations and several solutions have already been implemented. We are beginning to see some positive results, but keep in mind this is not something we expect to fully correct overnight. We anticipate our improvement process to continue over several quarters before our pad yields are sufficiently optimized.

Beyond yield optimization, we must achieve a certain level of sales volume before gross profit percentage in our pad business reaches a level comparable to our core CMP slurry business. We are confident that we will achieve that volume level over time. In fact, pad sales this quarter increased by approximately 85% over last quarter and our total number of pad customers has grown again. We now have 12 customers which is up from 11 customers last quarter and we continue to have over 20 other pad opportunities in various stages of testing, evaluation and qualification. Also, our pad finishing facility in Taiwan became ISO 9001 certified this quarter which is a factor in our customers' purchasing decisions. This is an important milestone and we are proud that we have reached it so early in the life of our Taiwan pad operations.

Next I will address our connecting with customers initiative. During the quarter, we completed installation and fully qualified our new 300 millimeter polishing tool for our Asia/Pacific technology center. We are delighted with the rapidly utilization of this tool which has been fully scheduled for customer demonstrations on our copper and barrier slurry products. We believe that this investment as well as our other R&D resources in the Asia/Pacific region will allow closer collaboration with our customers, increase our responsiveness and facilitate more efficient product development.

Underscoring our success and executing on our strategic initiatives, I'm excited to report that we have earned several supply awards during the quarter. A special note was our achievements of intels preferred quality supplier or PQS Award for the second consecutive year. Out of approximately 13,000 suppliers, 35 companies were granted this award. And we were the only supplier selected for 2007 to receive the PQS Award for supplying CMP consumables. We are very proud of this accomplishment and all of the hard work and dedication that our team at Cabot Microelectronics put forward in our effort to build upon our relationship with this important customer.

Now I'll provide an update on our engineered surface finishes or our ESF business. Last quarter I discussed a new market area that QED Technologies had begun targeting which is comprised of hundreds of smaller optics manufacturers throughout the world. Historically, QED sales efforts have been mostly concentrated on the few very large producers of high precision optics. I am pleased to report that we are making progress in this area as evidenced by shipments made to a number of these smaller optics shops during the quarter which represent new customers to our QED business.

We believe the continued execution of our strategic initiatives has allowed us to consistently generate strong cash flow. As a result, we made $10 million of share repurchases in our second fiscal quarter under our $75 million share repurchase program. This brings our total share repurchases for the fiscal year to $24 million and we have purchased $75 million of stock on a cumulative basis over the last four years. As I have said before, one benefit of our strong financial model is that we can reinvest in our business through research and development, acquisitions and capital expenditures, and at the same time return value to our shareholders by repurchasing our stock.

In closing, our second fiscal quarter was a solid quarter for the Company. Our core CMP slurry business remains strong and we are making solid progress with our growth businesses and we intend to continue to capitalizing on our strategic initiatives in order to drive future growth and profitability. And with that, I'll turn the call over to Bill Johnson. Bill?

Thanks, Bill. And good morning, everyone. Our revenue for the second quarter of fiscal 2008 was $94.5 million which represented our fourth sequential quarter of record revenue. Total revenue this quarter was up by 22.7% from $77 million in the year ago quarter and up 1.2% from $93.4 million in the prior quarter. The revenue increases versus both periods primarily reflect strong demand for our products as well as solid industry conditions. Sales for slurries for tungsten and dielectric applications increased from the year ago quarter as did revenue from our engineered surface finishes and polishing pads businesses. Revenue from our other business areas declined year-over-year.

Drilling down into the quarterly revenue level, tungsten slurries contributed 40.8% of total quarterly revenue with revenue up 32.2% from the same quarter a year ago and down 0.4% sequentially. During a quarter that on a historical basis has been seasonally soft, revenues for tungsten slurries remain nearly even with last quarter due to strong demand from memory customers especially in Korea where our sales nearly doubled from last year. Sales of copper slurries represented 14% of our total revenue and decreased 5.8% from the same quarter last year and 6.6% sequentially. The sequential decrease was partially due to seasonality as well as some loss in copper slurry business from one particular customer.

