CMC Materials, Inc. (CCMP) 2018 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Third Quarter Fiscal 2018 Earnings Call for Cabot Microelectronics. (Operator Instructions) I would now like to introduce your host for today's call, Ms. Colleen Mumford, Investor Relations Director. You may now begin, Ms. Mumford.

Thank you. Good morning. With me today are David Li, President and CEO; and Scott Beamer, Vice President and CFO. Last night, we reported results for our third quarter of fiscal 2018 which ended June 30, 2018. Whether you're joining us online or over the phone, we encourage you to review the investor slide presentation that we've made available under the Quarterly Results section of the Investor Relations center on our website, cabotcmp.com.

A webcast of today's conference call and the script to this morning's prepared comments will also be available on our website shortly after this live conference call. You may request any of the information by calling our Investor Relations office at (630) 499-2600.

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 Form 10-K for the fiscal year ended September 30, 2017. We assume no obligation to update any of these forward-looking information. Also, our remarks this morning reference non-GAAP financial measures. Our earnings release and slide presentation include a representation of non-GAAP to non-GAAP financial measures. Additionally, data is represented by rounded values throughout the discussion and in the supporting materials.

I will now turn the call over to Dave.

Thanks, Colleen. Good morning, everyone, and thanks for joining us. Last night, we announced another very strong quarter with record revenue, net income and earnings per share. This is the fifth consecutive quarter in which we have reported record revenue. We believe that this strong financial performance demonstrates continued execution of our strategic initiatives in addition to sustained, favorable industry demand conditions.

Let me start by providing our view of global semiconductor industry demand as well as some highlights of our performance. Scott will provide additional details about our financial results later in the call.

During the June quarter, we saw demand for our products remain strong across our memory, logic and foundry customers. In particular, the memory segment continued to be very strong and the continued transition to 3D NAND and strong demand for DRAM drove sales to our customers. Industry research would suggest that 2D to 3D NAND wafer capacity is approximately 50% converted with the remainder expected to be completed over the next several years, providing additional anticipated momentum to memory growth.

Despite some reported industry delays in capital equipment spending, we expect customers to continue to maximize fab utilization to satisfy demand, which should bode well for continued CMP consumable growth. We also see continued capacity expansions in 3D NAND and DRAM, primarily in Korea and China, as demand remains robust and DRAM capacity continues to appear relatively tight.

On the logic and foundry side, we saw continued solid demand for our solutions, particularly in the legacy technologies, which support a broad range of applications including automotive, industrial automation and the Internet of Things. In the advanced technologies area, consistent with recent customer and industry reports, we saw some softness in demand as the industry appears to be gearing up ahead of anticipated new consumer product launches expected later this year. We continue to work closely with our customers to help them transition to new technology nodes that likely will require the use of more advanced technologies and new materials, and remain confident about the long-term growth prospects in this important customer segment.

Now let me turn more specifically to company-related matters. This quarter, we recorded strong results in all 3 key product areas, tungsten slurries, dielectrics slurries and CMP pads. Geographically, revenues increased across regions. Notably, revenue in Korea was up 57% and China was up 24% compared to the previous year.

Turning to performance by product area. We delivered record revenue in our tungsten slurries, which was approximately 18% higher than in the same quarter last year. This growth was driven by the continued ramp of solutions supporting our 3D NAND customers, as well as strong growth in logic and foundry applications. As mentioned earlier, we expect to continue to benefit from ongoing strong demand for memory as well as our customers' ongoing transition to 3D NAND over the next several years.

In addition, during this quarter, we achieved record revenue from our dielectrics slurries. This was primarily driven by increased demand and the benefit of customer conversions to our ceria-based solutions in advanced memory applications. These are higher-margin products that provide lower total cost of ownership and better performance to our customers. We are excited about the growth we see in the adoption of our advanced dielectrics products, and believe we are well positioned to continue growing revenue while also improving margins in this product area.

