CMC Materials, Inc. (CCMP) 2014 Q1 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the first-quarter 2014 Cabot Microelectronics earnings conference call. My name is Britney and I will be the operator for today's conference. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session. (Operator Instructions).

At this time, I would now like to turn the presentation over to your host for today, Manager of Investors Relations, Ms. Trisha Tuntland. Please proceed, ma'am.

Good morning. With me today are Bill Noglows, Chairman and CEO, and Bill Johnson, Executive Vice President and CFO.

This morning, we reported results for our first quarter of fiscal year 2014 which ended December 31. 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 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, 2013. We assume no obligation to update any of this forward-looking information. I will now turn the call over to Bill Noglows.

Thanks, Trisha. Good morning, everyone, and thanks for joining us.

This morning we announced solid financial results for our first fiscal quarter of 2014. Our results reflect the soft industry conditions, including traditional seasonal weakness that we referenced last October when we reported results for our previous fiscal quarter. Even within this environment, however, our gross margins improved on lower revenue when compared to the same quarter last year and when combined with lower operating costs helped to mitigate the impact of soft demand conditions on our earnings.

During the quarter, we achieved revenue of $100.5 million, gross profit margin of 47.5% of revenue, a 50 basis point improvement year over year and earnings per share of $0.45. Bill Johnson will provide more detail on our financial results later in the call.

Let me start this morning with our views on the semiconductor industry. Industry reports generally indicate that the holiday sales of technology products were solid, driven primarily by demand for smartphones and tablets. Gartner announced that demand for PCs continued to be weak during the fourth quarter of 2013 and worldwide PC shipments declined for the seventh consecutive quarter, registering a decrease of approximately 7% year over year.

However, on a positive note some recent industry reports suggest that a variety of new form factors such as thinner and lighter hybrid notebooks may encourage PC replacement, and certain industry analysts are forecasting modest growth for the PC market in 2014.

This would represent an important shift from the contraction that has beset the PC market over the past two years and an incremental positive benefit to our industry. Due to the level of semiconductor sales relative to semiconductor device production, analysts believe that most IC inventories decreased during the December quarter and returned to more normal levels.

Earlier this month, the Semiconductor Industry Association reported that worldwide sales of semiconductors in November increased for the ninth consecutive month. The report indicated solid momentum across all geographic regions and most product categories and suggested that the industry is well-positioned headed into the new year. In addition some IC manufacturers are now reportedly seeing a pull in of orders from chip customers for delivery during the March quarter and, as a result, fab utilization rates now appear to be improving.

Last week, several of our executives attended SEMI's Industry Strategy Symposium or ISS conference in California. This is an annual event hosted by SEMI early in the calendar year and represents a great opportunity to network and compare views with other industry participants.

The theme of the conference this year was Pervasive Computing, highlighting the future opportunities of greater mobility, connectivity, and what is being called the Internet of Things. Our participants came away from the event energized about the long-term future opportunities for our Company, given emergent technologies such as FinFET and 3D NAND and the increasing role that highly engineered materials like our CMP solutions and formulated products are likely to play in the continued growth, development, and advancement of the semiconductor industry.

Looking forward, based on these recent reports from a number of industry analysts and public statements from some of our strategic customers as well as historical trends within similar seasonal demand patterns, we expect strengthening and overall semiconductor industry demand during the fiscal year. Having successfully navigated periods of both strong and soft industry demand environments, we believe these industry trends coupled with the continued successful execution of our strategic initiatives positions us well as we work to deliver another year of solid business performance in fiscal 2014.

Let me now turn to our core IC CMP consumables business. During the quarter we continued to pursue our long-term strategic business initiatives related to technology leadership, collaborating with customers and supply chain excellence. We continue to focus our R&D efforts on innovating for leading-edge applications for technology-leading customers. We are encouraged by some early indications from our new product development focus and R&D alignment and expect accelerating new product introductions and business wins in the future.

Our business and technical teams around the world are collaborating with customers on a wide range of new business opportunities and, during the quarter, we won new business with CMP products for tungsten, copper, aluminum, TSV, and pads applications.

We continue to believe that our global supply chain management and quality systems are unmatched within the industry. This capability gives our customers the confidence to trust that the high-performing and reliable solutions we provide for them will have the consistency and lack of variability that they demand in their fab operations.

As our customers' quality requirements continue to tighten and narrow, we are able to respond quickly and effectively by leveraging our entire supply chain and integrating our strategic supplies in the process to consistently meet or exceed our customers' requirements.

One specific example of our success in combining our capabilities and technology leadership collaborating with customers in supply chain excellence is our earning Western Digital Media's Supplier of the Year Award. This award recognizes our performance and quality, product development, and business support in fiscal 2013.

