CMC Materials, Inc. (CCMP) 2017 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Cabot Microelectronics' Fourth Quarter and Full Fiscal Year 2017 Earnings Conference Call. (Operator Instructions) I would now like to turn the call over to Director of Investor Relations, Trisha Tuntland.

Good morning. With me today are David Li, President and CEO; who is participating on our call from our office in Shanghai; and Bill Johnson, Executive Vice President and CFO.

This morning, we reported results for our fourth quarter and full fiscal 2017, which ended September 30. 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, 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 record quarterly and annual results for revenue, diluted earnings per share and cash flow from operations for our fourth quarter and full fiscal 2017. This reflects sustained successful execution of our strategic initiatives, coupled with strong semiconductor industry demand.

During the quarter, we achieved revenue of $136.8 million approximately 11% higher than in the same quarter last year and diluted earnings per share of $1.03, which represents an increase of 24% compared to last year.

In addition, we continued our strong cash flow generation trend with cash flow from operations of approximately $50 million. For full fiscal 2017, we achieved revenue of $507.2 million, approximately 18% higher than last year, well in excess of industry growth.

We also achieved diluted earnings per share of $3.40, which represents an increase of approximately 40% compared to full fiscal 2016, and cash flow from operations of approximately $140 million. We believe our record revenue and earnings performance in fiscal 2017 after also achieving record earnings in fiscal 2015 and 2016 is evidence of the strength of our focused business model, our continued technology leadership and strong execution. Bill will provide more detail on our financial results later in the call.

To provide some context for our fourth quarter results, let me first offer some perspectives on the global semiconductor industry environment. As reported by some of our customers and industry analysts, IC demand was strong during the September quarter, and our results reflect this. Reports suggest that overall semiconductor demand was driven by a continued robust memory market, generally due to the growing requirements for storage in a wide range of end-use applications as well as a healthier logic market, driven by mobile product launches.

Due to this, some of our customers and industry analysts have reported expectations for continued firm demand during the December quarter. This is also consistent with what I'm hearing from customers in Asia, and through October, we have seen continued solid demand for IC CMP consumables products. Later in the call, Bill will provide commentary on our revenue expectations for the December quarter.

Considering longer-term expectations for the semiconductor industry, we believe a number of factors will drive growth in semiconductor industry demand over time: first, the ongoing transition from traditional planar or 2D NAND memory to advanced 3D NAND, especially for mobile and server applications. General industry commentary, as well as what we have observed from our customers, suggest that the industry appears to still be in the early stages of transition in terms of wafer starts with around 30% of the NAND market having then converted to 3D memory. You may recall that the transition from 2D to 3D memory is significant for our business. Since 3D NAND technology requires roughly twice the number of CMP steps, in particular tungsten and dielectrics. With 2D memory still representing nearly 70% of the NAND market, we expect the industry transition from 2D to 3D memory will continue over the next several years.

Second, reports also indicate healthy demand for legacy logic technologies driven by demand in automotive, sensors and connected devices, along with strong demand in advanced logic, driven by high-performance computing, artificial intelligence and new smartphone introductions.

And third is semiconductor growth in China. China continues to be in the spotlight with a number of fabs under construction, others announced and additional domestic and international investments in both logic and memory capacity expected in the future.

We believe we are well positioned to benefit from these long-term industry demand trends based on our global resources, capabilities and infrastructure, which we believe uniquely position us to deliver innovative CMP solutions to our customers around the world and across the foundry, logic and memory segments. Based on our positioning, technology leadership and execution, we expect to continue to be able to grow our company faster than the industry.

Within that semiconductor industry context, now let me turn to company-related matters. During fiscal 2017, we experienced robust demand for our tungsten and dielectric slurries and polishing pad solutions, supported by the differentiated value-added total customer experience we provide. This drove approximately 18% year-on-year revenue growth for the full fiscal year. Of particular significance, we achieved year-on-year revenue growth of approximately 26% in China and 25% in Korea for the full fiscal year. Our strong positions in these countries are notable given expectations for long-term overall semiconductor growth in China and continued memory growth in Korea.

