ITEM
2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The
following "Management's Discussion
and Analysis of Financial Condition and Results of Operations", as well as
disclosures included elsewhere in this Form 10-Q, include "forward-looking
statements" within the meaning of the Private Securities Litigation Reform
Act
of 1995. This Act provides a safe harbor for forward-looking
statements to encourage companies to provide prospective information about
themselves so long as they identify these statements as forward-looking and
provide meaningful cautionary statements identifying important factors that
could cause actual results to differ from the projected results. All
statements other than statements of historical fact we make in this Form 10-Q
are forward-looking. In particular, the statements herein regarding
future sales and operating results; Company and industry growth and trends;
growth of the markets in which the Company participates; international events;
product performance; the generation, protection and acquisition of intellectual
property, and litigation related to such intellectual property; new product
introductions; development of new products, technologies and markets; the
acquisition of or investment in other entities; uses of the Company’s cash
balance; the construction of new or refurbishment of existing facilities by
the
Company; and statements preceded by, followed by or that include the words
"intends", "estimates", "plans", "believes", "expects", "anticipates", "should",
"could" or similar expressions, are forward-looking
statements. Forward-looking statements reflect our current
expectations and are inherently uncertain. Our actual results may
differ significantly from our expectations. We assume no obligation
to update this forward-looking information. The section entitled "Risk Factors"
describes some, but not all, of the factors that could cause these
differences.
This
section, "Management's Discussion
and Analysis of Financial Condition and Results of Operations”, should be read
in conjunction with Cabot Microelectronics’ annual report on Form 10-K for the
fiscal year ended September 30, 2007, including the consolidated financial
statements and related notes thereto.
FIRST
QUARTER OF FISCAL 2008 OVERVIEW
We
believe we are the world’s leading
supplier of high-performance polishing slurries used in the manufacture of
advanced integrated circuit (IC) devices within the semiconductor industry,
in a
process called chemical mechanical planarization (CMP). CMP is a
polishing process used by IC device manufacturers to planarize or flatten many
of the multiple layers of material that are built upon silicon wafers in the
production of advanced ICs. Demand for our CMP products for IC
devices is primarily based on the number of wafers produced by semiconductor
manufacturers, or “wafer starts”. We develop, produce and sell CMP
slurries for polishing materials such as copper, tungsten and dielectric in
IC
devices, and also for polishing the coatings on disks in hard disk drives and
magnetic heads. In addition, we develop, manufacture and sell CMP
polishing pads, which are used in conjunction with slurries in the CMP
process. We remain focused on the consistent and successful execution
of our three strategic initiatives within our core CMP business: maintaining
our
technological leadership, achieving operations excellence and connecting with
our customers.
In
addition to strengthening and
growing our core CMP business, through our Engineered Surface Finishes (ESF)
business we are exploring a variety of surface modification applications where
we believe our technical ability to shape, enable and enhance the performance
of
surfaces at an atomic level may provide previously unseen surface performance
or
improved productivity. By supplementing our internal development
efforts with externally acquired technologies and businesses, we seek to
leverage our expertise in CMP formulation, materials and polishing techniques
for the semiconductor industry to address other demanding market applications
requiring nanoscale control of surface shape and finish, and gain access to
a
variety of markets that we do not currently serve.
Revenue
for our first quarter of fiscal
2008 was $93.4 million, which represented an increase of 3.3%, or $3.0 million,
from the previous fiscal quarter and an increase of 14.1%, or $11.6 million,
from the first quarter of fiscal 2007. The increase from the prior
quarter primarily reflects solid business performance, strong industry
conditions through our first fiscal quarter and contributions from our polishing
pad business. We continued to see solid demand for our slurry
products from memory customers during the quarter, but we began to experience
some weakening in demand in the foundry and logic sectors of our
business. The first quarter of fiscal 2008 was our first quarter of
meaningful polishing pad revenue and we expect to see continued growth in pad
sales during our second fiscal quarter.
There
are many factors
that make it difficult for us to predict future revenue trends for our business,
including: the cyclical nature of the semiconductor industry; timing of
potential future acquisitions; short order to delivery time for our products
and
the associated lack of visibility to future customer orders; and quarter to
quarter changes in customer orders regardless of industry
strength. The recent weakening of the U.S. and global economy may
lead to slower economic growth, which may affect future customer demand for
our
products. Additionally, in recent years we have experienced lower
revenue during our second fiscal quarter, which we believe is due to the
seasonality of the semiconductor industry.
