10-Q 1 c84500e10vq.txt QUARTERLY REPORT UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ________ TO ________ COMMISSION FILE NUMBER 000-30205 CABOT MICROELECTRONICS CORPORATION (Exact name of registrant as specified in its charter) DELAWARE 36-4324765 (State of Incorporation) (I.R.S. Employer Identification No.) 870 NORTH COMMONS DRIVE 60504 AURORA, ILLINOIS (Zip Code) (Address of principal executive offices) Registrant's telephone number, including area code: (630) 375-6631 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. YES x NO ---- ---- Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2 ). YES x NO ---- ---- As of April 30, 2004 the Company had 24,818,602 shares of Common Stock, par value $0.001 per share, outstanding. CABOT MICROELECTRONICS CORPORATION INDEX
PAGE ---- PART I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Statements of Income Three and Six Months Ended March 31, 2004 and 2003................................... 3 Consolidated Balance Sheets March 31, 2004 and September 30, 2003................................................ 4 Consolidated Statements of Cash Flows Six Months Ended March 31, 2004 and 2003............................................. 5 Notes to Consolidated Financial Statements............................................... 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.................................................. 10 Item 3. Quantitative and Qualitative Disclosures About Market Risk............................... 21 Item 4. Controls and Procedures.................................................................. 22 PART II. OTHER INFORMATION Item 1. Legal Proceedings........................................................................ 22 Item 4. Submission of Matters to a Vote of Security Holders...................................... 22 Item 5. Other Information........................................................................ 23 Item 6. Exhibits and Reports on Form 8-K......................................................... 23 Signatures............................................................................... 24
PART I. FINANCIAL INFORMATION ITEM 1. CABOT MICROELECTRONICS CORPORATION CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED AND AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS SIX MONTHS ENDED MARCH 31, ENDED MARCH 31, 2004 2003 2004 2003 ---- ---- ---- ---- Revenue ................................................... $ 73,515 $ 62,201 $ 149,794 $ 119,474 Cost of goods sold ......................................... 37,366 31,786 76,392 59,451 ------------- ------------ ----------- ----------- Gross profit....................................... 36,149 30,415 73,402 60,023 Operating expenses: Research and development................................. 11,143 9,609 21,866 18,244 Selling and marketing.................................... 4,363 2,554 8,146 5,132 General and administrative............................... 5,749 4,595 10,873 8,963 Amortization of intangibles.............................. 85 85 170 170 ------------- ------------ ----------- ----------- Total operating expenses.............................. 21,340 16,843 41,055 32,509 ------------- ------------ ----------- ----------- Operating income............................................ 14,809 13,572 32,347 27,514 Other income (expense), net................................. (86) 43 (50) 38 ------------- ------------ ----------- ----------- Income before income taxes.................................. 14,723 13,615 32,297 27,552 Provision for income taxes.................................. 5,006 4,561 10,982 9,230 ------------- ------------ ----------- ----------- Net income............................................ $ 9,717 $ 9,054 $ 21,315 $ 18,322 ============= ============ =========== =========== Basic earnings per share.................................... $ 0.39 $ 0.37 $ 0.86 $ 0.75 ============= ============ =========== =========== Weighted average basic shares outstanding................... 24,785 24,346 24,761 24,325 ============= ============ =========== =========== Diluted earnings per share.................................. $ 0.39 $ 0.37 $ 0.85 $ 0.75 ============= ============ =========== =========== Weighted average diluted shares outstanding................. 24,926 24,593 24,935 24,589 ============= ============ =========== ===========
The accompanying notes are an integral part of these consolidated financial statements. 3 CABOT MICROELECTRONICS CORPORATION CONSOLIDATED BALANCE SHEETS (UNAUDITED AND AMOUNTS IN THOUSANDS, EXCEPT SHARE AMOUNTS)
MARCH 31, SEPTEMBER 30, 2004 2003 ---- ---- ASSETS Current assets: Cash and cash equivalents...................................................... $ 140,264 $ 111,318 Accounts receivable, less allowance for doubtful accounts of $580 at March 31, 2004 and $585 at September 30, 2003.............................................. 38,452 37,564 Inventories.................................................................... 23,861 23,814 Prepaid expenses and other current assets...................................... 5,902 4,010 Deferred income taxes.......................................................... 2,525 2,406 ---------------- -------------- Total current assets..................................................... 211,004 179,112 Property, plant and equipment, net................................................ 129,799 133,695 Goodwill ......................................................................... 1,373 1,373 Other intangible assets, net...................................................... 425 595 Other long-term assets............................................................ 862 842 ---------------- -------------- Total assets............................................................. $ 343,463 $ 315,617 ================ ============== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable............................................................... $ 14,398 $ 12,521 Capital lease obligations...................................................... 1,591 1,716 Accrued expenses and other current liabilities................................. 12,141 14,679 ---------------- -------------- Total current liabilities................................................ 28,130 28,916 Capital lease obligations......................................................... 6,835 7,452 Deferred income taxes............................................................. 6,148 5,384 Deferred compensation and other long-term liabilities............................. 2,521 2,092 ---------------- -------------- Total liabilities........................................................ 43,634 43,844 Commitments and contingencies (Note 8) Stockholders' equity: Common stock: Authorized: 200,000,000 shares, $0.001 par value Issued and outstanding: 24,813,063 shares at March 31, 2004 and 24,712,740 at September 30, 2003 ........................................... $ 25 $ 25 Capital in excess of par value of common stock................................. 135,171 131,913 Retained earnings.............................................................. 160,173 138,858 Accumulated other comprehensive income......................................... 4,651 1,187 Unearned compensation.......................................................... (191) (210) ---------------- -------------- Total stockholders' equity............................................... 299,829 271,773 ---------------- -------------- Total liabilities and stockholders' equity............................... $ 343,463 $ 315,617 ================ ==============
The accompanying notes are an integral part of these consolidated financial statements. 4 CABOT MICROELECTRONICS CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED AND AMOUNTS IN THOUSANDS)
