CMC Materials, Inc. (CCMP) 2011 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the First Quarter 2011 Cabot Microelectronics Earnings Conference Call. (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.

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 2011, which ended December 31, 2010. A copy of our earnings release is available in the Investor Relations section of our website Cabotcmp.com or by calling our Investor Relations office at 630-499-2600.

A webcast of today's conference call and the script of this morning's formal comments will also be available on our website. 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 our 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, 2010. 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 record financial results for our first fiscal quarter of 2011 which continues the strong positive momentum we experienced in fiscal 2010. In our view, the continued execution of our strategic initiatives has enhanced our competitive standing in the marketplace and our financial discipline has improved our profitability. Our record financial performance this quarter was driven by strong demand for our products with record quarterly revenue for our data storage and tungsten slurries. In addition, solid productivity improvements and high manufacturing capacity utilization drove increased profitability. Overall, we are encouraged by the strong start to what has the potential to be another impressive year for Cabot Microelectronics.

A few weeks ago, I participated in SEMI's Industry Strategy Symposium in Half Moon Bay, California and I was encouraged by the general optimism that I observed at this event. Following a very strong year for the semiconductor industry in 2010, companies and industry analysts are predicting other solid year in 2011 with annual semiconductor revenue growth estimates generally in the range of 5% to 10%. We expect corporate and enterprise IT spending to continue to drive a significant portion of semiconductor device demand and recent strong announcements from Intel and IBM bode well for this area.

Along with demand from this traditional segment, we expect increasingly important semiconductor market growth drivers in 2011 to include wireless multi-media platforms such as smartphones and tablets as well as connected home devices.

In addition, an increasing amount of semiconductor content is being added to automobiles in areas such as information and entertainment systems, power trains, fuel efficiency and safety mechanisms. As a supplier to all of the semiconductor manufacturers in the world, we are a beneficiary of the strong growth trends in these areas. In general, as worldwide semiconductor production increases, we expect CMP consumables demand to also increase regardless of the type of electronic systems for which these devices are manufactured.

Further, increasing semiconductor content with an electronic systems is driving additional chip demand. According to research firm IC Insights, semiconductor content reached an all-time high in 2010 with semiconductor content representing approximately 25% of the total cost of electronic systems. This is a 2.3 percentage point increase from the prior peak in 2006. In addition, a number of surveys by industry analysts show normal levels of semiconductor inventory within the supply chain.

Although we have historically experienced seasonal softening in the March quarter, we remain optimistic regarding the demand outlook for our full fiscal year. Last year we discussed how high capacity utilization at our customers had the potential to limit growth of semiconductor production which in turn could limit the growth in demand for CMP consumables.

In the second half of 2010, some of our customers started to bring new capacity on line and we see this trend continuing and accelerating through 2011. Certain industry analysts are predicting that semiconductor manufacturing capacity will grow by almost 10% in 2011, which would help to ease production constraints and provide room for long-term growth in global CMP consumables demand.

Turning now to company-related matters, we continue to develop our focused strategy of strengthening and growing our core CMP consumables business through the execution of our strategic initiatives. Historically, we have described these initiatives as technology leadership, operations excellence and connecting with customers. Over the past year or so, we have modified our mission and vision statements to become more customer-centric, while still focusing on technology and operational efficiency.

In light of this modification, our strategic initiatives have also evolved. And, I would now like to update you on this evolution and how we are executing on these initiatives. Expanding upon our technology leadership initiative, we are now focusing our development efforts on providing solutions to our customers. This involves a more customer-oriented approach to product development. Like before, we continue to collaborate early with our customers through joint development agreements and other less formal arrangements. We also continue to develop product platform that can be tuned to fit our customers' specific needs. The evolution of this initiative is that we are expanding upon our collaboration with customers to encompass not only the products we sell, but also to give greater consideration to the process in which they are integrated within our customers' operations.

Our goal is to provide innovative customized solutions while delivering superior cost of ownership and ease of use to our customers. Let me now provide a recent example of our progress on this initiative. As you know we are in the process of alpha testing our second generation polishing pad platform the Epic D200. This pad platform is unique in that it allows us to tune the hardness, porosity and pore size of the pad so it can be optimized for our customers' unique polishing needs.

Recently we have made progress in the commercialization of this new product platform. A couple of the companies alpha testing our D200 pads have advanced their evaluations and we believe we are near our first D200 qualification decision for an advanced node application. Meaningful revenue from this new pad platform is certainly several quarters away but we are encouraged to see this type of progress.

At the same time we continue to advance the adoption of our D100 pad products. This quarter we were successful in winning business with three new customers. We continue to believe that our pad business represents the most significant organic growth opportunity for our company and we are pleased to supply our pads to approximately 25 customers worldwide. Three of these customers are among the 10 largest semiconductor manufacturers in the world, in term of semiconductor revenue.

On the CMP slurry side of our business we have launched a number of new products across each of our slurry application areas, which we believe positions us well at advanced technology nodes. Earlier this week we announced our Novus A7000 series aluminum slurry product, which has been gaining traction with our technology leading customers over the past year. Although the aluminum slurry market is currently small, we expect this emerging application to grow significantly over the next several years as our customers increase their sales of advanced technology node products.

