Cabot Microelectronics F1Q08 (Qtr End 12/31/07) Earnings Call Transcript

| About: Cabot Microelectronics (CCMP)

Cabot Microelectronics (NASDAQ:CCMP)

F1Q08 Earnings Call

January 24, 2008 10:00 am ET

Executives

Amy Ford - Director of Investor Relations

William P. Noglows - Chairman, President and Chief Executive Officer

William S. Johnson - Vice President, Chief Financial Officer and Treasurer

Analysts

Suresh Balaraman - Think Equity Partners

Tim Summers - Stanford Group Company

Avinash Kant - Broadpoint Capital

John Roberts - Buckingham Research

Dmitry Silversteyn - Longbow Research

Analyst for Chris Blansett – J.P. Morgan

Steve O’Rourke - Deutsche Bank

Operator

Good day, ladies and gentlemen. Welcome to the First Quarter 2008 Cabot Microelectronics Earnings Conference Call. (Operator Instructions) I would now like to turn the presentation over to your host for today, Ms. Amy Ford, Director of Investor Relations.

Amy Ford

Good morning. With me today are Bill Noglows, Chairman and CEO and Bill Johnson, Chief Financial Officer. This morning, we reported results for our first quarter of full fiscal year 2008, which ended December 31, 2007.

A copy of our press release is available in the Investor Relations section of our website, cabotcmp.com, or by calling our Investor Relations office at 630-499-2600. Today’s conference call is being recorded and will be archived for four weeks on our website. The script of this morning’s formal comments will also be available there.

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 the forward-looking statements. These risk factors are discussed in our SEC filings, including our report filed on Form 10-K for the fiscal ended September 30, 2007. We assume no obligation to update any of this forward-looking information.

I’ll now turn the call over to Bill Noglows.

William P. Noglows

Thanks, Amy. Good morning, everyone, and thanks for joining us. This morning we announced strong financial results for our fiscal quarter of 2008. We reported another record quarter with $93.4 million in revenue. We maintained our gross profit margin near the high-end of our annual guidance range and also, managed operating expenses to the midpoint of our quarterly guidance range.

This resulted in strong profitability, including a 20% increase in net income over the last quarter and a 34% increase, compared to the same quarter a year ago. During the quarter, we continued to see strong demand for our slurry products from our memory customers. However, in the foundry and logic segments, we experienced some weakening in demand toward the end of our first fiscal quarter.

At this point, it is difficult to tell if this is related to a general slowdown in the semiconductor industry or if it is more indicative of the normal seasonality of the industry.

As we enter calendar year 2008, you are aware that a number of industry analysts have reduced their semiconductor industry revenue growth forecast for this calendar year, citing general concerns over the outlook for the global economy.

In addition, industry experts expect 2008 to be a down year for semiconductor capital equipment investment and this seems to have put a cloud over the near term prospects for much of the industry. Capital investment by our customers is relevant to our business over the long-term, but of much greater interest to us in the near-term are wafer starts.

Since our core business is CMP consumables, demand for our products is tied to our customers’ production of devices rather than their investment and equipment. Regardless, we believe we are well-positioned to operate successfully over a range of future industry and economic environments.

We have a proven track record of weathering industry cycles and have historically generated solid cash flow, even during market environments of moderating growth.

We believe the strong results that we reported this quarter reflect a consistent and successful execution of our three strategic initiatives within our core CMP business: technology leadership, connecting with customers and operations excellence, which I will now discuss.

We are pleased with the progress we have made on our technology leadership initiatives. We continue to innovate with the priority on high performing, low cost of ownership products for our customers.

As you all know, long development and commercialization cycles are common in this industry. So, investing early and continuously is necessary to secure customer wins two to five years down the road.

One important illustration of our commitment to technology leadership and providing technical solutions for the future was our entering into a long-term agreement with IBM this quarter to jointly develop CMP solutions for its 32 and 22 nanometer technology devices.

We have enjoyed a long and productive relationship with IBM and its technology associates. We are excited to have been selected to collaborate with a strategic customer to address the CMP technology challenges for a variety new applications and new materials.

As part of our connecting with customers initiative, we are always looking for ways to better serve our customer base around the world. During the quarter, we purchased and began installing a new 300-millimeter polishing tool for our Asia-Pacific technology center, which we believe complements our existing 300-millimeter capabilities in the United States.

We expect to utilize this new tool in the development of next generation copper and barrier products, and customer demos on this new tool is set to begin next month.

We believe that this investment, as well as our additional investments in R&D resources in Asia will allow more collaboration with our customers in this very important region, increase our responsiveness and allow for more efficient product development.

Additionally, we continue to focus on bringing value to our CMP slurry customers through our complimentary polishing pad offering. As evidence of our success in this area, the number of customers buying our pads has grown from 8 customers last quarter to 11 customers this quarter.

In addition, we have another 20 or so customer opportunities in various phases of testing, evaluation and qualification across a variety of applications, tools and technology nodes.