Similar to many other customer awards we have earned, we believe this recognition demonstrates our commitment to being a long-term trusted partner, delivering high-performing, high-quality, and reliable products and solutions.

Concluding my remarks today, with the continuation of positive trends in mobile connectivity and some recovery within the PC market we expect long-term growth and demand for our CMP consumables products. We believe our global footprint and our depth and breadth of product offerings differentiate us from our competitors and, in particular, our supply chain capabilities and quality systems represent a competitive advantage for us.

We continue to pursue our business objective of being the leading CMP solutions provider to the overall semiconductor industry. And with that, I will turn the call over to Bill.

Thanks, Bill, and good morning, everyone. Revenue for the first quarter of fiscal 2014 was $100.5 million which was down by 5.6% from the first quarter of last year and down by 13.5% for the record revenue we achieved in the prior quarter. We believe the decrease in revenue compared to the same quarter last year primarily reflects softer demand due to lower utilization at some fabs and continued soft demand for PCs. Compared to the previous quarter we believe the decrease in revenue primarily reflects soft demand within the global semiconductor industry including traditional seasonal weakness that we began to experience late last fiscal year and referenced last October when we reported results for our previous fiscal quarter.

Revenues were also adversely impacted by customary fluctuations in our QED business, primarily capital equipment-oriented, which also achieved record revenue in the prior quarter. Excluding QED revenue our CMP consumables revenue decreased by 9% sequentially.

Drilling down into revenue by business area, tungsten slurries contributed 37.2% of our total quarterly revenue with revenue down 8.2% from the same quarter a year ago and down 6% sequentially. We believe the lower utilization at some fabs and the continued soft demand for PCs primarily accounts for our lower tungsten business revenue this quarter.

Dielectric slurries provided 29.8% of our revenue this quarter with sales down 1.4% from the same quarter a year ago and down 7.9% sequentially. Sales of slurries for polishing metals other than tungsten, including copper, barrier, and aluminum represented 17.7% of our total revenue and decreased 1% from the same quarter last year and 16.1%, sequentially. Recall that we achieved a record revenue level for our aluminum slurry products in the prior quarter.

Sales of our polishing pads represented 7.4% of our total revenue for the quarter and decreased 12.4% from the same quarter last year and 14.6%, sequentially. Compared to the same quarter last year, we believe the revenue decrease is partially due to competitive pricing pressure as well as customer efficiency gains in use of our pads, which we have discussed in the past, and lower utilization at some fabs. We believe the sequential revenue decrease is primarily due to soft industry conditions, particularly at certain foundries.

Data storage products represented 5% of our quarterly revenue. This revenue was down 1.6% from the same quarter last year and up 1.1%, sequentially.

Finally, revenue from our Engineered Surface Finishes business, which includes QED, generated 3% of our total sales and was down 24% from the same quarter last year and down 67% sequentially.

Recall that our QED business achieved record revenue in the prior quarter and volatility in our QED revenue is expected, given that it is primarily a capital equipment-oriented business.

I would point out that similar to the first fiscal quarter of 2014, our QED business enters the second quarter with a very limited equipment order backlog.

Our gross profit this quarter represented 47.5% of revenue. This is up from 47% in the same quarter a year ago and down from 50.9% in the prior quarter.

Compared to the year ago quarter, gross profit percentage increased primarily due to benefits associated with a weaker Japanese yen versus the US dollar and higher manufacturing yields, partially offset by the lower sales volume and higher variable manufacturing costs including higher raw material costs.

The decrease in gross profit percentage versus the previous quarter was primarily due to the lower sales volume and higher variable manufacturing costs, including higher raw material cost, partially offset by lower fixed manufacturing costs including incentive compensation.

Our full fiscal year 2014 guidance range of 48% to 50% of revenue remains unchanged.

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 were $32 million or $1.4 million less than the $33.4 million reported in the same quarter a year ago, primarily due to lower clean room materials expense and depreciation expense.

Operating expenses were $3.5 million lower than the $35.5 million reported in the previous quarter, primarily due to lower staffing-related costs, including incentive compensation.

Recall that there is typically a noticeable increase in our operating expenses in the March quarter, due to certain annual factors such as merit salary increases, higher payroll taxes beginning with the new calendar year, and costs around our annual meeting in March. We continue to expect our operating expenses for full fiscal year 2014 to be in the range of $131 million to $135 million.