Next I would like to discuss the evolution of our operations excellence initiative. In parallel with our traditional focus on productivity improvement and variation reduction, we are also looking to differentiate our business in the eyes of our customers through our robust quality and supply chain management systems. Our ability to consistently supply high quality products with on-time delivery is a key reason why our customers choose to partner with us.

In this business, a supply interruption can cost our customers millions of dollars in yield or lost business. So, IC device manufacturers are very cautious and deliberate when evaluating suppliers and their products. As the leader in CMP slurries we have the experience, scale and infrastructure to invest in and develop robust quality systems and we have made it a key component of our culture and way of doing business.

We believe that numerous customer awards that we have received are a reflection of this commitment to quality. Over the past several quarters we have seen increasing momentum in demand for our products. Compared to our pre-recession peak, our quarterly revenue was up nearly 20% and our diluted EPS is up almost 40%.

To enhance our ability to meet our customers' demand, we are actively expanding our manufacturing capacity, particularly in the Asia-Pacific region where we derive approximately 80% of our revenue. To optimize our investment in capacity, we are installing additional production equipment within our existing facilities in Japan and Singapore. We also recently began construction of a manufacturing and research and development center in South Korea which is the second largest market for CMP consumables.

This new, 56,000 square foot facility is expected to be completed by the end of the calendar year at a cost of approximately $12 million. Initially, we plan to utilize this facility to develop and manufacture advanced dielectric CMP slurry products, which represents a strategic application that we are looking to further develop and grow. The facility is also designed for further expansion to support additional CMP consumables products, as needed.

I mentioned earlier that our new vision and mission statements are now more customer-centric. Therefore, our Connecting with Customers initiative is embedded in all that we do here at Cabot Microelectronics. From collaborating with customers on developing solutions to ensuring that our customers receive consistent quality products and services at a low cost of ownership, our focus is to continue to build on the trust that we have earned with our customers.

Being physically close to our customers and interacting with them in the same language and customs which -- with which they are comfortable, is key to developing strong relationships and forming lasting partnerships. For example, by moving our data storage business to Singapore in 2005, we enhanced our capability to serve our data storage customers located in Southeast Asia. Over the past year, we successfully utilized our capabilities in the region and won business with three new data storage customers. These new business wins, combined with solid seasonal strength have resulted in record quarterly revenue for our data storage business.

Given the importance of customer relationships and trust to our overall growth strategy, our recent inroads in South Korea, Singapore and Taiwan are great examples of our efforts to grow our presence in Asia. Our new facility under construction marks South Korea as the fourth country in the Asia-Pacific region where we have a manufacturing, and research and development presence. We believe this is a significant competitive advantage for the company and is valued by our customer base.

Concluding my remarks today, we are very pleased with our record financial results and progress in executing our strategy. Two years ago, we had a vision to emerge from the recession a stronger company. We leveraged the flexibility of our manufacturing operations; we continued to invest in and develop leading edge solutions; we retained our intellectual capital and we maintained our focus on the importance of customers and the relationships we hold with them.

Fast-forward to today and I believe we have been successful in building a stronger company and enhancing our competitive position. We are clearly outperforming pre-recession levels of revenue, gross profit margin and earnings per share. And we look forward to building on this positive momentum in the future. And with that I'll turn the call over to Bill.

Thanks, Bill. Good morning, everyone. Revenue for the first quarter of fiscal 2011 was a record $114.2 million, which was up by 16.9% from the first quarter of last year and up 3.5% from the prior quarter. The increase in revenue from the same quarter last year reflects increased demand across each of our business areas. Compared to the prior quarter, revenue increased within each of our business areas except CMP slurries for copper and dielectric applications.

Drilling down into revenue by business area, tungsten slurries contributed 36.7% of total quarterly revenue and revenue -- with revenue up 16.4% from the same quarter a year ago, and up 3.9% sequentially reflecting strong demand from the memory segment. Sales of copper products represented 18% of our total revenue and increased 18.5% from the same quarter last year and decreased 2.5% sequentially. Also, included in our copper business is our barrier removal product line revenue from which increased 5.8% sequentially.

Dielectric slurries provided 27.3% of our revenue this quarter with sales up 16.2% from the same quarter a year ago and down 1.6% sequentially. Data storage slurry products represented 6.2% of our quarterly revenue. This revenue was up 17.2% from the same quarter last year, and up 45.1% sequentially, which reflects several important customer wins, as Bill mentioned earlier. Sales of our polishing pads represented 7.3% of our total revenue for the quarter and increased 25.9% from the same quarter last year, and 1.6% sequentially. Finally, revenue from our ESF business which includes QED generated 4.5% of our total sales, and was up 6.2% from the same quarter last year and up 24.1% sequentially.

Our gross profit this quarter represented 50.3% of revenue which is slightly above our guidance range of 48% to 50% of revenue for full fiscal year 2011. This is down from 51.6% in the same quarter a year ago, and up from 48.7% in the prior quarter. Compared to the year ago quarter, gross profit percentage decreased primarily due to the absence of a $1.6 million raw material supplier credit that we recognized in the first quarter of fiscal 2010 as well as higher fixed manufacturing costs, partially offset by the benefit of increased utilization of our manufacturing capacity. The increase in gross profit percentage versus the previous quarter was primarily due to increased utilization of our manufacturing capacity.

