CMC Materials, Inc. (CCMP) 2017 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Cabot Microelectronics' first-quarter FY17 earnings conference call.

(Operator Instructions)

I would now like to turn the call over to Ms. Trisha Tuntland, Director of Investor Relations. Ma'am, you may begin.

Good morning. With me today are David Li, President and CEO, and Bill Johnson, Executive Vice President and CFO. This morning, we reported results for our first quarter of FY17, which ended December 31, 2016. A copy of our earnings release is available in the Investor Relation's section of our website, cabotcmp.com, or by calling our Investor Relation's 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, 2016. We assume no obligation to update any of this forward-looking information. Also, our prepared remarks this morning reference non-GAAP financial measures. Our earnings release includes a reconciliation of GAAP to non-GAAP financial measures. I will now turn the call over to David.

Thanks, Trisha. Good morning, everyone, and thanks for joining us. This morning we announced strong results for our first quarter of FY17, as we achieved record levels of revenue and profit for the second consecutive quarter. Our performance reflects strong semiconductor industry demand and the continued successful execution of our strategic initiatives, including continued momentum from last year in three key product areas: CMP slurries for polishing tungsten, dielectrics slurries, and CMP pads.

During the quarter, we realized record revenue of $123.3 million, approximately 23% higher than in the same quarter last year. Our gross profit margin was 49.9% of revenue and we achieved record diluted earnings per share of $0.88, which represents an increase of approximately 91% compared to last year. In addition, we continued our strong cash flow generation trend with cash from operations of $25.1 million. Bill will provide more detail on our financial results later in the call.

To provide some context for our first-quarter results, let me first offer some perspectives on the global semiconductor industry environment. As forecast by several of our customers and industry analysts, industry demand was solid during the December quarter and our results are consistent with this as well as the expectations we discussed during our fourth-quarter conference call in October.

You may recall that at the end of the September quarter, most IC inventories related to smartphone, wireless, network, automotive, and gaming markets were at lean levels. As a result of this, demand for our IC CMP consumer products remained healthy through the quarter, which historically has seen seasonally softer conditions. Now exiting the December quarter, industry reports and comments made recently by some of our strategic customers suggest that foundry and logic inventories may be slightly elevated due to some seasonality in mobile areas.

Conversely, other reports suggest that memory inventories, particularly 3D NAND and DRAM are lean due to robust and demand including the continued proliferation of solid-state drives and tight production capacity. Industry analysts generally hold a strong outlook for the semiconductor industry for the full year, but based on these near-term views, industry expectations are for a minor inventory correction for some ICs during the March quarter, which is historically seasonally soft. Since our Company supplies virtually all semiconductor manufacturers in the world, we believe we are well positioned for success even with differing near-term demand conditions across the foundry, logic, and memory segments. Later in the call, Bill will provide commentary on our expectations for demand of our IC CMP consumable products during the March quarter.

Transitioning to a longer term view, two weeks ago, our Company attended SEMI's Industry Strategy Symposium in California. This annual event early in the calendar year represents a great opportunity to compare views with other industry participants. The theme of this year's conference was growth within a changing landscape and amidst new opportunities. With the other overall industry sentiment expressed at the event decidedly bullish for 2017 and beyond.

Discussion at the conference highlighted two particular areas. The first is how industry consolidation among device makers, equipment companies, and material suppliers, along with efforts to establish a more robust domestic semiconductor industry supply chain in China, is changing the competitive landscape. The second area focused on growth opportunities, highlighting demand for ICs driven by automotive, industrial automation, and data center applications. Participants also predicted a stable demand outlook for consumer devices including smartphones, and additional future growth from the Internet of Things.

In particular, the outlook for memory seems to be strong given the storage required to support the needs for connected devices, and relatedly, the transition from 2D to 3D NAND. We believe our focused business model along with our broad product and technology portfolio and extensive global infrastructure position us well for continued growth within this expected environment. For example, in FY16, our revenue grew in the memory segment by approximately 18% and in China, our revenue grew by approximately 20%.