Now let me provide an update on each key product area, beginning with tungsten slurries. During fiscal 2017, we experienced strong demand for our tungsten slurry products across a wide range of applications and technology nodes. As a result, we achieved record revenue in our tungsten product area in the fourth fiscal quarter and for the full year. Robust demand for our unique, high-performing tungsten solutions, which embody broad and deep technology, covering a wide range of applications and technology nodes, drove year-over-year revenue growth of approximately 19% for the full fiscal year. This year, we continue to support our strategic customers' transitions to 3D NAND and FinFET technologies using our tungsten slurries.

For full fiscal 2017, approximately 28% of our tungsten revenue was driven by these advanced technologies. This is up significantly compared to 20% in fiscal 2016 and 13% in fiscal 2015. We believe the strong growth trajectory we have demonstrated in our tungsten product area reflects the continued successful execution of our strategies of technology leadership and supply chain and operations excellence.

Building on our robust intellectual property portfolio, we have introduced around 15 advanced tungsten solutions for 3D NAND and FinFET applications over the last 3 years. And our customers continue to be delighted by our quality and supply chain excellence. We believe this combination of innovation, execution and experience has enabled the leadership we've earned in this area and underscores our commitment to this important product area. From this strength, we expect continued profitable growth in our tungsten product area, as the industry continues to move to advanced applications, particularly in memory.

Moving on to our second key product area. During fiscal 2017, we continued to advance the broad transformation of our dielectrics slurries in conjunction with the commercialization of our family of higher-performing, lower cost and higher profitability products. Our success on this initiative over the last 3 fiscal years was a key contributor to the record quarterly revenue we achieved during the fourth fiscal quarter and the approximately 21% year-over-year revenue growth for the full fiscal year.

Throughout the year, we continued the qualification of our colloidal silica-based dielectric solutions, winning new opportunities, displacing incumbents and replacing some of our own legacy solutions. In addition, we also saw strong demand for our high-performing, ceria-based dielectric slurries, which have provided our customers with higher throughput, improved effectivity and lower cost of ownership.

As a result of our efforts, we are experiencing higher growth and profitability from the ceria and colloidal solutions. Across our tungsten and dielectrics product areas, we have a strong pipeline of active opportunities around the world covering foundry, logic and memory customers on both 300- and 200-millimeter platforms. And we look forward to winning more business with these solutions to drive profitable growth.

Turning to CMP pads, our third key product area. During the fourth fiscal quarter, we achieved record revenue for the eighth consecutive quarter. Our revenue for the full year was also a record and grew by approximately 32% year-over-year, well in excess of industry growth. We believe we have doubled our participation in pads in the past 2 years. Our growth in this area is a result of continued broad customer adoption of our products across the foundry, logic and memory segments as we leverage our global sales channel, technical resources and infrastructure to speed the qualification of our pad offerings. In addition, we are leveraging our supply chain capabilities, manufacturing expertise and quality systems to improve supply assurance, productivity and profitability in our pads product area.

Finally, during the year, we expanded our pad product offerings with the commercialization of a family of new configurations, focused on improving both performance and profitability in this product area. We continue to view CMP pads as the greatest organic growth opportunity for our company. Based on our full fiscal 2017 revenue of approximately $69 million and the momentum we have achieved in this product area over the past several years and consistent with what we have previously discussed, we are confident that we will be able to grow our pad revenue to over $100 million in fiscal 2019, which will reflect compound annual growth of, at least, 20%.

The execution of our strategic initiatives this year fiscal year also included progress on the commercialization of CMP slurry and pad consumable sets. Supporting this, we experienced customer pull for our combined products. As we have discussed in the past, we continue to see consumable sets as a growth driver. And we believe that given our broad product portfolio in CMP slurries, along with our technology and capabilities in CMP pads, we are uniquely positioned to deliver best-in-class slurry and pad consumable sets.

During fiscal 2017, we earned a number of significant awards from our customers in recognition of our ability to successfully deliver innovative, high-quality, high-performing and reliable CMP slurries and polishing pads. We are honored to have again earned Intel's Most prestigious award for Suppliers, the Supplier Continuous Quality Improvement Award for the fifth consecutive year; Texas Instrument Supplier Excellence Award, the outstanding performance supplier award for the second consecutive year from Inotera, a subsidiary of Micron; and SMIC's Best Supplier Award. We are proud of this recognition and also the awards we have received from other customers over the years.