Now, I'll turn to operating expenses which include research, development and technical, selling and marketing, and general and administrative costs. Operating expenses this quarter of $33 million were $2.9 million higher than the $30.1 million reported in the first quarter of fiscal 2010. The increase was primarily driven by higher staffing-related costs and travel expenses, partially offset by lower professional fees including costs to enforce our intellectual property.

This quarter our operating expenses included $1.1 million in benefit expenses associated with a cash payment of our variable incentive compensation related to fiscal 2010 performance and, as such, should not represent a recurring cost at this level. Operating expenses were approximately $300,000 higher than the $32.7 million reported in the previous quarter, mainly due to higher staffing-related costs, partially offset by decreased professional fees including costs to enforce our intellectual property.

For full fiscal year 2010, we expect our operating expenses to be near the upper end of our guidance range of $125 million to $130 million. Diluted earnings per share were a record $0.71 this quarter which is up from $0.56 reported in the first quarter of fiscal 2010 on higher revenue and a lower effective tax rate, partially offset by higher operating expenses. Compared to the previous quarter, diluted EPS was up from $0.66 mainly due to the higher level of sales and gross profit margin.

Turning now to cash and balance sheet-related items, capital spending for the quarter was $3.3 million, depreciation and amortization expense was $6.1 million and share-based compensation expense was $3.4 million. In addition, we purchased $10 million of our stock during the quarter under our $75 million share repurchase program which now has $15 million remaining. We ended the quarter with a cash balance of $263 million.

As previously announced, in recognition of our robust cash generating business model and belief in the long-term value of our business, our Board of Directors authorized a $125 million share repurchase program in November which represents our fourth and largest program. We also continue to look for ways to productively redeploy our cash in our business, such as through capital investments and acquisitions, as that remains our top priority for our cash.

I'll 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 a demand for our CMP consumables products increase slightly month-to-month throughout the quarter. As we observe orders for our CMP consumables products received to date in January, though we expect to ship by the end of the month, we see January results trending slightly lower than the average rate in our first fiscal quarter. 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'll turn the call back to the operator as we prepare to take your questions.

(Operator Instructions) And your first question comes from the line of Avinash Kant from D.A. Davidson & Company. Please proceed.

Good morning, everyone.

Good morning, Avinash.

A few questions. So clearly it looks like some of the capital spending announcements that we have seen from various chip companies seems to be pretty strong. Would you venture into kind of giving us some outlook or some expectation that you have for the year at this point in terms of wafer starts?

You want to take that?

We were happy with the revenue growth sequentially in -- and we increased our revenue 3.5% in light of what is normally a seasonally soft quarter. We did see some seasonality though within our business areas. Our copper and dielectric slurry decreased sequentially, but that was more than overcome by strong tungsten CMP slurry growth, as well as QED and data storage. So the quarter was not without some seasonality, but some strengthened -- our other business areas kind of overcame that.

We don't put a lot of attention into near-term forecasts of wafer starts. I think long-term our view is units, semiconductor units, grow at a 9% to 11% rate, you know, through cycles. We're encouraged by some of the strength we've seen recently. TSMC just announced this morning an expectation of some seasonality in the March quarter but lower seasonality than perhaps traditionally. I think they guided to down 3.9 -- 3.8% or 3.9%, and normal seasonality might be 5%. So some of the big players may be expecting better than seasonal results, but I don't think we could give you specific numbers for the full fiscal year. We do have a relatively optimistic outlook, though.

We can give you some qualitative observations, if you will. We see in all of our large customers, including TSMC, Intel, Samsung, and GLOBALFOUNDRIES all increase their capital spending estimates for the year, which bodes well for increased wafer starts.

You know, the emergence of this -- the wireless, what is being called wireless multimedia devices, particularly the tablets, is driving additional growth that we think will definitely help the year, and we saw the recent announcements from Intel and IBM both suggesting that enterprise spending, or maybe pent-up enterprise spending, has accelerated and will continue through the year. I think all those things will be good for the industry and good for Cabot Microelectronics from a CMP consumables point of view.

Right. Two other questions, one on the margin side. Clearly margins are pretty strong this quarter. Was it just -- revenues are not much higher than the previous quarter. So what was the reason for the upside in margins on a sequential basis?

If you look at our gross profit margin, it increased 1.6 percentage points on 3.5 -- 3.5% higher revenue. So, right, the margin increase was -- outpaced the revenue growth.

The single largest driver for the increase in gross profit was higher production volumes, and so increased utilization of manufacturing capacity, but we did see a benefit this quarter like we've talked about occasionally, where during the quarter we're actually selling products that may have been produced in the prior quarter. And these were lower unit cost products in general, because we have been operating at a relatively high utilization rate the last several quarters. So you may remember that on our fourth fiscal quarter, we talked about a bit selling through of higher unit cost products that depressed margin a bit in our fourth fiscal quarter of 2010. We saw a benefit in the first quarter of 2011 as we sold through lower unit cost materials, and that helped to lift gross margin a bit.

So would you say you have much of the lower cost materials left in your inventory right now, or is it pretty stable right now?