Last quarter, we shared with you our enthusiasm about a pad adoption that represented our first pad win in a copper polishing application at a leading edge technology node. This quarter, I’m proud to say that we have gained traction with this opportunity, as well as others, and as a result, our pad revenues have begun to substantially ramp.

Instead of selling a few hundred pads per month, we are now getting orders in excess of 1000 pads per month and most of these are for 300-millimeter wafers. It is now clear to us that demand is there, and now we are committed to producing these pads at high volume and with the high level of consistency and product support that is required in this industry.

We have demonstrated that we can develop, produce and sell pad products to meet our customers needs and performance requirements and we believe that we are well-positioned to successfully meet this new demand.

As we ramp our production of pads, successfully implementing our operational excellence initiative is vital to fulfilling the requirements of our pad customers. As we have discussed before, we planned and built our pad manufacturing infrastructure in advance of receiving significant orders, so that we would be prepared to supply customers in high volume when the demand materialized.

Now that we are running multiple shifts at both of our pad manufacturing locations, we are actively planning for the next phase of pad manufacturing capacity to effectively meet future demand.

To-date, we have been able to achieve this recent significant ramp in pad production smoothly and successfully and without any major supply chain, quality or operational issues. The close partnerships with our raw material suppliers and our solid supply assurance strategies have served us well in that regard.

In addition, we have worked hard to quickly staff our pad business to meet this new demand. And we are very satisfied with the quality of our new employees that we have attracted to this growing business opportunity.

Our long experience of meeting or exceeding our customer’s expectations for CMP slurries has more that prepared us for our ramp to high-volume manufacturing capability for pads. We are pleased that we’ve been able to move quickly on what continues to be a very exciting growth opportunity for the company.

Across our company, we’re executing on our operations excellence initiative to drive out variation in our products and processes and increase productivity. Over the past three years, we have achieved 18% cumulative productivity improvements through the consistent and successful execution of our company-wide Six Sigma efforts.

In today’s tough industry environment it is more important than ever to strive for continuous improvement and gain additional efficiency in our operations. To that end, we have again set aggressive goals for productivity improvements in fiscal 2008 and we are encouraged by the progress we have made to-date.

Next, let me provide an update on our engineered surface finishes or ESF business. Within our ESF business, QED Technologies, which we acquired 18 months ago, is a leading innovator in the field of automated precision polishing and metrology systems for the optics industry.

QED’s deterministic computer-controlled process has greatly enhanced product quality and repeatability and is providing a step change improvement in throughput, productivity yield and cost effectiveness at the highest end of the precision optics industry.

Until now, QED’s products have been primarily targeted to the ultra high-end optics manufacturers. However, QED has recently expanded its marketing efforts to appeal to the more traditional optics manufacturer, which represents a new market opportunity for the company.

There are hundreds of smaller optics manufacturers throughout the United States, Europe and Asia that continue to rely on traditional manual artisan labor to produce optical components and we believe these companies can benefit from QED’s automated approach.

During the quarter we were excited to receive orders for eight machines from this new segment of the market. And we are eager to bring QED’s automation to many more in the future.

Closing my comments, our first fiscal quarter was a strong quarter for the company. We believe that continued execution of our strategic initiatives has allowed us to maintain our solid profitability and generate strong cash flow. Consequently, we remain confident that we can adapt to a range of industry environments.

Last quarter, we completed our $40 million share repurchase program, which brings our total share repurchases to date to $65 million. This represents the second program that we have announced and completed over the last three and half years.

We were pleased to announce yesterday that our Board of Directors has authorized a new $75 million share repurchase program, which we view as a flexible and attractive means to return cash to our shareholders.

The benefit of our strong financial model and effective operating strategy is that we can execute a program of this size while continuing to reinvest in our business through research and development, acquisitions and capital expenditures.

And with that, I’ll turn the call over to Bill Johnson.

William S. Johnson

Thanks, Bill, and good morning, everyone. Our revenue for the first quarter of fiscal 2008 was $93.4 million, which represented our third sequential quarterly revenue record. Total revenue this quarter was up by 3.3% from the prior quarter and up 14.1% from the year ago quarter.

We believe the sequential increase primarily reflects solid business performance, strong industry conditions through the end of the calendar year, and contributions from our polishing pad business.

We saw a sequential revenue increases in slurries for tungsten and dielectric polishing applications, as well as in polishing pads and sequential decreases in revenue for our other business areas.

Drilling down into the quarterly revenue number, tungsten slurries contributed 41.4% of total quarterly revenue, with revenue up 10.8% sequentially, mainly on continued strong demand from our memory customers. In addition, we achieved our third sequential quarterly revenue record in our tungsten business.

Sales of copper slurries represented 15.2% of our total revenue and decreased 15.2% sequentially, mainly due to lower demand from the foundries in the Asia Pacific region.

Dielectric slurries provided 32.6% of revenue this quarter, with sales up 4.2% sequentially. Data storage products represented 5.2% of our quarterly revenue; this revenue was down 2.9% sequentially.

