Trisha Tuntland - Director, IR David H. Li - President and CEO William S. Johnson - EVP and CFO.

Arthur Su - Needham & Company Amanda Scarnati - Citi Research Chris Kapsch - Aegis Capital.

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Cabot Microelectronics Second Quarter of Fiscal 2017 Earnings Call. At this time, all participants are in a listen-only mode to prevent background noise. [Operator Instructions] We will have a question-and-answer session later and the instructions will be given at that time.

Now I would like to welcome and turn the call to Ms. Trisha Tuntland, Director of Investor Relations. You may begin..

Good morning. With me today are David Li, President and CEO, and Bill Johnson, Executive Vice President and CFO. This morning we reported results for our second quarter of fiscal 2017, which ended March 31, 2017.

A copy of our earnings release is available in the Investor Relations section of our Web-site, 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 Web-site.

Please remember that our discussion today may include forward-looking statements that involve a number of risks, uncertainties and other factors that could cause actual results to differ materially from these forward-looking statements.

These risk factors are discussed in our SEC filings, including our report filed on Form 10-K for the fiscal year ended September 30, 2016. We assume no obligation to update any of this forward-looking information. Also, our prepared remarks this morning reference non-GAAP financial measures.

Our earnings release includes a reconciliation of GAAP to non-GAAP financial measures. I will now turn the call over to David..

Thanks, Trisha. Good morning everyone and thanks for joining us. This morning we announced strong results for our second quarter of fiscal 2017, reflecting continued robust semiconductor industry demand and successful execution of our strategic initiatives.

In particular, we believe our results in the first half of this fiscal year reflect the continued momentum we have established in three key product areas, CMP tungsten slurries, dielectrics slurries and CMP pads, and we believe these will be drivers for continued profitable growth for the Company over the next several years.

During the quarter, we achieved revenue of $119.2 million, approximately 20% higher than in the same quarter last year. Our gross profit margin was 50.4% of revenue, the highest level since fiscal 2015, and we achieved diluted earnings per share of $0.71, which represents an increase of approximately 92% compared to last year.

In addition, we continued our strong cash flow generation trend with cash from operations of $32.8 million. Bill will provide more detail on our financial results later in the call. To provide some context for our second quarter results, let me first offer some perspectives on the global semiconductor industry environment.

General industry sentiment suggests a continued robust memory market, primarily driven by the demand for more storage in a wide range of end-use products as well as in data centers. As a result, reports indicate that memory device inventories are lean due to continued strong demand and tight production capacity.

Conversely, certain industry participants that are more closely tied to smartphones have reported softer demand conditions due to mobile products seasonality.

For the full year, industry analysts continue to hold a strong outlook for the semiconductor industry, driven by expectations for a continued strong memory market and semiconductor demand in China and a pickup in smartphone demand beyond the June quarter. Now let me turn to Company related matters.

During the quarter, we experienced strong demand for our tungsten and dielectrics slurries as well as our pad solutions across a wide range of applications and technology nodes. This drove approximately 19% year-on-year revenue growth for the quarter from our IC CMP consumables products.

Of particular significance, we achieved year-on-year revenue growth in China of approximately 25% for the quarter. Our strong business position there is notable, given expectations for long-term growth in China. Now let me provide a brief update on each key product area.

First, within CMP slurries, during the quarter we experienced robust demand for our tungsten slurries driven by our continued support of our customers' production ramps of 3D NAND and FinFET technologies as well as our leading supply positions in other applications.

As a result, in the second fiscal quarter we achieved revenue growth in our tungsten slurry product area of approximately 18% compared to last year. We believe this growth demonstrates our continued leadership in tungsten slurries across the foundry, logic and memory segments.

Our strategies in this product area are focused on continuing to innovate, enhance our supply-chain capabilities and quality systems and leverage our global technical support and infrastructure to better support our customers.

Over the years, we have seen sustained revenue growth from our tungsten products, which underscores our execution in and commitment to this important product area.