Now let me turn to Company related matters. During the quarter, we experienced strong demand for our tungsten and dielectric slurries and pad solutions across a wide range of applications and technology nodes. This drove approximately 24% year-on-year revenue growth for the quarter from our IC CMP consumable products.

Of particular significance, we achieved year-on-year revenue growth in China of approximately 36% for the quarter. Our strong business position there is notable given expectations for long-term growth in China.

Turning to CMP slurries, during the quarter, we experienced robust demand driven by the growing adoption of 3D NAND and FinFET technologies as well as our leading supply positions in other applications. As we have discussed in the past, 3D NAND and FinFET applications require additional CMP steps, in particular, tungsten and dielectrics. As a result, we achieved record revenue in our tungsten product area in the first fiscal quarter and year-over-year revenue growth of approximately 25%.

Over the years, we have seen sustained revenue growth from our tungsten products which underscores our continued leadership in and commitment to this important product area. In addition, we achieved significant growth from our dielectric slurries, with revenue up approximately 27% compared to the same quarter last year. This was primarily driven by demand for our ceria and colloidal silica-based dielectric solutions for advanced applications.

We believe these CMP solutions provide benefits of higher removal rate, improved defectivity, and lower cost of ownership. As a result, during the quarter, we won new business for 3D NAND and DRAM memory applications with our cerias solutions.

Across our slurry product areas, we have strong pipeline of active opportunities around the world covering logic, memory, and foundry customers on both 300 and 200 millimeter platforms and we look forward to winning more business with these solutions to drive profitable growth.

I'm pleased to report that during the quarter, we were one of only four consumable suppliers and the only CMP supplier to receive an outstanding performance supplier award from Inotera, a wholly-owned subsidiary of Micron, which is now our third-largest customer. For the second consecutive year, our Company was recognized for demonstrating outstanding performance in quality, technical service, safety, cost, and logistics.

We are honored to have earned this prestigious award and believe this repeated recognition from Inotera, along with the many other awards we have won over the years from a number of other customers are evidence of our long-term commitment to collaborating closely with our customers and our ability to deliver a broad portfolio of best-in-class CMP solutions to the highest standards for quality, performance, and technology.

Turning to CMP pads, this quarter we achieved record revenue and year-over-year revenue growth of approximately 54%. This was driven by continued strong pull for our products, including slurry and pad consumable sets. During the quarter, we added to our rich pipeline of new business opportunities across a wide range of customers and applications and we are working to expand our product offerings.

We continue to leverage our global sales channel and technical resources to speed the qualification and adoption of our pad offerings and we continue to experience significantly shorter qualification times than in our prior efforts. As a result, we are confident in our ability to grow our pads revenue from approximately $52 million that we achieved in FY16 to between $80 million and $90 million in FY18, which we have previously discussed.

In further support of our strategy to accelerate growth in our pads product area and to position our Company for sustained growth in China, in early November, we announced the collaboration with Konfoong Materials International, or KFMI. KFMI is a privately owned China-based company specializing in the development and manufacture of ultra-high purity metal materials and sputtering targets for the global semiconductor and integrated circuit industries.

The collaboration combines our NexPlanar pad technology with KFMI's experience in materials manufacturing including their ability to meet the strict quality standards required of the semiconductor industry. Also, this collaboration emphasizes our commitment to provide semiconductor manufacturers in China with reliable, local manufacture of the most advanced CMP pad technology. We are proud to partner with KFMI on this exciting initiative and look forward to updating you in the future on our progress.

Looking ahead, I am confident of the continued momentum in each of our tungsten, dielectrics, and pads product areas including CMP slurry and pad consumable sets, which we believe provide the foundation for continued profitable growth for our Company. We remain focused on delivering innovative, high-performing and high-quality CMP solutions which leverage our global resources, quality systems, and supply chain capabilities.

We believe these attributes, combined with our focused business model, differentiate us among leading suppliers of specialty materials to the semiconductor industry and position us well to deliver another year of strong performance. With that, I'll turn the call over to Bill for more detail on our financial results.

Thanks, Dave, and good morning, everyone. Revenue for the first quarter of FY17 was a record $123.3 million, which represents a 22.8% increase from the same quarter last year. The increase reflects continued strong global semiconductor industry demand that we began to see during the third quarter of FY16.