SIX MONTHS ENDED MARCH 31, --------- 2004 2003 ---- ---- Cash flows from operating activities: Net income................................................................... $ 21,315 $ 18,322 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization............................................. 8,554 7,512 Noncash compensation expense and non-employee stock options............... 29 (17) Provision for inventory writedown......................................... (348) 1,511 Provision for doubtful accounts........................................... 7 22 Stock option income tax benefits.......................................... 834 1,147 Deferred income taxes..................................................... 646 (217) Unrealized foreign exchange gain.......................................... (1,148) (466) (Gain) loss on disposal of property, plant and equipment ................. (5) 21 Other..................................................................... (18) 351 Changes in operating assets and liabilities: Accounts receivable....................................................... 827 (1,744) Inventories............................................................... 1,186 (2,154) Prepaid expenses and other assets......................................... (339) 101 Accounts payable, accrued liabilities and other current liabilities....... (1,481) (2,477) Income taxes payable, deferred compensation and other noncurrent liabilities (871) 536 -------------- -------------- Net cash provided by operating activities....................................... 29,188 22,448 Cash flows from investing activities: Additions to property, plant and equipment................................... (2,408) (4,714) Proceeds from the sale of property, plant and equipment...................... 13 1,770 -------------- -------------- Net cash used in investing activities........................................... (2,395) (2,944) -------------- -------------- Cash flows from financing activities: Prepayment of long-term debt................................................. - (3,500) Net proceeds from issuance of stock.......................................... 2,440 2,635 Principal payments under capital lease obligations........................... (400) (363) --------------- --------------- Net cash provided by (used in) financing activities............................. 2,040 (1,228) -------------- --------------- Effect of exchange rate changes on cash......................................... 113 5 -------------- -------------- Increase in cash................................................................ 28,946 18,281 Cash and cash equivalents at beginning of period................................ 111,318 69,605 -------------- -------------- Cash and cash equivalents at end of period...................................... $ 140,264 $ 87,886 ============== ==============
The accompanying notes are an integral part of these consolidated financial statements. 5 CABOT MICROELECTRONICS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED AND AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS) 1. BACKGROUND AND BASIS OF PRESENTATION We believe we are the leading supplier of high-performance polishing slurries used in the manufacture of the most 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, and is a necessary step in the production of advanced ICs. Planarization is a polishing process that uses CMP slurries and pads to level, smooth and remove excess material from the surfaces of these layers. CMP slurries are liquid formulations that facilitate and enhance this polishing process and generally contain engineered abrasives and proprietary chemicals. CMP pads are typically flat engineered "disks" that help distribute and transport the slurry to the surface of the wafer and across the wafer. Cabot Microelectronics, which was incorporated in October 1999 and formed from the assets of a division of Cabot Corporation, completed its initial public offering in April 2000. In September 2000 we became wholly independent upon Cabot Corporation's spin-off of its remaining ownership ("spin-off") in our company by its distribution of 0.280473721 shares of Cabot Microelectronics common stock as a dividend on each share of Cabot Corporation common stock. The unaudited consolidated financial statements have been prepared by Cabot Microelectronics Corporation ("Cabot Microelectronics", "the Company", "us", "we", or "our"), pursuant to the rules of the Securities and Exchange Commission ("SEC") and accounting principles generally accepted in the United States of America. In the opinion of management, these unaudited consolidated financial statements include all adjustments necessary for the fair presentation of Cabot Microelectronics' financial position as of March 31, 2004, cash flows for the six months ended March 31, 2004 and March 31, 2003 and results of operations for the three and six months ended March 31, 2004 and March 31, 2003. The results of operations for the three and six months ended March 31, 2004 may not be indicative of the results to be expected for the fiscal year ending September 30, 2004. These unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes thereto included in Cabot Microelectronics' Annual Report on Form 10-K for the fiscal year ended September 30, 2003. We operate predominantly in one industry segment - the development, manufacture, and sale of CMP slurries. The consolidated financial statements include the accounts of Cabot Microelectronics and its subsidiaries. All intercompany transactions and balances between the companies have been eliminated. 2. STOCK-BASED COMPENSATION In December 2002 we adopted the disclosure requirements of SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure" ("SFAS 148"). SFAS 148 amends FASB Statement No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based compensation and also amends the disclosure requirements of SFAS 123 to require prominent disclosures in both annual and interim financial statements about the methods of accounting for stock-based employee compensation and the effect of the method used on reported results. As permitted by SFAS 148 and SFAS 123, we continue to apply the accounting provisions of Accounting Principles Board ("APB") Opinion Number 25, "Accounting for Stock Issued to Employees", and related interpretations, with regard to the measurement of compensation cost for options granted under our Equity Incentive Plan and shares issued under our Employee Stock Purchase Plan. No employee compensation expense has been recorded as all options granted had an exercise price equal to the market value of the underlying common stock on the date of grant. Had expense been recognized using the fair value method described in 6 CABOT MICROELECTRONICS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED) (UNAUDITED AND AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS) SFAS 123, using the Black-Scholes option-pricing model, we would have reported the following results of operations:
THREE MONTHS SIX MONTHS ENDED MARCH 31, ENDED MARCH 31, 2004 2003 2004 2003 ---- ---- ---- ---- Net income, as reported.......................... $ 9,717 $ 9,054 $ 21,315 $ 18,322 Deduct: total stock-based compensation expense determined under the fair value method, net of tax.................... (5,096) (4,326) (9,625) (7,996) ----------- ----------- ------------ ----------- Pro forma net income............................. 4,621 4,728 11,690 10,326 =========== =========== ============ =========== Earnings per share: Basic - as reported......................... $ 0.39 $ 0.37 $ 0.86 $ 0.75 =========== =========== ============ =========== Basic - pro forma........................... $ 0.19 $ 0.19 $ 0.47 $ 0.42 =========== =========== ============ =========== Diluted - as reported....................... $ 0.39 $ 0.37 $ 0.85 $ 0.75 =========== =========== ============ =========== Diluted - pro forma......................... $ 0.19 $ 0.19 $ 0.47 $ 0.42 =========== =========== ============ ===========
3. EARNINGS PER SHARE Statement of Financial Accounting Standards No. 128 "Earnings per Share" requires companies to provide a reconciliation of the numerator and denominator of the basic and diluted earnings per share computations. Basic and diluted earnings per share were calculated as follows:
THREE MONTHS SIX MONTHS ENDED MARCH 31, ENDED MARCH 31, 2004 2003 2004 2003 ---- ---- ---- ---- Numerator: Earnings available to common shares.............. $ 9,717 $ 9,054 $ 21,315 $ 18,322 =========== =========== ============ =========== Denominator: Weighted average common shares................... 24,785,052 24,346,172 24,761,317 24,325,392 (Denominator for basic calculation) Weighted average effect of dilutive securities: Stock-based compensation ................... 140,707 247,176 173,446 263,130 ----------- ----------- ------------ ----------- Diluted weighted average common shares........... 24,925,759 24,593,348 24,934,763 24,588,522 =========== =========== ============ =========== (Denominator for diluted calculation) Earnings per share: Basic............................................ $ 0.39 $ 0.37 $ 0.86 $ 0.75 =========== =========== ============ =========== Diluted.......................................... $ 0.39 $ 0.37 $ 0.85 $ 0.75 =========== =========== ============ ===========
7 CABOT MICROELECTRONICS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (UNAUDITED AND AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS) 4. COMPREHENSIVE INCOME The components of comprehensive income are as follows:
THREE MONTHS SIX MONTHS ENDED MARCH 31, ENDED MARCH 31, ----------------------------- -------------------------- 2004 2003 2004 2003 ---- ---- ---- ---- Net Income....................................... $ 9,717 $ 9,054 $ 21,315 $ 18,322 Other comprehensive income: Net unrealized gain on derivative instruments ......................... 9 8 18 17 Foreign currency translation adjustment..... 1,225 179 3,446 1,313 ------------ ----------- ----------- ---------- Total comprehensive income....................... $ 10,951 $ 9,241 $ 24,779 $ 19,652 ============ =========== =========== ==========