Turning to CMP pads. Revenue increased 19% year-over-year as continued strong growth and adoption of our NexPlanar product line offset some softness in legacy pads revenues associated with weaker foundry demand. Our focus on potential new opportunities and our global support of customer qualifications remain catalysts for growth in our pads business and we remain confident of achieving our goal to reach at least $100 million in annual revenue by the end of fiscal 2019.

Looking ahead, we are excited about our sustained strong performance. We feel confident about our ability to continue delivering against our long-term financial goals of growth faster than the industry as well as margin expansion. Although recent reports suggest that industry growth may be beginning to moderate, particularly on the capital equipment side, we believe our business model, which is consumables focused and based on wafer starts, will allow us to continue to profitably grow. As a result, we currently expect fourth fiscal quarter revenue for our IC CMP consumables business to increase by low single digits compared to the third quarter.

And with that, I will turn the call over to Scott for more detail on our financial results.

Thanks, Dave. And good morning, everyone. My comments will generally follow the related slide presentation we posted on our website last night along with the press release.

Let's start with an overview of our financial performance this quarter, which is provided on Slide 3. Revenue for the third quarter of fiscal 2018 was a record $150 million, which was $22 million or 18% higher than the same quarter last year. The increase reflects continued strong global semiconductor industry demand and the focus on our key -- on our 3 key product areas.

Sequentially, total revenue increased $7 million or 5%, with IC CMP consumables revenue up 5%, which is at the higher end of our expectations that we shared on our previous conference call in April. Our net income of $35 million was also a record and represented an increase of $15 million or 76% over the same quarter last year, driven by higher revenues and increased gross margin. Non-GAAP net income was $36 million.

Now let's drill into revenue, which is shown in Slide 4. As previously stated, we defined tungsten slurries, dielectrics slurries and polishing pads as 3 key product areas that are strategically important to us. During the quarter, these accounted for approximately 80% of our revenue, and I'll mention each in order. Tungsten revenue was a record $64 million, an increase of 18% compared to the same quarter last year. Dielectrics slurries also delivered record revenue of $37 million, up 21% from the same quarter a year ago.

Sales of polishing pads delivered revenue of $21 million, up 19% compared to the same quarter last year. Sales of slurries for polishing metals other than tungsten, including copper, aluminum and barrier, represented $18 million, an increase of 13% from the same quarter last year. Finally, revenue from our Engineered Surface Finishes products, which includes QED, Data Storage and Electronic Substrates was up $10 million, up approximately 13% from the same quarter a year ago.

Now please refer to Slide 5, which provides some higher level P&L comparisons. Gross margin for the quarter was 53.6% compared to 48.9% in the same quarter a year ago. Excluding $1.3 million of amortization expense related to the NexPlanar acquisition, gross margin was 54.5%. Higher sales volume and higher valued product mix had a favorable impact on margins, and more than offset higher fixed manufacturing costs, including higher staffing-related expenses.

Year-to-date gross margin was 53% compared to 49.7% last year. This includes an adverse effect of $3.9 million related to the NexPlanar amortization expense. Our gross margin improvement was primarily driven by higher volumes in tungsten and dielectric product areas as well as progress towards our ongoing initiative to transition our dielectrics slurries portfolio to advanced, higher-margin products.

Operating expenses, which include research, development and technical as well as selling and marketing and general and administrative costs, were $39 million this quarter, an increase of $3 million over the same quarter a year ago. This primarily reflects higher staffing-related expenses and higher professional fees. As a percent of revenue, our operating expenses declined to 25.8% compared to 27.8% in the third quarter of fiscal 2017.

Our operating margin was 27.9% in the quarter, an increase of 690 basis points from the same quarter last year. The increase was driven by higher gross margins and prudent control of operating expenses. The tax rate for the quarter was 18%, which was below our previous expectation of 21% to 24%. This was due to a favorable impact of a change in a prior period tax position.

Diluted EPS was $1.34 this quarter, which was also a record, and represents an increase of 74% over the prior year quarter. Diluted EPS on a non-GAAP basis was $1.37. This was primarily driven by higher revenue and higher gross margins.