Dielectric slurries provided 31.7% of revenue this quarter with sales up 21.1% from the same quarter a year ago and down 1.6% sequentially. Included in this business is our rapidly growing advanced dielectrics product line which was up 115% from the same quarter last year and 26% sequentially. Data storage products represented 4.1% of our quarterly revenue. This revenue was down 23.2% from the same quarter last year and down 21.1% sequentially. Sales of our polishing pads represented 3.5% of our total revenue for the quarter and increased 84.5% sequentially. Given the momentum we've experienced in the pads business, we expect to see continued growth in our third fiscal quarter. Finally, revenue from our ESF business which includes QED, generated 6% of our total sales and our ESF revenue was up 40.3% from the same quarter last year and 64.4% sequentially. Growth this quarter was driven by a number of product shipments to new customers.

Our average selling price for slurry products increased 2.8% from the year ago quarter and 1.5% from the previous quarter. Increases from both periods were mainly driven by a higher price product mix and foreign exchange rate effects.

As a percentage of revenue, gross profit was 44.7% this quarter which was up from 43.9% in the same quarter last year and down from 47.9% last quarter. Compared to the same quarter a year ago, gross profit percentage benefited from higher manufacturing capacity utilization on our higher level of sales. Partially offsetting the year-over-year increase and contributing to the sequential decrease were higher fixed costs and lower manufacturing yields, primarily related to our polishing pad business, which Bill discussed earlier. Excluding the impact from our polishing pad business, gross profit as a percent of revenue would have been 3.6 percentage points higher for the quarter. Year-to-date, gross profit as a percentage of revenue is 46.3% and we continue to expect the gross profit will be within our guidance range of 46% to 48% of revenue for the full fiscal year.

Now I'll turn to operating expenses which include research, development and technical, selling and marketing, and general and administrative costs. Operating expenses of $32.2 million this quarter were up from both the $28.9 million reported in the year ago quarter and $28.5 million last quarter. These increases were primarily driven by higher compensation-related expenses that typically occur in our second fiscal quarter as well as higher legal fees, which Bill mentioned earlier. Excluding legal fees related to our intellectual property enforcement, our operating expenses would have been within our quarterly guidance range of $27 million to $30 million. The duration of the higher level of this spending is difficult to predict, but we expect it to continue over the next couple of quarters. Given this, we anticipate that operating expenses will exceed our prior guidance range of $27 million to $30 million per quarter through the end of fiscal 2008.

Reflecting our strong revenue achievement and higher costs associated with the pad business ramp and intellectual property enforcement litigation, net income for the quarter was $7.9 million, up 76.8% from $4.5 million in the same quarter a year ago, and down 34.9% from $12.2 million in the previous quarter. Diluted earnings per share were $0.34 this quarter up from $0.19 in the year ago quarter and down from $0.51 last quarter.

Turning now to cash and balance sheet-related items, capital additions for the quarter were $5 million, which includes costs associated with the purchase of a 300 millimeter polishing tool for our Asia/Pacific technology center as well as the expansion of our pad manufacturing capacity. Depreciation and amortization expense was $6.7 million in the second quarter and share-based compensation expense was $3.9 million. In addition, $10 million of share repurchases were made during the quarter.

I'll conclude my remarks with a few comments on recent sales and order patterns. Examining our revenues in each of the three months of the second fiscal quarter, sales activity remained relatively constant throughout the quarter and generally consistent with our sales levels from May through December of calendar 2007. As we observe orders for our CMP products received to date in April, that we expect to ship by the end of the month, we see April results trending generally in line with our second quarter of fiscal 2008. However, I would caution, as I always do, that several weeks of CMP-related orders out of the quarter represent only a limited window on full quarter results. Now I'll turn the call back to Stacy as we prepare to take your questions.

(OPERATOR INSTRUCTIONS) Your first question comes from the line of Suresh Balaraman with ThinkEquity. Please proceed.

Thanks guys. When we look at your third quarter for (inaudible) it has been up an average of roughly 15%, when you look at all of the data since you went public. And when you look at the quarter, the March quarter, it doesn't seem to have been any (inaudible) because your core products are pretty much in line with seasonality, they may not be-- I mean they ticked down probably slightly. So is there any reason to expect that the June quarter would not have a typical historical seasonal descent?