Drilling down into revenue by product area, tungsten slurries contributed 44.9% of total quarterly revenue. We achieved record revenue for the quarter with revenue up 24.5% compared to the same quarter last year. Our tungsten growth was driven by strong demand from both memory and logic applications, including 3D memory and FinFET, which we are confident will continue to drive profitable growth for our Company.

Dielectric slurries provided 23.8% of our revenue this quarter, with sales up 27.2% from the same quarter a year ago. As Dave mentioned earlier, during the quarter, we saw continued strong demand for some of our new, higher performing ceria and colloidal silica-based dielectric slurry products. Sales of polishing pads represented 13.2% of our total revenue for the quarter and increased 54.2% compared to the same quarter last year. Our pads product area achieved record revenue during the quarter.

Sales of slurries for polishing metals other than tungsten including copper, aluminum, and barrier, represented 12.8% of our total revenue and decreased 3.5% from the same quarter last year. Finally, revenue from our engineered surface finishes area and data storage products represented 4.1% and 1.3% of our quarterly revenue respectively.

Gross profit for the quarter was 49.9% of revenue compared to 50% of revenue we reported in the same quarter a year ago. This includes $1.2 million of amortization expense related to the NexPlanar acquisition. Excluding this, non-GAAP gross profit was 50.9% of revenue.

Other factors impacting gross profit this quarter compared to last year include higher sales volume, a higher valued product mix, and higher fixed manufacturing costs, including higher incentive compensation expense. Our full fiscal year GAAP gross profit guidance range of 48% to 50% of revenue remains unchanged. This includes approximately 100 basis points of NexPlanar amortization expense.

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 $33.4 million, including $0.5 million of NexPlanar amortization expense. Operating expenses were $2.4 million lower than the $35.8 million we reported in the same quarter a year ago, primarily due to the absence of costs related to both our NexPlanar acquisition and 2015 CEO transition and lower clean-room materials expense, partially offset by higher incentive compensation expense.

We continue to expect GAAP operating expenses for the full fiscal year to be between $137 million and $142 million. This includes approximately $2 million of NexPlanar amortization expense. Recall that we typically experience an increase in expenses in the March quarter due to certain factors related to the new calendar year such as merit salary increases and higher payroll taxes and also costs related to our Annual Meeting in March.

Diluted earnings per share were a record $0.88 this quarter or $0.92 on a non-GAAP basis excluding the NexPlanar amortization, which represents an increase of 91.3% compared to the $0.46 we reported in the first quarter of FY16. The increase in earnings this quarter was primarily driven by higher revenue and lower operating expenses, partially offset by a higher effective tax rate. Our effective tax rate for the first fiscal quarter was 20.3% compared to 15.5% in the same quarter last year.

The increase is primarily related to changes in the jurisdictional mix of our earnings and the absence of last year's retroactive reinstatement of the research and experimentation tax credit. We now expect our effective tax rate for the full fiscal year to be within the range of 19% to 22%. Previously, we had estimated 17% to 20% for the full fiscal year.

Turning now to cash and balance sheet related items, capital investments for the quarter were $4.9 million. For the full fiscal year, we continue to expect capital spending to be within the range of $20 million to $25 million. As we had previously discussed, this includes our ongoing facility expansion in South Korea.

Depreciation and amortization expense for the quarter was $6.7 million and we generated cash flow from operations of $25.1 million. We ended the quarter with a cash balance net of debt outstanding of $151 million. Our strong cash generation model has enabled us to implement a balanced capital deployment strategy, including organic investments, dividends, share repurchases, and M&A.

As of January 30, our next dividend payable date, we will have paid four quarterly cash dividends, nearly $18 million to our shareholders since the initiation of our dividend program in January 2016. This reflects a payout ratio of approximately 30% of our FY16 net income and 23% of free cash flow. We believe we are well positioned for continued delivery of significant value to our shareholders in this regard.