Sales of our polishing pads represented 1.9% of our total revenue for the quarter and increased over five times sequentially. This represents our first meaningful quarter of pad sales, and we believe that we are just beginning to see demand ramping.

Given the momentum we’ve been building in the pad business, we expect to continue to see strong growth in our second fiscal quarter.

Finally, revenue from our ESF business, which includes QED, generated 3.7% of our total sales, and our ESF revenue was down 18.9% sequentially. Although ESF revenue was low this quarter, we received a number of orders for equipment during the quarter that we expect to ship in our second fiscal quarter.

Recall that while our CMP slurry business is largely a make-to-order business, QED’s business is mainly capital equipment oriented and it sells from a backlog of orders. Given QED’s backlog at the end of December, we expect the March quarter to be much stronger for our ESF business than the December quarter.

On a geographic basis, sales in all regions grew sequentially, except Southeast Asia and China. The highest sequential growth this quarter was in Korea, with a 13.6% revenue increase. Notably, our sales in Korea nearly doubled this quarter from the same quarter last year.

Our average selling price for slurry products increased slightly, compared to the September quarter, and our average selling price was 1.9% higher than in the same quarter a year ago.

As a percentage of revenue, gross profit was 47.9% this quarter, which is near the upper-end of our full fiscal year guidance range of 46% to 48% of revenue. However, gross profit was 1.2 percentage points lower than the 49.1% of revenue we reported in the prior quarter and 0.2 percentage points lower than in the year ago quarter.

Contributing to the sequential decrease was higher fixed manufacturing cost, including some incremental costs related to our planned closure of our slurry production facility in the U.K., as we discussed last quarter. In addition, we incurred higher staffing related costs in our pad business, as additional employees were hired to meet an increase in demand.

Now I’ll turn to operating expenses, which include research, development and technical; selling and marketing; and general and administrative costs. Operating expenses of $28.5 million this quarter are in the middle of our quarterly guidance range of $27 to $30 million. This quarter’s expenses were $1.8 million lower than last quarter, primarily driven by lower staffing related costs.

This quarter’s operating expenses were $1.4 million higher than the $27.1 million reported in the same quarter last year. The year-over-year increase in operating expenses was mainly due to higher professional fees and higher staffing related costs, partially offset by lower depreciation expense.

Reflecting these strong operating results, net income for the quarter was $12.2 million, up 20.1% from $10.2 million last quarter, and up 33.7% from $9.1 million in the same quarter a year ago.

The weighted average number of shares outstanding on a diluted basis this quarter was 23.8 million. Diluted earnings per share were $0.51 this quarter, up from both the $0.43 last quarter and $0.38 in the year ago quarter.

On a comparable basis, this is the highest EPS level in our company’s history, excluding share based compensation expense, which we are not required to report prior to fiscal year 2006.

Turning now to cash and balance sheet related items, capital additions for the quarter were $7.9 million, which includes costs associated with the purchase of the 300-millimeter polishing tool for our Asia Pacific technology center.

Depreciation and amortization expense was $6.4 million in the quarter, and share based compensation expense was $3.5 million.

We ended the quarter with $209.4 million in cash and short term investments, which was $3.1 million lower than last quarter. Cash flow reflects $14 million of share repurchases and a $2.3 million increase in working capital.

As Bill mentioned, the $14 million of share repurchases completed our $40 million share repurchase program, and our Board has just authorized another $75 million program.

I’ll conclude my remarks with a few comments on recent sales and order patterns. Examining our revenues in each of the three months of the first fiscal quarter, sales activity remained relatively constant throughout the quarter and generally consistent with our sales levels from May through September of last year.

This was the first quarter in our history that revenues for each month of the quarter topped $30 million.

As we’ve discussed in the past, we believe that our core CMP business is unit-based and driven by overall wafer starts. As Bill mentioned, a number of analysts are expecting semiconductor growth to moderate in calendar year 2008, primarily due to anticipated weakness in the global economy, which may slow growth in the end device demand.

Also, keep in mind that historically, our second fiscal quarter, which is the first calendar quarter, has been a lower revenue quarter for our company, which we believe is due to the seasonality of the semiconductor industry.

As we observe orders for our CMP products received to date in January that we expect to ship by the end of the month, we see January results trending generally in line with our first quarter of fiscal 2008.

However, I would caution, as I always do, that several weeks of CMP related orders out of the quarter represent only a limited window on full quarter results.

Now I’ll turn the call back to Stacy as we prepare to take your questions.

Question-and-Answer Session

Operator

Your first question comes from the line of Suresh Balaraman - Think Equity Partners.

Suresh Balaraman - Think Equity Partners

Regarding the pads, how many of those 11 customers could be using it on thousands of wafer starts per month by end of this year?

William P. Noglows

Suresh, I think in previous calls, we’ve discussed the qualification process for our pad technology, and it’s difficult for us to say at any one time which of the 11 customers that are buying our pads today and where they are in their qualification process and how broadly they’ve incorporated our pad across their line.

