CMC Materials, Inc. (CCMP) 2010 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the first quarter 2010 Cabot Microelectronics earnings conference call. My name is Katrina, and I will be your operator today. At this time all participants are in a listen-only mode. Later we will conduct a question and answer session. (Operator Instructions).

I would now like to turn the conference over to Ms. Amy Ford, Director of Investor Relations. Please proceed, ma'am.

Good morning. With me today are Bill Noglows, Chairman and CEO, and Bill Johnson, Chief Financial Officer. This morning, we reported results for our first quarter of fiscal year 2010, which ended December 31, 2009. 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 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 risks, uncertainties, and other factors that could cause actual results to differ materially from these forward-looking statements. These risk factors are discussed in our SEC filings, including our report filed on form 10-K for the fiscal year ended September 30, 2009. We assume no obligation to update any of this forward-looking information. I will now turn the call over to Bill Noglows.

Thanks, Amy. Good morning, everyone, and thanks for joining us. This morning, we announced outstanding financial results for our first fiscal quarter of 2010. We are extremely pleased with our strong start to what we believe will be a very successful year for Cabot Microelectronics. In the first quarter, we achieved a record revenue of $97.7 million, a gross profit margin of 51.6% of revenue, which represents our highest quarterly level in eight years. And earnings per share of $0.56, which is a record when compared to historical results that are adjusted to include share based compensation expense.

This establishes this third successive quarter of solid financial results for the Company following the severe downturn last year, and we believe results reflects improved industry conditions, continued successful execution of our strategies, a robust business model, and prudent financial management. Last quarter, I referenced research indicating that double-digit semiconductor revenue growth typically follows global recessions. Recent industry analyst estimates, which project semiconductor revenue growth generally in the mid-teens, appear to support this trend for 2010. Over the last several quarters, we have seen improvement across all three of our major semiconductor segments, which include foundry, logic, and memory. Foundry was the first segment to recover from the downturn last year, and was a large contributor to our strong revenue growth in the June quarter last year.

Following this, the logic IDMs picked up production levels in the September quarter of 2009, driving further revenue growth for our business. Now in our first fiscal quarter of 2010, we have seen increased demand from our memory customers. With all three segments experiencing strong demand, semiconductor inventories at relatively low levels and generally solid forecasts from our customers, our current internal forecasts points towards a robust revenue environment in fiscal 2010 comparable to or exceeding the level we experienced in fiscal 2008.

Having said that, in the near term, we won't be surprised to see a slight sequential pullback in revenue during the March quarter based on typical seasonal patterns for the industry and our company. Beyond 2010, we are optimistic about the potential positive impact of new capacity additions by our customers. Many of our customers are currently ordering and installing capital equipment to increase their capacity and are also focusing on increasing productivity from their existing tools. As an example, TSMC, our largest customer, has announced a significant increase in its 300-millimeter fab capacity to be installed in the current calendar year. Over the long-term, capital investment and increased productivity by our customers generally drive increased demand for CMP consumables for higher wafer start capacity.

For the remainder of fiscal 2010, we plan to continue to focus on strengthening and growing our core CMP consumables business to the execution of our three key initiatives, technology leadership, operations excellence and connecting with customers. We also expect to continue to execute on our strategy to advance our engineered surface finishes business. Our successful execution of these strategies has served us well, and we remain dedicated to build on them in 2010 and beyond. From a technology leadership standpoint, we are confident in our new product pipeline, which contains a number of high value products that we expect will provide customers with enabling solutions in all major CMP application areas.

In the current environment where semiconductor fab capacity utilization is very high, particularly at leading edge technology nodes, we are getting strong customer interest in our new copper and barrier products, which are designed for low cost and high throughput achieved through shorter polishing times. By increasing the productivity of our customers existing tools, by decreasing polishing times, these new products have the potential to reduce our customer's capital equipment needs and overall cost of ownership. We are also making meaningful progress with our next generation pad platform, the D 200.

As I mentioned last quarter, we are alpha testing this new product platform with a small group of strategic customers, and we plan to take a disciplined commercialization approach like we did with our D 100 pad launch. We are currently targeting copper and barrier applications for advanced technology nodes, and the initial tests are indicating improved defectivity performance compared to our D 100 pad and the competing technologies. We have also begun to increase our D 200 sampling capability. We are pleased with the progress we're making with customer demos and evaluations to date for both slurry and pad opportunities, and we are optimistic about the potential for meaningful new product wins.