Moving onto our second key product area, during the quarter we experienced healthy demand for our dielectrics slurries with revenue up approximately 18% compared to the same quarter last year.

The execution of our strategies in this product area have led to the ongoing successful transformation of our dielectrics slurries with the growing adoption of a family of higher-performing, lower-cost and higher-profitability colloidal silica and ceria-based products.

For example, during the quarter we advanced customer adoption of our colloidal silica-based dielectrics slurries for advanced memory applications.

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.

You may recall that during our conference call last October, we discussed our plans to expand our existing facility and capabilities in South Korea to further support growing demand for our CMP solutions I'm pleased to report that in line with our expectations, during our second fiscal quarter we opened the expanded facility.

We believe this expansion enhances our global infrastructure and our ability to provide local development and manufacturing capabilities to support our customers within the region and we look forward to continue to leverage this facility to support future growth.

Turning to CMP pads, our third key product area, this quarter we achieved record revenue for the sixth consecutive quarter and year-over-year revenue growth of approximately 44%. This was largely driven by continued strong customer pull for our NexPlanar product line.

We continue to leverage our global sales channel and technical resources to speed the qualification and adoption of our pad offerings, and as a result during the quarter we won additional business with three of our technology leading customers for advanced logic and memory applications.

We believe these wins demonstrate our ability to proliferate our supply positions across our customer semiconductor fabs and underscore our pads' value proposition. In addition, we added to our strong pipeline of new business opportunities, including CMP slurry and pad consumable sets, across a wide range of customers and applications.

We believe that given our position as the leading supplier of CMP slurries with a broad slurry product portfolio along with our position as the second-largest CMP pad supplier, we are uniquely positioned to deliver best-in-class slurry and pad consumable sets. We look forward to advancing this initiative in the future.

In conjunction with our efforts to drive growth in our pads product area, and in particular to position our Company for sustained growth in China, during the quarter we made progress on our collaboration with Konfoong Materials International or KFMI.

This collaboration in China emphasizes our commitment to provide semiconductor manufacturers with reliable local manufacture of advanced CMP pad technology. We have received strong interest from our customers in China from early marketing efforts.

Based on the progress of our combined teams, we believe we are on track to begin customer sampling during the June quarter and would expect our first KFMI related revenue in fiscal 2018.

Through these efforts and continuing with the strong growth performance we have achieved, we are confident in our ability to grow our pads revenue to between $80 million and $90 million in fiscal 2018, consistent with what we have previously discussed, and are optimistic that we will be able to grow it to over $100 million in fiscal 2019.

During the quarter, we earned several awards from 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, as well as Texas Instruments' Supplier Excellence Award for our performance in 2016.

We are proud of this recognition and also of 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 technology, world-class operations, quality systems, and infrastructure, and close collaboration.

The financial performance we reported this quarter represents the continuation of a long-term trend of sustained strong profitability and cash flow generation. This has enabled us to execute a balanced capital deployment strategy over the years, including organic investments, dividends, acquisitions and share repurchases.

In further support of this, on March 7th, we announced that our Board of Directors declared a quarterly cash dividend of $0.20 per share on the Company's common stock, an increase of 11% over the regular quarterly cash dividend paid since the initiation of this program in January of 2016.

We believe this demonstrates both confidence in our ongoing cash generation and our continued commitment to delivering value to our shareholders. Looking ahead, we expect continued healthy semiconductor industry demand in the second half of our fiscal year, particularly in memory and in China.

Given this industry outlook and combined with our continued focus on and momentum in executing our strategic initiatives related to our three key product areas, growth in tungsten slurries including continued adoption of 3D NAND and FinFET technologies, the transformation of our dielectrics slurry product line, and growing CMP pad revenue including slurry and pad consumable sets, we are confident that we are well-positioned to deliver continued profitable growth for our Company.