I will conclude my remarks with a few comments on demand for our IC CMP consumables products. During the first fiscal quarter, we saw a 5% increase in revenue from our IC CMP consumable products compared to the fourth quarter of FY16. Earlier, Dave talked about general expectations of some industry participants for softer near-term semiconductor industry demand, consistent with traditional seasonal patterns.

In addition, recall that the Lunar New Year, which begins on January 28, typically introduces some fluctuation in demand around this holiday period. Consistent with all of this, we expect demand for our IC CMP consumables products in the March quarter to be around 5% lower than in our first quarter.

To summarize, from a financial standpoint, we continued our strong performance from the second half of FY16 and achieved record revenue and profit again this first fiscal quarter. Looking ahead, our expectations are for seasonably softer demand conditions during our second fiscal quarter and the typical increase in expenses due to the new calendar year. However, at present, we would expect some general seasonally strengthening of demand in the second half of our fiscal year. We believe we are well-positioned to deliver another year of strong performance in FY17. Now I will turn the call back to the operator as we prepare to take your questions.

(Operator Instructions)

Our first question comes from the line of Mike Harrison with Seaport Global Securities. Your line is now open.

Good morning, Mike.

Hi. Good morning. This is actually Jacob on for Mike.

Hi, Jacob. How are you?

I'm doing good. For my first question, I guess, you guys mentioned that China did well, looking at the other geographies, was the performance pretty strong and balanced across? Or did one perform better or worse than the other?

We saw year-over-year revenue increases in all the geographies. China was quite strong. Japan was also quite strong for us. Everything was in double-digit growth except for Europe, which was about 10%.

I think we wanted to call out China particularly because there has certainly been a lot of attention on semiconductor growth in China. We feel like we are well-positioned there. We had strong growth last year and think we are well-positioned this year. So it's something I think that's getting a lot of attention from industry and we certainly feel like we are well-positioned to grow with China.

Okay, and then related to China, the KFMI deal, did your $80 million to $90 million expected revenue for 2018 and include any sort of sales boost you're expecting from that collaboration or is it already baked into that?

We haven't broken out in that detail. I think the $80 million to $90 million by FY18 was really just an overall pads revenue growth and the KFMI collaboration is something quite new. But we are really excited about it.

We are doing there is bringing our NexPlanar pad technology to KFMI and KFMI is already a well-known supplier to the industry. They supply sputtering targets globally, so the really understand the requirements of the customers and it is a great way to provide a locally manufactured pad to our customers in China and that is certainly something that we have heard from our customers that they are looking for.

So we are encouraged, but that is a very early collaboration. But we are also very confident about the pads growth as well.

That is probably a contributor to revenue sometime in FY18, not in FY17.

Okay. Thank you. Thank you for answering my question.

Thank you, Jacob, for your questions. We'll take our next question please.

Thank you. Our next question comes from the line of Amanda Scarnati with Citi. Your line is open.

Good morning, Amanda.

Good morning. Thanks for the question. Just a quick little clarification. David, you commented that you are seeing new products in the pipeline and you are expecting to see continued momentum from tungsten, dielectric and pads. Should we expect this to offset some historic seasonality as these new products are continuing to gain momentum and as the pad business continues to grow and expand? Or is this continuing on the seasonal patterns that we've seen the last couple of years?

Thanks, Amanda. I guess what we would say is we are obviously very confident about and excited about our new products in tungsten and dielectrics and pads continues to grow significantly. If you are talking about the softness related to the January quarter, the industry is forecasting some softness. If you look at what TSMC has said, they are looking at 8% to 10% down sequentially.

Bill mentioned what we think about is around 5% lower for our CMP consumables, so there is some, potentially some softness in there, but obviously, in the full year, we expect a strong year and continued growth there. So, yes, so I think to your question is will it completely offset? I think what our comments would suggest is that we are seeing about 5% lower CMP consumables for the quarter, at least that's from our current vantage point.

Okay. That helpful. And then are you starting to see any sort of ASP pressures, typically in the pads business, as you grow that business and as you become a more formidable competitor to DOW, are you started to see them push back with customers in terms of ASPs or is it continuing as it has between you and them?