Our operations excellence initiative continued to contribute to our strong performance this quarter. Over the years, we have focused our efforts on variation reduction projects through our companywide Six Sigma activities which have driven sustained improvements in manufacturing yields for both our slurry and pad products. As we have maintained our average selling prices relatively constant over the past three years, we're realizing the positive impact of these and other productivity initiatives on our gross profit margin.

In addition, there are two structural factors positively impacting our gross profit margin. The first of these factors is Epoch, which we acquired last February. Epoch is a low cost highly efficient operation in Taiwan and the gross profit margin is accretive to our company's overall gross profit margin. Additionally, the logistics and purchasing synergies captured through the Epoch integration are reducing overall company costs and helping to boost gross profit margins. We're pleased with the progress of our integration with Epoch and we are on track to achieve nearly twice the level of synergies that we originally anticipated from the acquisition.

High pad revenue is the second structural factor, providing a positive impact on our gross profit margin. Although our pad business is currently achieving a lower gross profit margin than our overall company average, we have continued to increase revenue and manufacturing yields in our pad business over the past two years, resulting in increased pad margins. This increase has reduced the drag on our overall company average gross profit margin compared to what we experienced over the past couple of years, as we began to commercialize this new technology. We believe that over time with even higher sales, our pad business has the ability to attain a gross profit margin that is in line with our companywide gross profit margin. We also continue to make progress on our third key initiative, connecting with customers. During the quarter, we were honored to receive a supplier excellence award from TSMC for the second year in a row, in recognition of our high performance slurry and pad products and the associated strong support we provide.

Out of thousands of suppliers, we were one of only ten companies chosen to receive this prestigious award. Recall that during 2009 we installed and qualified our pad finishing equipment in one of TSMC fabs and we're now finishing a significant portion of the pads that we sell to TSMC through this newly added production site. This unique collaboration model is driving logistics and packaging savings, providing for a greener supply chain and enabling a faster turn around of customer requests.

Closing my remarks this morning, we are optimistic about the future outlook of the semiconductor industry. We are also pleased with the progress we're making on our strategies and key initiatives, which we believe have driven our record setting financial performance over the past couple of quarters. In our view, we are well-positioned to take advantage of the current strong environment with our robust product portfolio, world class quality systems, solid infrastructure and global sales and technical teams and continued prudent financial management.

With that, I will turn the call over to Bill Johnson. Bill.

Thanks, Bill. Good morning, everyone. Revenue for the first quarter of fiscal 2010 was a record $97.7 million, which was up by 55% from the first quarter of last year, and up 1.2% from the prior quarter. The increase in revenue from the same quarter last year primarily reflects improved economic and industry conditions, as well as contributions from our acquisition of Epoch in February 2009. Compared to the prior quarter, the slight increase in revenue during the December quarter, which is typically a soft seasonal quarter, was primarily driven by higher sales to memory device manufacturers.

Drilling down into revenue by business area, tungsten slurries contributed 36.9% of total quarterly revenue with revenue up 38.3% from the same quarter a year ago and up 7.8% sequentially reflecting strong demand from the memory segment. Sales of copper products represented 17.7% of our total revenue and increased 95.1% from the same quarter last year, including the benefit of the Epoch acquisition and decreased 5.7% sequentially. Also included in our copper business is our barrier removal product line, revenue from which increased 10.9% sequentially.

Dielectric slurries provided 27.5% of our revenue this quarter with sales up 37.1% from the same quarter a year ago and down 5% sequentially. Data storage slurry products represented 6.2% of our quarterly revenue. This revenue was up nearly 150% from the same quarter last year, reflecting an important customer win, and up 10.7% sequentially on strong industry demand. Sales of our polishing pads represented 6.8% of our total revenue for the quarter, and increased 91.4% from the same quarter last year and 2.1% sequentially. Finally, revenue from our ESF business, which includes QED, generated 4.9% of our total sales and was up 83.5% from the same quarter last year and up 6.3% sequentially.