5. INVENTORIES Inventories consisted of the following:
MARCH 31, SEPTEMBER 30, 2004 2003 ---- ---- Raw materials........................... $ 13,218 $ 13,327 Work in process......................... 1,231 1,110 Finished goods.......................... 9,412 9,377 ----------- ----------- Total................................... $ 23,861 $ 23,814 =========== ===========
6. GOODWILL AND OTHER INTANGIBLE ASSETS Goodwill of $1,373, as of March 31, 2004, was unchanged from our fiscal year ended September 30, 2003. The components of intangible assets are as follows:
MARCH 31, 2004 SEPTEMBER 30, 2003 ----------------------------- ----------------------------- GROSS CARRYING ACCUMULATED GROSS CARRYING ACCUMULATED AMOUNT AMORTIZATION AMOUNT AMORTIZATION ------ ------------ ------ ------------ Trade secrets and know-how............................... $ 2,550 $ 2,231 $ 2,550 $ 2,105 Distribution rights, customer lists and other............ 1,000 894 1,000 850 ------------ ----------- ------------ ----------- Total intangible assets............................... 3,550 3,125 3,550 2,955 ------------ ----------- ------------ -----------
Amortization expense of intangible assets was $85 and $170 for the three and six months ended March 31, 2004, respectively. Estimated future amortization expense for the remaining six months of fiscal year 2004 is $170 and $255 for the full fiscal year 2005. 8 CABOT MICROELECTRONICS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (UNAUDITED AND AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS) 7. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES Accrued expenses and other current liabilities consisted of the following:
MARCH 31, SEPTEMBER 30, 2004 2003 ---- ---- Raw materials accruals.................. $ 812 $ 2,305 Accrued compensation.................... 6,566 7,743 Warranty accrual........................ 841 836 Fixed asset accrual..................... 139 579 Other................................... 3,783 3,216 ----------- ----------- Total................................... $ 12,141 $ 14,679 =========== ===========
8. CONTINGENCIES LEGAL PROCEEDINGS We periodically become subject to legal proceedings in the ordinary course of business. We are not currently involved in any legal proceedings that we believe will have a material impact on our consolidated financial position, results of operations, or cash flows. PRODUCT WARRANTIES We record warranty expense in cost of goods sold in the period in which the warranty claims are incurred. We calculate our warranty reserve shown below using historical experience and any known conditions or circumstances, and we perform periodic reviews of our warranty reserve requirements and make appropriate adjustments to the reserve as necessary. Our warranty obligation is affected primarily by product that does not meet specifications or performance requirements and any related costs of addressing such matters. Our warranty reserve requirements increased during the first six months of fiscal 2004 as follows: Balance as of September 30, 2003........ $ 836 Net change.............................. 5 ----------- Balance as of March 31, 2004............ $ 841 ===========
INDEMNIFICATION DISCLOSURE In the normal course of business, we are a party to a variety of agreements pursuant to which we may be obligated to indemnify the other party with respect to certain matters. Generally, these obligations arise in the context of agreements entered into by us, under which we customarily agree to hold the other party harmless against losses arising from a breach of representations and covenants related to such matters as title to assets sold, certain intellectual property rights and, in certain circumstances, specified environmental matters. These terms are common in the industry in which we conduct business. In each of these circumstances, payment by us is subject to certain monetary and other limitations and is conditioned on the other party making an adverse claim pursuant to the procedures specified in the particular agreement, which typically allow us to challenge the other party's claims. 9 CABOT MICROELECTRONICS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (UNAUDITED AND IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS) We evaluate estimated losses for such indemnifications under SFAS No. 5, "Accounting for Contingencies" as interpreted by FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" ("FIN 45"). We consider such factors as the degree of probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss. To date, we have not encountered material costs as a result of such obligations and as of March 31, 2004, have not recorded any liabilities related to such indemnifications in our financial statements as we do not believe the likelihood of a material obligation is probable. 9. EFFECTS OF RECENT ACCOUNTING PRONOUNCEMENTS In December 2003, the Financial Accounting Standards Board ("FASB") issued SFAS No. 132 (revised 2003), "Employers' Disclosures about Pensions and Other Postretirement Benefits, an Amendment of FASB Statements No. 87, 88, and 106, and a Revision of FASB Statement No. 132" ("SFAS 132 (revised 2003)") which revises employers' disclosures about pension plans and other postretirement benefits plans including additional disclosures about the assets, obligations, cash flows and net periodic benefit cost of defined benefit pension plans and other postretirement benefit plans. It does not change the measurement or recognition of those plans required by FASB Statements No. 87, 88, and 106. The adoption of SFAS No. 132 (revised 2003) did not impact our consolidated financial position, results of operations or cash flow. In December 2003, the Staff of the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin No. 104, "Revenue Recognition" ("SAB 104") which supercedes Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" ("SAB 101"). The primary purpose of SAB 104 is to rescind accounting guidance contained in SAB 101 related to multiple element revenue arrangements, superceded as a result of the issuance of Emerging Issue Task Force Issue No. 00-21, "Accounting for Revenue Arrangements with Multiple Deliverables" ("EITF 00-21"). Additionally, SAB 104 rescinds the SEC's "Revenue Recognition in Financial Statements Frequently Asked Questions and Answers" ("the FAQ") issued with SAB 101 that had been codified in SEC Topic 13, "Revenue Recognition". Selected portions of the FAQ have been incorporated into SAB 104. While the wording of SAB 104 reflects the issuance of EITF 00-21, the revenue recognition principles of SAB 101 remain largely unchanged by the issuance of SAB 104. The adoption of SAB 104 did not impact our consolidated financial position, results of operations or cash flow. 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 statements 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 industry or general economic prospects or trends, our future results of operations or financial position 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 "Factors Affecting Future Operating Results" 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 the consolidated financial statements and related notes thereto included in Cabot Microelectronics' Annual Report on Form 10-K for the fiscal year ended September 30, 2003. 10 SECOND FISCAL QUARTER OVERVIEW We believe we are the leading supplier of high-performance polishing slurries used in the manufacture of the most advanced integrated circuit ("IC") devices within the semiconductor industry, in a process called chemical mechanical planarization ("CMP"). We develop, produce and sell CMP slurries for polishing copper, tungsten and oxide in IC devices, and also for polishing magnetic heads and the coating on disks in hard disk drives. We are currently operating as a value-added reseller of CMP polishing pads produced by a third party and are also developing our own pad technologies. Total revenue for our second fiscal quarter was $73.5 million, down 3.6% from the previous fiscal quarter, but up 18.2% compared to the same quarter in the last fiscal year. Sales volumes were up slightly from the prior quarter, but our average selling price decreased by 5.3% from the prior quarter, causing the revenue reduction. Approximately half of the average selling price decrease was due to a lower priced product mix, and approximately half was due to selective price reductions. In the second fiscal quarters of 2002 and 2003 we also experienced price reductions from the prior quarter, and we believe that, to date, pricing pressure has been particularly concentrated around a new calendar year. Net income of $9.7 