Now please refer to Slide 6, which provides some balance sheet and cash flow information. We generated cash flow from operations of $37 million. We ended the quarter with a cash and short-term investments balance of $311 million and had no debt outstanding. During April, we repatriated $200 million to the U.S. and paid off our remaining term loan of $138 million.

Capital spending for the quarter was $6.4 million bringing our to-date total to $15 million. Accordingly, our free cash flow was $30 million in the quarter. As previously communicated, we have committed to returning at least 50% of our prior year's free cash flow to shareholders by way of dividends and share repurchases. Through June, we have returned $51 million, which represents 85% of our full year target to return at least $60 million.

We provide some closing remarks on Slide 7. From a financial perspective, we achieved very strong performance this quarter, including records for revenue, net income and EPS, and I would like to highlight the operating leverage we are seeing on revenue growth.

In the third quarter, revenue increased $22 million from the prior year, while operating income increased $15 million, implying that approximately 2/3 of our incremental revenue dropped directly to operating income. Year-to-date, our operating leverage is 59%.

Finally, in the appendix on Slide 8, we provide a table showing updates to certain expectations. As we think about the fourth quarter of fiscal 2018, we expect solid demand conditions for our products to continue. With that said, and as Dave mentioned, we currently expect fiscal fourth quarter revenue for our IC CMP consumables to show a low single-digit increase compared to our strong third quarter results.

We are narrowing our full fiscal year gross margin guidance to between 52% and 53%, and we expect to be at the high end of that range. This would be consistent with our year-to-date margin of 53%. We also expect our operating expenses for the full fiscal year to be between $150 million and $155 million.

We expect to manage our operating cost to provide strong operating leverage and net income growth. We continue to expect our effective tax rate in the fourth quarter to be between the previously communicated range of 21% to 24%. Our capital spending expectation for the full fiscal year remains between $18 million and $22 million.

Now I'll turn the call back to the operator as we prepare to take your questions.

(Operator Instructions) Our first question comes from Edwin Mok with Needham & Co.

First, my question was for you, Scott. If I take -- I know you guys raised your gross margin target for the year, but if I kind of take the midpoint or even higher end on that, it implied gross margin will come down in the September quarter. Can you explain why?

I'm glad you asked that point, Edwin, because it's really important that we highlight that. Look, we have not communicated anything about margin pressures or deterioration in Q4. So year-to-date, we're at 53%. We said 52% to 53% is our range, but we said we expect to be at the high end of that range. So 53% for the full year compared to 53% year-to-date, that implies 53% for Q4. Now someone astute like yourself would point to our Q3 and say we just delivered 53.6% and you're indicating a 53% for Q4, what's going on with that? And I would say, at that point, we're probably beginning to split some hairs. And 60 basis points that we just take our revenue for this quarter of $150 million, 60 basis points is $900,000 in pretax dollars. So -- and we don't purport to try to forecast and guide within that sort of level of accuracy. So I hope that, that context helps. It's an important question. I'm glad you raised the point.

Okay. So maybe I'll ask you differently, right. Then on the June quarter, your margin was performing extremely well. Is dielectric a big driver of that? I think Dave mentioned dielectric was doing really well. And obviously, we know that the new product is driving -- or its margin (inaudible). Maybe you can kind of walk through what the driver is behind the very strong margin performance in the June quarter.

Yes. Thanks, Edwin. So you know our product lines, our main product lines very well. If you look at, from a mix standpoint, tungsten, we've talked about our strong leadership position there and that's above corporate gross margin. Dielectrics, that's a portfolio under transformation. So the newer products that we are really excited about and we continue to talk about our progress, those are also at or above our corporate gross margin. But then pads, an area that we consider our greatest growth opportunity is something below corporate gross margins, so there is a mix factor as well. The way Scott described it is exactly the right way to think about it. But this, in terms of those 3 product lines, they all come with different margin profiles as well.

Okay. Great. Maybe move to dielectric, just kind of focus on the growth there. It looks really good here. And I think, Dave, you mentioned that advanced memory was a big driver this quarter. Is there a way to kind of think about what -- where we are in that adoption curve. Are we in the first inning? Are we in the fifth inning for advanced memory? I think historic guidance you had talked about kind of (inaudible) you need to go after because you guys can offer a more cost-competitive solution for customer. Can you talk a little bit about where you stand on that?

