Good day, ladies and gentlemen, and welcome to the Cabot Microelectronics Third 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 follow at that time. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to Trisha Tuntland, Director of Investor Relations.

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 third quarter of fiscal 2017, which ended June 30, 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 third quarter of fiscal 2017, reflecting continued healthy semiconductor industry demand, as expected and discussed during our second quarter earnings conference call in April, as well as the continued successful execution of our strategic initiatives. During the quarter, we experienced sustained robust demand for our tungsten, dielectrics, and pad CMP solutions, across a wide range of memory and logic applications including 3D NAND and FinFET technologies. We believe our performance is evidence of our technology leadership, operational excellence, and close collaboration with our customers. During the quarter, we achieved record revenue of $128 million, approximately 18% higher than in the same quarter last year. Our gross profit margin was 48.9% of revenue and we achieved diluted earnings per share of $0.77, reflecting continued strong profitability. In addition, we continued our strong cash generation trend with cash flow from operations of $32.1 million. Bill will provide more detail on our financial results later in the call. To provide some context for our third quarter results, let me first offer some perspectives on the global semiconductor industry environment. As forecast by some of our customers and industry analysts, IC demand remained solid during the June quarter despite isolated softer conditions in certain smartphone applications, primarily affecting some advanced logic and foundry players due to mobile products seasonality. Reports suggest that overall semiconductor demand was driven by a continued robust memory market, generally due to the growing requirements for storage in a wide range of end-use applications. Due to this and semiconductor device manufacturers' inventory management, some of our customers and industry analysts have reported expectations for continued solid conditions during our fourth fiscal quarter, and through July we are seeing continued healthy demand for…

Thanks, Dave, and good morning everyone. Revenue for the third quarter of fiscal 2017 was a record $128 million, which represents an 18.3% increase from the same quarter last year. The increase reflects continued strong global semiconductor industry demand that we've seen over the last five quarters as well as the continued successful execution of our strategic initiatives. Year-to-date, revenue of $370.4 million represents a 20.3% increase from last year. Drilling down into revenue by product area, tungsten slurries contributed 42.8% of total quarterly revenue, with revenue – we continue to see strong demand for our tungsten slurries for advanced applications, including 3D memory and FinFET, and as Dave discussed earlier, this is a key product area that we expect will drive future profitable growth for our Company. Dielectrics slurries, representing the second key product area, provided 23.7% of our revenue this quarter, with sales up 19.4% 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 13.8% of our total revenue for the quarter, and increased 25.1% compared to the same quarter last year. Our pads product area achieved record revenue for the seventh consecutive quarter. Sales of slurries for polishing metals other than tungsten, including copper, aluminum and barrier, represented 12.6% of our total revenue and increased 0.3% from the same quarter last year. Finally, revenue from our Engineered Surface Finishes area represented 6.1% of our quarterly revenue and data storage products represented 1.1%. Gross profit for the quarter was 48.9% of revenue compared to 48.1% that we reported in the same quarter a year ago. This…

[Operator Instructions] The first question is from Dmitry Silversteyn of Longbow Research. Your line is open.

This is Alexandra Silversteyn on for Dmitry. So for the first question, we kind of went into the detail of the tungsten demand. About how much of that is kind of attributed to the newer technologies like [Sintec] [ph] and how much of that is more towards already incumbent market demand?

With regard to tungsten, right, so we're really excited about the opportunity for the advanced technologies for both FinFET and 3D, and exiting fiscal 2016 we talked about 20% of our tungsten revenue was driven by sales into these advanced technologies, with memory on a faster, stronger trajectory, and we'll update that advanced tungsten sales into advanced technologies next quarter. But as you probably have been following, there's a lot of investment going into memory and we think that offers a significant growth opportunity for us for both tungsten, dielectrics and pads. But for now, what we've talked about is 20% of our tungsten sales exiting FY 2016 and we'll update that again at the end of this next quarter.

Great, thank you. And then for the second question, Dave mentioned the 25% growth in your polishing pads for the quarter, which is great, but it kind of seems that is a bit lower than the growth from the previous two quarters and lower than our modelling. So could you just kind of tell us how we should think about the factors that are attributing to the decrease in growth or we should perhaps consider that 25% a new normal?

Right, so what we talked about is continued growth in pads, as we mentioned our seventh consecutive record quarter for pads revenue, and we also talked about our strong expectations for growth in the next several years. So we kind of measure it by how we're doing over time, not just quarters, and we've talked about our confidence in growing this business to over $100 million by our fiscal 2019. So that would be considerable growth versus certainly the timing of our NexPlanar acquisition. But we continue to see strong customer pull. We also talked about continued investments in capacity, so we're investing ahead of demand there. So we see strong growth potential on pads and expectations to grow more than $100 million by fiscal 2019.