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 second quarter of fiscal 2017 was $119.2 million, which represented 20.1% increase from the same quarter last year. The increase reflects continued strong global semiconductor industry demand that we began to see during the third quarter of fiscal 2016.

Year-to-date, revenue of $242.4 million represents a 21.5% increase from last year. Drilling down into revenue by product area, tungsten slurries contributed 43.5% of total quarterly revenue, with revenue up 18.1% impaired to the same quarter last year.

We continue to see strong demand for our tungsten slurries for advanced applications, including 3D memory and FinFET, and as Dave mentioned earlier, this is a key product area that we expect will drive future profitable growth.

Dielectrics slurries represented another key product area, provided 23.4% of our revenue this quarter, with sales up 17.6% from the same quarter a year ago. Our dielectrics growth was primarily driven by strong demand for our colloidal silica and ceria-based solutions.

We look forward to winning more business in this area with our higher-performing, lower-cost and higher-profitability products. Sales of our polishing pads, our third key product area, represented 14.4% of our total revenue for the quarter and increased 43.5% compared to the same quarter last year.

Our pads product area achieved record revenue for the sixth consecutive quarter. Sales of slurries for polishing metals other than tungsten, including copper, aluminum and barrier, represented 12.3% of our total revenue and increased 3.5% from the same quarter last year.

Finally, revenue from our engineered surface finishes area and data storage products represented 5.1% and 1.4% respectively of our quarterly revenue. Gross profit for the quarter was 50.4% of revenue, compared to 47.3% of revenue we reported in the same quarter a year ago.

This includes $1.2 million of amortization expense related to the NexPlanar acquisition. Excluding this, non-GAAP gross profit was 51.4% of revenue.

Factors impacting gross profit this quarter compared to last year include higher sales volume and a higher valued product mix, partially offset by higher fixed manufacturing cost including higher incentive compensation expense. Year-to-date, gross profit was 50.1% of revenue, compared to 48.6% last year.

This includes $2.4 million of amortization expense related to NexPlanar. Excluding this, non-GAAP gross profit for the first half of the fiscal year was 51.1% of revenue.

We currently expect our GAAP gross profit margin for the full fiscal year to be between 49% and 51% of revenue, and this is higher than our prior full-year guidance range of 48% to 50% of revenue. This includes an adverse impact of approximately 100 basis points related to 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 $36.1 million, including $0.5 million of NexPlanar amortization expense.

Operating expense were $1.5 million higher than the $34.6 million reported in the same quarter a year ago. This reflects higher incentive compensation cost and higher professional fees, partially offset by lower clean room materials expense.

Year-to-date, total operating expenses were $69.5 million, which includes $0.9 million of amortization expense related to NexPlanar. We continue to expect GAAP operating expenses for the full fiscal year to be between $137 million and $142 million, and this includes approximately $2 million of NexPlanar amortization expense.

Diluted earnings per share were $0.71 this quarter, or $0.76 on a non-GAAP basis excluding the NexPlanar amortization, which represents an increase of 91.9% compared to the $0.37 we reported in the second quarter of fiscal 2016. The increase in earnings this quarter was primarily driven by higher revenue and a higher gross profit margin.

Year-to-date, diluted earnings per share were $1.60, or $1.68 on a non-GAAP basis, which is 92.8% higher than the $0.83 we reported last year. Our effective tax rate for the second fiscal quarter was 20.8%, and 20.5% year-to-date. We continue to expect our effective tax rate for the full fiscal year to be within the range of 19% to 22%.

Turning now to cash and balance sheet related items, capital investments for the quarter were $6.7 million, bringing our year-to-date capital spending to $11.7 million. This includes the facility expansion in South Korea that we completed during the second quarter.

For the full fiscal year, we continue to expect capital spending to be within the range of $20 million to $25 million. Depreciation and amortization expense for the quarter was $6.5 million and we generated cash flow from operations of $32.8 million. We ended the quarter with a cash balance of $343.7 million, and $150.4 million of debt outstanding.