We believe these awards are an important part of our company's brand and evidence of the unique value we provide to our customers through close collaboration.

To summarize, as we enter fiscal 2018, I am confident that we are well-positioned for continued profitable growth in excess of the IC CMP consumables market based on the significant momentum in our tungsten, dielectrics and polishing pads product areas. We believe that our effective execution in these areas, along with our global resources, capabilities and infrastructure, differentiate us among leading suppliers of specialty materials to the semiconductor industry and position us well to continue delivering significant value to our shareholders.

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 fourth quarter of fiscal 2017 was a record $136.8 million, which represents an 11.5% increase from the same quarter last year. Total revenue for the full fiscal year was $507.2 million and a record level for our company, which represents a 17.8% increase from fiscal 2016.

Our fourth quarter and full year revenue results reflect the continued successful execution of our strategic initiatives and continued strong global semiconductor industry demand that we've seen over the last 6 quarters. Drilling down into revenue by product area, tungsten slurries contributed 43.6% of total quarterly revenue. We achieved record tungsten revenue for the quarter with revenue up 18% compared to the same quarter in fiscal 2016 and also record revenue for the full year, up by 19.5% compared to fiscal 2016. We continue to see strong demand for our tungsten slurries for advanced applications, including 3D memory and FinFET. And as Dave discussed earlier, we expect this key product area will drive future profitable growth for our company.

Dielectric slurries, representing a second key product area, provided 24% of our revenue in the fourth fiscal quarter. We achieved record dielectrics revenue for the quarter with sales up 21.2% from the same quarter in fiscal 2016. For the full year, dielectric slurry revenue increased by 21.3%. Our dielectric slurry growth was primarily driven by strong demand for our ceria and colloidal silica-based solutions. We look forward to winning more business in this area with our higher performing, lower cost and higher-profitability products.

Sales of polishing pads, our third key product area, represented 13% of our total revenue for the quarter and increased 14% compared to the same quarter in fiscal 2016. Our pads product area achieved record revenue for the eighth consecutive quarter. We also achieved record pad revenue for the full year, with revenue up by 31.9% compared to the prior year.

Sales of slurries for polishing metals other than tungsten, including copper, aluminum and barrier represented 11.9% of our total revenue and decreased 6.2% from the same quarter in fiscal 2016. For the full year, revenues here decreased by 1.8%.

Finally, quarterly revenue from our Engineered Surface Finishes business, or ESF, which includes QED technologies represented 6.6% of our total quarterly sales. For the full year, ESF achieved record revenue, which was up 24.7% compared to the prior year. Revenue from our data storage products represented 0.9% of our total quarterly revenue.

Gross profit for the quarter was 51.2% of revenue, which is 140 basis points higher than the 49.8% that we reported in the same quarter of fiscal 2016. This includes $1.2 million of amortization expense related to our NexPlanar acquisition. Excluding this, non-GAAP gross profit was 52.1% of revenue. Factors impacting gross profit this quarter compared to last year include benefits of lower raw material cost, higher sales volume and a higher value product mix, partially offset by higher fixed manufacturing costs, including higher incentive compensation expense.

For the full fiscal year, gross profit was 50.1% of revenue, which is 130 basis points higher than the 48.8% we reported in the prior year and slightly above our prior full fiscal year guidance for GAAP gross profit of 49% to 50% of revenue.

Our fiscal 2017 gross profit includes $4.8 million of amortization expense related to NexPlanar. Excluding this, non-GAAP gross profit was 51.1% of revenue. For full fiscal 2018, we currently expect our GAAP gross profit margin to be between 50% and 52% of revenue. This includes an adverse effect of approximately 100 basis points related to the NexPlanar amortization expense.

Now, I'll turn to operating expenses, which include research, development and technical, selling and marketing and general and administrative costs. Operating expenses this quarter were $37 million, including $0.5 million of NexPlanar amortization expense. Operating expenses were $1.7 million higher than the $35.4 million reported in the same quarter of fiscal 2016, primarily due to higher incentive compensation expense, partially offset by a gain on the sale of surplus research and development equipment and the absence of an impairment charge recorded in fiscal 2016 for NexPlanar intangible asset related to a technology under development.