million for the quarter was down by 16.2% from last quarter due to lower revenue and higher operating costs, and up 7.3% compared to the same quarter in the last fiscal year due to higher revenue but also higher operating costs. We believe there are three CMP industry trends that are currently impacting our business. First, we believe that rapid incorporation of CMP technology and growth of the CMP industry, combined with our customers' desires to gain purchasing leverage and lower their cost of ownership, have led to much greater competitive activity. Second, as CMP technology has become more advanced, we believe that CMP technical solutions have become more complicated, and leading edge technologies often require customization by customer, tool set and process integration approach. Third, as CMP technology has matured, we believe that semiconductor manufacturers' processes have become highly sensitive to CMP slurries, and customers now demand a very high level of consistency in CMP slurry products. Beyond product consistency, we believe that product quality requirements have also increased dramatically as IC feature sizes have continued to shrink, resulting in higher costs. We believe that these three trends have adversely impacted our margins, and going forward we expect our gross margin as a percentage of revenue to be 48%, plus or minus 2%. This is a reduction from our prior forecast for gross margin of 50% of revenue, plus or minus 2%. As we face the challenges associated with these trends, we intend to continue to focus on three key fundamentals: continuing to operate as the premium value slurry provider, innovating to differentiate ourselves through technology; leveraging our substantial existing global manufacturing and supply chain infrastructure to achieve the product quality and consistency required by our customers, while capturing economies and efficiencies we believe are accessible through our significant scale; and, continuing our focus on customer relationships. During the quarter, we entered into a fumed silica supply agreement with Cabot Corporation, which replaces the original fumed metal oxide agreement with respect to fumed silica, and accordingly amended our fumed metal oxide agreement with respect to its fumed silica terms such that the agreement now only applies to fumed alumina and runs through its original term of June 2005. This fumed silica supply agreement provides for improved supply assurance, reduces our risk to rising raw material costs and incorporates increased quality performance measures and requirements that support our initiative to increase product quality and consistency. 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. The contract provides for the cost of fumed silica to increase approximately 4% over the initial six-year term of the fumed silica supply agreement, and in some circumstances is subject to certain inflation adjustments and certain shared cost savings adjustments resulting from our joint efforts. 11 RESULTS OF OPERATIONS THREE MONTHS ENDED MARCH 31, 2004 VERSUS THREE MONTHS ENDED MARCH 31, 2003 REVENUE Total revenue was $73.5 million for the three months ended March 31, 2004, which represented an 18.2%, or $11.3 million, increase from the three months ended March 31, 2003. Of this increase, $11.9 million was due to an increase in sales volume which was partially offset by a $0.6 million reduction in weighted average selling prices. Our average selling price decreased due to selective price reductions granted to certain customers, partially offset by benefits of a higher priced product mix and foreign exchange fluctuation. Revenue for the three months ended March 31, 2004 would have been $1.2 million lower had the Japanese Yen and Euro average exchange rate for the quarter held constant with the prior year's second fiscal quarter average. COST OF GOODS SOLD Total cost of goods sold was $37.4 million for the three months ended March 31, 2004, which represented an increase of 17.6% or $5.6 million from the three months ended March 31, 2003. Of this increase, $6.1 million was due to an increase in volume which was partially offset by a $0.5 million reduction in costs, primarily due to improvements in our manufacturing yields and lower product costs compared to the year ago quarter. Fumed metal oxides, both fumed silica and fumed alumina, are significant raw materials we use in many of our CMP slurries. From the time of our initial public offering in April 2000 to January 2004, we purchased fumed silica and fumed alumina under a fumed metal oxide agreement with Cabot Corporation that was due to expire June 2005. In January 2004 we entered into a fumed silica supply agreement with Cabot Corporation, which replaces the original fumed metal oxide agreement with respect to fumed silica, and accordingly amended our fumed metal oxide agreement with respect to its fumed silica terms such that the agreement now only applies to fumed alumina and runs through its original term of June 2005. This fumed silica supply agreement provides for improved supply assurance, reduces our risk to rising raw material costs and incorporates increased quality performance measures and requirements that support our initiative to increase product quality and consistency. 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. The contract provides for the cost of fumed silica to increase approximately 4% over the initial six-year term of the fumed silica supply agreement, and in some circumstances is subject to certain inflation adjustments and certain shared cost savings adjustments resulting from our joint efforts. In addition, since December 2001, we have operated under a fumed alumina supply agreement with Cabot Corporation under which Cabot Corporation expanded its capacity for the manufacture of fumed alumina and we have the first right to all this expanded capacity. The agreement provides that the price Cabot Corporation charges us for fumed alumina is based on all of its fixed and variable costs for producing the fumed alumina, its capital costs for expanding its capacity, an agreed upon rate of return on investment and incentive payments if they produce more than a certain amount per year that meets our specifications. 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. GROSS PROFIT Our gross profit as a percentage of total revenue was 49.2% for the three months ended March 31, 2004 as compared to 48.9% for the three months ended March 31, 2003. The increase in gross profit expressed as a percentage of total revenue resulted primarily from the sales volume increase, a higher valued product mix and improved manufacturing yields, partially offset by 12 lower average selling prices. We continue to experience increasing competition and pricing pressure, along with increasing costs to support the higher product quality and advanced technology requirements of our customers. For these reasons, we expect our gross profit as a percentage of total revenue in the future to be in the range of 48%, plus or minus 2%. This is a reduction from our previous expectations of gross profit of 50% of revenue, plus or minus 2%. RESEARCH AND DEVELOPMENT Research and development expenses were $11.1 million in the three months ended March 31, 2004, which represented an increase of 16.0%, or $1.5 million, from the three months ended March 31, 2003. Research and development expense increased $0.6 million due to increased staffing, $0.4 million due to higher supplies and $0.4 million due to higher depreciation related to the purchase of equipment for our CMP polishing and metrology clean room. R&D efforts were mainly related to new and enhanced CMP products including slurry products for copper applications, new CMP polishing pad technology and advanced chemistry and particle technology. SELLING AND MARKETING Selling and marketing expenses were $4.4 million in the three months ended March 31, 2004, which represented an increase of 70.8%, or $1.8 million, from the three months ended March 31, 2003. The increase resulted primarily from our increased customer support initiatives, including our transition to selling direct to customers in Europe, Singapore, Malaysia and Japan, rather than through a distributor. Contributing to the increase were higher staffing costs of $0.7 million, higher customer support costs of $0.4 million, $0.3 million in separation costs for certain employees, including an executive, and increased technical and marketing support of $0.2 million. GENERAL AND ADMINISTRATIVE General and administrative expenses were $5.7 million in the three months ended March 31, 2004, which represented an increase of 25.1%, or $1.2 million, from the three months ended March 31, 2003. The increase resulted primarily from $0.5 million in higher staffing costs, $0.2 million in separation costs for an executive and higher insurance premiums of $0.1 million. AMORTIZATION OF INTANGIBLES Amortization of intangibles was $0.1 million for both the three months ended March 31, 2004 and 2003. OTHER INCOME (EXPENSE), NET Other expense was $0.1 million for the three months ended March 31, 2004 as compared to negligible other income for the three months ended March 31, 2003. Compared to the prior year, foreign exchange losses increased by $0.3 million and were partially offset by higher interest income. PROVISION FOR INCOME TAXES Our effective income tax rate was 34.0% for the three months ended March 31, 2004 and 33.5% for the three months ended March 31, 2003. The increase in the effective tax rate was due to the anticipated June 2004 expiration of current United States tax legislation related to research and experimentation credits and the decreased impact of these credits in relation to higher taxable income compared to the prior year. We expect our income tax rate for full fiscal year 2004 to be 34.0%. 