We've had for the last now, five quarters relatively strong performance, so this -- this swing of lower to higher unit cost products has been diminished maybe relative to more volatile periods, but we have been running relatively hard for the last several quarters, so there is probably less of that in this environment than you might expect in a more volatile one.

And the final question, Bill, of course, is, in the past business, it seems to be growing steadily, but given that you have signed up some three new customers you talked about and the qualification activity has been going on strong, what do you expect from it, what kind of growth should we think of from the past business?

Well, Avinash, we would like to grow the business as fast as we can, and that is -- you know, we have internal targets to grow as quickly as we can. We're limited by our customers. A pad qual is somewhat of a difficult and expensive qual. Same things that, you know -- there's strong demand and the high utilization right now has been great for fueling our Company's financial results, but it has somewhat slowed down our ability to do qualifications at HVM.

That being said, we're delighted to have won three new customers this quarter. You know, we have, by best count, 25 customers now that buy our pads. We have aggressive internal targets for what we're trying to achieve in the pad market. We have not shared them externally, but we see it as the single largest organic growth opportunity for our Company, and we're pursuing it as aggressively as we can.

I would assume that your expectations have improved over time compared to the last one, over time, or have they stayed the same? How would you say?

Well, so far we're happy with our D100 pad and its introduction into the marketplace. We're at the sort of early stages of introducing our second generation technology, which opens up a bigger portion of the pad market to us, given the tunability and flexibility of our D200 technology. I guess I could generally say we're more optimistic about our ability to be a significant player in the pad market. We are now the number two pad supplier to the CMP consumables market and our customers, and we just hope to, you know, gain our fair share of the market as we go forward. And our ability, like the rest of our core CMP business, our ability to innovate and bring new products to the market will be critical to our ongoing success.

Here is another reference point. We have established manufacturing capacity to produce the blank intermediate pads that would represent around 30% of the market. So we're well equipped to handle growth as it comes and have high expectations.

Perfect. Thank you so much.

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

Good morning, gentlemen. Congratulations on getting the year off to a solid start. Couple of questions -- first of all, you touched on it a couple of times but I just want to make sure I understand what the differences were in the quarter-to-quarter variability in growth rates. You had copper and dielectric being down a couple of percentage points. Everything else was up, you know, tungsten was up about 4%, I guess, that's the closest pure comp if you will that we can use. So was that just -- I mean, you talked about the memory market being strong, but doesn't memory also take dielectrics? I'm just trying to understand why the dielectric market was down together with copper but not with tungsten?

Typically, you would expect to see tungsten and dielectric to move roughly in line because, you're right, they're heavy usage, particularly heavy usage in memory. But we do have kind of variations for really unexplained reasons quarter-to-quarter, month-to-month among the various products, and this time we had relatively strong tungsten compared to dielectrics.

If you look back a couple of quarters, we had a similar period where actually we had lower than expected, perhaps, growth in tungsten, and then after a couple of quarters of that there is a catch-up in tungsten. So the order patterns tend to move in parallel but not in lock-step. And here is an example of that, I think.

So nothing more granular than that? Just variances in the quarter-to-quarter order patterns?

That's correct.

Okay. The new customers -- the new customer wins that you got in the data business which drove [3]5% sequential improvement in revenues. Are we looking at the new run rate for revenues in this business? Obviously with variations around it, or was this a one-time supply and then we should go back to kind of the old quarterly run rates in term of revenues?

Well, I think we should probably wait a couple of quarters to see what the new run rate might be. The data storage business is a very different business than our traditional IC business. It moves very quickly, and the business is much more open to new products and changes. We feel very comfortable and happy about these three new wins. It sort of validates our strategy to move closer to customers. As we talked about in our script, in 2005 we moved our -- picked up our whole team and all the infrastructure to support it and moved it to Singapore, where the bulk of our customers manufacture products. And I think that enabled us, because of our closeness, to get these three new wins.

We'll have to see, Dmitry, I think it is pretty new. We'll have to see how sticky these wins are and whether or not we can -- like I said before, we can come back into the market with next generation products that will continue to meet the demands in this sector.

Also, in the short-term, there could be an element of a pipeline fill, when we have two new business opportunities, there is some inventory that may need to be established at the customer. So you may see a little bit of pull back after a really strong quarter, even with consistent sales to those companies.

Got you. Okay. Now these three customers, my understanding was that this industry is fairly consolidated. Are these specialty customers, or are these customers that you're selling to already but these are just kind of three new projects that you won?

No, these are three new customers that manufacture hard disk drives or rigid disks, that we had been targeting for some time. So these are new customer wins.

Okay. Good. Can you update us on your initiatives in kind of the newer, for you at least, areas that you'll be trying to penetrate? Like you mentioned the barrier slurry, the business in copper that you've highlighted for us, the growth rate. And how shallow-trench isolation and your attempts to get into prime wafer polishing, kind of where do we stand in your ability to penetrate that market and, you know, when can we see the positive impact of that, hopefully on the bottom line or the top line, for that matter?

Well, I'll start out by talking about substrate polishing, and I'll ask Bill to field the dielectric and barrier question. We have inside our initiative that we call engineered surface finishes, we have a team of scientists and engineers that are working on developing solutions for the wafer polish industry. We have been at it now for probably a year and a half. We have some trials ongoing.