The next question is from Edwin Mok of Needham & Company. Your line is open.

Thanks for taking our questions and congrats on the top line quarter. So the first question is just on your pads business. In the past you've talked about how you've penetrated 8 out of 10 leading semi customers. Are there any new customers that you would like to share during the quarter, and then if not, then what are the state of engagements with the remaining two customers?

So for pads, we've talked about in the past 8 of 10, and the one thing, the interesting dynamic and what we're really encouraged by is, once you start selling pads into a customer, we're seeing continued really short qualification time. So a customer may bring in our pad for a certain application and what we've seen is rapid proliferation across different applications and different locations within the same customer. So, what we're seeing primarily now is increased proliferation within existing customers. That is also being complemented with a very strong pipeline of new opportunities with both existing and new customers. We also commented on a new pad configuration, which is really our launch of a new series called the Ultra series, building off, innovating off that NexPlanar platform. What we're doing there is providing our customers with better performance and also taking some cost out of our process. So we're excited about that new series, we're excited about the growth in pads, and we see a strong trajectory going forward.

Great, thanks for that. I think, David, you mentioned that you've had a new win for your higher-performing ceria dielectrics slurries for a 3D NAND application. Was that with a new customer?

We didn't mention about the new customer or not, but as you know, the number of customers in high-volume in 3D is pretty limited and we sell to just about everyone today. But one of the things we've talked about a lot in the past is our new family of colloidal silica products and we also have continued innovation in the ceria area. So this was just an example of continued innovation, working closely with our customers to hit a really stringent requirement in the ceria area. We've seen tremendous growth in both colloidal and ceria and we're excited about that new family. I think this area for dielectrics in general is an area where we are really taking strong technology leadership, continued innovation to an area where there has not been a lot of innovation in the past. So, whether it's our new family of colloidal silica-based products or our building of our family of ceria-based products, we feel really well-positioned for both memory and foundry and logic. But this was an example of a win in 3D NAND.

Got it. And then during the call you also talked about how you're seeing this demand for your CMP consumables coming from these non-leading-edge applications, and obviously the leading-edge is a strong driver for your business due to the higher CMP intensity, but when you think about the trailing edge, do you see this as an accelerating growth driver for Cabot and could you see a broadening of your business that could potentially offset some typical seasonality?

What we've seen, and following the industry I'm sure you're seeing the same, are that some of the traditional drivers are still certainly there, like smartphone, mobile, those types of applications, and also of course memory. But some of the other applications that are continuing to increase and grow significantly are what's being referred to as this third wave, which includes segments like automotive and industrial. And for example, we announced several months ago, we won an award from TI. We are honored to win that award. And TI recently announced they're seeing tremendous growth in automotive area as well. So, we feel like we're well-positioned to grow with those segments of the market, and certainly we're serving those already, but as those continue to grow, we do see the potential for less cyclicality and seasonality than we've seen in the past.

Great. If I could just squeeze in one more question, Bill, I just had a question on gross margin. You guys reported a strong revenue quarter but non-GAAP gross margins declined by 160 basis points quarter-over-quarter. I know in the past you've highlighted the swing factors for gross margins, but was the moderation this quarter mostly due to the stronger growth in the pads business?

It's actually, yes, we did see benefit of higher revenue and we did see one significant factor this quarter was higher fixed manufacturing cost. We've talked over the past several quarters about expanding our facility in Korea and expanding our pad manufacturing capacity in Hillsboro, and that's been to fuel significant growth. We've talked about a lot of growth in Korea and strong growth in pads, and that's meant more staff. So we have added people in a number of areas, and including in the pads area, beyond just sort of keeping up and staying ahead of strong demand and pull from customers. We've also added engineering capability to capture more productivity improvements. We've talked about our pads business as having gross margins below the Company average. We think there are opportunities to improve those margins over time with productivity improvements, more efficiency, more automation. That takes engineers, and so we've added some staff there, and you can see that in higher fixed manufacturing cost. In addition, we've talked over the year, we've mentioned about higher incentive compensation cost, and that is cost of goods sold also as well as operating expense. We've been performing quite well throughout the year, our performance versus our corporate goals, and so incentive compensation has been higher as well. But what we saw this quarter was a higher fixed manufacturing cost that was kind of the key factor. We did see stable ASP. So this wasn't a factor of ASP erosion or anything like that, it was just higher costs.

Great, Thank you for taking my questions.

The next caller is Chris Kapsch of Aegis Capital Corp. Your line is open.

Just to follow-up on the gross margin, so that was a pretty good explanation, but the IC comp accruals, was there like a catch-up accrual in this quarter that disproportionately affected the gross margin, because otherwise you would have expected some of these other costs that you've been investing in? The people and the fixed manufacturing cost presumably flowed through a little bit in your fiscal second quarter as well, so just trying to get a little more color on that.