Diluted earnings per share were $0.45 this quarter. This is up from $0.41 reported in the first quarter of fiscal 2013 and down from $0.69 reported in the previous quarter. Compared to the same quarter last year, earnings per share increased primarily due to lower tax expense on our foreign earnings, resulting from our election to permanently reinvest the earnings of certain foreign subsidiaries.

The first fiscal quarter of fiscal 2013 also included an adverse foreign tax adjustment that reduced our EPS by approximately $0.07. Compared to the prior quarter, earnings-per-share decreased mainly due to lower revenue and a lower gross profit margin, partially offset by lower operating expenses.

Turning now to cash and balance sheet-related items, capital investments for the quarter were $3.7 million and depreciation and amortization expense was $5 million. In addition, we purchased $8 million of our stock during the quarter under our share repurchase program, leaving approximately $82 million remaining in share repurchase authorization.

We ended the quarter with a cash balance of $246.5 million and have $159.7 million of debt outstanding.

I will conclude my remarks with a few comments on recent sales and ordered patterns. During the first fiscal quarter we saw a decrease in demand for our CMP consumables products of approximately 9% compared to the prior quarter, generally consistent with what we were seeing in the first few weeks of October when we last spoke to you. 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 approximately 5% lower than the average rate in our first fiscal quarter.

Recall as we approach the Lunar New Year which begins on January 31 that we typically experience some order fluctuation around this holiday period. 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.

Thank you. (Operator Instructions). Avinash Kant, Davidson Company.

The first one is that last quarter you guys had a significant benefit from Japanese yen. Could you give us some idea about what was the impact from the yen on a sequential basis?

On a sequential basis, it was relatively limited. We evaluate this based on an average exchange rate over the three months of the quarter, and if you look at the fourth quarter versus the first fiscal quarter, not any real significant change. There was a more material change year over year; but even though you have seen the yen weaken further to around JPY104 to the $1, recently, when you look at it averaged across the quarter it's not much of a change.

Okay. And also, Bill, on the tax rate, tax rate seems to be trending a little bit lower than what we have been modeling. We have been modeling roughly 30%. You seem to be hovering around 26%, 27%. Is that what we should be thinking of going forward?

If you think about the full fiscal year 2014 we are thinking more around 30% now. The big factor here is sort of the mix between earnings subject to the US tax rate of around 35% versus earnings in some of our foreign subsidiaries that are subject to lower tax rates. That's the biggest driver of the lower tax rate that we are seeing now.

Now, this 30% number that we are talking about, does it include if there were to be any R&D tax credits, or not?

No. We are assuming -- until we see that happen we would not put that into our tax rate. So, that's assuming no renewal of the R&D tax credit.

And if it were to happen, what's the extent of impact that we would typically see?

I am speaking from memory but I think it was something less than $1 million effect on an annual basis. We've gotten a quarter of that in the December quarter.

Now, talking about the units and the pads business, more importantly, that clearly seems to have a lot of volatility around it. Is the downside coming primarily from the one key customer that you have or is there something else that you see?

We think the sequential weakness was weakness in the foundry business, Avinash. We have spoken before about that -- sort of longer term we have seen, as we have discussed, we have seen price competition and we have seen our customers really pushing our value proposition and really extending the pad life of our technology, which is a good thing for us and it validates what we went into the market with and it gives us additional power in our sales pitch.

But the sequential change, we believe, is related to weakness or softness in the foundries.

My final question is that if the other customers are able to extend the pad life to the extent that they are doing, shouldn't that be an incentive for other customers to adopt it quickly?

We think so, Avinash. I think what we've said before is that we -- just to give you some numbers -- we have some 30 customers that are buying our pads today and we have some other 40 to 50 activities ongoing today with either those existing customers or new customers evaluating our pad or have it in trials. So we are excited about the level of activity and we continue to be bullish about the pad opportunity as one of our biggest single incremental growth opportunities for the Company.

I agree. Thanks very much.

Edwin Mok, Needham.

Good morning so you since we brought up the pad, so I guess I have two questions around that. Of the 40 to 50 customers that is on a project you have going on on an evaluation basis, right, how many of those do you think you can turn into actual revenue customers? And what is -- I think basically you talked about how qualification can take a long time for pad. Do you have any idea, can you give us some sense around what is the qualification cycle time now?

Hello?

(technical difficulty)

Who's on next?

Hi, Dmitry. Good morning.

Good morning, everybody. A couple of questions, if I may. You talked about a little bit of a pricing competition in pads and it sounds like pricing is not really a driver in the slurry side of the business.

Can you talk a little bit about the overall environment? We have had a couple of years now of fairly strict or stiff increases in technical requirements for the slurry business and I am assuming you are competing against a smaller number of capable competitors.