So, we’re going to be cautious on what we say in our future revenue or future pad sales because we have limited ability to either predict or control the qualification process going forward.

As you know, there’s probably a handful of customers that might buy pads on the orders of thousands per month, so we’re delighted with the pad sale that we talked about this morning, that we talked about last quarter, that which is at the leading edge node in copper technology. And we’re delighted that that one has ramped as quickly as it has. And we would expect and hope that others would do the same over this full fiscal year and into next year.

But we’re going to be cautious about what we say about qualifications going forward. Because I’ve been wrong before, as some of you may remember, about my enthusiasm about our pad technology and how fast it would be incorporated, so we’re going to be careful going forward, on what we say and what we think.

Suresh Balaraman - Think Equity Partners

And I, for one, was surprised by the strength of Q4, and historically the way I remember is that Q4 has planned shutdowns during the Christmas holidays and that has been seasonally weaker. Has something changed in this year versus prior years? Why is it much stronger?

William P. Noglows

I think what we’ve heard, Suresh, and you’ve probably heard the same things, is that electronic systems and electronic products and consumer electronics products sales prior to and through the Christmas holiday were very strong. And I think they were stronger than people expected or anticipated.

What we’ve come to learn and hear is that most of the consumers, particularly in North America, they may have canceled trips and not bought expensive handbags, but they ran out and bought iPhones and laptops and iPods. And I think that drove a lot of the consumer electronic demand through the holiday season.

It’s yet to be seen what will happen in the current quarter, with Chinese New Year in front of us, and some of the planned shutdowns that occur around the Chinese New Year timeframe in the Asia-Pacific region. But what we saw in our order pattern through the quarter was very strong orders from essentially all of our customers with a bit of a turndown with the foundries in Asia.

William S. Johnson

Actually, Suresh, if you look at, for our company, our last four or five fiscal years, our second fiscal quarter has been a weaker quarter, and the first fiscal quarter, which would be the fourth calendar quarter, has been stronger than that.

Suresh Balaraman - Think Equity Partners

And the last question is, your margins looked pretty good. How much of that is due to the weaker dollar?

William S. Johnson

Actually, not very much. You’re aware that we saw most of our products in U.S. dollars; around 13% to 15%, something like that, of our sales are denominated in yen. But we also have a substantial manufacturing presence in Japan, so we have a lot of yen-based costs as well, and additionally, a substantial sales office in Tokyo, and so we have some operating expenses in yen as well.

We are naturally hedged between revenue and costs. So, there was not much of a foreign exchange effect on margin.

Operator

Your next question comes from the line of Tim Summers - Stanford Group Company.

Tim Summers - Stanford Group Company

Just curious, some of the big memory guys in Taiwan have announced extended fab shutdowns that go beyond the Chinese New Year. Some have also indicated they are going to be taking 200-millimeter plants and dismantling them. As you look at your memory business over the next, say, three to four months, do you anticipate this to have an unusually large impact on your seasonal downturn for sales to that market?

William P. Noglows

Tim, that’s a great question. I wish we had more visibility into what may or could happen going forward. Clearly on the memory side, there’s been an overbuild of capacity. I think we saw it in the rapid reduction in ASPs for DRAM over the last six months.

I said in my earlier comments, we’re driven by wafer starts and many of these new factories and memory foundries that have gone into place, they are going to run those plants and they are going to drive wafers through them, which is good for us. It certainly supports and helps our tungsten CMP sales.

But we’re watching very carefully and cautiously to see how this all shakes out on the memory side. I think it’s difficult to predict. So, it’s really difficult for us to predict right now what may happen in the next quarter or in the next two quarters on the memory side.

Tim Summers - Stanford Group Company

And if I could just ask a quick follow-up, Bill, if you can give us an idea of what your average selling price of your pads are.

William S. Johnson

Just as with our slurry business, we prefer not to disclose pricing. On the slurry side, we talk about change in average selling price. But given that we’re so early in the pad business, I think we’d prefer to not disclose that at this time.

William P. Noglows

I think what we’ve said, though, in previous calls, is that we’re pricing our pad technology competitively. We believe today that we are bringing enhanced value to our customers in the form of longer pad life and, in some cases, higher yield.

And we would hope to price our products in such a way where we give our customers a cost advantage and we give Cabot Microelectronics a market advantage. And we continue to take that approach on our pads and our slurries.

William S. Johnson

There’s also quite a difference in pricing between a 200-millimeter application and the price of a 300-millimeter pad. And I think we’ve mentioned that given the strong ramp that we’re seeing right now, the bulk of our pads that we sold this quarter were 300-millimeter applications, so you get some benefit from higher price in the mix in that.

Operator

Your next question comes from the line of Avinash Kant - Broadpoint Capital.

Avinash Kant - Broadpoint Capital

I had one or two questions. The first one was a follow-up of the previous question on the pads. You may not give us the ASPs, but could you talk a little bit about the margin profile of that business as that grows? Would it be compatible to the margins you have on the slurry side, or how would that compare?