It's been, you know, it's been as usual, we find that from start to finish, it's either 18 months to 24 months for us to penetrate one of these markets, one of these applications, so I would tell you we're on track. That industry is a bit of a slower-moving industry than what we're used to. That being said, we think we have some high-value solutions to bring to bear there that reduce our customers' costs as well as increase their performance. I mean, we can pursue that application.

In barrier -- well, when we talk about growth opportunities, where we have the opportunity in the CMP space to grow in excess of market, the biggest organic growth opportunity is pads. But there are two areas where we have been historically underrepresented, and that's barrier slurries and advanced dielectric slurries. In the barrier market, we have a relatively small share of roughly a $100 million market, and so there is an opportunity there.

We have a number of ongoing customer evaluations with new barrier products, and some of these are progressing. It is just like Bill talked about with the qualification of pads. We're less of a big established player in barrier, despite our overall market leadership in CMP slurries, and the qualifications take time. So we need to continue to work with these customers and develop these evaluations.

I would say the same thing in the advanced dielectrics area. Again, another market that is roughly $100 million, something like that, and we have less than a 10% share, so it's a big opportunity for us to get a more representative share, but the qualifications take time. We have a range of new products that they're under evaluation in a number of places, and we just need to keep working through that qualification process.

So it sounds like to the extent that you will be getting some reasonable revenues out of these businesses incremental to what you are already getting, it may be more kind of second half of this year or maybe even fiscal 2012 before you start seeing something.

I think that is probably a fair estimate.

It is a long sale process and it's really difficult to point to any particular time frame. We view it as an opportunity where we're underrepresented and we have the capabilities to do better in both of those areas, so it is an area of focus.

Got you. That is helpful.

Switching gears on the pad business, you talked about that being your biggest opportunity, you know, your D200 pad is making its way through the qualification process. Is it basically going to be using same manufacturing facilities both in Illinois as well as the grooving facilities that you have with customers, or are you going to have to spend some incremental capital to get some different pieces of equipment to be able to produce this pad?

In general, we use all the same equipment. We use some ancillary equipment to produce the raw material pad, but it is insignificant from a capital point of view, Dmitry.

Hopefully this pad will have as good if not better unit margin than the D100 pad, so that there can be a little bit of, as the take-up begins, there would be a little bit of a positive mix-shift as well?

Well, we would hope so, given the technical sophistication of this material and its ability to be customized. We would hope that we could price accordingly to return some of that value. This pad can be tuned pretty aggressively to meet very specific needs on the platen. We think that brings value. As you know, we try to price for value. And we'll see what we can do.

I would caution us all. I've gotten out in front of the pad business before. I don't want to do it again. We are at the early stages of commercializing D200. We're delighted with where we are. We have about seven customers that are looking at it. We think we're closed to a POR with our D200 pad. But I think we have several more quarters of trials and qualifications to go through before we can start talking about meaningful revenue contribution from our D200 pad.

Got you. That is helpful.

Question on -- kind of continuing with the pad business, you know, you have been at it for several quarters, you're gaining meaningful market share. As you said, you're a number two player now in the industry. Any new developments in terms of competitive response or how the industry is looking at, you know, you versus the entrenched player, anything changing that's making your life easier or harder in penetrating the pad market?

Well, we typically don't talk about competitors. You could expect that we're seeing -- what I would describe as a normal competitive reaction to a new entrance into a market that's been sort of locked up for a long time. You know, we envisioned a fairly significant competitive response in our plan, our long-range plan and our business plan for this business and, you know, we're seeing it.

And, you know, I think what's important for us is that our -- we're selling our pad on performance and value. We're not selling it on cost and price, and, you know, our pad has clearly demonstrated its ability to provide longer pad life and in many cases higher yields and better pad-to-pad consistency, and we're sticking there and we're selling there and we're valuing there, and that will hold up. We think we'll have this same differentiated value proposition on our D200 pad and avoid the whole discussion about unit price and unit cost.

That being said, however, we're getting -- this is the semiconductor industry, we get pressure from our customers all the time to find ways to lower their cost of ownership, and we're working our way through it. In the meantime, our yields continue to increase. And our gross margins continue to grow as our volume grows. So we think we're on plan and on track.

Very good. Very good.

And then the final question, can you update us on what's going on with the lawsuit with DA NanoMaterials, you know, your costs have gone down in this quarter compared to previous quarters, but kind of what's the status and when can we expect maybe a resurgence of higher cost quarters?

We're currently in the appeal process. And as we've talked about in the past, we expect that our costs through this appeal process would be relatively low. There is no preparation or execution of a jury trial.

We filed our appeal brief, and that's public, last week. We expect DA Nano will reply by early March, and then we'll have the opportunity to reply to their filing. After that, the circuit court would set arguments, and this would play out over an extended period of time. I think we're comfortable that in this appeal process we're not spending money at the run rate that we had been during the last fiscal year.

Okay. Is there any hope that this can get settled like you've settled your problems with, you know, Rohm and Haas back in the day, and without the further court involvement, or has the relationship deteriorated to where really the court is the only answer?

Well, Dmitry, we don't see ourselves as an adversarial litigious company, and we always look for an opportunity to settle these sorts of things. If that opportunity presents itself, we're certainly open to consider it. But right now we're in the appeal process, and we'll see where that goes.