So, if you talk about some of the consolidation versus fragmentation trends in the industry, the increased complexity of the slurry development business and perhaps talk about pricing as a possible lever going forward?

Sure. That was a big question, Dmitry. I will try to cover all of that if I can.

Let me start with the industry and the sort of macro issues that we are looking at. Consolidation has, of course, been a big deal for everybody in this industry. As our customers have consolidated very quickly we have seen that semicap equipment guys consolidate just as quickly and the most recent one was AMAT and TEL, which was a big one. We have not seen that kind of consolidation on the materials side of the business yet although we have seen a couple of transactions recently -- the Merck AZ transaction.

So, I think consolidation is here, it's real. In the CMP space, as you mentioned, we have fewer competitors certainly than we had in 2003 -- or let's call them claim competitors and we are down to a smaller group that supports and supplies CMP solutions to the industry. As the technology advances, the customers -- our customers continue to look and find new materials to put into their integration schemes and the challenges of these smaller and smaller feature sizes and the integration schemes they are putting together, we believe, is really good for our business and our technology and the solutions we offer.

We have said this before -- we like it when it gets harder. We think we are well-suited and kind of uniquely positioned to take advantage of some of the technical challenges that our customers are faced with.

On the pricing side, I think you are aware our ASPs have been relatively flat for I guess the last four years. In that environment we have been able to increase our gross margins through disciplined pricing and very aggressive and effective cost management at the gross margin level. We think we can continue that trend.

You know, we raised our gross margin guidance this year to 48% to 50%. We think we can continue to value price and we talk about value pricing as our strategy. We work very hard and spend a lot of money to bring these CMP solutions to the marketplace. We validate them and then we back them with the supply chain and the quality systems that we talk a lot about.

We think that brings a lot of value to our customers as well as their support we have in the field and the people we have around the world that support these products and customers and that's kind of the brand that is Cabot Microelectronics. So, as long as we can continue to charge for that value we bring to the marketplace and we can continue to look for ways to become more efficient, we feel pretty good about our ability to keep our CMP slurry prices where they have been and protect our gross margins.

Great. That is very helpful, Bill. Thank you. Just a follow-up on a couple of comments that you made about and then just looking at the performance of the revenue line over the last two or three years, the acquisitions that you've made that brought capacity in South Korea and in Taiwan -- kind of the evolution of PC versus the mobile market.

Have you taken a look at your asset footprint as far as manufacturing of slurries is concerned between the two large plants and at least two or three smaller plants? Is there any rationalization or other capacity rightsizing that is possible to increase your utilization rates and perhaps lower your fixed costs a little bit?

Sure. We have four manufacturing -- really five manufacturing facilities in the world, today. We have one in North America, we have one in Japan, we have one in Kaohsiung, Taiwan, and we have another one in South Korea which we built -- just to be clear we built that facility three years ago. We didn't acquire it. We acquired the one in Taiwan.

We made the investment in Taiwan a fairly long time ago, back in 2008, 2009 and we made that investment just in recognition of the foundry business and the importance and growing importance at that time of the foundry business. The same approach -- we used the same approach in considering and ultimately investing in South Korea as we were watching the importance of memory devices as they go into things like tablets and smartphones and all these gizmos that people carry around with them.

So, I think we have really got a great global footprint around the world now and as the market moves to Asia -- and it's been steadily moving to Asia -- we have been sort of backing off our US facility. When the yen was JPY74, JPY75 to the $1 we were moving as quickly as we could to ship products out of our manufacturing facility in Geino, Japan to our other two facilities in South Korea and Taiwan.

So, we have a team of men and women that manage this every day and they are aggressive about looking for opportunities to source our products from the lowest possible cost manufacturing facility. That's somewhat gated or governed by our customers' willingness to requalify plants and products. It can take up to a year or year and a half to get through that qualification process to actually move a CMP slurry from one plant to another.

But we do that and we do it as aggressively as we can. I think over time, long term, I believe that our footprint that we have in the world today is enough. I don't see another big capital -- you know, for us, a big capital investment would be a building somewhere in the world. We don't see that on the horizon in the next three or four or five years. I think the footprint we have on the ground today is more than sufficient and we will rationalize it as time goes by.

Thank you very much. I will let somebody else ask questions now.

Edwin Mok, Needham & Company.

Thanks for taking my question. I guess go back to the first question I had which was regarding the pad. Just kind of wanted to understand how many of those 40 to 50 ongoing evaluations do you think you can turn into actual customers this year? Give us an update in terms of qualification timeline.

I hope we turn them all, but I know that's not realistic. But our approach and the way we are thinking about the pad business is to be -- as quickly as we can become a very meaningful second supplier to the industry.