Right. We're really excited about what we've seen from the customers and their adoption of NexPlanar and, if you recall, the way that we've approached customers and why we thought this technology was so compelling to begin with is it really provides a performance differentiation.

It is not an alternative or a low-cost alternative, and we are still seeing the shorter qualification time. I would say that the competitive intensity is about the same as when we first introduced it. We're really pleased with the progress and we continue to grow our pipeline.

Just a little more color on that, Amanda. So year-over-year pad revenue was up about 54% and this is the first quarter where we sort of calendarized the NexPlanar acquisition. We acquired that in October 22, 2015. So now the year-over-year comparisons are almost matched. We are three weeks shy of a full quarter in 2016 and so most of that growth now is really growth in NexPlanar as opposed to just the impact of the acquisition.

Thanks. And then one last question on China, continuing on with that. Are you starting to see this as sort of the very early stages of growth in China? If you hear from the CapEx companies, they are saying that China really isn't expected to pick up until 2018. So are you seeing that too that the early stages of what has already been in production in China that is starting to grow versus any sort of new production?

Right. So I think you've captured it accurately, Amanda, that the current capacity, installed capacity, whether it is the domestic players like SMIC or QALY, they are running quite strongly. So we are seeing that consumables use very strong. And then a lot of investment going into China also from domestic and international customers both, and that capacity is expected to come online in the next couple years.

So you've seen a lot of CapEx going to China and we expect to see consumables follow that as wafer starts start to go up in China, as well. So, really strong currently with the installed capacity and the new capacity coming online in the next couple years, as you mentioned.

Great. Thanks, guys.

Thank you, Amanda, for your questions. We'll take our next question, please.

Our next question comes from the line of Chris Capps with Aegis. Your line is now open.

Good morning, Chris.

Good morning. Chris Capps with Aegis Capital. Just a couple of follow-ups just quickly on China, the strength there in the existing install base. Does that tend to be leading-edge technology nodes or is it lagging? Can you tell based on the products that you are shipping to those existing installed capacity customers?

Sure, Chris. Again, you have to segment China into a few different areas. For the domestic customers, they are primarily foundry. So for example, SMIC, and they tend to be two or three generations behind a leading edge player like an Intel or a TSMC and they are running quite strongly. I think SMIC is fully in HVM for 28 and working on 16 today.

For the international customers, for example, a Samsung or SK Hynix that are producing memory in China, they are producing leading-edge memory in China already. So, it really depends on which segment that you are talking about and we obviously sell into both of those different segments.

That is helpful, and then you mentioned memory and obviously a driver here has been this conversion over to 3D NAND. Do you have a sense of how many of the leading memory guys or how far along are they in the conversion to HVM for 3D NAND?

It was kind of the behemoth memory with a couple of the second and third largest closely behind in that conversion, but can you guys update us on how far along is, in your perception, is this transition to 3D NAND?

I still think it is in the early stages, Chris, although there are a few more customers that are in high-volume. Samsung is clearly still the leader, fully ramped in their facility in China and also ramping in a facility in Korea. We have also seen other customers producing like Micron. We mentioned Micron is now our third largest customer and so they are making progress there and then the others perhaps a little earlier in the process, the SK Hynix and Toshiba.

And in addition, we see a lot of follow-on investment even from those that are already in HVM, so Samsung and Micron. I know the Intel facility in Dalian is also producing 3D NAND using a Micron process, so we are still early on in that transition from our perspective.

That's helpful, and then just one more. Just on the above normal seasonality in the December quarter, in your formal remarks, you mentioned that coming into the December quarter, chip inventories were a little lean, so that contributed to it partly. But given the broad-based strength in demand for your consumables, it seems like it was maybe more than that.

Can you point to any one thing that you feel is contributing or contributed to the above seasonal strength in the December quarter? Is it simply this memory transition, or was there any sort of end markets where you might have seen abnormal strength in the quarter?

Right. Chris, thanks for the question. If you look at where our focus is for our core business, it's on tungsten, dielectrics and pads. And we've seen really strong growth across those product segments and if you look at how they correlate to the industry, for example, tungsten, and dielectrics, and pads as well, really are a big part of both the leading-edge memory, so like 3D that you just mentioned as well as FinFET.