Fair enough, Bill. Thank you very much. That's all I got.

We'll take our next caller, please.

Your next question comes from the line of Paul Leming from Soleil Securities. Please proceed.

Good morning, and thanks for taking my questions. And I would add my congratulations on a great quarter.

I wanted to drill down a bit further into the strong performance in tungsten in the quarter. You mentioned that you did well in memory, or memory did well in the quarter, but as I look at the SIA data for the December quarter, looks to me like the memory market units were pretty weak in the December quarter. So was wondering if you could provide any color as to whether or not you think you gained share in memory, or if we're just seeing a very typical kind of quarter-to-quarter noise, as perhaps your mix of customers bought a little heavier this quarter or not. Did you really see any shifts in the marketplace in the quarter, or is this perhaps some of the noise that you referenced occurring a few quarters back?

There's always a bit of noise, month-to-month, quarter to quarter. So it's hard to draw, you know, any real firm conclusions. But when we think about our tungsten business, we have a very strong competitive position, you know, excellent technology position, and we've developed some, you know, really robust new products that build upon our robust historical legacy products. So we think we're building strength on strength. So this could represent, you know, some increase in share. I think we would have to watch this over time to sort of confirm that. But we feel, you know, very good about our tungsten business.

Fair enough. The second question I wanted to ask is, you mentioned in your remarks the raw materials supplier credit in last year's first quarter, and I just want to be sure I understand the comment correctly on the -- you really had a, if you will, positive credit of $1.6 million in cost of goods last year in the first quarter related to some raw material issues, it's just that straightforward?

Yes, that's correct. In the first quarter of fiscal 2010, we had a gross profit margin of 51.6% of revenue. But if you strip out that $1.6 million supplier credit, it was around 50.1%, and that is probably a more comparative level to compare against results in the first quarter of 2011.

During calendar 2009 there was a lot of volatility due to the global recession, so we had a real soft first half of the year and a real strong second half of the year, and that caused some -- resulted in this credit, because we have some volume-based price tiering, and so we had this adjustment in the December quarter of last year. We don't have that this year. But it was sort of an unusual item based on the volatility of the market in 2009.

I apologize for doing the arithmetic on the call, but you said adjusting for that, it would have taken your gross margin down to, I think you said, 50.2%, something like that. 1.6 million -- oh, I just found the mistake I was doing. I apologize. Let me move on to another question.

Okay.

Just wanted to touch base on share-based compensation. There seems to be some seasonality in that, that it's a bigger number in the first half of the year, your fiscal year, than in the second half of the year. Is there really kind of any underlying reason for that, or am I looking at something that maybe at the end of the day just is kind of coincidental over the last few years?

No, it's -- there's no -- shouldn't be any real seasonality. There are some adjustments occasionally. When you calculate share-based compensation, you have to assume a forfeiture rate of the awards. And after all of the awards vest for a particular grant period, depending upon the actual forfeiture versus that assumed forfeiture, then you have to do a true-up. And periodically we've seen a true-up in the December quarter, based on how forfeitures actually play out versus the assumed playout. So that has been something that's caused some fluctuations in the past.

Fair enough.

But in terms of our equity-based compensation, the processes around that have been relatively consistent for the past several years, so it is only these sort of accounting adjustments that might drive some significant changes.

Fair enough. Those were all of my questions. Thanks very much.

Thanks, Paul.

We'll take our next question, please.

And your next question comes from the line of Jay Harris from Goldsmith & Harris. Please proceed.

Good morning, gentlemen. First question is on the -- what I thought you were referring to as a bonus pool charge in the first quarter, of $1.1 million, is that bonus pool for last year, or is it something else?

Yes, that's for last year. Throughout the fiscal year and fiscal year 2010, based on strong performance versus Company goals, on a quarterly basis we accrued for the annual bonus that's actually paid in cash in December, when you actually -- and it was a relatively healthy bonus, given strong performance against goals.

When you actually pay that cash bonus, there is some employer-paid fringe expenses associated with that. In the US, it is a 401(k) match, and in overseas locations it could be a pension contribution. But there was about $1.1 million of operating expense, and there was also a little bit in cost of goods sold related to fringe expense associated with the cash payment of that bonus in December.

So what we're doing going forward is we're going to accrue that sort of fringe expense as we accrue bonus through the year. So this is sort of a spike in costs that we wouldn't really expect going forward.

This is the second time in several years where this has occurred. So you're going to switch to just taking a percentage of pre-tax profits going into bonus pool?

No, no, no. Our bonus process is not changing. It is only the process by which we will accrue the fringe expense that's attached to this bonus.

But what you're referring to, maybe a couple of years ago, based on very strong performance in the second half of the year, we had larger bonus accruals in the third and fourth fiscal quarter because of this strong performance in the second half of the year. But our annual incentive plan or program, our annual cash bonus process has been relatively consistent over the past several years.

In other words, you're just going to take a larger percentage of pre-tax profits as an accrual for the bonus pool going forward?

No, no, what we do, we set targets, and based on performance against those targets, we'll set a bonus pool and we'll accrue for that. This is sort of a second order effect. There is around an 8% or so fringe expense.

Why don't you just fold that into the accruals for the bonus pool?