William P. Noglows

In previous calls, we’ve talked about the technology that we’re bringing to bear to produce pads. We use continuous process technology, which we think has a fundamentally lower cost structure than some of the batch process technology that’s used today to manufacture pads for the CMP space.

Given that it’s continuous process technology, there is a breakthrough point we have to get through where we cover our fixed costs and begin to generate margins that fall to the bottom line.

Also, relative to our technology, I would describe the capital expenditure as very low to support our pad manufacturing capability. We’ve essentially invested the bulk of the money that we need to support the ramp that we’re enjoying right now. We invested the money in the prior three or four quarters and we’re bearing all of that in our gross margins today.

So, we expect that breakeven point to be fairly low, and once we get through it, we also anticipate that our gross margins from pad sales are similar to the gross margins we enjoyed today in our core CMP slurry business. So, around 46% to 48%.

Avinash Kant - Broadpoint Capital

And in terms of operating margin, also that will flow through in a similar fashion?

William P. Noglows

Again, we expect it to contribute strongly to operating margin, because, remember, we have the bulk of the infrastructure in place today to support the sale of the pads and to support the technical service on the pads. We haven’t had to add a lot of people on the operating cost side to support our pad business.

It’s largely the same infrastructure and the same support infrastructure that exists for our CMP slurry business. It will support our pad business. So, we would expect a healthy portion of that gross margin dollar to fall to the bottom line.

Avinash Kant - Broadpoint Capital

And I had a bit of a longer-term question. As we anticipate memory guys are starting to move to copper, have you done some work in terms of how would that impact your business, both from the tungsten and the copper side.

One of the businesses will grow, one of them may come down some, but overall impact in revenues, how would you see that? Have you done some work on that?

William P. Noglows

In general we see copper and memory as an opportunity for Cabot Microelectronics; it’s an incrementally new application of copper in the CMP space, and then we’ve been all over it and we work with all the leading-edge memory manufactures, and we would hope and expect to be part of the transition of copper into memory, if and when it occurs.

To-date, we don’t feel like it will have a significant impact on our tungsten business. People will continue to use tungsten in devices that use copper wiring. So, we see the application of copper in memory as an opportunity and we’re going after it.

I’d ask Bill if he has anything to add to that.

William S. Johnson

Sure. With the transition of copper into memory, we think it’s going to be incremental. For example, a device manufacturer might convert to copper on a single wiring line, and then continue with aluminum wiring on the other several wiring lines.

So, there could be an incremental opportunity for copper sales, but still not much of an impact on tungsten. In fact, in some cases the tungsten demand could increase even with this kind of transition to copper, and some memory devices.

Avinash Kant - Broadpoint Capital

And any idea in terms of the timeline when that could start to happen in terms of what you’re seeing with your customers?

William S. Johnson

We’ve seen one large North American customer move to copper in memory. And the leaders are all, I would describe it, in development or working with copper to understand the value it might bring in memory devices. But, we think it’s going to come in, and it’s going to happen. It’s just taken a lot longer than people thought it would.

Avinash Kant - Broadpoint Capital

And one near-term question of course, you did talk about some seasonality in the first calendar quarter in terms of Q2. Historically, what has been the seasonality, do you have any quantification for that on an average terms? And what’s the expectation of wafer starts in the March quarter and the full year at this point?

William S. Johnson

If you look at our full history as a company, you don’t see as much seasonality you have seen in the last four or five years. In the last four or five years each second fiscal quarter has been down slightly from the first fiscal quarter.

So, it’s a relatively new phenomenon, and so that may be a guideline for the future. But, in the past, the prior of those years, we actually had some ups and downs in the second fiscal quarter. So, it’s a relatively new thing over the four, five years.

Avinash Kant - Broadpoint Capital

And do you have any growth forecast or any assumptions for the wafer starts for the quarter and for the year?

William S. Johnson

We really don’t. There are others in the space that pay a lot more attention to wafer starts month to month and quarter-to-quarter, and we don’t have that insight. As Bill mentioned and we’ve talked about in the past, our visibility into near-term revenue is relatively limited, and we see quite bit of volatility in month to month, and in quarter-to-quarter. So, I don’t think we would have a real number to give you.

William P. Noglows

I think if we were to summarize what’s been published by some experts out there, and if we try to take a consensus of it, we see industry growth in the high-single digits on a dollar basis, and some people are suggesting that wafer starts will be somewhere between 10% and 15% for the year.

But, as we know, as the year goes on, those forecasts tend to change, and we’ll watch them. But as Bill said, we don’t talk about wafer starts or try to predict wafer starts; we take what we can learn from the market and from the industry experts.

William S. Johnson

And just to be clear, the numbers Bill just quoted, that would be for a full calendar year ‘08 versus ‘07, not just specific to the quarter.

Operator

Your next question comes from the line of John Roberts - Buckingham Research.