Suresh, this is Bill Noglows. Suresh, Q2 for us is typically our seasonal low quarter and we tend to be down roughly about 4% to 6% historically. Yes, the third quarter, I think we--as you know, we don't guide on earnings but as Bill said in his script, we see our sales in the first couple weeks of April being at the same level as we saw through this quarter which we think was a relatively strong quarter given that we only saw a sequential drop in our core CMP slurry business by about 2%. So we remain I think I said in my prepared comments we continue to think that unit starts and wafer starts will remain relatively strong for the remainder of the fiscal year in the high single-digit kind of growth rate so-- and we think it's potentially going to be a pretty-- relatively strong year for the Company.

When we look at the inventory levels of the your balance sheet, the inventories are up pretty significantly compared to December-- in March despite the fact that revenues are pretty flattish.

That's right. And most of that was attributed to our pad business. We were ramping volume pretty rapidly and filling the pipeline and preparing to serve these-- the high volume customers. So we added several million dollars of inventory and really pad-related. And it's not just finished goods, it's kind of raw materials work in progress and finished goods. But most of that was pads-related.

And the last question is, the (inaudible) increase in the cost of goods sold just because of the manufacturing really seems kind of high because your total revenues from pads only about the same level. Do you have like a bunch of products at 0%. I mean it should have been pretty big, an issue and when you go to the next quarter you said it will take several quarters to optimize. I don't know how we should read it. I mean are we going to get to June quarter (inaudible) when your pad will be--would not have such a major impact on a nonbooking business? How should we rate that statement?

Two things going forward, Suresh. Let me talk about the covering our fixed costs first. We would expect-- we saw very rapid growth in our pad business from Q1 to Q2 where we recorded $1.8 million and then we saw again this quarter, we saw as we said in our prepared comments an 85% growth in our pad business to $3.5 million. We would hope and expect that growth rate to continue. I wouldn't expect it to grow at those kind of rates. But as we see opportunities to grow and fill up our capacity, that'll drive down our fixed cost utilization and eventually get us over our sort of break-even point on the yield type.

On the other side, we had set up this business and we entered the pad space with the guidance from me that we were going to do everything we could to make sure that I-- we delighted our customers and we didn't disappoint them in either the quality of our pad, the performance of our pad or our ability to supply and support that pad, and that's how we've entered the business. I think because we took that philosophy and that approach it's driven some additional, let's call them yield-related costs, in that we are doing all we can with our quality systems to make sure that the materials and the pads that we get to our customers are perfect. And that has caused us to be perhaps a little more critical of some of what we would describe as our internal specifications and we set a very high standard. And that has driven some of our yield expenses up and some of our quality costs up.

We have as you know, we've-- because this Company embarked on a 6 Sigma initiative about three and a half, four years ago, we are using those tools that are part of what we do at Cabot Microelectronics today to resolve those issues. It's not just one issue, it's sort of a host of issues that we have teams organized around and we're focused on. And we would expect that both as the volume goes up and as we implement our initiatives and our projects and we execute on them to drive down these yield costs, we would expect that to occur over the next several quarters. And I think it would be probably inappropriate of me to try to tell you what we could expect for the June quarter or the following quarters. But we clearly have a plan and a path and we've begun to execute on that plan to drive down these yield-related costs.

(Inaudible) guided for the 46 to 48 for the whole year. So I'm assuming you should have a pretty meaningful improvement in the yield expenses for the June quarter?

We'd expect to be within that 46% to 48% for the full year. So that would imply year-to-date we're at 46.3%. So we're within the guidance range and our expectations will stay within that guidance range.

Okay, great. Thank you, guys.

Thank you.

Thanks Suresh, we'll take the next question, please.

Your next question comes from the line of Christopher Blansett with JPMorgan.

Hi, guys. Along the lines of your pads growth did that come-- was that broad-based demand strength or does that come from a few larger customers?

Good morning, Chris, Bill Noglows. We are currently selling to 12 customers. And those customers range from what I would describe as small customers, intermediate customers and very large leading edge customers. I think in our September quarter, we announced that we had a win at 65 nanometer 300 millimeter copper customer. And as you can guess there's not too many 65 millimeter 300-- 65 nanometer 300 millimeter copper developers today. So that, that mix of customers has been driving our growth, I think inside that group of 12 there's one or two that are predominantly larger customers that are driving a disproportionate share of that growth.