For the full fiscal year, total operating expenses were $142.1 million, which includes $1.9 million of NexPlanar amortization expense. Previously, we had expected our GAAP operating expenses for the full fiscal year to be between $140 million and $142 million. Operating expenses were $6.4 million higher than the $135.7 million reported in fiscal 2016, primarily due to higher incentive compensation expense. We currently expect our GAAP operating expenses for full fiscal 2018 to be between $142 million and $147 million. And this includes approximately $2 million of NexPlanar amortization expense.

Operating income for the quarter represented 24.2% of revenue, which was 320 basis points higher than in the same quarter of fiscal 2016. Operating income for the full fiscal year of 22.1% of revenue was 480 basis points higher than in fiscal 2016. The significant year-over-year increases represent operating leverage driven by revenue growth, combined with our ongoing attention to controlling cost and progress toward achieving our multiyear financial objective of expanding profit margins, which we introduced during our fiscal 2017 investor event.

Our effective tax rate for the quarter was 19% compared to 16.5% in the same quarter of fiscal 2016. For the full fiscal year, our effective tax rate was 20.5%, which is slightly below our expected effective tax rate range for the full fiscal year of 21% to 22% compared to 15% in fiscal 2016.

The year-over-year increases are primarily due to the absence of last year's retroactive reinstatement of the research and experimentation tax credit and changes in the jurisdictional mix of our earnings. We currently expect our effective tax rate for full fiscal 2018 to be within the range of 24% to 27%. This is higher than the rate for full fiscal 2017, primarily due to the expiration of the tax holiday benefit in South Korea that we received based on our investment in new facilities there in fiscal 2011.

Our net income for the quarter was a record $26.5 million, which was 28% higher than the $20.7 million reported in the same quarter of fiscal 2016. The increase was primarily due to higher revenue and a higher gross profit margin, partially offset by a higher tax rate and higher operating expenses. Excluding amortization expense related to NexPlanar, net income this quarter was $27.6 million on a non-GAAP basis.

For the full fiscal year, our net income was a record $87 million, which was 45.3% higher than the $59.8 million reported in fiscal 2016. Excluding the reference amortization expense, net income this fiscal year was $91.2 million on a non-GAAP basis.

Diluted earnings per share were a record $1.03 for the fourth fiscal quarter, which represents an increase of 24.1% compared to the $0.83 reported in the same quarter of fiscal 2016. Excluding the NexPlanar amortization expense, diluted earnings per share this quarter were $1.07 on a non-GAAP basis. We also achieved record diluted earnings per share for the full year of $3.40, which is 39.9% higher than the $2.43 reported in fiscal 2016. Excluding the amortization expense, diluted earnings per share this fiscal year were $3.56 on a non-GAAP basis.

Turning now to cash and balance sheet-related items. Capital investments for the quarter were $5.3 million, bringing our full year capital spending to $21.2 million. This is near the low end our prior guidance range of $21 million to $23 million for the full year. As previously discussed, our capital spending in fiscal 2017 included our facility expansion in South Korea, which we completed during the second fiscal quarter, and expansion of our polishing pads manufacturing capacity to support anticipated growth.

For full fiscal 2018, we currently expect our capital spending to be within the range of $18 million to $22 million. Depreciation and amortization expense for the quarter was $6.4 million. In addition, we purchased $8.3 million of our stock during the quarter under our share repurchase program and $12 million for the full fiscal year, which leaves approximately $122 million of authorization remaining as of September 30.

We generated record cash flow from operations of $51.4 million in the fourth fiscal quarter and a record $141.4 million for the full year, representing an increase of $46.2 million compared to fiscal 2016. We ended the year with a cash balance of $397.9 million, and we have $143.9 million of debt outstanding.

Our strong cash generation model has enabled us to implement a balanced capital deployment strategy over the years, for which our priorities continue to be funding organic investments, to improve our global capabilities in our core CMP consumables business, dividends, acquisitions in closely related areas and share repurchases. Consistent with this, in fiscal 2017, we increased our quarterly cash dividend by 11% over the regular quarterly cash dividend paid since the initiation of this program in January 2016. We believe this demonstrates both confidence in our ongoing cash-generation capabilities and our continued commitment to delivering value to our shareholders.