As Dave mentioned, we were pleased to have increased our quarterly cash dividend during the quarter, which would represent an annualized rate of $0.80 per share or approximately $20 million in aggregate, and a payout ratio of approximately 33% of our fiscal 2016 net income and 26% of free cash flow.

Looking ahead, our current priorities for uses of cash are; organic investments to fund growth within CMP consumables; dividends, including increasing our quarterly dividend as earnings grow; acquisitions in closely related areas that leverage our core capabilities; and share repurchases.

With these capital deployment priorities and our continued focus on the profitable growth of our Company, we believe we are well-positioned for continued delivery of significant value to our shareholders. Now I'd like to offer a few comments on recent revenue and order patterns.

During the second fiscal quarter, we saw a 4% decrease in revenue from our IC CMP consumables products compared to the first quarter of fiscal 2017. This is slightly better than the approximately 5% reduction we had referenced during our first quarter conference call in January and which we had confirmed during our Annual Meeting in March.

Earlier, Dave talked about general industry expectations for continued strong demand, and in particular for memory devices. Consistent with that outlook, we expect demand for our IC CMP consumables products in the June quarter to be around 3% higher than in the second fiscal quarter.

To summarize, from a financial standpoint, we've now achieved strong performance over four consecutive quarters. As we think about the second half of fiscal 2017, we expect continued solid demand and we are raising our full fiscal year gross profit margin guidance range to 49% to 51% of revenue.

Based on our revenue growth and profitability through the first half of fiscal 2017 and expected continued momentum in tungsten and dielectrics slurries and polishing pads, we believe we are on track to deliver another year of strong performance. Now I'll turn the call back to the operator as we prepare to take your questions..

[Operator Instructions] Our first question is from the line of Edwin Mok with Needham & Company. Your line is now open..

This is actually Arthur on for Edwin. Bill, you just talked about how demand for IC consumables in the June quarter was expected to be up 3% quarter-to-quarter, and I think as David mentioned, one of your largest customers has talked about smartphone related inventory adjustment in their second quarter guidance.

Are CMP consumables up for you guys mostly due to greater 3D NAND and has it factored in this inventory adjustment at your largest customer?.

It's Dave. As you mentioned, we have been following closely some of the recent industry communications around CSMC. Particularly they talked about some softness related to some near-term smartphone inventory. But overall, they continue to hold a strong outlook for the year.

But as you mentioned, we feel really confident about our ability to grow because of how well we are positioned in two areas of the market that are poised to grow strongly. One is memory and the other is China. So we've talked about the transition from 2D to 3D NAND. That's still underway and going on strongly.

It looks from the memory industry environment that that looks like it's going to be tight capacity and constrained for a while. And then also China, there's a lot of additional capacity. We talked about our growth in China in the prepared comments. So, those are two areas where we're positioned well and the industry is positioned well to grow as well..

Then another area where we expect to grow would be pads, and we mentioned that we've grown our pad revenue by 44% year-over-year for the quarter, and I just want to point out that that's on a comparable – the two quarters are on a comparable basis now.

Both the second quarter of last year and this second quarter, both contain, they include the NexPlanar acquisition. So, clearly a strong growth in pads, and so we expect that to continue in the second half..

Perfect, thanks for that color.

And maybe staying on the topic of pads, can you provide a little bit more color on what drove the strong performance from NexPlanar? Was it, was the growth due to increased sales efficiency or is it due to better traction of pad consumable sets among your customers? And should we think about this as sort of an inflection point where we start getting towards that $80 million to $90 million fiscal year 2018 target?.

Right, so what we talked about is, what we believe is our ability to grow our [indiscernible], so our pads revenue to $80 million to $90 million in fiscal 2018 and then over $100 million in fiscal 2019, so really strong trajectory of growth for pads.

And as Bill talked about, this was our sixth consecutive quarter of record revenue for pads, so clearly a lot of demand, primarily driven by the NexPlanar product line. And what we have talked about before still holds true. We think this product is providing customers with a lot of performance benefit.