Yes. So dielectrics, I think, also is a bit -- it gets a little bit less visibility than perhaps tungsten and pads for us, but we're really excited about it. First, dielectric as a total TAM for CMP is actually the largest TAM within CMP. So it's a big potential market that we can continue to grow in. Our products, we talked about advanced memory and the growth there, that's the ramp-up of some wins that we talked about a couple of quarters ago with some of the major memory manufacturers. But the portfolio that we've introduced with both ceria and colloidal is really applicable to both the legacy logic and foundry as well as with the advanced memory, and I'd say that we're still very early on in that conversion. But of course, we're really encouraged and excited by what we see in the pipeline. And then you've seen the last couple of quarters have been record quarters for dielectrics, so we really like the momentum that we're seeing in the product area.

Okay. Great. One last -- just quickly, a housekeeping question. I missed it if you mentioned it, sorry about that. Did you mention what tax rates you used for the quarter?

Yes. We're not changing that, Edwin. We still expect between 18% and 21% for the final quarter for us. We mentioned that we came in lower this quarter and that was an adjustment to prior period tax position, which was -- yes, 21% to 24% for the quarter. Maybe I misspoke it, but it's on the slide. We expected 21% to 24% for Q3. We expect the same for Q4. Q3, actually, came in lower because of this adjustment to a prior period tax position, which was really a onetime item.

Our next question comes from Mike Harrison with Seaport Global Securities.

This is Jacob, on for Mike. Thank you guys for putting out the slides last night. I really appreciate it on a busy earnings day today. Thanks for that.

Okay. Thank you.

My question, so you commented that given this delay that people are talking about on the memory side of capital spending, that you expect customers to maximize utilization in the meantime. And also, in the past, I think you've commented that pads helped improve yield. And so for these customers that are looking to maximize the utilization, do you think that this sort of delay could actually work out in your favor and kind of be a positive?

Yes. Jacob, so this is Dave. In terms of the memory side and the dynamic there, I think there's been a lot of attention recently on sort of the push outs of capital equipment spending. And I think it's just a good point to just remind everyone that we are 95% consumables based. So although the capital equipment cycle gets a lot of attention, we really sort of offset from that cycle. And what we've seen is a lot of tools sold in to the industry over the last, I'd say, 1.5 years, and those tools are just starting to come online in certain instances so we're seeing strong growth and we are confident about continued strong growth in the memory area. Your question specifically around whether a delay would help us with certain product areas. We work with customers all the time. So our pads, for example, or even our ceria-based solutions that are primarily used in memory, all of those have some benefits to customers whether it's lower cost of ownership. Our pads also have best-in-class defectivity. The ceria solutions that we have offer some really unique performance benefits. So all of those are helping customers. I would say we continue to hope that the industry continues to move forward from a technology perspective and we're working with customers on advanced memory. I would say that there's just kind of been a pause in the capital equipment cycle, but our momentum in terms of growth is really more towards wafer starts and we feel really good about that dynamic going forward.

Okay. Yes. That makes sense. And then -- so looking at the pad growth, I think, over the past several years, you've increased revenue sequentially every quarter. And then this quarter, I think it looks like it's the first one that kind of slowed down. So do you expect that this was just sort of onetime thing? I know you commented that there was some legacy pad weakness, but do you expect the sequential growth cadence to pick back up next quarter?

Yes. First, I think, more importantly, long term, we feel we continue to be confident about our goals that -- our stated goal of growing to $100 million or more by FY '19. So the long-term growth story of pads, we remain really confident and excited about. We saw this quarter, we try to add some color there as we have a legacy pad line that's primarily used in foundry. As you know, foundries had some weakness over the last several quarters, so we kind of attribute that softness to that foundry demand weakness. But we continue to see growth with our NexPlanar product line, and that's what we're excited about. That's the pad that we're really developing our slurries on going forward and that's the platform that we expect to really be proliferating the market with going forward. So we really like the growth momentum, the pipeline that we see, and so I wouldn't comment quarter-to-quarter. But the long-term growth trajectory of pads, we feel really confident in.