13 NET INCOME Net income was $9.7 million for the three months ended March 31, 2004, which represented an increase of 7.3%, or $0.7 million, from the three months ended March 31, 2003 as a result of the factors discussed above. SIX MONTHS ENDED MARCH 31, 2004 VERSUS SIX MONTHS ENDED MARCH 31, 2003 REVENUE Total revenue was $149.8 million for the six months ended March 31, 2004, which represented a 25.4%, or $30.3 million, increase from the six months ended March 31, 2003. Of this increase, $29.3 million was due to an increase in sales volume and $1.0 million was due to an increase in weighted average selling prices from both an improved sales mix and favorable foreign exchange rate changes, which more than offset selective price reductions that were granted to certain customers. Total revenue for the six months ended March 31, 2004 would have been $2.7 million lower had the average exchange rates for the Japanese Yen and Euro during the six month period held constant with the prior year's six month average. COST OF GOODS SOLD Total cost of goods sold was $76.4 million for the six months ended March 31, 2004, which represented an increase of 28.5%, or $16.9 million, from the six months ended March 31, 2003. Approximately $14.6 million of this increase was due to higher sales volumes and $2.4 million was associated with higher average costs due to product mix, higher fixed manufacturing costs and higher costs from lower yields associated with meeting customer requirements for higher product performance. GROSS PROFIT Our gross profit as a percentage of total revenue was 49.0% for the six months ended March 31, 2004 as compared to 50.2% for the six months ended March 31, 2003. The decrease in gross profit expressed as a percentage of total revenue resulted primarily from increased costs associated with meeting customer requirements for higher product performance that was partially offset by an increase in weighted average selling prices. RESEARCH AND DEVELOPMENT Research and development expense was $21.9 million for the six months ended March 31, 2004, which represented an increase of 19.9%, or $3.6 million from the six months ended March 31, 2003. Research and development expense increased $1.7 million due to higher staffing costs, $0.6 million due to higher technical service and consulting fees, $0.7 million due to higher supplies and $0.5 million due to higher depreciation related to the purchase of equipment for our CMP polishing and metrology clean room. R&D efforts were mainly related to new and enhanced CMP products including slurry products for copper applications, new CMP polishing pad technology and advanced chemistry and particle technology. SELLING AND MARKETING Selling and marketing expenses were $8.1 million in the six months ended March 31, 2004, which represented an increase of 58.7%, or $3.0 million, from the six months ended March 31, 2003. The increase resulted primarily from our increased customer support initiatives, including our transition to selling direct to customers in Europe, Singapore, Malaysia and Japan, rather than through a distributor. Contributing to the increase were higher staffing costs of $1.3 million, higher customer support costs of $0.5 million, increased consulting fees of $0.5 million and $0.3 million in separation costs for certain employees, including an executive. 14 GENERAL AND ADMINISTRATIVE General and administrative expenses were $10.9 million in the six months ended March 31, 2004, which represented an increase of 21.3%, or $1.9 million, from the six months ended March 31, 2003. The increase resulted from $0.9 million in higher staffing costs, $0.3 million due to higher insurance premiums, $0.3 million of increased professional fees and $0.2 million in separation costs for an executive. AMORTIZATION OF INTANGIBLES Amortization of intangibles was $0.2 million for both the six months ended March 31, 2004 and 2003. OTHER INCOME (EXPENSE), NET Other income (expense), net was negligible for both the six months ended March 31, 2004 and 2003. Compared to the prior year, foreign exchange losses increased by $0.3 million, which was partially offset by decreased interest expense due to the February 2003 prepayment of our entire $3.5 million unsecured term loan and increased interest income. PROVISION FOR INCOME TAXES Our effective income tax rate was 34.0% in the six months ended March 31, 2004 and 33.5 % for the six months ended March 31, 2003. The increase in the effective tax rate was due to the anticipated June 2004 expiration of current United States tax legislation related to research and experimentation credits and the decreased impact of these credits in relation to higher taxable income compared to the prior year. NET INCOME Net income was $21.3 million in the six months ended March 31, 2004, which represented an increase of 16.3%, or $3.0 million, from the six months ended March 31, 2003 as a result of the factors discussed above. LIQUIDITY AND CAPITAL RESOURCES We had cash flows from operating activities of $29.2 million in the six months ended March 31, 2004 and $22.4 million in the six months ended March 31, 2003. Our cash provided by operating activities for the six months ended March 31, 2004 originated from net income from operations of $21.3 million and non-cash items of $8.6 million, which were partially offset by a net increase in working capital of $0.7 million. In the six months ended March 31, 2004, capital spending was $2.4 million, primarily due to the purchase of production-related equipment to be used in our Aurora, Illinois facilities and equipment for our CMP polishing and metrology clean room. Full fiscal year 2004 capital spending is anticipated to be approximately $17.0 million, down $5.0 million from our previously planned spending level of $22.0 million due to slower than expected spending on clean room equipment. In the six months ended March 31, 2003, capital spending was $4.7 million, primarily due to the purchase of production-related equipment to be used in our Aurora, Illinois facilities, and for metrology tools to support increased polishing capacity in our clean room. In addition, we received cash of approximately $1.8 million from the January 2003 sale of our distribution center and land in Ansung, South Korea. 15 Cash flows from financing activities were $2.0 million in the six months ended March 31, 2004. Cash provided from financing activities resulted from the issuance of common stock associated with the exercise of stock options and the Employee Stock Purchase Plan, which was partially offset by principal payments made under capital lease obligations. In the six months ended March 31, 2003 we used $1.2 million of cash to fund financing activities. On February 6, 2003, we prepaid the entire $3.5 million unsecured term loan that had been funded on the basis of the Illinois State Treasurer's Economic Program, which had been due on April 3, 2005 and had incurred interest at an annual rate of 4.68%. We also made principal payments under capital lease obligations. Cash used for these purposes was partially offset by funds received from the issuance of common stock for the exercise of stock options and the Employee Stock Purchase Plan. We believe that cash generated by our operations and available borrowings under our revolving credit facility will be sufficient to fund our operations and expected capital expenditures for the foreseeable future. However, we plan to expand our business and continue to improve our technology and, to do so, we may be required to raise additional funds in the future through public or private equity or debt financing, strategic relationships or other arrangements. OFF-BALANCE SHEET ARRANGEMENTS At March 31, 2004 and September 30, 2003, 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 March 31, 2004 and the effect such obligations are expected to have on our liquidity and cash flow in future periods.