Our gross profit this quarter represented 51.6% of revenue compared to 45.6% in the same quarter a year ago, and 48.4% in the prior quarter. Compared to the year ago quarter, gross profit percentage increased, primarily due to increased utilization of our manufacturing capacity on significantly higher demand. The increase in gross profit percentage versus the previous quarter was primarily due to a higher valued product mix as well as the benefit of a $1.6 million raw material supplier credit related to achieving a certain volume threshold.

From October 2006 to April 2009, we had provided full year gross profit margin guidance in the range of 46 to 48% of revenue. However, we suspended this guidance last April, due to the uncertainty in the global economic and industry environments caused by the severe economic downturn. In light of the stabilizing industry environment and resulting increased visibility, we now expect our gross profit margin to be in the rage of 46% to 50% of revenue for the full fiscal year 2010. As Bill discussed, there are two structural changes that are positively impacting our gross profit margin, our acquisition of Epoch and associated synergies as well as our increased pad revenue levels and improved manufacturing yields. Due to these factors, we are increasing the upper level of our previous guidance range. This guidance is for the full fiscal year and quarter to quarter our gross profit percentage may be above or below this new guidance range.

Now I will turn to operating expenses which include research, development, and technical, selling and marketing, and general and administrative costs. Operating expenses this quarter of $30.1 million were $0.7 million higher than the $29.4 million reported in the first quarter of fiscal 2009. The increase was primarily driven by higher staffing-related costs, partially offset by lower professional fees. Operating expenses were $2.2 million higher than the $28 million reported in the previous quarter, mainly due to higher staffing-related costs including higher accruals for our annual intentive bonus programs and share based compensation expense. For full fiscal year 2010 we continue to expect our operating expenses to be in the range of $120 million to $125 million.

Diluted earnings per share were $0.56 this quarter, which is the second consecutive quarter of record earnings per share, when compared to historical results that are adjusted to include share based compensation expense. This is up from both the $0.01 reported in the first quarter of fiscal 2009, and $0.52 reported in the prior quarter. Both of these increases were driven by the higher level of revenue and gross profit margin percentage partially offset by higher operating expenses.

Turning now to cash and balance sheet related items, capital additions for the quarter were $1 million, depreciation and amortization expense was $6.4 million, and share based compensation expense was $3.3 million. We ended the quarter with a healthy cash balance of nearly $225 million, which is roughly $25 million higher than last quarter and we have no debt outstanding. Due to our strong cash generating business model and solid balance sheet, we believe we have a great deal of flexibility to take advantage of attractive, potential acquisition opportunities that could arise such as another Epoch-like deal or one that might leverage the capabilities we have developed in supply chain management and quality systems in supplying the semiconductor industry. In addition, we have $50 million available under our current share repurchase program.

I will conclude my remarks with a few comments on recent sales and order patterns. Examining revenue patterns within the three months of our first fiscal quarter we saw demand for our CMP consumables products trend relatively even across all three months of the quarter. As we observe orders for our CMP consumables products received to date in January, that we expect to ship by the end of the month, we see January results trending at roughly the same rate as we have seen in the past seven months. However, I would caution as I always do that several weeks of CMP related orders out of a quarter represent only a limited window on full quarter results. Now I will turn the call back to the operator as we prepare to take your questions.

(Operator Instructions) Our first question will come from the line of Avinash Kant from DA Davidson & Co. Please proceed.

Good morning. One or two quick questions. Just first of all in terms of the directionality during the quarter, if you can talk about that of course you are expecting a very good fiscal year 2010, and you did mention that the March quarter could be down some from what you have seen in the December quarter. Going beyond March, would you expect to see sequential improvement throughout the fiscal year or do you see some different pattern there?

Avinash, this is Bill. I think we see a couple of things for the next quarter. For seven of the last nine years we experienced a sequential reduction in our March quarter which caused us to be a little conservative about what might happen next quarter. The other thing is I think you probably saw TSMC announced this morning and they're forecasting reduction of about 2.5% for their calendar first calendar quarter, so we wouldn't be surprised to see a little bit of a downturn in the next quarter.