It's hard for us -- just to be straight up with you -- we won't predict when we are going to turn these opportunities because we just don't know. I just don't think it would be responsible for us to call it, given the process that we engage in with our customers.

Depending on the customer and the customer's end use application and their qualification and their change management process, these qualifications can take a very long time. I think what we look to and we are excited by is the level of activity and the number of engagements we have around the world with our pad technology. That keeps us optimistic and excited about the opportunity.

I wanted to get a better sense -- Bill, when you say a very long time, is it five years, is it five quarters, or five days?

We have seen it as short as, I want to say, a year or a year and a half and as long as two or three years. It just depends again on the customer and their appetite for change and their appetite for going to their customers with a change management process.

Okay. That's fair. Thanks. And then if I look at -- obviously you guys don't give quality guidance but at least for the month of January it was trending down around 5%, right, relative to last quarter.

If I just use that as kind of a baseline for the fiscal second quarter, I have two questions around that. One is, is fiscal second quarter, given the Chinese New Year, typically more back end loaded, or is it more linear for the quarter? That is my first question.

Second question is if I apply that 5% down on the second quarter, you have to grow basically double digit in 3 and 4Q to come, to make this year a growing year, right? Am I thinking of it the right way?

That's right. If you look at kind of typical seasonality, September quarter is our strongest quarter. There is weakness in the December quarter. The weakest is typically the March quarter. It strengthens in June, strengthens again in September. If you look at the March quarter, historically 10 of the last 14 years we have been sequentially down in the March quarter.

As to your question about within the quarter what sort of trends do we see in revenue? I don't think there's anything that's normal. Lunar New Year moves around a bit and depending upon how heavy demand is, sometimes the customers produce right through that.

So, I don't think there's any intra-period or quarter trend that I could point to. But now, this is the third year that we are seeing pretty pronounced seasonality softness in the first half and then strength in the second half. So, I think what we believe is the industry is becoming less cyclical, more seasonal and here is the third year we are seeing this kind of pronounced seasonality. So, not a big surprise as we have been watching the last couple of years.

I see. Great. That is very helpful commentary. And then I guess, given the seasonality impact on your topline, I would imagine your gross margin also trend in a similar trend just because of volume? Is that the right way to think about it?

That's right. The sales level or production level is an important element of our gross margin but also product mix, because we have a range of different products that have different pricing and margin dynamics. But yes, capacity utilization is a big factor as has been product mix in the past.

I see. One last question and I will let someone else ask. So, on the new position that you won, Bill, that you mentioned I notice that you didn't mention anything on Advanced Dielectrics. Am I reading too much into that?

You may be reading too much into that. I did not mention Advanced Dielectrics. It's just the quarter and in the quarter, we talked about the wins that we had; we just didn't talk about A.D. That doesn't mean we are any less excited about our opportunities to get our A.D. products into the marketplace.

In fact, Bill mentioned with this refocused R&D effort that we are getting some interesting early indications on some new product development and there's a family of products around Advanced Dielectrics that seems pretty interesting. But, no specific wins this quarter.

Great. That's all I have. Thank you.

Jairam Nathan, Sidoti.

Just following up on Dmitry's question on the manufacturing footprint, given your presence in Japan, does it make sense to move manufacturing around given the yen depreciation? And the other follow-up question is, would you use that, the increase in the gross margins, the benefit to gain share -- how should we think about that?

Well, we wouldn't use the low cost. We would never use low-cost to gain share, Jairam, that's just not the way we run our Company. We are about value and we are about value pricing. That idea wouldn't work.

To give you a little background, the plant in Japan has historically, let's say over the last five years, has been our largest plant by volume. I am not sure standing here today -- I think it is still our largest plant by volume. It's an important plant not -- because not only does it supply the Japanese market, which remains an important market to us and one where we have a significant position -- there are some customers there that we remain highly engaged with, but we have used it historically to export products to Southeast Asia, Korea and Taiwan. We continue to do that.

I said it earlier -- our ability to move products out of Geino and get them requalified in places like South Korea and Taiwan, is highly gated by our customers' desire and willingness to help us do that. I think I've said, we don't do it at a discount. We don't offer discounts to do it but if it suits them and it suits us we work together to try to get a requal.

Our plant in Japan is still highly loaded and still our largest plant. We have slowed down. It wasn't so long ago -- it was only, what, a year ago the yen was at JPY76, JPY75. And now it's at JPY104. So, what we were doing a year ago is different than what we are doing today.