So it is lower defectivity versus the industry standard. Also what we're continuing to find is that the qualification times are much shorter because it's closer to a drop-in versus the industry standard while it's providing better performance. We also talked about further proliferation with some of our existing customers.

So what happens when you bring a pad into a customer is that if they find good performance, they'll bring it onto a different application or a different fab and continue to proliferate through their system, and that's what we saw this quarter.

So, strong pipeline and additional proliferation with existing customers is what we've seen and what we expect to continue to see in the future..

Thanks for that color. It was very helpful.

Last question from me, can you talk a little bit about the slurry competitive landscape and whether you're seeing or if you're anticipating any increased competition, particularly with regard to tungsten slurries?.

So tungsten obviously is an area that we are focused on quite a bit. You can see from our long track record of profitability. We also increased our gross margin guidance that we expect continued profitability.

From the competitive environment for slurry, we don't see a lot of new entrants in the area and we obviously continue to feel like we are the clear leader in tungsten but also in dielectrics and other CMP areas. I think we're the only supplier that can provide the whole portfolio of CMP slurries and now with pads.

So we feel really good about our tungsten position and I would say the competitive dynamics are more or less similar to what they've been in the past..

Thanks and a great quarter..

Our next question is from Amanda Scarnati with Citi. Your line is now open..

Kind of continuing on with the China discussion, the collaboration with KFMI and you're seeing, starting to sample in the June quarter with first out in 2018.

Is there anything in the contract that would prevent you from continuing with sales in China outside of the collaboration, or is it you can still continue with organic growth plus the collaboration at above and top of what you are able to do?.

So what you've mentioned is our collaboration with a company called KFMI. We're early in that collaboration but what we talked about is the early interest from customers locally in China has been strong. And so we see that as significant upside for us in China to grow our pads business by offering a local alternative.

But as you know, in China there are both domestic and international customers. So we would continue our efforts in China alongside KFMI. We think they are very complementary to us, and we think, as we mentioned we're early in the collaboration, we expect first revenue in our fiscal 2018..

Okay.

And then on the dielectrics product line, the transformation of those product lines from historically weaker margins to now better, are you seeing significantly more demand now at this point from the newer product line versus the older, or is there still some kind of runway of those older product lines going forward?.

So for dielectrics, we're really excited because we continue to see momentum. As you know, it takes time for new products to be qualified and ramped up. But for both colloidal and ceria product families, we've seen significant progress in the adoption.

And even in our prepared comments, we talked about progress with qualification and ramp-up of our colloidal family of dielectrics with two memory customers. Those were actually displacements.

And so, what we've seen is this continued transformation of our dielectrics product line as you mentioned from a lower profitability to a product line that we can see some growth in and higher profitability in the future. So we're seeing a lot of qualifications underway and we're encouraged by what we see both on the colloidal and ceria side..

So Amanda, within dielectrics, the overall product area grew by 18% year-over-year. The higher growth is obviously from those new higher performing products, but there's still strong demand for the legacy products. And as we talk about this transformation, this is something we expect to play out over the next several years.

So there is still quite a bit of runway ahead of us..

And then the last question I have just on the three additional wins in the pads business, are those new pads customers or are those existing pads customers that are taking on new product lines, if you can give that modelled information?.

So the three we talked about are existing customers and it's really that dynamic that I mentioned earlier, which is customers taking in our pad, being very pleased with the performance and then proliferating it beyond the initial application or the initial facility that they had planned, and we saw that this quarter and that contributed to the continued growth.

So those were three existing customers that just broadened their usage of our pads..

Great. Thank you..

And our next question is from the line of Chris Kapsch with Aegis Capital. Your line is open..

I just had a follow-up on the dielectrics product line and transformation, as you referred to it, when this product was introduced, you did anticipate both gaining market share as well as cannibalizing your own business.

And then just based on the comment that Bill just had, it sounds like you have obviously strong growth in the new colloidal and ceria-based products but also growth in your legacy products.

