Good day ladies and gentlemen and welcome to the Cabot Microelectronics First Quarter Fiscal 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question and answer session and instructions will be given at that time. [Operator Instructions] I would now like to turn the call over to Ms. Trisha Tuntland, Director of Investor Relations. Ma'am you may begin.

Good morning. With me today are David Li, President and CEO, and Bill Johnson, Executive Vice President and CFO. This morning we reported results for our first quarter of fiscal year 2017, which ended December 31, 2016. A copy of our earnings release is available in the Investor Relations section of our website, cabotcmp.com, or by calling our Investor Relations office at 630-499-2600. A webcast of today’s conference call and the script of this morning’s formal comments will also be available on our website. Please remember that our discussions today may include forward-looking statements that involve a number of risks, uncertainties and other factors that could cause actual results to differ materially from these forward-looking statements. These risk factors are discussed in our SEC filings, including our report filed on Form 10-K for the fiscal year ended September 30, 2016. We assume no obligation to update any of this forward-looking information. Also, our prepared remarks this morning referenced non-GAAP financial measures. Our earnings release includes a reconciliation of GAAP to non-GAAP financial measures. I will now turn the call over to David.

Thanks, Trisha. Good morning everyone and thanks for joining us. This morning we announced strong results for our first quarter of fiscal 2017 as we achieved record levels of revenue and profit for the second consecutive quarter. Our performance reflects strong semiconductor industry demand and the continued successful execution of our strategic initiatives including continued momentum from last year in three key product areas, CMP slurries for polishing tungsten, dielectric slurries, and CMP pads. During the quarter, we realized record revenue of $123.3 million, approximately 23% higher than the same quarter last year. Our gross profit margin was 49.9% of revenue and we achieved record diluted earnings per share of $0.88, which represents an increase of approximately 91% compared to last year. In addition, we continued our strong cash flow generation trend with cash from operations of $25.1 million. Bill will provide more detail on our financial results later in the call. To provide some context for our first quarter results, let me first offer some perspectives on the global semiconductor industry environment. As forecasted by several of our customers and industry analysts, industry demand was solid during the December quarter and our results are consistent with this as well as the expectations we discussed during our fourth quarter conference call in October. You may recall that at the end of the September quarter, most IC inventories related to smartphone, wireless, network, automotive and gaming markets were at lean levels. As a result of this, demand for our IC CMP consumable products remained healthy through the quarter which historically has seen seasonally softer conditions. Now, exiting the December quarter, industry reports and comments made recently by some of our strategic customers suggest that foundry and logic inventories maybe slightly elevated, due to some seasonality and mobile areas. Conversely, other reports…

Thanks, Dave and good morning everyone. Revenue for the first quarter of fiscal 2017 was a record $123.3 million, which represents a 22.8% increase from the same quarter last year. The increase reflects continued strong global semiconductor industry demand that we began to see during the third quarter of fiscal 2016. Drilling down into revenue by product area, tungsten slurries contributed 44.9% of total quarterly revenue. We achieved record revenue for the quarter with revenue up 24.5% compared to the same quarter last year. Our tungsten growth was driven by strong demand from both memory and logic applications including 3D memory and FinFET which we are confident will continue to drive profitable growth for our company. Dielectric slurries provided 23.8% of our revenue this quarter with sales up 27.2% from the same quarter a year ago. As Dave mentioned earlier, during the quarter we saw continued strong demand for some of our new higher performing Ceria and colloidal silica-based dielectric slurry products. Sales of polishing pads represented 13.2% of our total revenue for the quarter and increased 54.2% compared to the same quarter last year. Our pads product area achieved record revenue during the quarter. Sales of slurries for polishing metals other than tungsten including copper aluminum and barrier represented 12.8% of our total revenue and decreased 3.5% from the same quarter last year. Finally revenue from our engineered surface finishes area and data storage products represented 4.1% and 1.3% of our quarterly revenue respectively. Gross profit for the quarter was 49.9% of revenue compared to 50% of revenue we reported in the same quarter a year ago. This includes $1.2 million of amortization expense related to the NexPlanar acquisition. Excluding this, non-GAAP gross profit was 50.9% of revenue. Other factors impacting gross profit this quarter compared to last year…

[Operator Instructions] And our first question comes from the line of Mike Harrison with Seaport Global Securities. Your line is now open.