My other question is on pads. Looking at it from a different angle, given the share gain, can you give us an idea of what your -- how much have you outperformed the market in the pad market in fiscal 2013? How should we think about that outperformance in fiscal 2014?

Actually, our revenue in pads was relatively flat fiscal year 2012 to 2013. That's one of the things we've have talked about that we have been disappointed. We made a strong start in pads from fiscal year 2007 through 2011, we had really nice growth but the growth has been -- the business has been relatively flat since then.

We continue to view this -- like Bill talked about earlier -- as a significant opportunity. It's a great adjacency. It's a big market right next to our CMP slurries business and we utilize a lot of the same capabilities, so it continues to be a high priority. Given the pipeline of new opportunities we hope that that can become another -- get back on the growth trajectory. But we actually did not grow from fiscal year 2012 to 2013, unfortunately.

Last question is on your capital allocation. We saw a more significant increase in your share count. Does that require a more aggressive share repurchase plan going forward? You have regularly [repurchased] around $8 million to $10 million. Does that need to go up?

Capital allocation is a topic that we discuss actively within the company with the Board of Directors on an ongoing basis and you can understand that given the strong cash generating capability of the Company and our strong balance sheet. This quarter we did see an increase in shares, driven by some option exercises of a couple of award cycles that were near expiration.

Also our share price has moved up nicely. The same driver that might cause options to be exercised might mean that you wouldn't necessarily want to be aggressive purchaser at that time. When we have been in the market in the past we have been a relatively consistent buyer and we reported today $8 million of share repurchases and on average we have been around $10 million or so when we have been in the market but it's not something that we have ever communicated any plans forward. We think it represents a part of an overall capital allocation strategy along with M&A, internal investment, potential dividends, things like that.

So I would not want to guide toward future activity but I could comment like I have on what we have done in the past.

Okay. Thank you.

(Operator Instructions). Chris Kapsch, Topeka Capital Markets.

Good morning. Just to follow up on the sequential trends that you talked about thus far into the fiscal second quarter -- on average the order patterns in January being 5% down sequentially. You also mentioned though in your prepared release about the notion that there are some signs of improving utilization rates at the foundry.

So, I am just wondering if that's something that you see is happening, it just hasn't factored its way into your order patterns yet and therefore you'd expect to see that sort of for the balance of January into February and March? Or just want to reconcile those sort of opposite kind of trends.

Bill's comments this morning were our visibility to date into the next quarter we're down 5%. He always cautions that the limited window doesn't indicate performance for the full quarter.

We have talked a lot about seasonality and this is our second fiscal quarter and we are in our second fiscal quarter and we are always looking for indications of strengthening because that's what we believe will happen. It's because it has happened for the last two years that we will have this kind of slow start to our fiscal year and the second half will be strong.

We look at all the same things you look at, probably, and read all the same analyst reports. It seems like things are firming a little, but will I predict what it means this quarter? I certainly can't do that. We just don't have the visibility to do that with any kind of accuracy.

That's what I would say. We have seen TSMC come out with 10% up for the year. TSMC is 20% of our overall revenues so you would expect that to have an impact on our future ability to grow in the second half. So, that's all we can probably say about what we see for the rest of the year.

I just wanted to get a little more granular on some of the product lines. You mentioned that I guess the aluminum -- and copper and aluminum product line collectively was down, I think, 16% sequentially. My understanding is that's where products like the newer high-K metal gate product line would be included there which is revenues being driven by adoption at sort of leading edge technology.

Just wondering why the sequential sales for that particular line was more pronounced in terms of weakness versus say the rest of your products? Is it a function of just the copper side of that product line or was there curtailment in some of the production ramping at the leading edge with some of your advanced customers?

So when we aggregate sales for -- slurries for polishing other metals -- that includes copper, aluminum, and barrier. So the turndowns -- the sequential turndown was really across both aluminum and copper and a couple of things that work there.

One, just the seasonality caused some of that. Then, with respect to aluminum, one of the things we are starting to see are some efficiencies in usage by some of our customers. This is consistent with what we've seen in past years when a new process or a new product is adopted, as the customer gains more experience then there are opportunities for efficiency gains. We are seeing a little bit of that in aluminum.

With respect to copper our strategy is to replace our old legacy products with newer, more highly concentrated products that are high gross margin but can shrink the market a little bit. That's something we have talked about over the past year or so. With respect to slurries for polishing these other metals it was kind of a combination of seasonality, some efficiencies in aluminum and then just the implementation of our strategy on copper.

Okay. Thanks for the color there. Just curious about the commentary about the possibility that, after a couple of years of cannibalization of the PC market at the expense of handhelds and smartphones and so forth, and -- just curious if there was, given the mention of prognostications about PC sales recovering or maybe even just not declining, if they were to happen to recover just wondering how that would affect your mix? Presumably would it drive copper revenues and how might that flow through in your mix looking at the balance of 2014?