I'll conclude my remarks with a few comments on demand for our IC CMP consumables products. During the fourth fiscal quarter, we saw a 7% sequential increase in revenue from our IC CMP consumables products compared to the third quarter of fiscal 2017. This is stronger than the expected 2% increase for the fourth quarter that we referenced during our conference call in July. Earlier, Dave talked about general industry expectations for continued firm demand during our first quarter of fiscal 2018. Consistent with that outlook, we expect demand for our IC CMP consumables products in the December quarter to be slightly higher than the record level of revenue we achieved in our fourth fiscal quarter even though the December quarter is traditionally seasonally softer than the September quarter.

To summarize, from a financial standpoint, we have now delivered a strong performance for 6 consecutive quarters and record revenue, earnings and cash flow for our fourth quarter and full fiscal 2017. For fiscal 2018, our expectations are for continuing firm near-term demand, sustained solid gross margin performance and ongoing prudent management of operating cost on continued cost discipline. Based on all of this, we believe we are well-positioned to deliver another year of successful performance in fiscal 2018.

Now I'll 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.

This is actually Jacob on for Mike. Congrats on a great quarter. In dielectrics, over the past few years, you guys have done a great job, taking what was once a stagnant product line, introducing the new superior products and then driving significant growth and margin performance. So I'm curious, do you see any possibility to do this within the other metal slurries' product lines? Any opportunities to introduce advanced copper or advanced barrier and turn that into a dielectric-type story over the next couple of years?

You're right, in dielectrics over the past several years, we've commercialized these new higher performer -- performance, lower cost and higher-profitability products, like based on colloidal silica, abrasive, as well as ceria. And yes, we're seeing significant growth in those products over the past couple of years. And that's driving some expanded margins in that area. If you look in the non-tungsten metals area, the revenue has been more flat. Actually, our revenue in that area was slightly down year-over-year. And that includes barrier, copper and aluminum. Although we've had some interesting dynamics in the aluminum area because that was used at an advanced gate application at 28- and 20-nanometer technology. And we saw a run-up in the demand for that over a couple of years but then that flattened out and decreased a bit. There's -- with legacy logic growing now, we're seeing some growth in demand for aluminum. But with respect to copper, that's a pretty competitive area, and that's not 1 of the 3 key product areas that we focus a lot on. We think there could be some opportunities in copper going forward, but probably more focus on aluminum within the non-tungsten metals and then really, greater focus by the company on tungsten, dielectrics and pads.

Yes, Jacob, just to add something to Bill's comments, another example, where we're introducing new products that have better profitability or just better performance or both is also in the area of tungsten. We've talked about the growth in our advanced tungsten solutions, which is really exciting, growing from -- it's 28% of our revenue now. But we've also introduced a new family of tungsten products, which replaced some of our legacy products and customers are adopting those because they offer lower cost of ownership, better performance and also improved defectivity and also allow us to continue our strong profitability in that area, too. So that's another example of continued innovation in the area of tungsten.

Got it, got it. And then on an unrelated question, could you just break down how much of the sequential gross margin improvement was from the raw material benefit versus the volume leverage in the kind of...

Jacob, I could -- I have trouble hearing your question.

Sorry. What -- the sequential gross margin improvement, what was some of the raw material benefits versus the volume leverage and mix?

Yes, I couldn't quantify that exactly. But there was -- the sequential increase was 230 basis points, and we attributed that to lower production cost. Some of that was raw materials, but also the higher sales volume and a higher-value product mix and then partially offset by a higher fixed cost, including incentive compensation cost. We -- I couldn't tell you exactly the contribution of each of those 3, but we tend to do those in terms of order. So I think the lower production cost and the higher sales volume were more impactful on that 230 basis point than the other factors.

Our next question comes from the line of Amanda Scarnati with Citi Research.

In terms of the conversion to 3D NAND and the benefit that Cabot sees, do you see a bigger benefit just in the conversion itself from planar to 3D? Or do you also see some real benefit as you're jumping from 64 to 96, 128 layers?