Our next question comes from Chris Kapsch with Loop Capital Markets.

Chris, you with us?

(technical difficulty)

We'll go to the next line and maybe Chris can get back in the queue.

Yes. Can we move to the next caller, please. Operator, are you with us?

Yes. I'm with you. Chris, your line is open.

Can you hear me now?

Okay. Now we can hear you, Chris. Thank you.

We got you, Chris.

Sorry for the technical difficulties. So I want to focus on the really strong...

(technical difficulty)

Okay. It sounds like we're having problem with Chris' line. Maybe we can move to the next caller and then Chris could join again.

(Operator Instructions) Our next question comes from Amanda Scarnati with Citi.

Just talking about changes in materials that are potentially being used for (inaudible) transition. Applied Materials just talked about cobalt. Can you talk about opportunities that Cabot has in terms of slurries or pads with new materials being used on 7 or 5 nanometer nodes?

Yes. Amanda, I think cobalt is one of those materials that's being considered and -- with some limited application in 7 and 5 nanometers for logic and foundry. You can be sure we have programs in place and are working closely with customers on cobalt. And if that becomes a significant CMP opportunity, we expect to be right there and leading. I'd say for now, we, of course, expect and want to work with our customers to advance the technology. It doesn't appear that cobalt is right now a significant contributor to the CMP consumables market. But of course, as we move to the smaller feature sizes, it may become important. There are other alternative materials as well that are being considered beyond cobalt, ruthenium, and we've got programs there. As you'd expect, as the leader, we've got programs in all of these advanced materials. And -- but what we see right now is the impact of a cobalt on CMP consumables is a pretty limited opportunity.

And then these other opportunities I assume would they be combined in that copper and other metals slurries until it becomes a larger portion of sales potentially?

Yes. I think it's also just the number of potential wafer starts, customers and applications. We hope also that there is new applications end-use demand for advanced logic and foundry. But of course, that sort of where if there's any sign of growth moderating, that's been the area that's been a little bit weaker than the rest of the market. So where we -- for example, where we participate, we provide our products to everyone that makes the chip, but we've seen the strongest growth from memory, legacy logic and foundry. And then advanced logic and foundry was a little bit softer from a demand perspective, so that also contributes to the limited contribution from a cobalt, so far.

And then could you just remind us about the JV in China and how that's tracking towards your expectations at this point. I think it's about a year or so into the JV. I mean can you also talk about if you're seeing any sort of IP-related concerns or trade or tariff-related concerns in relation specifically to the JV at this point?

Yes. So I'll cover the China partnership and then I'll have Scott to talk about the tariff situation, obviously, we're watching that closely. So just to clarify, that's not a JV. It is a good partnership we have with a company called KFMI, where we transferred some of our advanced pad technology to them to provide local pads to our local customers in China. The relationship is strong. The partnership is underway, and we did realize first revenue. We do think that's going to be a longer-term play in China where we like our position. We have -- obviously, we liked the growth potential of pads, but these things take time. So we'd say that's kind of on track for right now, but it's early stages of that partnership. But it's not really a JV. In terms of IP, the way we've designed that partnership has also been very important to us where, I think, while we're allowing our customers in China to access our latest pad technology, we feel really comfortable with the way we've structured that transfer so that we are protecting the sensitive parts of the technology for pads on our side.

And Amanda, I'll comment then about the tariffs as it relates to any business in China. One thing that we think is a real competitive advantage for us is our global supply chain. And we talked about the fact that we have 50% of our people and our assets in the region over there throughout Asia. We generally produce and supply to our customers locally so we think that, that gives us a competitive advantage, which we're really proud of. So far, any impact has been not material from anything that we see from a cost perspective. Broadly speaking, if there begins to be tariffs on the end products in which the chips are used, certainly that might have a headwind going forward for the entire industry, but we haven't seen any material impact from our cost perspective or otherwise.

And our next question comes from Chris Kapsch with Loop Capital Markets.