All right, so now when you think about then resolving these yield issues and your current manufacturing capacity for those products, are you capacity constrained? Is it just a matter of improving yield to grow your output? How should we kind of think about where you are, how fast the line is running, and what kind of overhead you have to potentially grow future growth this year?

Sure. We do not believe we're capacity constrained. We have grooving capability in both North America and Taiwan now. We have our sort of foundation product manufacturing line, which has more than enough capacity to get us where we'd like to be over the next three years. So we're on the manufacturing side, we feel very comfortable about our ability to supply the market and the growth as we see it. On the operating expense side, we've added very little expense on the operating expense side to promote and supply this business. We're using our existing sales force. We're using our existing application engineers. We're leveraging our technical facilities here in Aurora and then the APTC in Japan as well as our laboratories in Taiwan. So all of that footprint was on the ground prior to our introduction of the D100 pad. So from our point of view it's been a very low cost opportunity for us to get into what we believe is going be a high growth opportunity for Cabot Microelectronics.

All right. And then one, one last question. And the reason I'm kind of pinging on this is obviously this is moving the numbers around quite a bit. What kind of headcount do you expect to add throughout the year to support the pads business growth or to help improve the manufacturing productivity and yields?

We've actually added quite a number of heads in the pad business. And if you look at carefully in the press release where we talked about Cabot Microelectronics, we reference a headcount of approximately 800 people currently. And the last time we reported, I think we said approximately 750 people. Most of those incremental heads were added in the pad production area.

Okay. Thanks, guys. Appreciate it.

Thanks, Chris. We'll take our next question, please.

Your next question comes from the line of Steve O'Rourke with Deutsche Bank. Please proceed.

Thank you, good morning. Could you talk a little about the loss in copper slurry that you mentioned and how much of a contributor was this to the copper slurry revenue declining?

Good morning, Steve. Bill Noglows again. We-- I think in Bill's prepared comments, we said we were down 6.6% sequentially in copper which is sort of the our normal seasonality Q1, Q2. We, I think in the past we've talked about the copper segment as being the most competitive of all of the CMP slurry segments we compete in. And in any one quarter, we typically-- because of the nature of the competition, we would typically win a couple and maybe lose a couple and it's just sort of moving around. In this corner, this is one of those instances where we believe that we have lost business and a customer. We think it was meaningful enough to disclose in this call, and that's why we brought it up. I don't know how much of it drove-- and I think there was a little bit of that loss in the March quarter numbers and we would expect more going forward, but our reasons for talking about it was we thought it was meaningful enough to get out on this call.

Okay and then one other question along these lines. The ESF revenue was up. You talked about some product shipments to new customers. Was this something that all kind of converged in this quarter or should we expect this kind of run rate going forward or just kind of lumpy?

No, I would suggest that we should continue to expect it to be lumpy until we have a significant enough sales volume where the lumpiness is absorbed in the total size of the business?

Okay so there was a chunk of tool shipments that went out?

That's right.

What's important about that is that it does represent an effort within our QED business to tap a different market than they've really been focusing on in the past. The focus in the past has been at the highest end, the largest producers of the most of the highest end precision optics. There's a substantial market of smaller traditional optics manufacturers, hundreds of these shops and now they're also focusing in addition to continuing to service at high-end, to also push on sales of equipment to automate some of these smaller shops. And we're seeing some progress in that area this quarter.

Okay and one last question. When you talk about the lower than expected manufacturing yields in the pad business, you talked a bit about just holding yourself to rather stringent specifications. Is it that or is the manufacturing process not quite ready for prime time when it comes to volume manufacturing?

Well, Steve, it's a little of both. We are bringing a new material and a new manufacturing process online and we're up and running at HVM rates. And you look-- to some degree, we're learning about how the process and the product performs at those high rates. That's-- I consider that very normal and we anticipated that going into the-- going into this business and we also anticipate that we have more than enough capability and ability to solve the problems going forward. I just-- I don't want people to overreact to this. I think this is very normal when you bringing a very new material and a very new process technology to the market.

Fair enough, that's helpful. Is it a function of the incoming material quality?