Yes, thanks, Amanda. And as we mentioned in our prepared comments, memory is an area we're really excited about. And you're right, the transition offers tremendous opportunity for us, and we're early. We estimate that only about 30% from a wafer start basis of the NAND today has been converted to 3D. What we've seen is we see that doubling of steps when you do the initial transition from 2D to 3D and then something more incremental when you get to more and more layers. So for example, today, most of the players, Samsung continues to be in the front -- forefront, but most players are yielding at around 40x or trying to ramp up 60x. So when they move up layers, we might see some incremental increase in consumable usage, but it's not like the initial transition. But we still think the initial transition is in the very early stages and has several more years of runway before we get to full conversion.

That's very helpful. And in terms of kind of the growth in the pads business, I think you mentioned that you were seeing sort of 50% -- I might have the number wrong, 50% unit growth. How are the ASPs kind of tracking it between next planar products and organic products? And is that growth all unit driven on similar ASPs? Or is there an ASP benefit or a loss as well on the next planar versus the organic business?

Yes, well, we're really pleased with the growth we've seen in pads. And what we talked about in our prepared comments is we've basically doubled our participation in that area. And we think it's -- there's obviously still a lot of runway for growth. And we think it's our greatest growth opportunity. So we talked about how -- to your question on the ASPs, one of the things why we're so delighted with the NexPlanar technology is we're not competing on price. We're really competing on performance, and we're winning on performance. So when customers sample this pad, what they're finding is, one is it's very easy to qualify. It's similar to the incumbent, which in most case is Dow. It's the same it's kind of thermoset type of material that offers better performance in the form of defectivity, significant improvements in many cases. So we're finding that we're winning on performance and not on price.

Our next question comes from the line of Edwin Mok with Needham & Company.

Trisha, it's Arthur on for Edwin. Congrats on the great quarter. David, for my first question, I wanted to ask you about the split between 3D NAND and FinFET. I think, last year, you had said 20% of your tungsten slurries in fiscal '16, about half of it came from 3D NAND, half came from FinFET. So I wanted to see if you could provide an update to that mix and how you think that mix will shift going into fiscal '18?

Yes. So we mentioned about 28% of our tungsten revenue came from those advanced solutions. It's still -- it's was about half maybe 3D solutions going into 3D slightly more than advanced logic, which is more or less FinFET. Going forward, what we would project is that's a -- the memory portion would grow faster. But when we talk about the 28%, it's roughly evenly split, but memory growing faster than the FinFET part.

Got it, got it. And then, I think last quarter, you talked about some customers in China. We're sampling your pads through your cash SEMI collaboration. Can you share some feedback from what your customers have said about those samples? And whether you are still in tract to recognize first revenues in fiscal '18?

Right. We do think we're on track to recognize revenue in fiscal '18. It is a really exciting partnership for us. and as Trisha mentioned, I'm in China now. So it continues to be a partnership that we feel really excited about. And customer feedback from our early marketing efforts, along with KFMI, have been very positive. What we've done is, we've brought some of our most advanced pad technology to China. So just similar to the earlier comment about how we're winning in pads, customers are seeing those same benefits only from a locally produced pad in China, which of course, they prefer.

Our next question comes from the line of Dmitry Silversteyn with Longbow Research.

Trisha, congratulations on a very strong quarter, good to have you here. A couple of questions, if I may. Your performance in the quarter -- so first of all, let's put an end to sort of discussing this quarter. Your performance in the quarter, both in terms of top line and gross margin was above expectations, above your guidance by quite a bit. As you kind of look back on the dynamics that have been displayed during the quarter, what would you attribute that to? Is it just the market overall doing better? Is it your products that are gaining traction faster than you expected? Can you talk a little bit about sort of the level of out-performance that you saw versus your own guidance for the quarter?

Yes, so we continue to see a strong industry environment, and that's benefited us and other close suppliers to the industry. But we think, in particular, the 3D NAND conversion, pads, China, those 3 things, we're well-positioned in each of those areas. We, for the full year guidance and gross margin, we had 49% to 50%, and so we're slightly above that 50.1%. But pretty significant improvement quarter-over-quarter on gross margin. You remember our third quarter gross margin, we were a little disappointed in that. But we talked about some higher cost and some transient effects and in the fourth fiscal quarter, that was kind of behind us and some of those trends and effects that we've seen in the past, weren't present. So we had more expected gross margin percentage. We also continue to have, we think, strong control of cost and operating expense area. We did have year-over-year increases. But we attribute that primarily to incentive comp, and that's based on strong performance against corporate goals for the year and compared to last year, when we didn't performed as well against our corporate goals. I think that's a combination that accounts for the strong performance this quarter.