John Roberts - Buckingham Research

I was surprised when you reported your 10-K just before the end of the year that Korea wasn’t up to 10% of your sales yet, and we have pretty strong growth, I thought all last year. And it was still it’s very strong, I guess you said it was up 13.5% sequentially this quarter, which wouldn’t be in last year’s numbers.

But could you maybe comment about that with the strong growth that we’ve had in memory for sometime now, why that country hasn’t yet popped up like Taiwan and Japan, as a disclosable 10% region?

William P. Noglows

I am going to try to answer the question. I think a lot of the memory growth that we’ve seen in the last year has come from Taiwan and some of the upstarts in Taiwan. We enjoyed a very strong position in Korea with our tungsten dielectric and some emerging copper business. And so, I’m not sure I can quantitatively give you an answer to the question.

John Roberts - Buckingham Research

We’re under $40 million, obviously, in sales there last year, or it would have been disclosed?

William P. Noglows

We disclosed greater than 10% customers, and so there’s not a customer in Korea that represents greater than 10%.

John Roberts - Buckingham Research

You disclosed Taiwan as a country and Japan as a country?

William P. Noglows

Yes. There are a handful of large players in Korea, and as we mentioned, we’ve had some substantial growth in that area. But, yes, you’re right, we haven’t disclosed a customer or the country as a greater than 10% customer.

John Roberts - Buckingham Research

Maybe a little bit different cut at it, since you disclosed Taiwan and Japan, if you subtract them from your disclosed Asian sales, Asia ex-Taiwan and Japan, I think was $97 million in ‘07, and that was only up 5.5%. And that would be China and Korea combined.

I assume that was distorted by the distributor shift early in the year maybe a little bit, but could you at least give us a range, or approximately what the growth combined Korea and China were last year?

William P. Noglows

No, not off-hand, but we had some significant sales in the Southeast Asia through both the semiconductor space and also data storage. And so that’s another factor that you need to consider in your analysis.

John Roberts - Buckingham Research

That 5.5% growth in Asia, ex-Japan and Korea, would be reflective, then, of the actual growth last year in those regions, including data storage, everything combined?

William S. Johnson

Yes, but I don’t have that kind of detail in front of me. But, if you took Asia, subtracted Taiwan and Japan, you’d be left with these geographies that we’re talking about, that’s right.

Operator

Your next question comes from the line of Dmitry Silversteyn - Longbow Research.

Dmitry Silversteyn - Longbow Research

Congratulations on getting the year off to a solid start here. I was encouraged to hear you talk about pad business and actually start to break down some revenues for us. We’re growing accustomed to the seasonality in the slurry business; as pads become a bigger portion of your revenue stream, can you give us an idea of what the seasonality in pads look like? Is it similar to the slurries or is there some counter seasonal forces at work?

William P. Noglows

Dmitry, that’s a tough question. I think at least for us, as we win new accounts and new customers, we would probably not expect to see seasonality in the same way when we started in the CMP slurry business, and people were rapidly incorporating CMP technology in their manufacturing operations, we live through those seasonal cycles as well, as well as the cycles of the industry.

So, I think for Cabot Microelectronics today, if we continue to win new customers and new accounts, we might be insulated from seasonality. I would expect that the same seasonality that we see in CMP slurries would apply to CMP pads, because we’re both driven by wafer starts, and if there is a seasonal drop-off in wafer starts, people will use less CMP slurries and they’ll use fewer CMP pads. That’s what we would expect to see.

Dmitry Silversteyn - Longbow Research

Sticking with pads, in the previous two or three quarters when you started disclosing some pad revenue, at least qualitatively, I think at one time you said that there is about $1 million to $1.5 million negative gross margin impact per quarter for the pad business.

Given that it has grown five-fold or better sequentially, can you give us an idea where you stand on the gross margin breakeven? In other words are you there, or are you going to be there in the next quarter or two? We can start seeing gross margin or pads becoming a positive contributor to gross margins?

William P. Noglows

Dmitry, Bill and I both are going to answer this question. I’m going to answer it qualitatively, and Bill will answer it quantitatively. You’re right, I think last quarter we talked about the impact on gross margins was somewhere around I think $1.4 million Bill? Something like that.

We have focused very hard on our first introductions on making sure and making certain that our supply chain is as robust as we believe it to be, and that our products receive product that’s indicative of what we believe our manufacturing technology is capable of.

So, I would expect that we would bear, and we have been bearing what I would describe as some additional quality-related costs at the front end of our ramp here, that we fully expect to drive out of our process as we go forward.

So, I think certainly in the quarter we just finished and into the next quarter, and maybe through three quarters of this fiscal year, we will bear certain costs that will go away once we’re in continuous high volume manufacturing across our system.

But, I think we’re very close and will be very close to covering our fixed costs in the next several quarters. And I am looking to Bill to get his reaction to what I just said.

William S. Johnson

In fact, Dmitry, I think there was still a drag on gross margin of our pad business this quarter, but on the order of a few hundred thousand dollars.

Dmitry Silversteyn - Longbow Research

And that’s the level that we should expect going forward, until you get these quality related extra costs and inefficiencies out of a more mature business?