Gross
profit expressed as a percentage
of revenue for our first quarter of fiscal 2008 was 47.9%, which is near the
upper end of our full fiscal year guidance range of 46% to 48% of
revenue. Gross profit decreased from both the 49.1% reported in the
previous fiscal quarter and the 48.1% reported in the first quarter of fiscal
2007 primarily due to higher fixed manufacturing costs related to
staffing. We may experience quarterly gross profit above or below our
annual guidance range due to a number of factors, including fluctuations in
our
product mix and the extent to which we utilize our manufacturing
capacity.
Operating
expenses were $28.5 million
in our first quarter of fiscal 2008, compared to $30.3 million in the previous
fiscal quarter and $27.1 million in the first quarter of fiscal
2007. Total operating expenses this quarter are in the middle of our
quarterly guidance range of $27 to $30 million. The decrease from the
previous fiscal quarter was primarily driven by lower staffing related
costs. The increase in operating expenses from the same quarter in
the prior year was mainly due to higher professional fees and higher staffing
related costs, partially offset by lower depreciation expense.
Diluted
earnings per share for our
first fiscal quarter was $0.51, an increase from the $0.43 per share reported
in
the previous fiscal quarter and from the $0.38 per share reported in the same
quarter of fiscal 2007.
We
completed our $40 million share
repurchase program during our first quarter of fiscal 2008, which was authorized
by our Board of Directors in October 2005. In January 2008, our Board
of Directors authorized a new share repurchase program for up to $75 million
of
our outstanding common stock. Additionally, during this fiscal
quarter, we purchased and began installation of a 300-millimeter polishing
tool
for our Asia Pacific technology center which complements our 300-millimeter
capabilities in the United States. We expect this tool will be placed
in service during our second quarter of fiscal 2008.
CRITICAL
ACCOUNTING POLICIES AND ESTIMATES AND EFFECTS OF RECENT ACCOUNTING
PRONOUNCEMENTS
We
discuss our critical accounting
estimates and effects of recent accounting pronouncements in “Management’s
Discussion and Analysis of Financial Condition and Results of Operations”
included in Item 7 of Part II of our annual report on Form 10-K for the fiscal
year ended September 30, 2007. We believe there have been no material
changes in our critical accounting estimates during the first fiscal quarter
of
2008. As discussed in Note 8 of the Notes to the Consolidated
Financial Statements, we adopted the provisions of FASB Interpretation No.
48,
“Accounting for Uncertainty in Income Taxes – an Interpretation of FASB
Statement 109” (FIN 48) during the quarter. The cumulative effect of
adopting FIN 48 was immaterial; however, FIN 48 substantially increases the
sensitivities of the estimation process used in the accounting for and reporting
of tax contingencies. New accounting pronouncements issued are
discussed in Note 11 of the Notes to the Consolidated Financial
Statements.
RESULTS
OF OPERATIONS
THREE
MONTHS ENDED DECEMBER 31, 2007, VERSUS THREE MONTHS ENDED DECEMBER 31,
2006
REVENUE
Revenue
was $93.4 million for the three
months ended December 31, 2007, which represented a 14.1%, or $11.6 million,
increase from the three months ended December 31, 2006. Of this
increase, $10.3 million was due to increased sales volume in our core CMP
business and $1.3 million was due to a higher weighted average selling price
for
our slurry products, primarily resulting from a higher-priced product
mix.
COST
OF GOODS SOLD
Total
cost of goods sold was $48.6
million for the three months ended December 31, 2007, which represented an
increase of 14.4%, or $6.1 million, from the three months ended December 31,
2006. Of this increase, $5.3 million was due to increased sales
volume, $2.8 million was due to increased fixed manufacturing costs and $1.9
million was due to certain other manufacturing variances. These
increases were partially offset by a $1.9 million benefit of a lower-cost
product mix and by a $1.9 million benefit of higher utilization of our
manufacturing capacity on the higher level of sales.
Fumed
metal oxides, such as fumed
silica and fumed alumina, are significant raw materials that we use in many
of
our CMP slurries. In an effort to mitigate our risk to rising raw
material costs and to increase supply assurance and quality performance
requirements, we have entered into multi-year supply agreements with a number
of
suppliers. For more financial information about our supply contracts,
see “Tabular Disclosure of Contractual Obligations” in this filing as well as in
Item 7 of Part II of our annual report on Form 10-K for the fiscal year ended
September 30, 2007.