Sure, and that's a bigger factor year-over-year. We did see some sequential increase, but yes, that was not the biggest part of it, it was kind of broader fixed manufacturing cost. But you look at other profitability metrics, gross profit decreased sequentially but our operating income, EBITDA margin, net income margin, all expanded sequentially. So I think we're comfortable with the overall model, but we did see some higher costs in Q3 in manufacturing.

So, on the IC comp expense that you called out, was there a catch-up accrual there or is it just more being added given the performance that you guys put up sequentially?

We true up that accrual every quarter and we did have a classification between manufacturing cost and operating expense that did cause a bit of that tick upward in fixed manufacturing cost.

But Chris, as Bill mentioned earlier, it's really us, what you're seeing this quarter is investing ahead of demand for pads and timing of hires, especially in Hillsboro, we referenced capacity expansion and we're investing there. We believe that capacity will be online in early FY 2018 first half. And so that's really what you're seeing this quarter.

Okay, so it's more people than fixed capacity related cost, correct, in terms of that part of the higher manufacturing cost?

I think it's a combination of the two. We're adding manufacturing capacity in pads in particular, and people, and then people to support the strong growth in Korea. So it's a combination of the two I think.

Okay. Is there new capacity that was being ramped up in the process of being qualified that was flowing through the P&L?

When you look at our – we have added staff and you can see that in our press release where we talk about – where we've given approximate number of employees, and you can see an increase in that number. So yes, we have added people to help support the growth in pads in particular but also in Korea.

No but I was asking about new capacity in the form of hard capacity assets.

Right, so we added, we expanded our Korea facility. That was an $8 million capital investment. And then we're in the process of adding new hard assets in pads, but also you add people as you ramp up production from the existing assets. So it's a combination of those two things.

Okay, that's helpful. And just I don't mean to be too nitpicky, just given the strength in some of your – the sales trend of some of your highest margin products, just trying to understand why that wouldn't have flowed through more, and it sounds like it relates to just the transient aspect of ramping up your capacity in pads and to a lesser extent in I guess Korea specifically to address the growth that you see looking forward, if that's one way?

Yes, I think that's a fair characterization. In our history, we've seen some fluctuations in gross margin quarter to quarter, and there's an element of that, but I think your characterization is fair.

And just to be clear, currency didn't influence the margins whatsoever it sounds like?

No, really there was really no significant currency effect.

And then my follow-up unrelated was, just on your commentary about the fiscal fourth quarter, the way you describe it is a little different than the way you used to about the trend, you don't necessarily call out the order trends I guess thus far into July, but the 2% higher sequential revenues that you expect in the September quarter vis-a-vis the June quarter, are the demand trends that you see so far in June consistent with that, are they above that, or do you need further sequential seasonal strengthening to hit that sort of bogie or metric?

So if you remember, last quarter we kind of departed from our traditional approach of just referring to orders to date in the month, where we were at the time of the earnings call, and we used kind of more judgment and based on our internal forecast, last quarter we said we expected a 3% increase in IC CMP consumables from Q2 to Q3, and we're carrying on that practice this time. We take into account what the orders are to date in July, but also our view of August and September. And so, yes, we've seen continued strong orders in July, and for the quarter the expectation is some growth, approximately 2%, Q3 to Q4. So it's a different approach that we started last quarter, now we're continuing this quarter.

The next question is from Michael Harrison of Seaport Global Securities. Your line is open.

This is Jacob on for Mike. In your prepared remarks, you kind of talked about that softness in smartphone, so I'd be curious to get your take on how you think that market will shape up in the back half of the calendar year? And sticking with the ordering, have you been seeing any order activity pick up in regards to the customers more levered to the smartphone market?

So consistent with what some of the releases have been recently, including TSMC, they actually had a down quarter this quarter and are expecting a strong quarter going forward, and we believe that is related to smartphone launches, whether it's the iPhone 8 or other devices that are in preparation for launch. For us, for those advanced logic and foundry applications, we're well-positioned to grow with those ramps, especially because in FinFET there's a tungsten gate requirement that's very challenging, we obviously have the leadership position in tungsten. So we feel we're well-positioned to grow with that growth in advanced logic. I do think, you pointed out correctly what the industry analysts would say is that this quarter that we're currently reporting on, the only soft spot in the industry, memory continue to be strong, the legacy logic and foundry continue to be strong, and the only kind of soft spot was that advanced logic which seems to be ramping up in preparation for those new launches. And as Bill referenced, we have some expectations of about 2% growth, that's broad-based industry strength, and of course we'd be well-positioned to grow with advanced logic.

Got it, all right. Thank you for answering my question.