William S. Johnson

I don’t want to predict too much. But if you look at the pattern, at the current revenue rate in pads, we have relatively modest gross margin drag. So, with some additional volume ramp, I think you’d turn positive on gross margin relatively quickly.

As we mentioned, there’s some few incremental operating expenses. So, it would still continue to be a drag on pre-tax profit margin. But as Bill mentioned, we’ve got relatively low costs, and we think it’s not too high a volume before you start actually contributing to earnings.

Dmitry Silversteyn - Longbow Research

Okay, excellent. And then switching to R&D costs, which were down this quarter year-over-year, I believe, as well as sequentially, which is not unusual. I just want to make sure that this is still related to how much your metrology laboratory wafer consumption is?

And also, as you bring this new 300-millimeter polishing machine on in Japan, should we expect some step change in the spending in R&D, sometime towards the second half of 2008?

William P. Noglows

I think our operating costs guidance remain the same through the full fiscal, Dmitry. I think we’re working hard to manage our operating costs as flat as we can. As we talked before, we’ve transitioned a fair bit of our resource base to the Asia-Pacific region, and we’ve tried to that in a way where we moderated the numbers of people that we’ve hired in the United States, and we will continue to do that.

I hate to belabor this, but part of our operations excellence initiative goes over into our R&D organization in the way we do experiments and design experiments and we do that with an eye on efficiency in the product development process and make sure we are doing our experiments in the most sufficient way possible. We’re not wasting wafers and we are not wasting time on our tools.

And I think through those efficiencies, we’ve been able to hold our costs relatively flat, and do as much or more work than we had been doing say three or four years ago.

Dmitry Silversteyn - Longbow Research

Okay, I understand that. And then one final question on QED, you talked about going down-market, so to speak, to get up a bigger addressable market with the second tier or the smaller optics manufacturers.

Can you give us some idea of what’s allowing you to do that? In other words, is this a stripped down version of the machine or you’re making the financing somehow easier for the smaller players that they can afford the QED machine?

William P. Noglows

I think two things are happening, Dmitry. I think the market demand for high precision optics and the emergence of aspherical optics is pulling the QED technology into let’s call it the mid-market. I don’t want to call it the low-end market; we’ll call it the mid-market.

So, the people that are manufacturing optics today are being drawn into this high technology realm because they have to. It’s turning out to be the only way to do it is to use these sophisticated tools, so they can do it repeatedly and deterministically.

So, that’s happening on the optics market side. On the QED side, I wouldn’t describe what we are trying to do is provide a stripped down tool to the industry. I think what we are trying to do is provide a tool that’s affordable and that gives our customers the productivity achievements and advancements that they can go out and make money with the tool, but we are not selling a stripped down version.

Dmitry Silversteyn - Longbow Research

Okay. So, the margins of that business are comparable to your margins to the large customers?

William P. Noglows

Yes, we would expect that. And Bill, correct me, if I am wrong, this would be the last quarter or the first quarter when we’d no longer have the inventory that we have been carrying since the purchase.

William S. Johnson

Yes. That’s right. You recall that when we made the acquisition, we had to write up the acquired inventory at market value. And as we sold that through there’s a gross margin hit that you take as you sell those machines. And now in the first fiscal quarter we sold the last of those, so we won’t have that drag on QED’s margin going forward.

Operator

Your next question comes from the line of Chris Blansett – J.P. Morgan.

Analyst for Chris Blansett – J.P. Morgan

It’s Jenny (Beunen?) for Chris Blansett. Can you talk about the effect that the closure of the Wales facility had on gross margins or OpEx?

William S. Johnson

When we talked about sequential changes in gross margin, we went from 49.1% in the fourth quarter of fiscal ‘07 to 47.9% in the first quarter of fiscal ‘08, that 1.2 percentage increase, most of that is due to the higher fixed cost. We had higher fixed costs in two areas: one was related to the Barry Wales closure, the other was higher costs associated with our pad manufacturing operations that hired more people.

So, those were the largest factors. And the bigger factor was the Barry Wales facility impact.

Analyst for Chris Blansett – J.P. Morgan

And then on OpEx?

William S. Johnson

No, it’s really the gross margin level; it’s cost of goods sold.

Analyst for Chris Blansett – J.P. Morgan

And then will there be any effects in the first quarter from this closure?

William S. Johnson

In our second fiscal quarter, you would expect some continued costs, because what we are doing is we are transitioning to close the plant I think in June, and so we will have this cost impact until we close that. We essentially ramped down all the costs over the remaining production life of the facility.

Analyst for Chris Blansett – J.P. Morgan

So would it be similar to the impacts from last quarter, split between the higher head count, and then the closure of the facility?

William S. Johnson

I couldn’t be very precise about that, but you would expect to have an impact of the Barry Wales closure in our March quarter and also in our June quarter.

Analyst for Chris Blansett – J.P. Morgan

And then are there any plans to close down any other facilities?