As Bill's comments said, in the first three weeks of January we continue to see the same sort of order pattern that we saw for the last three months, but we're hopeful for the remainder of the year. I think we see pretty strong environment right now, low inventories, and we see our customers expanding as quickly as they can, particularly the foundries, and so we're pretty for us to sound bullish about anything is kind of interesting. We're usually very conservative. We think we're in a pretty strong environment this year.

You also mentioned that you have more of the memory customers now coming back. Does that mean that the correlation you've had with the foundry guys would be kind of a little bit less than what you have seen in the past one or two quarters?

I think what our comments are, we saw kind of a three part recovery as the industry turned up and we saw the foundries go first and then the IDMs and then memory followed in strength. I don't think what we were seeing was that we have a disproportionate share of either one. I think we were talking about the how the market roared, Avinash, so I think those trends and that consistently with the foundries still in fact and we should still look to them as a proxy for how our company might do.

Also, the contribution from Epoch, you may or may not break down how much was the revenue from them but would you give us some idea compared to the previous quarter? Did they grow more than the overall growth that you saw or less or in line?

Actually, Epoch revenue was down a bit sequentially. You may remember in the fourth fiscal quarter, Epoch was around $7 million of revenue. It was a bit lower this quarter, but we're in the process of transitioning towards direct sales in a portion of the geography they serve, and so we had a bit of an inventory issue where our distributor drained their inventory and that we think that impacted the Epoch sales a bit in the quarter, but they were down a little bit sequentially.

So like $6.5 million or so?

A little bit less than $6 million.

Less than $6 million. Okay. And one final question. In terms of wafer starts, you have some assumptions of wafer starts for maybe calendar year 2010. I will try to see end of last quarter what did you expect for wafer starts in calendar year 2010 and what's your expectation now? Has it changed any?

Bill and I are standing here looking at each other, and we don't typically talk wafer starts. We tend to use -- we have wafer start data, but we tend to look more to the analysts, the industry analysts that cover the industry.

Would you say that you have seen -- are you a little bit more positive on wafer starts now or kind of pretty much in line with what you were thinking a quarter ago? I am trying to see where the directionality is.

I think we have a little more visibility now and a little more confidence in the strength of the industry if that's what you're asking, than we would have had at the end of our last quarter. It appears that things are stabilizing and we're seeing our customers clearly at the leading edge of the fab capacity fully loaded, and 300-millimeter capacity is fully loaded and some of our customers, many of our customers are scrambling to increase capacity either through capital addition or looking for ways to squeeze more wafers through existing fabs. So I think our visibility is much clearer on the rest of the year and as we said in our prepared comments, we're looking for pretty strong year here that with revenue equivalent or perhaps better than what we did in 2008.

And of course given your structure a little better, I would expect the EPS would be better even on the same revenue EPS would be better than what did you in fiscal year 2008, right?

If given the gross margin guidance that we're putting out, 46 to 50%, that would translate to some perhaps improved margin as well.

And very recently there has been of course a lot of talk about China trying to slow the economy down. Have you seen any one of your customers talk about that? Have you seen any impact of that in the food chain up until now?

Not yet, Avinash. Not to this point in time. I think when you slow down from 100 to 90, it is hard to see. We'll have to wait and see.

Perfect. Thank you so much.

Go ahead and take our next caller, please.

Our next question will come from the line of Jay Harris from Goldsmith and Harris. Please proceed.

Thank you for taking my question. If we could look forward long-term to fiscal 2011, and if we assumed wafer starts were going to be flat, what are the positives and the negatives relative to wafer starts that we should focus on, such as improving profitability in your pad business? Are there other things?

I think, Jay, I think there is a number of things. We clearly have what we think is a great pad technology, and we would expect to grow that business on the top line. We haven't slowed down. We it continue to have many customers looking at our pad technology, our current technology being D 100 and the new technology being D 200, so we would see revenue growth from our incremental revenue growth from our pad business, and as we have explained before, we have what we believe is a very low cost process for manufacturing pads and the more pads we sell the greater leverage we get on our fixed costs, so we would also anticipate our gross margin contribution from our pad business would continue to rise.