CONTRACTUAL OBLIGATIONS LESS THAN 1-3 4-5 AFTER 5 (IN MILLIONS) TOTAL 1 YEAR YEARS YEARS YEARS ----- --------- ----- ----- ----- Capital lease obligations.......................... $ 8.4 $ 1.6 $ 2.9 $ 2.3 $ 1.6 Operating leases .................................. 0.7 0.3 0.3 0.1 0.0 Purchase obligations .............................. 49.6 28.7 14.9 3.4 2.6 Other long-term liabilities ....................... 2.5 0.0 1.1 0.0 1.4 ------- --------- -------- -------- -------- Total contractual obligations...................... $ 61.2 $ 30.6 $ 19.2 $ 5.8 $ 5.6 ======= ========= ======== ======== ========
CAPITAL LEASE OBLIGATIONS Since December 2001 we have operated under a fumed alumina supply agreement with Cabot Corporation, under which Cabot Corporation expanded its capacity in Tuscola, Illinois for the manufacture of fumed alumina. Payments by us with respect to capital costs for the facility have been treated as a capital lease for accounting purposes and the present value of the minimum quarterly payments of approximately $0.3 million resulted in a $9.8 million lease obligation and $9.8 million related leased asset. The agreement has an initial five-year term, which expires in 2006, but we can choose to renew the agreement for another five-year term, which would expire in 2011. We also can choose to not renew the agreement subject to certain terms and conditions and the payment of certain costs, after the initial five-year term. In January 2002 we entered into a CMP tool and polishing consumables transfer agreement with a third party under which we agreed to transfer polishing consumables to this entity in return for a CMP polishing tool. The polishing tool has been treated as a capital lease and the aggregate fair market value of the polishing consumables resulted in a $2.0 million lease obligation. The term of the agreement is approximately three years, expiring in November 2004. 16 OPERATING LEASES We lease certain vehicles, warehouse facilities, office space, machinery and equipment under cancelable and noncancelable operating leases, most of which expire within ten years and may be renewed by us. PURCHASE OBLIGATIONS Purchase obligations include our take-or-pay arrangements with suppliers, and purchase orders and other obligations entered into in the normal course of business regarding the purchase of goods and services. In the fourth quarter of fiscal 2003, we recorded a $2.0 million liability for a raw material supply agreement for a polishing pad technology that was previously under development, but is no longer being pursued. Our total obligation with respect to this agreement is $2.2 million, of which $1.1 million is recorded in current liabilities and shown in the preceding table under purchase obligations and $1.1 million is included in other long-term liabilities, which are discussed below. From the time of our initial public offering in April 2000 to January 2004, we purchased fumed silica and fumed alumina under a fumed metal oxide agreement with Cabot Corporation that was due to expire June 2005. Under this agreement, we were obligated to purchase at least 90% of our six-month volume forecast of fumed silica from Cabot Corporation and were obligated to pay for the shortfall if we purchased less than that amount. In January 2004 we entered into a fumed silica supply agreement with Cabot Corporation, which replaces the original fumed metal oxide agreement with respect to fumed silica, and accordingly amended our fumed metal oxide agreement with respect to its fumed silica terms such that the agreement now only applies to fumed alumina through its original term of June 2005. Under the fumed silica supply agreement, we continue to be obligated to purchase at least 90% of our six-month volume forecast 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. Also, under our fumed alumina supply agreement with Cabot Corporation we are obligated to pay certain fixed, capital and variable costs through December 2006. This agreement has an initial five-year term, but we can choose to renew the agreement for another five-year term, which would expire in December 2011. If we do not renew the agreement, we will become subject to certain terms and conditions and the payment of certain costs. Purchase obligations include $20.5 million of contractual commitments based upon our anticipated renewal of the agreement through December 2011. We have an agreement with a toll manufacturer pursuant to which the manufacturer performs certain agreed-upon dispersion services. We have agreed to purchase minimum amounts of services per year and to invest approximately $0.2 million per year in capital improvements or other expenditures to maintain capacity at the manufacturer's dispersion facility. The initial term of the agreement expires in October 2004, with automatic one-year renewals, and contains a 90-day cancellation clause executable by either party. Purchase obligations related to this agreement are $10.1 million, which include a termination payment if the agreement is not renewed. We expect to renew the agreement at the end of the initial term. We have a distribution agreement with an existing supplier of polishing pads to the semiconductor industry pursuant to which the supplier sells product to us for our resale to end users. The initial term of the contract runs through September 2007 and we are required to make certain agreed-upon payments in order to maintain the agreement. Purchase obligations include $1.8 million of contractual commitments related to this agreement. We have the ability to cancel the agreement at any time with no cancellation fee. In June 2003 we entered into a technology licensing and co-marketing agreement with a semiconductor equipment manufacturer under which we plan to develop, manufacture and sell polishing pads utilizing endpoint detection window technology licensed from the manufacturer for use on the manufacturer's equipment. Under this agreement, we are obligated to supply this manufacturer with free polishing pads, up to an agreed upon dollar amount, for particular uses over a seven year period. We currently estimate our total cost associated with these products will be $2.0 million over the remaining period. Also included in purchase obligations is $0.5 million related to certain marketing and technical support services, which was paid in April 2004. We are also obligated to supply the equipment manufacturer with polishing pads, up to an agreed upon dollar amount over the seven year period, which the manufacturer will purchase from us at our cost. 17 We will also pay a royalty to the equipment manufacturer and, in certain circumstances, to another party to whom we are a sub-licensee under our agreement, based upon net revenue earned with respect to commercial sales of polishing pads covered under the agreement. The agreement's term lasts as long as the patents on the technology subject to the license agreement remain valid and enforceable. OTHER LONG-TERM LIABILITIES Other long-term liabilities include the $1.1 million long-term portion of the purchase obligation discussed above, that we recorded for a raw material supply agreement for a polishing pad technology that was previously under development, but is no longer being pursued. Also included is $1.4 million for pension and deferred compensation obligations. EFFECTS OF RECENT ACCOUNTING PRONOUNCEMENTS In December 2003, the Financial Accounting Standards Board ("FASB") issued SFAS No. 132 (revised 2003), "Employers' Disclosures about Pensions and Other Postretirement Benefits, an Amendment of FASB Statements No. 87, 88, and 106, and a Revision of FASB Statement No. 132" ("SFAS 132 (revised 2003)") which revises employers' disclosures about pension plans and other postretirement benefits plans including additional disclosures about the assets, obligations, cash flows and net periodic benefit cost of defined benefit pension plans and other postretirement benefit plans. It does not change the measurement or recognition of those plans required by FASB Statements No. 87, 88, and 106. The adoption of SFAS No. 132 (revised 2003) did not impact our consolidated financial position, results of operations or cash flow. In December 2003, the Staff of the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin No. 104, "Revenue Recognition" ("SAB 104") which supercedes Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" ("SAB 101"). The primary purpose of SAB 104 is to rescind accounting guidance contained in SAB 101 related to multiple element revenue arrangements, superceded as a result of the issuance of Emerging Issue Task Force Issue No. 00-21, "Accounting for Revenue Arrangements with Multiple Deliverables" ("EITF 00-21"). Additionally, SAB 104 rescinds the SEC's "Revenue Recognition in Financial Statements Frequently Asked Questions and Answers" ("the FAQ") issued with SAB 101 that had been codified in SEC Topic 13, "Revenue Recognition". Selected portions of the FAQ have been incorporated into SAB 104. While the wording of SAB 104 reflects the issuance of EITF 00-21, the revenue recognition principles of SAB 101 remain largely unchanged by the issuance of SAB 104. The adoption of SAB 104 did not impact our consolidated financial position, results of operations or cash flow. FACTORS AFFECTING FUTURE OPERATING RESULTS RISKS RELATING TO OUR BUSINESS WE HAVE A NARROW PRODUCT RANGE AND OUR PRODUCTS MAY BECOME OBSOLETE, OR TECHNOLOGICAL CHANGES MAY REDUCE OR LIMIT INCREASES IN CMP CONSUMPTION Our business is substantially dependent on a single class of products, CMP slurries, which historically has accounted for almost all of our revenue. Our business would suffer if these products became obsolete or if consumption of these products decreased. Our success depends on our ability to keep pace with technological changes and advances in the semiconductor industry and to adapt and improve our products in response to evolving customer needs and industry trends. Since its inception, the semiconductor industry has experienced rapid technological changes and advances in the design, manufacture, performance and application of IC devices and these changes and advances, including 300 mm wafers, are expected to continue in the future. Developments in the semiconductor industry could render our products obsolete or less important to the IC device manufacturing process. 