Okay, makes sense. Then second question, just sort of bookkeeping question. Your data storage business is now less than 1% of revenue. Obviously, it's not a growing market. Is there any thought of either consolidating this business into perhaps, your copper and metal policy or some other business units as it continues to sort of wither away. Kind of how do you think about that business continuing to be part of your portfolio and part of an area that you break out for?

Yes, Dmitry, so on data storage, we continue to talk about how the revenue split out. But obviously, you're talking about the overall trend, which is a -- that is a tough environment for the overall industry. Obviously, for us, a large portion of that is storage moving from hard disk to 3D NAND. And so we're also excited about that growth opportunity it provides. But one of -- to your question about whether we would stop breaking out data storage as a separate product area, we'll take it under consideration.

Okay, fair enough. You've referenced lower raw material cost, that's helping you a little bit on the gross margin line. That's a little bit unique in the industry in the materials industry, at least. Right now, everybody's talking about price increases and raw material cost. So can you talk about sort of the dynamics going into 2018 as well as which raw material specifically, or at least, family of raw materials that are giving you the benefit?

Yes, so when we think about our raw materials, the biggest cost element is abrasive particle. And so typically, when we're talking about raw material cost dynamics, with respect to the abrasive particle, and based on some contracting and renewal of contracts, that sort of thing. We had a period of higher raw material content -- cost with respect to some abrasive particles, and we worked through that, such that now in this quarter, we had lower, kind of a more steady-state cost related to some of those abrasive particles. And we would expect that to continue going forward. But it has to do with specific contracts around a couple of key abrasive particles.

Okay. But you guys are not -- I mean your ASPs are not really tied to raw material, so these continue to go down. It does not necessarily mean that you will be bringing pricing down, right?

No, that's correct. We sell based on performance and technology, and it's not -- absolutely, not a cost plus kind of business model for us.

Yes, didn't think so, okay. And then the final question on the Chinese expansion and sort of the government strategy of moving up in terms of being more self-sufficient in semiconductors and whatnot. You now have local production of fabs through your alliance in China. I know you're supplying this market right now with slurries from your South Korean and your Japanese plants. Is there going to be a need in the next couple of years to have actually assets on the ground in China to produce slurries? Or do you think you'll be able to continue to import into the country and you really don't need local capacity?

Yes, Dmitry, we're going to continue assessing it. Obviously, we're very pleased with our performance in growth in China. We talked about the growth over 25%, 26% year-over-year and that pad partnership that we're very excited about, so we're looking at several options of what to do. We're obviously, playing from a position of strength there, both from the domestic customers that we've had very long-term relationships with, as well as the international customers that have put facilities in China, that we also have strong positions that have been ported over. So China is one -- it's an exciting environment. It's one that we're going to continue to assess our options, but we like our partnership with KFMI.

(Operator Instructions) Our next question comes from the line of Chris Kapsch with Loop Capital Markets.

To follow-up in margin discussion, which was -- Bill, you mentioned transient costs. A lot -- this quarter was related to investments and helped track productivity at the next planar facility. But the fact that we saw the sequential (technical difficulty) did notwithstanding your comments just now about (technical difficulty) cost. Are you -- is it transient effect of the headcount? Did it work? And we're now seeing margins for that business already?

Yes, Chris, it's Bill, and you're breaking up a bit. So let me -- I'll see if I got your question, right. But it has to do with the sequential improvement in margins from Q3 to Q4. And so you'll recall in our discussions in Q3, we had quite a bit of discussion about the gross margin then because we had some higher fixed cost and some other things. We attributed the higher fixed costs, hiring in -- for the pad business in Hillsboro and also some overtime, I think, in Japan because we've been running really hard there. And then also additional heads in Korea as we grow that business. Yes, there's some lumpiness that we've seen historically, quarter-to-quarter in costs and gross margin. And I think we saw sort of a confluence of several factors in the third quarter, but then we didn't see all those factors in the fourth quarter. So yes, we're happy with the gross margin this quarter, perhaps the Q3 was a little disappointing. This one is back where we would expect given our full year guidance.