So I think we are well-positioned in those areas that are ramping. China is also another area that is ramping and growing quickly and we are well-positioned there. I think that contributes to the strong demand that we've seen from consumables. I think we are positioned well where the industry is growing.

A little data behind that. On a sequential basis, our tungsten revenue grew by 9.5%, dielectrics grew by 8.1% and pads grew by 4.2%, so well over our normal seasonal trends.

Okay. Thank you.

Thank you, Chris, for your questions.

Thank you.

(Operator Instructions)

Our next question comes from the line of Edwin Mok with Needham & Company. Your line is now open.

Good morning, Edwin.

Hello, everyone. This is Arthur on for Edwin.

Hello, Arthur.

The first question is on gross margins. Gross margins were strong this quarter at the high-end of your FY17 guidance range, but given your commentary for some near-term softness in IC consumables, how should we think about the impact to gross margins in the March quarter?

In the March quarter, one of the things we pointed out was just a reminder that we typically see some higher costs in the March quarter associated with the new calendar year and we talked about that in prior calls in prior years. So for example, with the new calendar year, there are merit salary increases, payroll taxes start up again, and we also have our annual meeting in March and so the Board of Directors equity compensation mostly hits in that March quarter.

You would see a bit of headwind in gross margin and also in operating expense quarter-to-quarter. We're comfortable with our guidance on the full-year 48% to 50% of revenue, but there is likely a bit of a headwind in the March quarter for those reasons along with the seasonal softness would provide a bit of a headwind also.

Got it. Thanks for that.

Next question is on your dielectric slurries. It sounds like you guys are making good progress with your advanced dielectrics slurries. What are you getting from your customers that is driving demand and how can we think about the mix of these advanced slurries going forward?

When we talk about dielectrics, the newer products that we are seeing a lot of growth in our colloidal silica-based slurry and a ceria-based slurry. The ceria-based slurry tends to be more preferred by memory customers and so we are seeing a lot of traction there and we have several products in the market that are providing a lot of value to customers in that area.

For our colloidal product, that is a family of products that we think is really revolutionary to this dielectrics market. We believe they can target up to $100 million of business opportunities, and we have been talking about that for a while.

That can be used by customers in memory and logic and across difference wafer sizes, 200 millimeter and 300 millimeter. So the growth we've seen in dielectrics is really, I think, a recognition by our customers that they are seeing the performance benefits of both our new ceria, which really primarily goes to memory, and colloidal, which is broader-based. We are seeing a lot of pull for those products, a full pipeline, and we are excited about the future there.

Thanks for that. The last question, how much did NexPlanar contribute during the quarter?

The NexPlanar revenue was around 55% of our total pad revenue. Total pad revenue is a little over $16 million, and almost $9 million of that was based on the NexPlanar pads.

Great. Thanks.

Thank you, Arthur, for your questions. We will take our next question, please.

Our next question comes from the line of Dmitry Silversteyn with Longbow Research. Your line is now open.

Good morning, Dmitry.

Good morning, guys. Congratulations on the great start to the year.

Thanks.

A couple of questions. Number one, the one product family that you have not talked about in any great length over the last several quarters and the one that has been sort of peaked out at about $75 million, $76 million, it's been slowly trending down, is the copper and the barrier and aluminum polishing slurries.

Is that sort of because it is a sunsetting technology or at least a flattish technology versus the growth of dielectrics and tungsten that are driven by FinFET and the 3D NAND conversion? Is it market share give ups? Less attractive market, given it is not considered leading-edge anymore? Can you talk about what is going on with your metal-polishing business outside of the tungsten market?

Yes. That area we call slurries for polishing other metals, so aluminum, copper, and barrier. We had seen a ramp-up a couple of years ago, particularly in aluminum, given the aluminum gate that was in 28 nanometer and 20 nanometer logic technology. And so we saw significant growth in aluminum, but then as those kind of plateaued and then our customers captured some pretty significant efficiencies, we've seen the aluminum decrease and now I think now it was relatively flat quarter-to-quarter.