So I'm just wondering, to the extent that you are getting traction in new process of record wins with the new product, is that all basically new nodes or new applications or market share gains vis-a-vis say cannibalizing your own business, or have you also been doing – it has a little bit of cannibalization having taken place as well?.

Chris, it's probably a combination of all those. If you look at the progress we've made so far in colloidal and ceria, the three that we talked about or two that we talked about this quarter just happen to be displacements in memory where we were displacing competition with our product.

But we've also seen cases where we've cannibalized our own business. In both cases, one, we're improving our profitability, other, we're doing both, we're gaining positions and also gaining revenue and profitability. So it's a combination of both. As you know, it takes time to displace, but we're pleased with our progress and our pipeline..

So if you were to strip out the growth of the new product introductions in that dielectrics line, your legacy dielectrics slurries sales are actually showing growth in spite of cannibalization? And that would to me speak to strength of the overall industry across technology nodes. That's kind of what I'm curious about as well..

I can't recall exactly the performance of the legacy to ILD area, but we've had continued strong demand. I don't know if it maybe went up slightly or down slightly, but it has held pretty firm. So I think that underscores the overall strength of the industry..

As Bill mentioned, this is going to play out over not just quarters but over several years.

The legacy business tends to be very sticky and customers are very pleased with the products that they are using, so they continue using them, but we feel over time they will migrate to this higher-performing, lower-cost product family and it will play out over time.

If you look at how tungsten and dielectrics performed this quarter, they kind of moved together, which represents a bit of how the industry moved as well over the last several months..

Okay. And then I had a question about the upward revision in gross margin guidance.

For the full year, obviously part of that is just having the first half under your belt with the solid margin performance that you've had, but just wondering if you could parse out the contributors also for the full year? Clearly you get mix benefit from the strength in tungsten.

I think also it sounds like dielectrics, the new products have nice margin. But the highest growth business right now is the pad business. And when you guys acquired NexPlanar, if I recall correctly, the gross margins of that business were below your corporate average.

So your highest growth business with below-average gross margins, you could say that maybe dragged down gross margin.

So I'm just wondering, has that business structurally gotten enough scale where you've improved the margin profile so that the growth there is accretive to margins, or not quite yet? And then separately, is there anything going on in FX? I think the dollar have been strong post the Trump election. Now it's kind of taken a breather here.

So maybe that reversal is also contributing to the upward guide as well. So a few questions in there, but just parsing out the gross margin trends for the balance of the year. Thank you..

Sure. So first of all, foreign exchange really had a very minor impact. So that's not really a factor.

So if you look at the full-year FY 2016, we had 48.8% gross margin and we're at slightly over 50% year-to-date, and a lot of that is stronger sales volume, so greater capacity utilization which helps margin, and also product mix, and then partially offset by some higher fixed cost, mainly related to higher incentive compensation expense.

So if you think about the three big areas that we talk about as growth initiatives, tungsten growth with 3D NAND should be accretive to gross margin, the dielectrics transformation should be accretive to gross margin. The pads area will be dilutive to gross margin.

Margins in pads are below the Company average and our expectation is that that will remain below the Company average. But given the significant growth opportunity in revenue, even if that's slightly dilutive to gross margin percentage, there are a lot more gross margin dollars and then EPS that should come with that..

Right, okay. So you're able to up your – you increased your gross margin guidance in spite of sort of the dilutive effect of margins from the growth in pads. It's a good problem to have..

That's right. Two out of three of those initiatives are going to be accretive to gross margin, and the pads growth would be a headwind to gross margin percentage, but should add gross margin dollars..

Okay. Thank you very much..

That is all the questions we have this morning. I am pleased to announce that on May 23rd, we will host a virtual investor and analyst event or a CCMP experience at your convenience. On May 2nd, we will issue a press release with further details. We look forward to your participation. Thank you for your time and your interest in Cabot Microelectronics..