That's clearly one big area of potential future growth. Well past 2011, 2012 and 2013, we hope and think we can major player in the pad business. We're already the number two player in this business, and we fully expect to grow. Alongside that is what we have always done and think we're getting really good at and much better at is developing and bringing new products to bear in this marketplace, and we are active, very active at leading edge technologies as well as working at some of the legacy technologies to help our customers reduce their cost of ownership and increase throughput, so we would expect to see some incremental revenue growth through the introduction of some of those new products as we go forward, and anything we do as part of our ESF initiative, we're chasing what we think are fairly solid opportunities there in wafer slicing and wafer polishing for both the solar and semiconductor industry, so we're pretty positive about our growth ability and some of these incremental activities that are close to what we do but they're new to us, like pads and wafer polishing and wafer and so on.

Also within the CMP slurry area two specific areas that we have been under represented in the past would be barrier and advanced dielectric. We have new barrier products being heavily evaluated by the market now in addition some activity and advanced dielectric, so we can gain a more representative portion of the slurry business that could represent growth in excess of wafer start type behavior.

Are there any negative trends that we should be mindful of?

There is macro trends. Let me start off. From a technical perspective, we try as best we can to stay close to the national laboratories and our leading edge customers. There is always this underlying fear that some day someone will invent some technology that replaces CMP technology. We don't see that on the horizon. We don't -- if that was to happen, it certainly isn't going to happen in the next ten years. That threat is sort of off the table.

I guess from an industry structure point of view, it is clear that our customers are consolidating rapidly, the global foundries chartered semiconductor, AMD, combination, and I think we'll see more of those. We could end up with really powerful handful of really powerful customers that we're selling to, and that causes us pause and we think about how do we structure our business and our company to compete in that kind of environment, but other than that, Jay, I think and believe and I have said this for a couple of years now that there will be opportunities for consolidation on the supply side to the semiconductor industry. We're hopeful that we can put our cash balance to work for us, and find ways to bring more electronic materials into our supply chain, and just leverage what we have on the ground today with more products and generate more revenue on top of the infrastructure we have in place around the world today.

One more question and that is could you share with us the percentage of your cost of goods sold that's fixed?

We haven't disclosed that specifically. Instead we have sort of characterized our cost structure as mostly variable and semi fixed. If you have toured any of our manufacturing facilities just looking around, you can see that we're not a capital intensive business. There is not a lot of depreciation and not a heavy staffing element. So we don't have specific breakout, but relatively limited fixed costs.

Thank you.

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

Our next question will come from the line of Aaron Husock from Lanexa Global. Please proceed.

Great. Thanks for taking the questions. Maybe just to kind of address gross margins a little bit. Can you help me understand why 50% is the high-end of the range so if we strip out the supplier rebate, you were at 50% this quarter. And that was a weak Epoch quarter where as Epoch is higher gross margin. As we look forward, down a little bit revenue perspective in the March quarter, but then revenue is grows seasonally in June and September. There is some leverage and pads continue to ramp up. I would tend to think there might be a little bit room above the high-end of that range just assuming normal seasonality in June and September. Can you help me understand why you set the top of the range at 50 instead of 52?

Sure. First of all, the guidance is for the full fiscal year, and so like this quarter we can see quarters where you tripped up above or below either end of the range. One of the things that helped us on gross margin this quarter was relatively rich product mix. If you follow this for a while, product mix can move gross profit margin around by a percent or two relatively easy just quarter to quarter. So we had a pretty strong product mix, very high capacity utilization, historically we have seen some impacts of lower capacity utilization or weaker product mix or also lower manufacturing yields. We had really strong manufacturing yields this quarter and that benefited our gross profit margin. So I think the way we characterize the gross margin utilization, historically we have seen some impacts guidance was that we have a bit more visibility, some greater stability in the environment, and so we put a broader range of gross margin guidance out there. I think we'll watch this and see how our performance behaves and then to the extent we need to update this sometime over the succeeding quarters we can certainly do that.

Okay. If you look at the pad gross margin, I think the overall pad gross margin is still below corporate average, but if you just look at the incremental gross margin on growth in pad revenue, every incremental $1 million of pad revenue flowing through at a gross margin that is similar to corporate average, or is growth in the pad business still a drag on total gross margins?