That's what we're doing going forward. This was a significant item in 2010, and so we will do that going forward.

Sorry to beat it to death.

Second question -- your new aluminum slurry, I heard the comments in the -- comments made on it. It was a great scientific breakthrough but a very small market. Where are -- where is aluminum used in semiconductor manufacture, other than in memory devices?

Well, it's beginning to be used to enable advanced High-K and Metal Gate device integration schemes, Jay. I think -- let me take you back to our Investor Day. We talked about the -- it's a very small market but a very high growth rate of 60% to 70% between 2010 and 2013.

So if you can imagine the High-K and Metal Gates are only being incorporated at the leading edge technology sort of sub-45 nanometer, so as those applications and those nodes come into the market and get commercialized and begin to proliferate, we would expect the aluminum CMP market to grow.

We truly have a unique product here. We already have a second generation product, which we believe is significantly better than the first product we brought to market. So we're, you know, we're happy to be right up at the leading edge of this technology and the incorporation of this technology. And we'll see where it goes. We're expecting some fairly high growth rates, but starting from a very low base.

What do you think, looking out five years, the fab expenditures on -- for kinds of applications are likely to be?

I think it's difficult to predict the incorporation of High-K and Metal Gate technology. It is a single-pass CMP application at the transition level. It may over time evolve into a multiple-pass application, but right now we see it as a single-pass application. It's designed to remove aluminum in the complex stack of metals within the transistor gates. I think, Jay, it would be -- it wouldn't be right for me to predict a target five years out. Because we don't control the rate at which our customers incorporate these technologies.

I didn't really mean a target for your company, but a target for all suppliers. In other words, how big a marketplace is this likely to be?

Well, we see -- I was going to say all -- but most of the leading edge technology developers are moving to High-K and Metal Gate technology at the transistor level. So we think this will be a successful technology going forward, and we think we're really well positioned to take advantage of it.

Very interesting.

Finally, on your pad business, I'd like to hear a little discussion about -- either in terms of absolute terms or relative terms -- where you think the margin structure on your pad business could go to when it grows up, and where are you on this scale at this point in time?

Well, we've said many times before, we would expect the gross margins for our pad business to be approximately at the same level of the margins we enjoy in our core CMP slurry business. We are heading in that direction with our D100 technology, and we would expect the same for our D200 technology.

A couple of intermediate data points. The year that we had $15 million of revenue, we said we roughly broke even at a gross margin level, and then at $18 million the subsequent year, we said we had low double-digit gross profit margin and then kind of a run rate like we saw in fiscal 2010, we're sort of at a 40% gross margin. We probably won't give more visibility to that going forward, but there's two or three data points that might give an indication of how margins can improve with revenue.

And what is the total size of the pad market today?

We think it's about a $500 million market, Jay.

Okay. Very good. Thank you.

You're welcome.

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

And your next question comes from the line of Aaron Husock from Lanexa. Please proceed.

So there's been a large move in the Taiwanese dollar over the past couple of months. Can you tell us what percentage of your revenue is denominated in Taiwanese dollars, and how much of a benefit roughly are you thinking that will give you in Q1 -- I mean calendar Q1?

I think it's around 18% of our revenue or so is transacted in foreign exchanges -- currencies other than the US dollar. Most of that is yen-based. Most of the business we do throughout the world is US dollar-based. With the acquisition of Epoch, we gained some NT dollar-based revenue, but it is small relative to the yen. With the weakening dollar against both the yen and the NT dollar, we saw some benefit to revenue, but we also have yen and NT dollar-based costs.

There is a relatively even match. We actually had slightly larger costs that are foreign exchange denominated than revenue. So weakening of the US dollar helps revenue, but it hurts costs, and the net effect is relatively limited. So with -- the bigger driver has been the yen as opposed to the NT dollar, and probably sequentially maybe we lost a couple of cents of EPS as a result of the yen going from, say, 86 to -- 82 yen to the dollar, something like that. But the NT dollar effect is much smaller.

Okay. If we look at guidance from TSMC this morning, they're guiding -- their calendar Q1 sales down about 3% to 5% sequentially, but a piece of that is foreign currency making it worse for them. I think if we were to translate it into dollars, they would be guiding almost flat sequentially, so much better than normal seasonality for a March quarter.

You mentioned that your January was a little bit below the fiscal Q1 run rate. I mean, how are you thinking about kind of the historical correlation of your revenue to TSMC holding up? Do you think -- are you generally thinking that you'll be better than seasonal this March quarter along the lines of what they've guided for?

Just a couple of disclaimers. First of all, Bill said one month of a quarter doesn't necessarily predict the whole quarter. And we've seen that before many, many times.

The second thing -- the second data point I would share with you is, seven out of the last 10 years we experienced a sequential revenue decrease in the March quarter. That being said, TSMC represents about 18% of our revenue. They are a very big, large, important customer. You know, when they -- they're usually right about what they say.

I think we got a couple of things working here. We have the Chinese New Year, which starts next week -- Lunar New Year -- I'm sorry -- which starts next week and goes for 10 days, and that is typically a time of slowdown in the Asia-Pacific region. We'll just have to wait and see.

With the first fiscal quarter, our revenue was up as TSMC's was down. But, you know, some of the strength admittedly was non-IC related, data storage and QED. So those had an effect this quarter. And the correlation, you know, was strong but not perfect, obviously.