It would probably drive almost all of our product lines. It would definitely drive our tungsten line, our copper line and our pad business would grow as a result. Overall, it would drive incrementally more wafer starts.

The semiconductor content of a laptop and a PC is about twice as much as a tablet. Rule of thumb. So, to get PCs and laptops back on an upswing, even if it is modest, it helps the entire industry in terms of more wafer starts. I think it would be good for almost all of our products lines if we were to see growth come back to the PC segment.

Okay. Thanks. And then just one quick one. What was the bottomline EPS impact from the disruption around the commentary around QED?

Bottomline?

I don't think I can be that precise. I think that our engineered surface finishes revenue was down by 67%. So, around what? $6 million or so.

QED -- that's a high-margin business. When sales are up it's like the rest of our business -- there is a lot of technology in that and so it tends to be relatively high margin. We probably did see some of that in EPS but I don't know offhand what that exactly was.

Jason Ursaner, CJS Securities.

I just want to make sure I understand all the questions and commentary you've got on the month-to-month trends. You mentioned the January trending 5% lower. That's relative to the month of December? Or that's the average over Q1?

That was relative to the average across Q1.

Okay. So at a high level, it sounds like right now we are balancing the current, slower pace of business with expectations for this improvement in wafer starts during your fiscal second half and that's getting you to flat for the full year? Or do you still expect to be seeing growth?

We don't give revenue guidance and we don't give EPS guidance for the full year. What we said and continue to say is we expect the year to start out relatively soft for the first half and then strengthen in the second half that we have seen for the last two years.

Okay. And besides the improvement in foundry, and stabilization in PC -- are there any other key factors you are looking at that are still providing confidence and a more optimistic outlook for the second half ultimately materializing? Or is it really just more [sentiment] at this point?

Like I said earlier, we read and look at what everybody else reads and looks at. Morris Chang recently said he expects TSMC to do 10% this year, which wouldn't be inconsistent with what we have seen TSMC do for the last two years. They start out soft and they get stronger in our second half of our fiscal year. That's all we can do and we just watch and pay attention to what our customers say and the way our customers order.

That's our indication. But as we said before, we have very limited visibility. At best, it's a month. We are a make-to-order business and so we are reluctant and we don't provide any kind of forward guidance because we just don't have the visibility to do it.

If you look past the fiscal year and you think about industry trends, one of the things we mentioned was new -- leading technologies like FinFET and 3D NAND that are going to become more important over time -- not necessarily this fiscal or calendar year.

But things like that -- higher technology demands more of the consumable materials and it also had CMP polish steps. To the extent that those new applications are adopted we expect to be part of that and that could be another driver. Longer term, we expect to continue to grow our pad business. That's a great adjacency and it's a high priority for the Company.

So, that's what we think about when we think about longer term beyond just the constraints of the fiscal year.

Just the business you are seeing right now, is it the slurry formulations that are more -- the newer ones geared towards more advanced nodes or is it some of the older slurry formulations that tend to go into more legacy applications? How did those perform in the quarter?

I think it is all of those. We have a very large position in what you might describe as legacy business. We have an equally large position in emerging technologies and new business. So, I am not sure I can specifically quantify an answer to your question.

We are engaged in all of it. And we are highly engaged in the leading edge technologies with a raft of new products in all of our product areas. So it just goes across our business.

Okay. And then just last question from me. Free cash flow was very strong during the quarter. Can you maybe just talk a little bit about timing of CapEx or working capital and what drove that, relative to net income? Would you continue to expect to see that kind of gap relative to reported income as the year progresses?

We will file the Q here shortly. One of the things you will see in the cash flow is actually some interesting things from a working capital standpoint. You can see that in our balance sheet. We had a reduction in payables because in December we pay our annual cash bonus and so that was a reduction of payables, so a use of cash.

And in addition, there is an increase in, I think, other current assets which is a tax receivable and that is related to some of the options -- stock option exercises. So actually from a cash from operations standpoint it was relatively modest this quarter but that was really driven by a couple of unusual items.

We have a history and expectation for future strong cash flow. We have demonstrated solid growth and strong profitability, limited capital intensity so we have been a strong cash generator although cash from operations was somewhat limited this specific quarter.

In terms of CapEx for the year we are guiding to about $15 million and we spent a little less than $4 million in the first quarter. We are on pace to achieve that through the first quarter but we expect to continue to be a strong cash generator going forward.