Good morning, Mike.

Hi, good morning. This is Jacob on for Mike.

Hi, Jacob. How are you?

I’m doing good. My first question, I guess, you guys mentioned that China did well. Looking at the other geographies, was the performance pretty strong and balanced across or did one performed, better or worse than the other?

Yes, we saw year-over-year revenue increases in all geographies. China was quite strong, Japan was also quite strong for us. Everything was in double-digit growth except for Europe which was about 10%. We just – I think we wanted to callout China particularly because there has certainly been a lot of attention on semiconductor growth in China. We feel like we are well positioned there. We had strong growth last year and think we are well positioned this year. So it’s something I think it’s getting a lot of attention from the industry and we certainly feel like we are well positioned to grow with China.

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

We haven’t broken out in that detail. I think the $80 million to $90 million by fiscal 2018 was really just an overall pads revenue growth and the KFMI collaboration is something quite new. But we are really excited about it. What we are doing there is bringing our NexPlanar pad technology to KFMI and KFMI is already a well-known supplier to the industry. They supply sputtering targets globally. So they really understand the requirements of the customers and it’s a great way to provide a locally manufactured pad to our customers in China and that’s certainly something that we’ve heard from our customers that they are looking for. So, we are encouraged, but that’s a very early collaboration, but we are also very confident about the pads growth as well.

That’s probably a contributor to revenue in sometime in fiscal 2018, not in fiscal 2017.

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

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

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

Good morning Amanda.

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

Yes, thanks, Amanda. I think what we would say is, we are obviously very confident about and excited about our new products in tungsten and dielectrics and pads continues to grow significantly. If you are talking about the softness related to the January quarter, the industry is forecasting some softness. If you look at what TSMC has said, they are looking at 8% to 10% down sequentially. Bill mentioned what we think about is around 5% lower for our CMP consumables. So there is some – potentially some softness in there, but obviously in the full year, we expect a strong year and continued growth there. So yes, I think to your question is, well it’s completely offset, I think what our comments would suggest is that we are seeing about 5% lower CMP consumables for the quarter, at least that’s from our current advantage point.

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

Right, so, we are really excited about what we’ve seen from the customers and their adoption of NexPlanar and if you recall the way that we’ve approached customers and why we thought this technology was so compelling to begin with is, it really provides a performance differentiation, it’s not an alternative or a low cost alternative. So – and we are still seeing the lower – shorter qualification time. So, I would say the competitive intensity is about the same as when we first introduced it, we are really pleased with the progress and we continue to grow our pipeline.

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

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

Right, so, I think you’ve captured it accurately Amanda. The current capacity, installed capacity, whether it’s the domestic players like SMIC or QALY, they are running quite strongly. So we are seeing that consumables used very strong. And then a lot of investments going into China also from domestic and international customers both and that capacity is expected to come online in the next couple of years. So we’ve seen – you’ve seen a lot of CapEx go into China and we expect to see consumables follow that as wafers start to go up in China as well. So, really strong currently with the installed capacity and then the new capacity coming online in the next couple of years as you mentioned.

Great. Thanks, guys.

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

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

Good morning Chris.

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

Sure, Chris. So, again, you have to segment China into a few different areas. For the domestic customers, they are primarily foundry. So for example, SMIC and they tend to be two or three generations behind leading-edge player like an Intel or TSMC and they are running quite strongly. I think, SMIC is fully in HVM for 28 and working 16 today. For the international customers, for example, a Samsung or an SK Hynix that are producing memory in China, they are producing leading-edge memory in China already. So, it really depends on which segment that you are talking about and we obviously sell into both those different segments.