I'd just add a comment, Chris, for pads, we obviously consider that a strong growth business for us. And so continued investment there in order to meet what we think is going to be continued strong growth. We mentioned the projection of being over $100 million by FY '19. So that's something we continue to be excited about.

Then with respect to pads gross margin that you ask about, yes, we think there's a lot of opportunities for productivity improvement over time. But that will take some time. It is projects that improve workflow and raw material yield and things like that. So that's not -- we didn't see an impact of that in Q3 to Q4 . But it's what we would expect over the coming quarters and years.

Okay, and just to follow-up on the gross margin. If you've gotten to basis points at the mid-point anyway of improvement (technical difficulty) speak to what you think the key drivers there will be for raw material situation. Is it mix? Is it continued growth of your highest-margin products, more mature ones, combination or all of the above? Just you must have some sense for (technical difficulty) confident in outlook through the year -- expansion from already record levels?

Right. So as we put out guidance for gross margin for full fiscal year 2018, it's 50% to 52%. And so that's consistent with what we've talked about during our virtual investor event, where we laid out multi-year expectations for expanding margins, expanding gross margins, leveraging operating expenses, such that we can expand operating margins and EBITDA margins. So this is -- FY '18 is the first year into that multi-year. So this is a function of our expectations around the 3-key initiatives, growth in tungsten with 3D NAND and FinFET, the transformation of dielectrics area; and improving margins there and then our growth in pads, even though pads would have a lower than company average gross margin and then all of that continued with cost control around operating expense. And an element of that would be the raw material savings. But really it's the combination of the 3 initiatives that's really driving that.

Okay. Got it. And then I just feel like I have to ask a question on capital allocation. And I figured for you guys, this may be a conundrum, a problem to have you guys -- have demonstrated ability to generate free cash really every year since what company. Now we have a situation (technical difficulty) the end-market backdrop is healthy, mainly the secular drivers that David, you (technical difficulty) along with that also comes diminished seasonality or cyclicality with the (inaudible) market. As we sit here with almost like a $200 million net cash on your balance sheet, I think it was in (inaudible) maybe $300 million of net cash guided to do the special divi. Your narrative of that (inaudible), I think you said in the past, you'd do some buybacks, but you don't shrink the flow to the company, that doesn't establish a regular dividend. And that's -- but you'll continue to grow that. But are you -- is the company or the board thinking about other (technical difficulty) to address the situation. You have some comp (technical difficulty) there are companies now that are public or running their companies with multiples (technical difficulty) of cash on the balance sheet. So I guess this creates a conundrum for you guys. So additional comments on addressing that situation.

Yes, first, thanks, Chris. So first just to reiterate what our priorities are, it's whatever we need to fund the business which obviously, you know, is not a capital-intensive business. Dividends as you noted, we've instituted a dividend and increased it over time share repurchases, which we've been active and still have a lot remaining and then acquisitions. So I think we have a lot of flexibility. It's certainly something that the Board talks about a lot and thinks about different options. But we like the flexibility right now that we have, and we think we've got a really good, balanced allocation program in place.

Is there any commentary that you can make about the (technical difficulty) because you have gone from sort of very narrow focus in terms of willingness to do complementary bolt-on sort of deals to scope a little there. Is there anything you could share of anything actionable in terms of (inaudible) looking at?

Yes, Chris, I -- we've been asked that question in the past. And I would say, in general, no surprises. But when we think about what would be interesting opportunities for us, they would be very likely in the materials areas, so staying away from the equipment side. And then it would just get into what -- where -- what are some areas where we add value. So obviously, we feel like we've got a world-class infrastructure to support our semiconductor customers. So more materials into those -- into that, those customers that leverage our channel. We also feel like we've got some world-class talent on surface modifications. So if there's applications and materials that we can bring into other industries. So those are the types of opportunities we look at, but I couldn't get more specific than that at this point.

That is all the time we have this morning. Thank you for your interest in Cabot Microelectronics. We look forward to talking with you again soon.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a wonderful day.