The other factor is we have introduced some more advanced copper slurries that are more concentrated and so higher ASP, but lower volume, higher gross margin percentage, but fewer gross margin dollars, and those have been adopted by a few customers. So to the extent we transitioned from an older legacy copper to these newer copper products and we see some revenue and headwind, although more profitable. Then at barrier, we've had relatively stable business there, but that is one area where this quarter represents a decrease in barrier revenue due to a loss position on some legacy application.

Okay, Bill, that is very helpful. Thanks for that granularity, which leads me to my next question. Future shrink has been a characteristic of this market and has provided repeated opportunities for you guys to differentiate yourself in the marketplace with the technology and your broad capabilities.

Where do we stand these days on sort of the leading-edge feature, small feature ICs? Where are your customers in terms of both utilization rates on these new lines as well as yields? In other words, if we look out three, four quarters out, could we be running into the same issue there that you seem to have run into with aluminum, where enhancing yields are offsetting -- or enhancing yields are what's driving the IC growth, but that may not necessarily be reflected in the growth of your slurries?

Dmitry, again, you have to separate the different segments: logic, foundry, in memory. For the logic and foundry area, the leading-edge customers are working on 10 and sub-10. What we have seen, as Bill mentioned, is move away from aluminum gate at 2820 to FinFET, which is a tungsten gate. That's really -- we feel like we are well-positioned there. I'd say that there are just one or two customers that are fully ramped and high-volume for that advanced logic technology.

From memory, 3-D, we have talked about already on the call, but still I just comment it is early. There are different technical challenges and requirements for 3-D. Even though it may not be a shrink, there are different technical challenges, and we feel like we are well-positioned there. As we mentioned, Samsung is our biggest customer now. Micron is our third biggest customer. I feel like we are well-positioned there, but it is early in the transition, as well.

Okay. If I think about -- again, not the next quarter, but the next couple of years, as FinFet and 3-D NAND as they become more -- technologies that people are more comfortable with and the yield increase, how should I think about the slurry sales into those applications, even if the market continues to grow at, pick a number, 5%, 7%?

In general, Dmitry, we feel like we should grow with wafer starts. There will always be some offset by efficiencies or pricing, but especially for the memory side. They are going to continue to advance, not the shrink but the number of layers they are trying to build on a vertical NAND device. That technology challenge will continue to march forward. Similarly for the logic, perhaps there will be some efficiencies, but they are also moving out to more advanced technologies as well. Similar dynamic, although I think memory is a little different than logic foundry.

So that's commentary around CMP slurries based on the overall leadership position that we have their. Separate, we would expect the growth in pads, so it's certainly is not tied to wafer starts, it would be tied to business wins. We would expect to grow well in excess of the market in the area.

Got it, Bill. One final question on the cash yields you got. You guys are now back over $300 million in cash on hand, which was the highest point since the end of your FY15. Your share count continues to expand, obviously, on the diluted shares and options because given where your stock price is.

How should we model using that cash going forward? I don't mean plowing it all into share repurchases hypothetically. What is it that you intend to do with that $305 million in cash on hand?

The cash balance is around $305 million, but on a net cash basis it is $151 million, roughly, because we have some debt outstanding. The priorities we have articulated for capital deployment really have not changed.

Just as a reminder, organic investments -- and this year we will spend $20 million to $25 million of dividends and will, with our fourth dividend payment in later, on the 30th, that will bring this to about $18 million in dividends in respective FY16. Share repurchases have been a big factor.

Then, M&A, we list fourth really because there are not dozens of attractive actual opportunities, but we have had, and continue to have, on ongoing effort in corporate development to look for acquisitions in related areas where we can leverage capabilities. We will continue to do that. We have been very disciplined in it. That continues to be a priority in things that we're spending some time on as a leadership team.

Okay. You guys are generating north of $50 million in free cash, and that's after the high spend on CapEx. So it sounds like acquisitions are not going to be a big use of cash. It is basically between dividends, share repurchases, and I guess letting cash accumulate. Okay. Thank you.