I don't know the answer to that offhand. I can point you to two data points that we have shared in the past. In fiscal year 2008 we had $15 million of pad revenue and roughly a break even gross profit margin for pads. In fiscal year 2009 we had around $18 million of pad revenue and gross profit margin in the low double-digits, so on $3 million of incremental revenue we swung gross profit pretty considerably, so there is a lot of leverage on the incremental revenue, but I don't have a specific number to give you. Can you disclose since we're in a public forum what the pad gross margin was last quarter? No, we didn't.

I know you didn't, but could you.

No. Just like other parts of our business, we don't disclose gross margin by application area, and I think that continues to be our practice. Instead we have sort of characterized or tried to get some qualitative color around that, and I think I can't give you much more than that with pads this quarter.

Can you give me if it was over or under 30%?

I think I can't tell you more than I have already told you. I appreciate your interest and persistence.

All right. I just one last question. Did you buy back any stock in the quarter?

No, we did not.

Okay. Thank you.

We'll go ahead and take our next caller, please.

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

Good morning, gentlemen, and ladies, and congratulations on a good start to the fiscal year. Just wanted to understand a little bit in the individual businesses in the slurries your copper and dielectric slurries were down sequentially, but you did talk about the IDM and the logic market really coming back, so I am just wondering I would have thought that logic coming back would be better for copper. Is it just the case that the memory guys grew even faster and that's why you had your copper revenues down a little bit sequentially?

No. I think I was -- when I was in my prepared comments, Dmitry, I was talking about when they came back and we saw the foundries come back two quarters ago. We saw the IDMs come back last quarter, and we saw the memory customers come back in the quarter we just completed. So we saw a surge in foundry back in the last fiscal year. We had some moving parts in the copper business, and I will let Bill talk about that relate to going direct and different parts of the world that caused the build up last quarter in copper and then subsequent reduction this quarter, and so go ahead, Bill, and explain.

That's right. Really the sequential decrease in copper is primarily driven by this transition in Epoch where we're taking advantage of our global sales network to distribute the Epoch products outside of Taiwan that had been handled by distributors, and so in one geography, we transitioned during the quarter and so there is a draining of distributor inventories and that adversely affected Epoch revenue, and that accounted for essentially all of the sequential decrease in copper.

Got you. That's helpful. What about the dielectric? You also saw down revenues in dielectric where according to you you had a pretty strong memory sales?

The correlation is good there, but it is not perfect, and just based on order patterns quarter to quarter and month to month with different customers we saw a downtick. I don't think we draw any specific conclusions from that. No apparent loss of competitive position or anything like that. Just sort of the vague reason, the normal fluctuations we sometimes see quarter to quarter in orders.

And your ASPs sequentially and year-over-year, how did they hold up?

ASPs were actually up sequentially on the strong mix and also foreign exchange benefits.

And year-over-year?

Year-over-year was down, but mainly driven by the impact on average selling prices of Epoch like we talked about in the past.

Got you. Okay. Can you give us an idea, I know your assets and your sales are fairly well matched as far as geographic location, the weak US dollar, how does that affect your profitability in terms of margin or in terms of profit dollars?

It has actually the strong yen weak dollar has somewhat of an adverse effect on our gross profit margin on the percentage basis. When you take that all the way to the operating income level, though, really not a material impact of either the yen or any change in the new Taiwan dollar. We have a natural hedge given the revenues in the currencies in the associated costs and denominated in those currencies.

Right. Okay. Can you speak a little bit about raw material trends? You talked about the supplier credit that you got of $1.6 million, which was just a volume credit, I understand. We have had at least in other parts of the industry we've had raw materials play a big positive role in 2009, but seem to be reversing here. Are we seeing the same thing in the fume silica and cirri and the markets that are important to you as raw materials?

Not like other people might see, Dmitry. We're not exposed to the carbon costs associated with oil and so we don't have those big fluctuations that are driven mostly by the price of oil in the world today. We have in many cases we have long-term arrangements with our suppliers that protect us and them on both sides against price fluctuations.

Okay. So you're not really looking -- you weren't helped much in 2009 but raw materials and you're not looking at much of a head wind this year, so I know you have some internal rate of return type of contracts with your large supplier that does not automatically mean that your prices will be going up this year?

Given those long-term contracts, there is quite a bit of stability around those products, and if you think about our raw materials costs after the abrasive particle which is the largest single element, and mainly long-term contracts, so price stability or cost stability there, after that, then it is labor costs which have been relatively constant and then our chemical costs are really a long list of small amounts of specialty chemicals, and the individual costs of any of those and any inflation or deflation in those costs of those trace chemicals is not a big driver of our overall cost structure.