Okay. Great. Thank you.

Thanks, Aaron. We have time for one last caller.

And your last question comes from the line of Chris Kapsch from BDR Research Group. Please proceed.

Yes, hi, I had a question about the big picture comments about the capacity in the industry coming on, and I'm just wondering, I think you said, you know, industry pundits talking about 10% capacity growth.

And I was just wondering if you look at it from your bottoms-up customer-by-customer perspective, if you felt that -- if you could characterize that capacity growth. Is it more sort of technology buys versus capacity buys, is it more leading edge nodes versus sort of more middle of the road nodes, and even maybe characterize it, say, memory versus logic?

Man, I'm not -- Chris, that's an onion I'm not sure I want to peel this morning, because I'm not sure I have anything to add to it. We have seen, as you have seen, we've seen the large semiconductor manufacturers all increase their capital expenditure budgets for the year, and it's been kind of across the board. It's usually the big leaders. It's TSMC, Intel, Samsung, and GLOBALFOUNDRIES. So they're all spending and they're all trying to get capacity. We've seen people increase their capacity for 200-millimeter wafers as well as 300-millimeter wafers. So it is kind of hard for me to dig in there and give you an answer that has any substance.

From our perspective, we just like the increased wafer starts. It doesn't matter to us whether it is a 200-millimeter wafer or a 300-millimeter wafer, leading edge or lagging edge. We sell to all of them, and more capacity means more CMP consumables (technical difficulty).

So it's pretty broad-based. But just to follow up on that, whether it is 200 or 300, the capacity, it used to be like when new capacity like that ramped initially, chip producers would sort of have difficulty getting their desired yield, die yield from their wafers, which could lead to, you know, a disproportionate amount of consumables used in the process. I'm just wondering if that is sort of -- you know, an old scenario, or if they still have that challenge when they ramp new capacity.

No, I think that challenge still exists, and I actually believe it is becoming much more complex as the technology evolves and we go to these smaller and smaller feature sizes. And we will continue to see that yield challenge going from sort of R&D to high volume manufacturing. You know, this technology is getting really hard and really challenging.

Right.

You know, we'll see. But, you know, from our perspective, hard and challenging is kind of what we like and what we do, and, you know, I look forward to the challenge.

Right.

And then just to follow up on that thought is, in the context of your earlier comments about your, you know, more and more customer collaboration as being part of the strategic focus of the Company, I'm just wondering as these integration schemes for these chip makers get more and more complex at the leading edge, like the example you gave integrating the High-K or Metal Gate dielectrics, I'm just wondering if helping customers solve those more, you know, sophisticated integration challenges and collaborating with them gives -- if you feel like you're going to be in a position to actually gain share as the sort of the bulk of the industry shifts more and more towards those advanced nodes?

Well, I think and believe that we've positioned the Company and developed our resources in the Company to take advantage of that trend. You know, we have the advantage of scale. We are the largest CMP slurry provider, which enables us to sort of interface and collaborate with all the leading edge customers.

Which I think makes us, perhaps, gives us an advantage from a technology point of view, because we have a deep understanding of what our customers are trying to do, the materials they're trying to incorporate, and how they're trying to integrate all those materials in their integration schemes. You know, those collaborations from us, we go the full spectrum. We've had opportunities to sit at the table with chip designers and help them think through what capabilities we could give them through the CMP process that might enable them to do different designs on the chip or the wafer.

And then we go from that, which is kind of the best collaboration, all the way down to some customers, we still throw a bucket over the fence and they come back and tell us what they think about what is in the bucket. But we think the industry is moving to a much more collaborative model. We believe that because the technology is so complex and it is so difficult, that we can bring value to our customers in the form of collaboration and scientific engagement and, you know, we believe, again, that we've positioned the Company to be successful in that arena, and we would hope to gain share over time if we're successful in executing that business model.

Just shifting gears a little bit, just your investment in Korea this year, just curious if do you currently service that market direct or through distribution, just wondering if there is sort of an opportunity to do there what you've done in Taiwan, basically?

Well, our model is Taiwan. We are currently -- we sell directly in Korea, and we've had relatively, I would say, moderate-sized sales force in Korea for many years that service the business with imports, but we sell direct and we service direct, and we have for a very long time now.

You know, the model -- the model we're following is somewhat straightforward. It is the same model we followed in Singapore and then we followed again in Taiwan, and now we're doing the same thing in Korea and we did the same thing in Japan in the late '90s, is to try to get infrastructure and people and capability as close to the customers as we can. It gives us more flexibility; it gives our customers faster response time. And we do it all in the local language and culture. So that's sort of the model we're following. No different than what we've done before.

Got you. And then just one point of clarification on the pad business you talked about. I think you said three new pad customers, and then you also said three customers were, three of your pad customers are in the top 10. Just wondering if it is three of your existing 25 or those three new customers were top 10 producers?

Three of our existing 25.

Okay.

So the 25 is with the addition of these three.

But those three were top 10 or not necessarily?

No, no. Three of the top 25. Not three of the new ones.

Got you. Thank you, guys.

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

Thank you for participation in today's conference. This concludes the presentation. You may now disconnect. Have a good day.