It's a little-- we have opportunities in each area, Steve. We have opportunities in the incoming material, we have opportunities in the extrusion process, we have opportunities in the final finishing. So I wouldn't describe it as problems in any one area. I think of it more as opportunities to increase yield and improve quality across the whole process.

Fair enough, thank you.

Thanks, Steve. We'll take our next caller, please.

Your next question comes from the line of Dmitry Silversteyn with Longbow. Please proceed.

Good morning, couple of questions. First of all, on the copper business. I understand that the customer lost impact. Beyond that, how can you -- how would you describe the reason that the copper revenues were down both year-over-year and sequentially given the strength you're seeing in dielectric and tungsten? Is it just less memory, I mean less logics sales and more memory sales? Or can you give us a little bit understanding on what's going on in the copper business?

Sure. Dmitry, it's Bill Johnson. Historically, our copper business had a pretty volatile pattern quarter-to-quarter. For example, going from Q3 to Q4 of fiscal year '07 we were up about 14%. The following quarter we were down about 15%, so probably some smoothing out there. In the second quarter of '08, we're down 6.6%. You're aware that we have a lot of business with the foundries. And if you look at the foundries that have reported, they're down sequentially 6% and 11% or something like that, between TSMC and UMC for example. So it's ordinarily some seasonality and we think that drove a portion of this 6.6% sequential reduction and then the loss of some business with the customer would be a part of that as well.

Okay. So there's nothing abnormal going on with the dynamics of the copper market versus dielectric and tungsten market then?

We don't believe so, Dmitry.

And it just continues to be highly competitive. And one of the things Bill mentioned we could reinforce here is that copper remains competitive and we continue to slug it out for a business. There's another additional opportunity in the barrier area where we feel like we've got some new products that are very high performing, and that's still an area where there are significant opportunities for differentiation. So it's an area where we're excited about some of the new products that we're bringing out.

Got you. Second question on the pad [longs]. If I did my math right, you said it was about a 3.6 impact on gross margin, it was about a-- then $3 million, $3.5 million loss on the gross margin line. If that math is correct. And the second question is, I know, Bill, you didn't want to kind of give a timeline when you're going to turn around that business and improve the efficiencies and yields, but is this level of loss something we should look forward to over the next quarter or two? Or do you expect losses to narrow rather quickly but just remain at a loss for some period of time?

Well let me first make a point with respect to your math. If you took out the pad business, revenue and cost, the remaining business would have been 3.6 percentage points higher at a gross margin level. So as you do that math, you take out not only the cost but the revenue and pads has been a drag on our gross profit margin. By our calculation, I think it was a drag of about $1.8 million this quarter rather than the $3.6 million.

Okay, roughly.

But that is quite a bit higher than the drag last quarter. I think it was a few hundred thousand dollars last quarter. I think as we flex the manufacturing process and work out some of these efficiencies, I think you're going to see some puts and takes quarter-by-quarter. For example, you have the drag in the fourth quarter of fiscal '07 is quite a bit higher than we saw last quarter. So I think you're going to see a little volatility until we get (inaudible) our yields optimized.

Okay, okay. Then switching tracks here a little bit. Memory storage devices, that business has been suffering from revenue losses going back on two years now, I guess this is the ninth quarter. At which point are we going to see an anniversary in the revenue (inaudible), I mean I understand where it's stemming from, I'm just trying to understand when someone can expect that business to stabilize?

Dmitry, Bill Noglows. Data storage market is an interesting market, as you know we've seen so much consolidation now in Western Digital, in (inaudible), and Seagate shut down their plant in (inaudible) Valley which is consistent with us closing our plant in [Berrywells]. I just think there's been a lot of movement in the data storage business. There's a very small group of competitors that we compete against in the data storage business and the volume and the sort of the accounts tend to move around across the three or four of us and we've seen a drop off in our business there. We lost a bit of business as a result of the closure in Ireland and we're moving that business back.

As you know, two and a half years ago, we moved our data storage business and our data storage team to Singapore to be closer to our customers in Malaysia and Southern Malaysia. We think that's beginning to pay off in the form of closer interaction and relationships with those customers and our ability to meet those customers (inaudible) in the form of new products. But again, those new products, it's hard for me to speculate. We would hope to see some of those new products at the market in again the next several quarters.