18 A SIGNIFICANT AMOUNT OF OUR BUSINESS COMES FROM A LIMITED NUMBER OF LARGE CUSTOMERS AND OUR REVENUE AND PROFITS COULD DECREASE SIGNIFICANTLY IF WE LOST ONE OR MORE OF THEM AS CUSTOMERS Our customer base is concentrated among a limited number of large customers. One or more of these principal customers may stop buying CMP slurries from us or may substantially reduce the quantity of CMP slurries they purchase from us. They also hold considerable purchasing power, which can impact the pricing, and terms of sale of our products. Any cancellation, deferral or significant reduction in CMP slurries sold to these principal customers or a significant number of smaller customers could seriously harm our business, financial condition and results of operations. Our five largest customers, of which one is a distributor, accounted for approximately 54% of our revenue for the six months ended March 31, 2004. For the six months ended March 31, 2003 our five largest customers, of which two were distributors, accounted for approximately 62% of our revenue. In June 2003, we completed our transition to selling directly to customers in Europe, Singapore and Malaysia who previously had been serviced through one of these distributors. ANY PROBLEM OR INTERRUPTION IN SUPPLY OF OUR MOST IMPORTANT RAW MATERIALS, INCLUDING FUMED METAL OXIDES, COULD DELAY OUR SLURRY PRODUCTION AND ADVERSELY AFFECT OUR SALES Fumed metal oxides, both fumed silica and fumed alumina, are significant raw materials we use in many of our CMP slurries. Our business would suffer from any problem or interruption in our supply of fumed metal oxides or other key raw materials. We operate under three raw material supply agreements with Cabot Corporation, one of which for the supply of fumed silica and two of which for the supply of fumed alumina. Under these agreements, Cabot Corporation continues to be our primary supplier of particular amounts and types of fumed alumina and fumed silica. We believe it would be difficult to secure alternative sources of fumed metal oxides in the event Cabot Corporation or another supplier becomes unable to supply us with sufficient quantities of fumed metal oxides which meet the quality and technical specifications required by our customers. In addition, contractual amendments to the existing agreements with, or non-performance by, Cabot Corporation or another supplier, could adversely affect us as well. Also, if we change the supplier or type of key raw materials such as fumed metal oxides we use to make our existing CMP slurries or are required to purchase them from a different manufacturer or manufacturing facility, whether Cabot Corporation or another party, or otherwise modify our products, in certain circumstances our customers might have to requalify our CMP slurries for their manufacturing processes and products. The requalification process could take a significant amount of time to complete, possibly interrupting or reducing our sales of CMP slurries to these customers. OUR BUSINESS COULD BE SERIOUSLY HARMED IF OUR EXISTING OR FUTURE COMPETITORS DEVELOP SUPERIOR SLURRY PRODUCTS, OFFER BETTER PRICING TERMS OR SERVICE, OBTAIN CERTAIN INTELLECTUAL PROPERTY RIGHTS OR IF ANY OF OUR MAJOR CUSTOMERS DEVELOP OR INCREASE IN-HOUSE SLURRY MANUFACTURING CAPABILITY Competition from current CMP slurry manufacturers, new entrants to the CMP slurry market or a decision by any of our major customers to produce, or increase the production of slurry products in-house could seriously harm our business and results of operations. Competition has increased from other existing providers of CMP slurries and opportunities exist for other companies with sufficient financial or technological resources to emerge as potential competitors by developing their own CMP slurry products. Increased competition and additional in-house production has and may continue to impact the prices we are able to charge for our slurry products as well as our overall business. We may also face competition arising from significant changes in technology, such as the development of polishing pads containing abrasives and emerging technologies such as electrochemical mechanical planarization ("ECMP"). In addition, our competitors could have or obtain intellectual property rights which could restrict our ability to market our existing products and/or to innovate and develop new products. 19 BECAUSE WE HAVE LIMITED EXPERIENCE IN MANUFACTURING AND SELLING CMP POLISHING PADS AND BECAUSE PRICING HAS BECOME INCREASINGLY COMPETITIVE, EXPANSION OF OUR BUSINESS INTO THIS AREA MAY NOT BE SUCCESSFUL An element of our strategy has been to leverage our current customer relationships and technological expertise to expand our business into new product areas and applications, including manufacturing and distributing CMP polishing pads. We have had limited experience in developing, manufacturing and marketing these products, which involve technologies and production processes that are relatively new to us. Further, we, our suppliers of the raw materials that we use to develop our polishing pads, or our provider of pads for whom we act as value-added reseller, may not be able to produce products that satisfy our customers' needs or may be unable to keep pace with technological or other developments in the design and production of polishing pads. In addition, under our value-added reseller model, our suppliers may not be able to produce and we may not be able to sell pads at prices that are competitive and provide a positive contribution to our business. Also, our competitors may have or obtain intellectual property rights which could restrict our ability to market our existing products and/or to innovate and develop new products. WE ARE SUBJECT TO SOME RISKS ASSOCIATED WITH OUR FOREIGN OPERATIONS We currently have operations and a large customer base outside the United States. Approximately 68% of our revenue was generated by sales to customers outside the United States for our fiscal year ended 2003. For the six months ended March 31, 2004, approximately 73% of our revenue was generated by sales to customers outside the United States. We encounter risks in doing business in certain foreign countries, including but not limited to, adverse changes in economic and political conditions, as well as the difficulty in enforceability of business and customer contracts and agreements, including protection of intellectual property rights. In June 2003 we completed our transition to selling directly to customers in Europe, Singapore and Malaysia who previously had been serviced through a third party distributor. Selling directly may increase our risk of conducting business in foreign countries. BECAUSE WE RELY HEAVILY ON OUR INTELLECTUAL PROPERTY, OUR FAILURE TO ADEQUATELY OBTAIN OR PROTECT IT COULD SERIOUSLY HARM OUR BUSINESS Protection of intellectual property is particularly important in our industry because CMP slurry and pad manufacturers develop complex and technical formulas for CMP products which are proprietary in nature and differentiate their products from those of competitors. Our intellectual property is important to our success and ability to compete. We attempt to protect our intellectual property rights through a combination of patent, trademark, copyright and trade secret laws, as well as employee and third-party nondisclosure and assignment agreements. Our failure to obtain or maintain adequate protection of our intellectual property rights for any reason could seriously harm our business. OUR INABILITY TO ATTRACT AND RETAIN KEY PERSONNEL COULD CAUSE OUR BUSINESS TO SUFFER If we fail to attract and retain the necessary managerial, technical and customer support personnel, our business and our ability to maintain existing and obtain new customers, develop new products and provide acceptable levels of customer service could suffer. Competition for qualified personnel, particularly those with significant experience in the CMP and IC device industries, is intense. The loss of services of key employees could harm our business and results of operations. DEMAND FOR OUR