That’s helpful. And then, you mentioned memory and obviously a driver here has been this conversion over to 3D NAND. Do you have a sense of how many of the leading memory guys or how far along are they in the conversion to HVM for 3D NAND, it was kind of the behemoth memory with the couple of the second, third largest closely behind in that conversion, but can you guys update us on how far along is, in your perception, this transition to 3D NAND?

I still think it’s in their early stages, Chris, although there are a few more customers that are in high volume. So, Samsung is clearly still the leader, fully ramped in their facility in China and also ramping in a facility in Korea. We’ve also seen other customers producing like Micron. We mentioned Micron is now our third largest customer and so they are making progress there and then the others perhaps a little earlier in the process, the SK Hynix and Toshiba. So, and in addition, we see a lot of follow-on investment, even from those that are already in HVM. So, Samsung and Micron, I know the Intel facility in Dalian is also producing 3D NAND using a Micron process. So we are still early on in that transition from our perspective.

That's helpful. And then, just one more. Just on the above normal seasonality in the December quarter, in your formal remarks you mentioned that coming into the December quarter, chip inventories were a little lean, so that contributed to it partly, but given the broad-based strength in demand for your consumables, it seems like it was maybe more than that. Can you point to any one thing that you feel is contributing, or contributed to the above seasonal strength in the December quarter? Is it simply this memory transition? Or was there any sort of end-markets where you might have seen abnormal strength in the quarter?

Right, so, Chris, thanks for the question. If you look at where our focus is for our core business, it’s on tungsten, dielectrics and pads and we’ve seen really strong growth across those product segments and if you look at how they correlate to the industry for example, tungsten and dielectrics and pads as well really are a big part of both the leading-edge memory. So like, 3D that you just mentioned, as well as FinFET. So I think we are well positioned in those areas that are ramping. China is also another area that’s ramping and growing quickly and we are well positioned there. So I think that contributes to the strong demand that we’ve seen from consumables. I think we are positioned well where the industry is growing.

Just little data behind that. So, on a sequential basis, our tungsten revenue grew by 9.5%, dielectrics grew by 8.1% and pads grew by 4.2%. So well over normal seasonal trend.

Okay. Thank you.

Thank you, Chris for your questions.

Thank you. [Operator Instructions] And our next question comes from the line of Edwin Mok with Needham & Company. Your line is now open.

Good morning, Edwin.

Hi everyone. This is Arthur on for Edwin.

Hi, Arthur.

Hey. So, the first question is on gross margins. Gross margins were strong this quarter at the high-end of your fiscal 2017 guidance range. But given your commentary for some near-term softness in IC consumables, how should we think about the impact to gross margins in the March quarter?

In the March quarter, one of the things we have pointed out was just a reminder that we typically see some higher cost in the March quarter associated with the new calendar year and we talked about that in prior calls in prior years. So for example, with the new calendar, there are merit salary increases, payroll taxes start up again and we also have our Annual Meeting in March and so the Board of Directors equity compensation mostly hits in that March quarter. So you would see a bit of headwind in gross margins and also in operating expense quarter-to-quarter. We are comfortable with our guidance on the full year of 48% to 50% revenue, but there is likely a bit of a headwind in the March quarter for those reasons. Along with the seasonal softness would provide a bit of a headwind also.

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

Right, so, when we talk about dielectrics, the newer products that we are seeing a lot of growth in our colloidal silica-based slurry and a ceria-based slurry, the ceria-based slurry tends to be more preferred by memory customers and so we are seeing a lot of traction there and we have several products in the market that are providing a lot of value to customers in that area. For our colloidal products, that’s a family of products that we think is really revolutionary to this dielectrics market. We believe they can target up to a $100 million of business opportunities and we’ve been talking about that for a while. That can be used by customers in memory and logic and across different wafer sizes, 200 millimeter or 300 millimeter. So, the growth we’ve seen in dielectrics is really, I think a recognition by our customers that they are seeing the performance benefits of both our new ceria which really primarily goes to memory and colloidal which is broader based and we are seeing a lot of pull for those products of full pipeline and we are excited about the future there.