Can you hear me now?

Yes. We can hear you clearly, Chris. We kind of lost you halfway last time.

Sorry about that. So the question is focused on the strength in the oxide business, and you called ceria especially. So I'm wondering just -- because it's more pronounced when the memory industry first started shifting from 2D to 3D NAND, it was really all about tungsten slurry and the benefit there. But now it seems that this phenomenon, the ceria-based slurry

(technical difficulty)

Chris, keep going. You're kind of in and out.

Yes. Is it -- just wondering if it's a function of that material being consumed on the 3D NAND architectures with greater stacks or is it just sort of the belated adoption? I'm just wondering what's driving the outsized growth there.

Yes. We're really pleased with the growth we've seen with our ceria products and we see a really good runway there. Both of course -- when you transitioned from 2D to 3D, just to remind there's basically a doubling of CMP steps, and most of those steps are in tungsten and dielectrics. In particular, there have been some challenges in the dielectric CMP space where customers have asked us to help them achieve a certain performance whether it's a staircase or a different kind of challenge with dielectrics polishing there. And our ceria solutions have been able to address those needs. And so some of that is 3D NAND ramping up, some of that is actually displacement of competitors within the dielectrics area and us winning new business, and then seeing that ramp-up within the memory space as well. So again, we're really excited about the progress there and look forward to continued growth.

And just a follow-up on the colloidal silica side of the oxide business. How far along is the sort of transition as you see it from sort of legacy products more commoditized to your advanced colloidal-based silicas? Is it -- and is it more -- or is that transition is more about, currently about the cannibalization of your own legacy products or are you also taking share in those applications?

Yes. And so the colloidal side of dielectrics is also an area we're excited about the long-term potential of. Just broadly speaking, if you divide colloidal and ceria, colloidal is more preferred or favorable -- favorably used by our logic and foundry customers, and there has been some kind of softness in the advanced side. The legacy side has been going really strong so that presents some challenges just in terms of qualification, speed, and customers continue to really like our legacy products. Just as an example, you may have noticed we announced a price increase on our legacy products. Some of that was to incentivize, motivate customers to perhaps move on to our advanced technologies, and some of that's the colloidal platform as well. So that's going along. We're seeing progress there, but not as quickly and not as strong of a growth trajectory as we've seen in ceria. Longer term, we think that is a really, really unique series of products on the colloidal side, with performance that's not matched by anyone in the industry, so we see strong adoption in the long term.

Great. Okay. Helpful. And then if I could follow up also just on -- you sound -- your formal comments and around the NexPlanar pads and the PORs, very bullish. What I'm wondering though is the future adoptions that you're seeing. Are they sort of NexPlanar pads in standalone applications or are they being qualified as consumable sets and therefore pulling through some of your advanced slurry products as well? And also, are the bullishness that you expressed in terms of future PORs, is it balanced across foundry, logic and memory or is it more skewed towards, I guess, foundry and logic?

Yes. We've seen adoption across all segments in all customer types, both advanced and legacy. We mentioned, I think several quarters ago, that we're selling to just about all of the top 10 manufacturers. So those are pretty equally distributed amongst logic, foundry and memory. In terms of where we are in consumable sets, I think we're really unique in being the only company out there that can really truly offer a consumable set given our broad portfolio of CMP slurries and then our NexPlanar pad platform. We -- I think you'll see us be more active in that space in the future, but we're still really early on right now. And so although some of those NexPlanar pad wins and ramp-ups are with our slurries, I think when we go to market with a true consumable set, it's with the idea that we can provide customers with a differentiated solution and we want to make sure we're very clear on the value that we're contributing there. So I'd say we're still early in those efforts, but there are some -- obviously, some pads, NexPlanar pads, being used by our customers in conjunction with our slurries today.

Okay. Thank you. Ladies and gentlemen, I'm showing no further questions in the queue at this time. I would now like to turn the call back over to Ms. Colleen Mumford for any closing remarks.

Right. Thank you. That is all the questions we have for this morning. Thank you, all, for your time and your interest in Cabot Microelectronics Corporation. Have a great day.

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