Our
need for additional quantities or
different kinds of key raw materials in the future has required, and will
continue to require, that we enter into new supply arrangements with third
parties. Future arrangements may result in costs which are different
from those in the existing agreements. In addition, rising energy
costs may also impact the cost of raw materials, packaging and freight
costs. We also expect to continue to invest in our operations
excellence initiative to improve product quality, reduce variability and improve
product yields in our manufacturing process.
GROSS
PROFIT
Our
gross profit as a percentage of
revenue was 47.9% for the three months ended December 31, 2007, as compared
to
48.1% for the three months ended December 31, 2006. The slight
decrease was primarily due to higher fixed production costs related to staffing
and higher manufacturing variances partially offset by a favorable product
mix
and increased capacity utilization. We expect our gross profit as a
percentage of revenue to be in the range of 46% to 48% for full fiscal year
2008. Quarterly gross profit may be above or below this range due to
fluctuations in our product mix, the extent to which we utilize our
manufacturing capacity or other factors.
RESEARCH,
DEVELOPMENT AND TECHNICAL
Total
research, development and
technical expenses were $11.4 million for the three months ended December 31,
2007, which represented a decrease of 6.7%, or $0.8 million, from the three
months ended December 31, 2006. The decrease was primarily related to
lower clean room materials and laboratory supplies.
Our
research, development and technical
efforts are focused on the following main areas:
·
|
Research
related to fundamental CMP
technology;
|
·
|
Development
and formulation of new and enhanced CMP consumable
products;
|
·
|
Process
development to support rapid and effective commercialization of new
products;
|
·
|
Technical
support of CMP products in our customers’ manufacturing facilities;
and
|
·
|
Evaluation
of new polishing applications outside of the semiconductor
industry.
|
SELLING
AND MARKETING
Selling
and marketing expenses of $6.3
million for the three months ended December 31, 2007, were 14.8%, or $0.8
million, higher than the three months ended December 31, 2006. The
increase was primarily due to higher staffing related costs.
GENERAL
AND ADMINISTRATIVE
General
and administrative expenses
were $10.8 million for the three months ended December 31, 2007, which
represented an increase of 15.0%, or $1.4 million, from the three months ended
December 31, 2006.
The increase resulted primarily from
$1.7 million in higher professional fees, including costs to enforce our
intellectual property and $0.2 million in higher staffing related
costs. These increases were partially offset by a $0.4 million
decrease in depreciation expense.
OTHER
INCOME, NET
Other
income was $1.6 million for the
three months ended December 31, 2007, compared to $1.2 million in the three
months ended December 31, 2006. The increase in other income was
primarily due to $0.5 million greater interest income from higher interest
rates
and higher average balances of our cash and short-term investments.
PROVISION
FOR INCOME TAXES
Our
effective income tax rate of 31.7%
for the three months ended December 31, 2007 was comparable to 31.6% for the
three months ended December 31, 2006. In October 2007, we adopted FIN
48 which did not have a material effect on our consolidated financial position,
results of operations or cash flows. See Notes 9 and 11 of the Notes
to the Consolidated Financial Statements for further information on the adoption
of this pronouncement.
NET
INCOME
Net
income was $12.2 million for the
three months ended December 31, 2007, which represented an increase of 33.7%,
or
$3.1 million, from the three months ended December 31, 2006, as a result of
the
factors discussed above.
LIQUIDITY
AND CAPITAL RESOURCES
We
had cash flows from operating
activities of $16.0 million in the first quarter of fiscal 2008, and $6.9
million in the first quarter of fiscal 2007. Our cash provided by
operating activities in the first quarter of fiscal 2008 originated from $19.7
million of net income adjusted for non-cash items, partially offset by a $3.7
million decrease in cash flow due to a net increase in working
capital. The increase in cash from operations was primarily due to
increased net income in the quarter and a smaller increase in working capital
as
compared to the first quarter of fiscal 2007, due to improved accounts
receivable collections and the timing of accounts payable and accrued liability
payments, partially offset by higher inventory levels.
In
the first quarter of fiscal 2008,
cash flows used in investing activities were $2.5 million. We used
$5.6 million in cash for purchases of property, plant and equipment primarily
for the purchase and installation of a 300-millimeter polishing tool and related
metrology equipment at our Asia Pacific technology center. This cash
outflow was partially offset by $3.1 million provided by net sales of short-term
investments. In the first quarter of fiscal 2007, cash flows used in
investing activities were $1.7 million. Purchases of property, plant
and equipment of $3.5 million were made primarily for the expansion of our
pad
manufacturing capabilities and $3.0 million was used to acquire a license of
patents. These cash outflows were partially offset by $4.7 million in
net sales of short-term investments. We estimate that our total
capital expenditures in fiscal 2008 will be approximately $20.0
million.