Got you. Can you remind us when you usually flow through the P&L the bonuses and the variable comps? I would understand that they may be better this year than they were last year.

That's accrued during the year quarter by quarter based on our assessment of performance against those goals, and so in the prepared comments, we mentioned that we had some increase in operating expense and you would also see that in cost of goods sold related to increased accruals for those incentive compensation plans.

But the final adjustment would be made in the September quarter in your year end?

That's right. We try to match performance with the accrual with the performance against the full year goal and then kind of true up quarter by quarter with a final true up if necessary at the end of the year and then payment, cash payment in the December month of December.

Okay. So would actually in other words payments for 2009 calendar year were already in the first fiscal quarter that you reported?

Well, we paid modest bonus in December of 2009 in respect of fiscal year 2009 so in the first quarter we accrued for bonus for fiscal 2010 that if approved by the comp committee and if we hit required thresholds would be paid next December, December 2010.

Right. Okay. Turning your attention to the ESF part of the business, it has been underperforming for several quarters. This quarter seemed to be pretty good result versus the comp a year ago. Obviously it is a lumpy business, but on the other hand the good part about it is it is a capital equipment business so you do have an order book and some visibility. Can you share with us what the outlook for the business looks like to the extent your order book provides you visibility?

Yes, Dmitry we can. We had what we think was a good quarter at QED, and a darn good quarter at QED, and the new technology that QED introduced, the aspherical interferometry has clearly garnered a lot of attention in the marketplace. We see several orders for equipment going forward. I would be hesitant to declare victory in the equipment side of the business yet. I think this quarter is probably not indicative of future quarters, so we're still cautious about the future outlook, but the book is filling, and it is maybe not filling as rapidly as we would like it to, but we're excited about this new technology and this new piece of equipment that QED has introduced into the marketplace.

And that's already gone through alpha and beta testing, actually in the market being bought?

Oh, yes. We sold I think three of these pieces of equipment.

Okay. And final question. You continue to reference your barrier slurries as part of the copper slurry business. Can you give us an idea how big that business has gotten for you maybe as a percentage of copper revenues or some idea to help us quantify what this 11% sequential growth in the revenues was?

We may do that some time in the future. I don't have the specific breakout, and we haven't done that in the past instead focusing on growth rate because admittedly we have a relatively small position to date. I think if we continue to gain traction and acceptance from some of these I think there are 20 odd customers looking at this right now, to the extent we gain in that can be a more material part of our revenue, then we think about breaking that out separately, but I don't have that right in front of me right now.

Okay. Who is the number one player in that segment if you are not? Is it Plainer Solutions?

Yes, it is plainer. We don't like to talk about competitors. It is Plainer in this case. At least we believe it is Plainer, Dmitry, and, yes.

All right. Thank you very much. I will leave it at that. Thank you.

Thank you.

We'll take our next caller, please.

Our next question will come from the line of Chris Kapsch from BDR Research. Please proceed.

Just had some follow-up questions. One on the sequential margin performance. I understand the benefit from good manufacturing variances and your manufacturing yields and Six Sigma efforts and so forth, also the continued growth in the pad business, but you didn't mention tungsten as a benefit to margins. I am wondering if that was a contributor sequentially.

Clearly we had a richer mix this quarter and that did have a positive impact on our gross margins.

Okay. And then just one quick follow-up on the Epoch business. I understand that's primarily copper slurries. Is it just bulk and soft landing or is there also some barrier technology in that business?

I don't think we think of it that way, and we're quickly going to begin to stop talking about Epoch as a separate entity of Cabot Microelectronics. The products that we market and sell around the world, we sell barrier products. We sell bulk, soft landing, and STI products. The business of Epoch had us as we have said had a great position in copper, and essentially all the copper products that are sold to the market today in Taiwan and several other locations outside of Taiwan, so I think that's close as I am going to come to answering a question.

Okay. And then just one follow-up on the raw material threshold rebate essentially. I am guessing the street doesn't really give you credit for that in terms of the quarterly number. Some could debate that. I am wondering given the increased visibility on a look forward basis, is there any way, you know, that you can anticipate better this year hitting that threshold maybe accruing the benefit from that so they don't have to exclude it one time?