Okay. Great. Appreciate the commentary.

Edwin Mok, Needham & Company.

First question I have is, you guys mentioned 3D NAND as one potential driver for your business. How much do you think that can incrementally benefit your business this year? Is it still going to be a small percentage of group sales? What type of CMP slurries -- is it dielectric mostly or do you see some tungsten or other materials, as well?

We think 3D NAND could be important to us. As Bill said earlier, we're not certain we will see it this year or next year but we think it will be a combination of dielectrics and tungsten CMP slurries. It might equate to about two to five additional CMP steps so we think of it as a pretty good opportunity to see some of our slurry sales grow for both our advanced dielectrics and tungsten applications. I would describe it as small at this time. It's hard to predict growth as we go forward.

Okay. That's fair. And then just going back to your engineering surface finish business, if I look at the last three years you have been running somewhere around $24 million per year, per fiscal year revenue -- and quite lumpy. Do you expect similar lumpy business this fiscal year? Is it going to be at a similar level, obviously the first quarter was only $3 million, much lower than that level. How do you kind of think about that?

Most of our Engineered Surface Finishes business is QED, which is largely capital equipment-oriented. Depending upon the number of machines we ship in a particular quarter that would drive the revenue and it has been volatile or lumpy in the past. So to the extent that continues to be capital equipment-oriented we would expect that to be lumpy in the future.

One of the things we pointed out in the October call was that -- what was a little different for our QED business is we didn't have much of an equipment order backlog as we reported in October and so that was borne out with the relatively low QED or ESF revenue this quarter. We also don't see much of a backlog now, so that would be another data point.

Okay. Great. That's all I have. Thank you.

Thank you, Edwin. We will take our last question, please.

Avinash Kant, Davidson Company.

Thanks for taking the follow-up. One or two questions here. The first one I had for Bill was, if we think of the next quarter and of course you're not giving any guidance but if you think of some sequential downtick in the March quarter, was there anything -- of course it looks like the ESF business impacts your margins negatively, but if it were to be down sequentially is there anything on the OpEX that you could do to bring it down further or would there be an outside margin impact because of some mix issue in the March quarter?

Let me answer the first question about OpEx. As you've seen in the past, we've been very responsive and aggressive with our OpEx when things get soft, and we would do the same in this situation if we saw a deeper decline in the current quarter than we are expecting or that we are seeing in January. We would certainly act on it.

Like I say, we have a track record of doing that. And we would do it again. As you know we have a significant investment in R&D and research and development and innovation and new product development and customer support. That's an area that we think is -- for our Company is competitive advantage and it's not an area that we would look to trim down in a quarterly downturn on any of that sort of stuff. We would look at that longer term and think hard about it.

I have forgotten the second part of your question which was what?

So, marginwise did you see something different this quarter? What I am saying is that if revenues were to be down next quarter, would margins be down too? Or was there anything special this quarter that may not lead to a decline next quarter?

The variances we talked about in gross margin sequentially were kind of the lower-level of sales. Some manufacturing cost fluctuations but the bigger driver is the lower sales. There wasn't anything unusual but one of the things with respect to operating expense that we pointed out in the prepared comments and I would just remind you there is a little bit of seasonality in operating expense. When we -- operating expense is largely people and we have a January 1 cycle for salary merit adjustments to the extent that we grant those, that would be a new cost for us as of January 1.

Also a new calendar year brings new payroll taxes and things like that. We also have an annual meeting and so if you look at historically we have seen an increase in operating expenses generally in the March quarter, compared to the December quarter. Like Bill talks about, since most of our operating expenses -- it's people. There's not a lot that we are going to do sort of quarter to quarter to trim that.

And then one final question, the reconciliation -- if I look at the numbers in the current quarter and the previous quarter, if I punch in the numbers that you have reported in the press release I get $0.46 for the current quarter and $0.70 for the previous quarter. Is there something else going on there that is leading to that $0.01 or so difference?

Right. Not with respect to this quarter it could just be rounding. You may recall that we reported our fourth fiscal quarter results as initially as $0.70 and then as we issued the 10-K and we issued an 8-K in conjunction with that it adjusted the calculation of EPS such that the fourth quarter result went from $0.70 to $0.69 and the full-year result went from $2.16 to $2.14. We issued an 8-K about that in conjunction with our 10-K but there should be nothing like that. It could just be rounding with respect to the current quarter.

Okay. Perfect. Thank you so much.

Thank you, Avinash. That is all the questions we have this morning. Thank you for your time and your interest in Cabot Microelectronics.

Ladies and gentlemen, that concludes the presentation for today's conference. You may now all disconnect and have a wonderful day.