Thanks for that. And then just the last question, how much did NexPlanar contributed during the quarter?

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

Great, thanks.

Thank you Arther, for your questions. We’ll take our next question please.

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

Good morning, Dmitry.

Good morning, guys, and congratulations on a great start to the year.

Thanks.

Couple of questions. Number one, sort of the one product family that you have not talked about in any great length over the last several quarters and the one that’s been sort of peaked out at about $75 million, $76 million. It's been slowly trending down, is the copper and the barrier and aluminum polishing slurries. Is that sort of a - because it is a sunsetting technology or at least a flattish technology versus the growth of dielectrics and tungsten that are driven by FinFET and the 3D NAND conversion? Is it market share give ups, less attractive market, given that it’s not considered leading-edge anymore? Can you talk about sort of what’s going on with your metal polishing business outside of the tungsten market?

Yes, so that area we call slurries or polishing other metals. So, aluminum, copper and barrier, we have seen a ramp up a couple of years ago, particularly in aluminum given the aluminum gate that was in 28 nanometer and 20 nanometer logic technology. And so we saw a significant growth in aluminum, but then those kind of plateaued and then our customers captured some pretty significant efficiencies, we’ve seen the aluminum decrease and then I think now it’s relatively flat quarter-to-quarter. The other factor is that we’ve introduced some more advanced copper slurries that are more concentrated and so, higher ASP but lower volume higher gross margin percentage, but fewer gross margin dollars and those have been adopted by a few customers. So to the extent we transition from an older legacy copper to these newer copper products, and we see some revenue headwind although we are profitable. Then in barrier, we had relatively stable business there, but that’s one area where this quarter represents a decrease in barrier revenues due to a loss position on some of the legacy applications.

Okay, Bill, that’s very helpful. Thanks for that granularity, which leads me to sort of my next question. Future shrink has been a characteristic of this market and has provided repeated opportunities for you guys to differentiate yourself in the marketplace with the technology and your broad capabilities. Where do we stand these days on sort of the leading-edge feature, small feature ICs and where are your customers in terms of both sort of utilization rates on these new lines, as well as yields? In other words, if we look out three, four quarters out, can we be running into the same issue there that you seem to have run into with aluminum where enhancing yields are offsetting or enhancing yields are what's driving the IC growth but that may not necessarily be reflected in the growth of your slurries?

Yes, Dmitry, so, I think, again, you have to separate the different segments, logics, foundry and memory. For the logic and foundry area, the leading-edge customers are working on 10 and sub-10. What we’ve seen that Bill mentioned is, move away from aluminum gate at 28 20 to FinFET which is a tungsten gate, so that’s really we feel like we are well positioned there and I’d say that those - there are just one or two customers that are fully ramped in high volume for that advanced logic technology. For memory 3D we’ve talked about already on the call, but still I just comment it’s early and there are different technical challenges and requirements for 3D. So even though it may not be a shrink there are different technical challenges and we feel like we are well positioned there as we mentioned, Samsung is our biggest customer now, Micron is our third biggest customer. So, we feel like we are well positioned there, but it’s early in that transition as well.

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

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

And then, so that’s the commentary around CMP slurries based on real leadership position that we have there. Separate, we would expect growth in pads certainly is not tied to wafer starts, it would be tied to business wins and we’d expect to grow well in excess of the market in that area.

Got it Bill. And then one final question on the cash use, you got - you guys are now back over $300 million in cash on hand which was the highest point since the end of your fiscal 2015. Your share count continues to expand obviously on diluted shares and options because given where your stock price is. What are we - how should we model you are using that cash going forward and I’ll mean ploughing it all into share repurchases hypothetically, I mean, what is that you intend to do with that $305 million in cash on hand?