In
the first quarter of fiscal 2008,
cash flows used in financing activities were $13.8 million, primarily as a
result of $14.0 million in repurchases of common stock under our share
repurchase program. In the first quarter of fiscal 2007, cash flows
used in financing activities were $6.1 million, including $6.0 million in
purchases of common stock under our share repurchase program. We
completed this share repurchase program during the first quarter of fiscal
2008,
which was authorized by our Board of Directors in October 2005 for up to $40.0
million. In January 2008, the Board of Directors authorized a new
share repurchase program for up to $75.0 million of our outstanding common
stock. Share repurchases will continue to be made from time-to time,
depending on market conditions, at management’s discretion. The new
program is expected to be funded from our available cash balance. We
view this program as a flexible and effective means to return cash to
stockholders.
We
have an unsecured revolving credit
facility of $50.0 million with an option to increase the facility up to $80.0
million. This agreement runs through November 2008, but we expect to have a
new
agreement in place prior to its expiration. Interest accrues on any
outstanding balance at either the lending institution’s base rate or the
Eurodollar rate plus an applicable margin. We also pay a non-use
fee. Loans under this facility are anticipated to be used primarily
for general corporate purposes, including for working capital and capital
expenditures. The credit agreement also contains various
covenants. No amounts are currently outstanding under this credit
facility and we believe we are currently in compliance with the
covenants.
We
believe that cash generated by our
operations and available borrowings under our revolving credit facility will
be
sufficient to fund our operations, expected capital expenditures, including
merger and acquisition activities, and share repurchases for the foreseeable
future. However, we plan to expand our business and continue to
improve our technology, and to do so may require us to raise additional funds
in
the future through equity or debt financing, strategic relationships or other
arrangements.
OFF-BALANCE
SHEET ARRANGEMENTS
At
December 31, 2007, and September 30,
2007, we did not have any unconsolidated entities or financial partnerships,
such as entities often referred to as structured finance or special purpose
entities, which might have been established for the purpose of facilitating
off-balance sheet arrangements.
TABULAR
DISCLOSURE OF CONTRACTUAL OBLIGATIONS
The
following summarizes our
contractual obligations at December 31, 2007, and the effect such obligations
are expected to have on our liquidity and cash flow in future
periods.
CONTRACTUAL
OBLIGATIONS
|
|
|
|
|
Less
Than
|
|
|
1-3
|
|
|
3-5
|
|
|
After
5
|
|
(In
millions)
|
|
Total
|
|
|
1
Year
|
|
|
Years
|
|
|
Years
|
|
|
Years
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital
lease obligations
|
|
$
|
4.4
|
|
|
$
|
1.1
|
|
|
$
|
2.3
|
|
|
$
|
1.0
|
|
|
$
|
-
|
|
Operating
leases
|
|
|
1.5
|
|
|
|
1.1
|
|
|
|
0.4
|
|
|
|
-
|
|
|
|
-
|
|
Purchase
obligations
|
|
|
60.0
|
|
|
|
51.8
|
|
|
|
7.0
|
|
|
|
1.2
|
|
|
|
-
|
|
Other
long-term liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
contractual obligations
|
|
$
|
68.3
|
|
|
$
|
54.0
|
|
|
$
|
9.7
|
|
|
$
|
2.2
|
|
|
$
|
2.4
|
|
We
operate under a fumed silica supply
agreement with Cabot Corporation under which we are obligated to purchase at
least 90% of our six-month volume forecast for certain of our slurry products
and to pay for the shortfall if we purchase less than that
amount. This agreement has an initial six-year term, which expires in
December 2009 and will automatically renew unless either party gives certain
notice of non-renewal. We currently anticipate meeting minimum
forecasted purchase volume requirements. We also operate under a
fumed alumina supply agreement with Cabot Corporation that runs through December
2011, under which we are obligated to pay certain fixed, capital and variable
costs. Purchase obligations include an aggregate amount of $29.9
million of contractual commitments for fumed silica and fumed alumina under
these contracts.
Refer
to Item 7 “Management’s
Discussion
and Analysis of Financial Condition and Results of Operations”
of
Part II of
our
annual report on Form 10-K for the fiscal year ended September 30, 2007,
for additional information regarding our contractual obligations.