PRODUCTS AND OUR BUSINESS MAY BE ADVERSELY AFFECTED BY WORLDWIDE ECONOMIC AND INDUSTRY CONDITIONS Our business is affected by current economic and industry conditions and it is extremely difficult to predict sales of our products given uncertainties in these factors. For example, our quarterly revenue trends in fiscal years 2001 through 2003 were affected by the global economic slowdown and weakening in demand for electronic systems, coupled with higher than normal 20 chip inventories. While the semiconductor industry is now recovering from the prolonged downturn, any further declines or lack of improvement in current economic and industry conditions could continue to adversely affect our business. RISKS RELATING TO THE MARKET FOR OUR COMMON STOCK THE MARKET PRICE MAY FLUCTUATE SIGNIFICANTLY AND RAPIDLY The market price of our common stock has and could continue to fluctuate significantly as a result of factors such as: economic and stock market conditions generally and specifically as they may impact participants in the semiconductor industry; changes in financial estimates and recommendations by securities analysts who follow our stock; earnings and other announcements by, and changes in market evaluations of, us or participants in the semiconductor industry; changes in business or regulatory conditions affecting us or participants in the semiconductor industry; announcements or implementation by us, our competitors, or our customers of technological innovations, new products or different business strategies; and trading volume of our common stock. ANTI-TAKEOVER PROVISIONS UNDER OUR CERTIFICATE OF INCORPORATION AND BYLAWS AND OUR RIGHTS PLAN MAY DISCOURAGE THIRD PARTIES FROM MAKING AN UNSOLICITED BID FOR OUR COMPANY Our certificate of incorporation, our bylaws, our rights plan and various provisions of the Delaware General Corporation Law may make it more difficult to effect a change in control of our company. For example, our amended certificate of incorporation authorizes our board of directors to issue up to 20 million shares of blank check preferred stock and to attach special rights and preferences to this preferred stock. Also our amended certificate of incorporation provides for the division of our board of directors into three classes as nearly equal in size as possible with staggered three-year terms. In addition, the rights issued to our stockholders under our rights plan may make it more difficult or expensive for another person or entity to acquire control of us without the consent of our board of directors. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK EFFECT OF CURRENCY EXCHANGE RATES AND EXCHANGE RATE RISK MANAGEMENT We conduct business operations outside of the United States through our foreign operations. Our foreign operations maintain their accounting records in their local currencies. Consequently, period to period comparability of results of operations is affected by fluctuations in exchange rates. The primary currencies to which we have exposure are the Japanese Yen and, to a lesser extent, the British Pound and the Euro. From time to time we enter into forward contracts in an effort to manage foreign currency exchange exposure. However, we may be unable to hedge these exposures completely. Approximately 17% of our revenue is transacted in currencies other than the U.S. dollar. We do not currently enter into forward exchange contracts or other derivative instruments for speculative or trading purposes. MARKET RISK AND SENSITIVITY ANALYSIS OF FOREIGN EXCHANGE RATE RISK We have performed a sensitivity analysis assuming a hypothetical 10% adverse movement in foreign exchange rates. As of March 31, 2004, the analysis demonstrated that such market movements would not have a material adverse effect on our consolidated financial position, results of operations or cash flows over a one-year period. Actual gains and losses in the future may differ materially from this analysis based on changes in the timing and amount of foreign currency rate movements and our actual exposures. 21 ITEM 4. CONTROLS AND PROCEDURES Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, have conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(e) and 15d-15(e) as of the end of the period covered by this report. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective to make known to them in a timely fashion material information related to the Company required to be filed in this report. There have been no significant changes in the Company's internal controls or in other factors that could significantly affect internal controls between the date of their evaluation and the filing of this report. While we believe the present design of our disclosure controls and procedures is effective to make known to our senior management in a timely fashion all material information concerning our business, we will continue to improve the design and effectiveness of our disclosure controls and procedures to the extent necessary in the future to provide our senior management with timely access to such material information, and to correct any deficiencies that we may discover in the future. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS We are not currently involved in any material legal proceedings. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS At the annual meeting of stockholders of Cabot Microelectronics held on March 9, 2004, the following proposals were approved: Proposal I - Election of two directors, each for a term of three years
Number of Votes For Election Number of Votes Withheld ---------------------------- ------------------------ Juan Enriquez-Cabot 23,412,240 299,423 H. Laurance Fuller 23,198,274 513,389
Proposal II - Ratification of the election of William P. Noglows to the board of directors A proposal to ratify the election of William P. Noglows was approved with 23,406,833 shares cast for, 263,090 shares cast against, and 41,740 shares abstaining. Proposal III - Ratification of the selection of PricewaterhouseCoopers LLP as the company's independent auditors for fiscal 2004 A proposal to ratify the selection of PricewaterhouseCoopers LLP as the company's independent auditors for fiscal 2004 was approved with 23,147,781 shares cast for, 540,285 shares cast against, and 23,597 shares abstaining. Proposal IV - Approval of our Second Amended and Restated 2000 Equity Incentive Plan A proposal to approve our Second Amended and Restated 2000 Equity Incentive Plan was approved with 15,537,783 shares cast for, 4,672,245 shares cast against, and 185,732 shares abstaining. In addition, there were 3,315,903 broker non-votes. 22 ITEM 5. OTHER INFORMATION Pursuant to Section 10A(i)(2) of the Securities Exchange Act of 1934, as added by Section 202 of the Sarbanes-Oxley Act of 2002, we are responsible for disclosing to investors the non-audit services approved by our Audit Committee to be performed by PricewaterhouseCoopers LLP, our independent auditor. Non-audit services are defined in the law as services other than those provided in connection with an audit or a review of the financial statements of the Company. During the quarter covered by this filing our Audit Committee approved or reaffirmed approval of the following non-audit services performed by PricewaterhouseCoopers LLP: (1) tax compliance and consultations related to research and experimentation tax credits; (2) tax compliance and consultations related to our foreign operations; and (3) tax consultations with respect to our Equity Incentive Plan and other compensation plans. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits The exhibit numbers in the following list correspond to the number assigned to such exhibits in the Exhibit Table of Item 601 of Regulation S-K:
EXHIBIT NUMBER DESCRIPTION ------ ----------- 10.40 Amendment No. 2 to Fumed Metal Oxide Agreement, between Cabot Microelectronics Corporation and Cabot Corporation. 10.41 Amendment No. 3 to Fumed Metal Oxide Agreement, between Cabot Microelectronics Corporation and Cabot Corporation. 10.42 Fumed Silica Supply Agreement (confidential treatment applied for).+ 10.43 General Release, Waiver and Covenant Not to Sue.* 31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. + This Exhibit has been filed separately with the Commission pursuant to an application for confidential treatment. The confidential portions of this Exhibit have been omitted and are marked by brackets. * Management contract, or compensatory plan or arrangement.
(b) Reports on Form 8-K In a report dated January 22, 2004, Cabot Microelectronics reported under Item 7. "Financial Statements and Exhibits" and Item 12. "Results of Operations and Financial Condition" that on January 22, 2004 Cabot Microelectronics reported financial results for its first fiscal quarter ended December 31, 2003. 23 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. CABOT MICROELECTRONICS CORPORATION Date: May 7, 2004 /s/ WILLIAM S. JOHNSON ------------------------------------------ William S. Johnson Vice President and Chief Financial Officer [Principal Financial Officer] Date: May 7, 2004 /s/ THOMAS S. ROMAN ------------------------------------------ Thomas S. Roman Corporate Controller [Principal Accounting Officer] 24