The acquisitions are sort of binary, right. We would be looking for something that would be material to the Company in a related area that would leverage capability. Those -- there are not a long list of opportunities, but we continue to scour the industry for that.

Got it. Thank you very much.

Thank you for your questions, Dmitry. We'll take our next question, please.

Thank you. We have a follow-up question from the line of Chris Capps with Aegis. Your line is now open.

I have to just follow up on that capital allocation discussion. I mean, this Company has generated positive free cash flow, basically, every year since you were public. As you pointed out, at the end of this year, probably rough math you'll probably have net cash of over $200 million on your balance sheet given the free cash flow characteristics even in a quote-unquote spike in CapEx, which Dmitry pointed out.

You have peers, one that was just created six month ago, that is levered at 2.7 times. You have net cash on your balance sheet. Everybody talks about the lack of capital intensity in the business. What is the appropriate capital structure for this Company? Do you think it is right to have this much cash sitting on your balance sheet?

The approach we have taken a continue to take is: we like to have the flexibility on the balance sheet to enable M&A. On our history, the two significant deals we have done have been within the CMP consumables space: Epoch, the Taiwan CMP slurry company in 2009 and NexPlanar, which we acquired in 2015.

We continue to look for M&A in related areas. I think we like the balance sheet flexibility that the cash balance gives us.

If you look back in 2012 when we had $300 million of net cash and we didn't have significant actual or attractive M&A opportunities, we did a leveraged re-capitalization and paid about a $350 million special cash dividend. I think our strategy going forward is, again, organic investments, dividends, share repurchases, and M&A. We will continue to look for related opportunities.

If we found ourselves where we didn't have actual opportunities, then I think we could consider other things like another special cash dividend. No plans for that now. We continue to carry on.

Chris, I think we've demonstrated a track record of returning value to shareholders, whether it's through a dividend, share repurchases, or special cash dividend. I think that is a proven track record that we have shown, and obviously one of the strengths of our business model, as you pointed out.

Where is the cash? Are the repatriation issues?

Of the total cash balance, around 60% is overseas in around 40% is in the US.

Okay. If I could just follow up one on the strength you are seeing in your oxide slurry, and in the colloidal, colloidal-based products specifically? The strength -- the adoption that you are seeing for that new product, is it right now more about cannibalizing your legacy fumed silica-based products, or are you gaining share in that space? Or is it a combination of both that is driving the growth of the product?

It is a combination of both, Chris. It is geared towards both the advanced and legacy applications for dielectrics. Some of those positions, of course, are ours. If customers are looking to gain some performance, as well as a lower cost of ownership, they may choose to look at that product. That would be good with us because it is a lower cost of ownership, but also more of a profitable product for us, especially than some of the higher solids, dielectrics products we've had out there in the market in the past.

Also, the $100 million of new business opportunity that we talk about is not including any cannibalization of our products. So that is going after business that we don't have today, and we are seeing a lot of interest from customers there as well. I think just adding the combination of having a pad like the NexPlanar pad that can also be used with that slurry as a pad in slurry consumables. That has also been -- is also showing a lot of interest by our customers as well.

Thank you, guys.

Thank you, Chris, for your follow-up question.

Thanks. I just want to make one other comment. Some of you may have seen a 13-D filing from Hudson Executive Capital, filed yesterday. First, it should not detract from the continued strong operating performance and results of the Company. I just wanted to comment on the filing because to the extent that the filing suggests it that there have been a sense of discussions between our Company and Hudson, I wanted to make sure it was clear that that is not correct.

We have had only routine conversations with Hudson of the type that we have with any of our significant shareholders, and as part of any ordinary shareholder engagement program. We have not and do not intend to engage in any non-routine discussions with them. Again, this filing, from our perspective, does not affect our strategy, the operation of our business, or our focus on continuing to create long-term value for all our shareholders. I thought it was important to point that out.

Just a little more color. Hudson has been an investor in our stock for over a year, and this 13-D filing was triggered by their beneficial ownership of 5% of our stock based on calculations under the SEC. Of that, less than half is directly owned and greater than half is based on call options, which will expire in April of this year. Those may or may not be exercised.

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