So we should continue to see double-digit declines in revenues for the time being then?

I don't think we could forecast revenues but as Bill mentioned, the dynamic in that industry is well different from the CMP slurry or pad business for semiconductors. For example, we talk about 12 customers that we have in our pad business for $3.5 million of revenue in the quarter. In the data storage business, we have a comparable now revenue a bit more than a handful of customers. So the customers are very aggressive in terms of adopting, trying and adopting new products, so things can move pretty quickly. But it's been a business that's gone kind of sideways overall for a number of years. It continues to be a very attractive incremental business for us. It's a great translation of our CMP technology that we developed for the semiconductor under this (inaudible) into another demanding application. So it's right consistent with our strategy. But the competitive dynamics within our customers have made it a pretty tougher business than some of the others that we compete in.

Okay fair enough. On engineered surface finishes, the new machines that you've begun shipping to the smaller players, and you have a little bit simpler stripped down versions whatever, are they-- do they command the same gross margin as the regular equipment that you-- that ESF used to sell or is this a higher or lower margin business?

I think that the-- it may be a little different but I think in general the gross margins on the smaller machines should be comparable. The benefit you'd have would be they'd be more standard than some of the customized machines that QEDs done in the past. The higher customized machines, the price may be higher but you may have to sell two or three of them before you achieve the margin. Where these more standardized machines you'd expect to get margin more quickly. And so I think it can be a comparable margin product.

Okay. And this surge in shipments that you saw this quarter, was it accompanied or preceded by a surge in the sales force of QED or are you accomplishing with the same cost structure you had before?

No, we've added a handful of people at QED, both on the R&D side, the quality side and sale side. I'd say a handful is a very small number. We had been leveraging our existing Cabot Microelectronics sales force around the world. We have a QED tool in our laboratory in Japan now at the [APTC] that we use for customer demos in Japan and around the region. And that's-- Dmitry, that's the was we're trying to route the business. We're trying to leverage as much of the Cabot Microelectronics infrastructure as we can to support the growth of QED.

Okay.Thank you very much.

Thanks, Dmitry. We'll take one last question, please.

You have a follow-up question from the line of Christopher Blansett with JPMorgan. Please proceed.

Hi, guys. Just in the near term when you look at your legal expenses, how are they going to trend relative to the first calendar quarter in the very near term?

We'd expect them to stay up for the next couple of quarters. We're in the-- still in the discovery phase of our litigation with DuPont Air Products NanoMaterials. And that's a period of time where you're making pretty intensive use of some outside talent. And so that's one of the things that drove the relatively high costs this quarter. We'd expect that to continue probably for another couple of quarters.

Is there a timeframe when you are at least targeting this to peak out or to trend down?

Well the discovery phase is really intensive. As you head toward a trial phase, it should ramp down to more like a level I think maybe we'd seen the prior several quarters. But I-- it really depends on sort of the ebbs and flows of the process, so it's really difficult to predict. But I would-- we would tell you that over the next couple of calendar-- or couple of fiscal quarters, the end of the fiscal year we ought to expect continued high litigation fees.

And then one quick question over on ESF. What was your level of slurry sales for that segment during the quarter and how has that been trending over the past year?

Well, Chris, we don't call what we use at MRF slurries. We use-- we call it MRF fluids. Oh, I'm sorry, ESF, I misunderstood you. Bill's going to get a number here.

It's small relative to the QED. QED probably makes up 80% or so of ESF revenue. What we're trying to do in the ESF space outside of QED, it's organic development in a number of different application areas. And so that's really sort of classic business development and rather through M&A activity. So it'd take some time to develop that.

I just wasn't sure if you had started to see some of the benefits of continued incremental shipments of your equipment.

Chris, I think we're answering two different questions here. The MRF tool doesn't use conventional CMP slurry. It uses what's called a MRF fluid which is Magneto-Rheological fluid.

Right.

And the QED business lumps that into service and support. And I'm not sure we have that number in front of us today. We could certainly give it to you.

That's all right. Thank you.

Thanks, Chris. And thank you for your time this morning and your interest in Cabot Microelectronics. We hope to see you at our upcoming investor day on June 5th. Thanks.

Thank you for your participation in today's conference. This does conclude your presentation. You may now disconnect. Good day.