William P. Noglows

No. I want to just reinforce that the Barry facility was a very small facility, and it was an underutilized facility in our system of manufacturing facilities. And I don’t want anyone to think it’s a bigger deal than it really is. It was a very small piece of our manufacturing infrastructure.

I’m laughing because we’re trying to figure out and we are in the process of our long range plan and we are beginning to about where do we go next and what do we do with our manufacturing capacity in Japan and North America. So, no we have absolutely no plans to close facilities anywhere in the world today.

Operator

Your next question comes from line of Steve O’Rourke - Deutsche Bank.

Steve O’Rourke - Deutsche Bank

The copper slurry was down quarter-over-quarter, and you commented that it was the foundry. Was there anything more to it than just wafer starts slowing up the foundries?

William S. Johnson

Steve, remember last quarter that we saw our copper revenue go up about 14% sequentially, and then fall back this quarter. And it was up 14%, which is well above what the tungsten and dielectric slurries stated over the same period.

So, we saw the normal lumpiness in some of the ordering patterns by some of our big foundry customers in Asia. It was the primary driver behind that. And in addition to what we said earlier, was a bit of a slowdown in some of the foundries in Asia.

Steve O’Rourke - Deutsche Bank

Okay. And one other question on the pads business, I think last quarter you had spoken of another customer win. You have a few more this quarter, and about 20 evaluations ongoing last quarter and this quarter. Are you expecting a couple of customers per quarter in the early phases of this to convert to actual customers over the next few quarters?

William P. Noglows

Steve, we would love a couple of new customers every quarter at the level that we’re ramping now. I said earlier in my comments, it’s so difficult for us to predict when a customer will move to HVM and begin to buy pads from us at significant levels per customer, and I don’t want to do it.

As we’ve said earlier, the qualification process is taking much longer than we anticipated. Some customers move faster than others, but in general, it’s taken longer than we anticipated.

But we are delighted to have 11 customers today, again that’s 3 more customers than we had last quarter. And we’re delighted to have another 20 that are in that qualification process that is difficult to predict.

Steve O’Rourke - Deutsche Bank

Fair enough. And one last question. You talked a bit about uncertainty over how things may evolve over the next few quarters just because of the general macro environment to what you’re seeing in semiconductors. How do you handicap that? How are you looking at that from Cabot’s perspective as opposed to say third party analysts looking at it?

William P. Noglows

Steve, I’m going to turn to Bill on this as well, but as we’ve said many times before, we have very little visibility into future sales. Bill’s comments in the prepared remarks this morning, the first three weeks of January look a lot like the last three months of our first fiscal quarter.

You and I were both at the ISS meeting last week, and it was a gloomy meeting. The tone was fairly negative and gloomy, and as we sit here in January, having three weeks behind us, we don’t see that gloom, certainly in the orders that we have on the books today.

And so, we’re paranoid like everybody else and we’re cautious about what we do. But so far, we don’t see a turndown that you would have expected to see based on what we heard last week.

William S. Johnson

Additionally, Steve, I would just remind you that there’s a difference, some of the gloom that you heard last week could have been more capital equipment related. But I think all the forecasts are for down CapEx year in 2008, and we are at 10% to 15% versus 2007, that’s really going to impact the capital equipment folks.

But we’re consumables, and so long-term that capital investment is important to us, but in the nearer term it’s really wafer starts. And like Bill says, we haven’t seen it yet. We’ve been surprised in the past, so we could be surprised again, but no signs yet as we sit here on February 24.

Amy Ford

Stacy, we’ll take one more question.

Operator

Your final question comes from the line of Tim Summers - Stanford Group.

Tim Summers - Stanford Group

One more question on the pad business. Have you reached a level of production where you have seen any competitive response from what I would call the traditional suppliers like Rohm and Haas and [inaudible] and also, how closely are you working with Applied Materials, since they tend to dominate the CMP tool business?

William P. Noglows

Let me try to answer the first question first. We entered this space because we believe that our pad brings incremental value to the incumbent technology. This is a value play. Our pads are demonstrating longer pad life in every application. And we think that value is transferable into the prices we charge and we’re trying to manage the business that way.

But, we would expect a competitive response from the incumbent suppliers. I’m not prepared today to talk about what we think we see or what may or may not have happened, but we believe that our technology is such that it brings added value to our customers, and we believe that our manufacturing technology is such that it provides us a fundamentally lower cost. And that’s the way we’re approaching the business, and that’s the way we’re think about it, Tim.

The second question, we work with all the major CMP tool manufacturers. It’s in our interest to work with all the major CMP tool manufacturers, and we have relationships with all of them.

The nature and depth and breadth of those relationships is not something I’m going to share on this phone call; we consider it proprietary and confidential to how we manage and run our business. But you would expect and clearly understand why we would work very closely with, you mentioned Applied, but there are others as well.

Amy Ford

Thank you for your time this morning and your interest in Cabot Microelectronics. We look forward to the next opportunity to speak with you. Good bye.

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