Yes, the cash balance is around $305 million, but on a net cash basis, it’s $151 roughly, because we have some debt outstanding. But the priorities we’ve articulated for capital deployment really haven’t changed and just as a reminder, organic investments and this year we’ll spend $20 million to $25 million at dividends and we will – with our fourth dividend payment in later on the 30th that will bring us to about $18 million in dividends in fiscal – in respect to fiscal 2016. Share repurchases have been a big factor and then M&A, M&A we list fourth really because it’s – there are not dozens of attractive actionable opportunities, but we have had and continue to have an ongoing effort in corporate development to look for acquisitions and related areas where we can leverage capabilities. And we will continue to do that. We’ve been very disciplined in it, but that continues to be a priority and things we are spending some time on as the leadership team.

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

Okay, thank you.

Yes, the acquisitions are sort of binary, right.

Right.

But we’d be looking for something that would be material to the company and a related area that would leverage capabilities and those – they are not a long list of opportunities, but we continue to see the industry for that.

Got it. Thank you very much.

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

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

Hi, Chris.

Yes, hey. I have to just follow-up on that capital allocation discussion. I mean, this company has generated positive free cash flow basically every year since you are public. As you pointed out, at the end of this year, probably rough math, you’ll probably have net cash of over $200 million on your balance sheet, given the free cash flow characteristics even in “spike in CapEx”, which Dmitry pointed out. You have peers one that was just created, six months ago that is levered at 2.7 times you have net cash on your balance sheet. Everybody talks about the lack of capital intensity in the business. What’s the appropriate capital structure for this company? I mean, do you think it’s right to have this much cash sitting on your balance sheet?

The approach we’ve taken and continue to take is, we like to have the flexibility on the balance sheet to enable M&A and on our history, the two significant deals we have done have been within the CMP consumable space, Epoch, the Taiwan CMP slurry company in 2009 and NexPlanar which we acquired in 2015. So we continue to look for M&A and related areas and I think we like the balance sheet flexibility that the cash balance gives us. If you look back in 2012, when we had $300 million of net cash and we didn’t have significant actual or attractive M&A opportunities, we did a leverage recapitalization and paid about $350 million special cash dividend. I think our strategy going forward is again organic investments, dividends, share repurchases and M&A and we’ll continue to look for related opportunities. If we found ourselves where we didn’t have actual opportunities, then I think we could consider other things like another special cash dividend. But no plans for that now. We continue to carry on.

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

Where is the cash for the repatriation issues?

The total cash balance around 60% is overseas and 40% is in the US.

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

It’s a combination of both, Chris. So it is geared towards both the advanced and legacy applications for dielectric. Some of those positions of course are ours and so if customers are looking to gain some performance as well as a lower cost of ownership, they may choose to look at that product and that would be good with us, because it’s a lower cost of ownership, but also more of a profitable product for us then especially than some of the higher solids dielectrics products we’ve had out there in the market in the past. But also, the $100 million of new business opportunity that we talk about is not including any cannibalization of our products. So that’s going after business that we don’t have today and we are seeing a lot of interest from customers there as well. And I think just adding the combination of having a pad like the NexPlanar pad, that can also be used with that slurry as a pad in consumable – pad in slurry consumable set has also been – is also showing a lot of interest by our customers as well.

Thank you guys.

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

Thanks, I just wanted to make one other comment. Some of you may have seen a 13D filing from Hudson Executive Capital filed yesterday and in first it shouldn’t detract from the continued strong operating performance and results of the company. But I just wanted to comment on the filing, because, to the extent that the filing suggested that there have been extensive discussions between our company and Hudson, I wanted to make sure it was clear that that is not correct. We have had only routine conversations with Hudson of the type that we have with any of our significant shareholders and as part of any ordinary shareholder engagement program and we have not and do not intend to engage in any non-routine discussions with them. So, again, this filing from our perspective does not affect our strategy, the operation of our business or focus on continuing to create long-term value for all our shareholders and I thought it was important to point that out.

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

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