Yes. In fact, really, the tact that we got the credit, that's an unusual item, and really a function of the extreme volatility in the business last year, so volumes were very low in the first half of the fiscal year. They picked up of course in the second half of the fiscal year, and we based this on a calendar volume, so we took relatively low volumes in the first half of the year and so we're accruing as a higher price with a strong end of the calendar year that put us into a lower price tier and so there was a true up. It was only because of this extreme volatility in the industry and our business last year that drove this. This is not something that we would normally see, and so normally pricing should track more appropriately with volume. This is an unusual event.

The fact that you're a September year and your suppliers probably supply agreement was probably based on calendar year, right, so the true up comes in your first fiscal quarter, but for 2010, given the general strength of the industry, your currently accruing at a more beneficial sort of cost of those raw materials, I assume, is that what you're saying?

You're right about the calendar year for the contract, and it is an unusual item. I don't think we have ever seen anything like this before and again a function of the wide swings last year and we haven't seen that before given the stability we're seeing, improved stability. We probably wouldn't expect that this year. We would accrue and accrue the pricing appropriate to the volume throughout the year.

I get it. Thank you.

Thanks, Chris. I think we have time for one more question now.

Our question will come from the line of Steve O'Rourke from Deutsche Bank. Please proceed.

Thank you. Good morning. Bill, a question, Applied Materials I think announced in November a new CMP tool they're introducing which they say will substantially reduce use of consumables. Do you have any comment on what that could do to the use of consumables and how it might impact slurry usage going forward?

Sure, Steve. As you know, we work with all the tool suppliers, and we work closely. The tool is called a GT tool. We're aware of about four of them or a handful that are in the field today in sort of R&D applications target at the 32-nanometer node and below. It is another one of these announcements about a tool that can reduce slurry flow. You think about the 4,000 or so tools that are in the field today. I don't think it has any meaningful impact in the near term on the slurry business or the pad business, and we'll see where it goes. As you know, we have seen these tools come and go before.

In some ways for us it is an opportunity. It is another pad opportunity. It is some more slurry. We don't look at it as a totally a negative thing. Our customers go to 32 and 22-nanometers, they're looking for ways to drive costs out of their process, and if a tool like this can help them, we want to be part of that and work with the supplier to help our customers, but I don't think we'll see an impact from this tool. You call it when 32-nanometer technology is going to come online. Is that going to be 2013, 2014, or 2015.

So I don't think we should be worried about it. I don't think anybody should be worried about it in the near term. At least for the next couple of years. First, it has to be demonstrated whether it is actually successful and then second it will take a long time for a tool like that to have any meaningful impact the overall or total slurry sales in the world today.

Fair enough. And just to follow up on the D200 pads. I know you talked a bit about those. They're in qualification now. Any update on timing of qualification, your expectation for that and when it could transition to production.

I stuck my foot in that before, Steve, and I am not going to do it again.

Fair enough.

The thing is, you know this as well as we do. We don't really control the pace of qualification. Our customers do. We came through a really vicious cycle last year, a sharp downturn and a very rapid up turn. And so we are always dealing with things like engineer availability at our customers and tool availability at our customers, so there is too many uncertainties to predict when a qual will go to HVM with one of our customers.

One last question. Tax rate was a bit lower this quarter. Could you explain why and how should we look at tax rate for the rest of the year?

Actually it was higher, I think about 34.7%, something like that. Really, a couple of impacts there. One is tax exempt interest with interest rates coming down. We have significant cash invested in tax free investments, and really not earning much right now, so there is a little of that benefit. In addition, another tax benefit we take advantage of the research and experimentation tax credit, R&E, expired December 31st, and until or if that's renewed, then we don't recognize that benefit that we have enjoyed over the past several years. So those the two factor that is kind of affect our tax rate and both of those credits are relatively limited right now.

How should we look at taxes for the rest of the year, roughly a 35% range?

Yeah, the tax rate that we use for the quarter is an expectation for the full year, so that, whatever the tax rate was, 34.7% or so you ought to think around that for a range for the year.

Great. Thank you.

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

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.