CABOT MICROELECTRONICS CORP - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Edgar Glimpses Via Acquire Media NewsEdge) The following "Management's Discussion and Analysis of Financial Condition and Results of Operations", as well as disclosures included elsewhere in this Form 10-Q, include "forward looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. This Act provides a safe harbor for forward looking statements to encourage companies to provide prospective information about themselves so long as they identify these statements as forward looking and provide meaningful cautionary statements identifying important factors that could cause actual results to differ from the projected results. All statements other than statements of historical fact we make in this Form 10 Q are forward looking. In particular, the statements herein regarding future sales and operating results; Company and industry growth, contraction or trends; growth or contraction of the markets in which the Company participates; international events, regulatory or legislative activity, or various economic factors; product performance; the generation, protection and acquisition of intellectual property, and litigation related to such intellectual property; new product introductions; development of new products, technologies and markets; natural disasters; the acquisition of or investment in other entities; uses and investment of the Company's cash balance; financing facilities and related debt, payment of principal and interest, and compliance with covenants and other terms; the Company's capital structure; the construction and operation of facilities by the Company; and statements preceded by, followed by or that include the words "intends," "estimates," "plans," "believes," "expects," "anticipates," "should," "could" or similar expressions, are forward looking statements. Forward looking statements reflect our current expectations and are inherently uncertain. Our actual results may differ significantly from our expectations. We assume no obligation to update this forward looking information. The section entitled "Risk Factors" describes some, but not all, of the factors that could cause these differences.

This section, "Management's Discussion and Analysis of Financial Condition and Results of Operations" (MD&A), should be read in conjunction with our annual report on Form 10-K for the fiscal year ended September 30, 2012, including the consolidated financial statements and related notes thereto.

FIRST QUARTER OF FISCAL 2013 OVERVIEW The softening of demand within the semiconductor industry that we saw late in the fourth quarter of our fiscal 2012 continued in our first quarter of fiscal 2013. Some industry analysts predict that this soft industry demand environment will continue through March 2013 as semiconductor manufacturers continue to reduce their inventory to what are generally considered to be more normal levels. We believe the continued positive trends in mobile connectivity, mobile internet devices, including tablets and smart phones, cloud computing and emerging markets will be key drivers for growth in 2013 and beyond. There are many factors, however, that make it difficult for us to predict future revenue trends for our business, including those discussed in Part II, Item 1A entitled "Risk Factors" in this Form 10-Q.

Revenue for our first quarter of fiscal 2013 was $106.5 million, which represented an increase of 4.3% from the first quarter of fiscal 2012 and a decrease of 3.7% from the previous fiscal quarter. The increase from the first quarter of fiscal 2012 was primarily due to growth in our polishing pads business as well as growth in revenue in South Korea, partially offset by decreased revenue in our Engineered Surface Finishes (ESF) business. We believe the decrease in revenue from the prior fiscal quarter was primarily due to a softening of demand in the semiconductor industry that we began to see late in the fourth quarter of fiscal 2012, as well as decreased ESF revenue.

20-------------------------------------------------------------------------------- index Gross profit expressed as a percentage of revenue for our first quarter of fiscal 2013 was 47.0%, which represented a decrease from 48.3% reported in the first quarter of fiscal 2012 and a decrease from 48.6% in our prior fiscal quarter. The decrease in gross profit percentage from the first quarter of fiscal 2012 was primarily due to certain higher manufacturing costs and a lower-valued product mix, partially offset by increased sales volume. The decrease in gross profit percentage from the prior fiscal quarter was primarily due to higher variable manufacturing costs and lower manufacturing yields, partially offset by lower fixed manufacturing costs and a higher valued product mix. We continue to expect our gross profit percentage for full fiscal year 2013 to be in the range of 46% to 48%. However, we may continue to experience fluctuations in our gross profit due to a number of factors, including the extent to which we utilize our manufacturing capacity and fluctuations in our product mix, which may cause our quarterly gross profit to be above or below this annual guidance range.

Operating expenses were $33.4 million in our first quarter of fiscal 2013, compared to $34.0 million in the first quarter of fiscal 2012 and $33.3 million in the previous fiscal quarter. The decrease in operating expenses from the comparable quarter of fiscal 2012 was primarily driven by the absence of professional fees related to our leveraged recapitalization with a special cash dividend that we completed in March 2012, partially offset by increased staffing-related costs, including costs associated with our annual cash incentive bonus program (AIP). We continue to expect full year fiscal 2013 operating expenses to be in the range of $132 million to $136 million.

The results of operations for the three months ended December 31, 2012 include a foreign tax adjustment to correct prior period amounts, which we have determined to be immaterial to the prior periods to which it relates and is expected to be immaterial to our full fiscal year 2013 results. This adjustment reduced net income for the first quarter of fiscal 2013 by $1.7 million and diluted earnings per share by approximately $0.07. This adjustment relates to the reversal of a deferred tax asset for cumulative net operating losses (NOLs)associated with our facility in South Korea since its opening in 2011,as these NOLs are expected to be consumed during periods a tax holiday is in effect.

Diluted earnings per share for our first fiscal quarter were $0.41, which represents a decrease from $0.45 reported in the first quarter of fiscal 2012 and from $0.49 reported in the previous fiscal quarter. The decrease in diluted earnings per share from the first quarter of fiscal 2012 is primarily due to the previously mentioned tax adjustment and higher interest expense, partially offset by higher revenue, foreign exchange gains and lower operating expenses.

The decrease in diluted earnings per share from the prior fiscal quarter primarily reflects lower revenue and a lower gross profit margin, partially offset by foreign exchange gains.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES AND EFFECTS OF RECENT ACCOUNTING PRONOUNCEMENTS We discuss our critical accounting estimates and effects of recent accounting pronouncements in "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in Item 7 of Part II of our annual report on Form 10-K for the fiscal year ended September 30, 2012. We believe there have been no material changes in our critical accounting estimates during the first three months of fiscal 2013. See Note 16 of the Notes to the Consolidated Financial Statements for a discussion of new accounting pronouncements.

21-------------------------------------------------------------------------------- index RESULTS OF OPERATIONSTHREE MONTHS ENDED DECEMBER 31, 2012, VERSUS THREE MONTHS ENDED DECEMBER 31, 2011 REVENUE Revenue was $106.5 million for the three months ended December 31, 2012, which represented a 4.3%, or $4.4 million, increase from the three months ended December 31, 2011. The increase in revenue was driven by a $4.0 million increase due to a higher-priced product mix and a $2.0 million increase due to higher sales volume. We experienced revenue increases in our dielectric slurry, copper slurry and polishing pad product lines compared to the same quarter of last year, due to further adoption of our pad products, growth of our business in Korea and other factors. These increases were partially offset by decreased revenue in our ESF business. However, we are experiencing continued soft industry demand that we first began to see late in the fourth quarter of fiscal 2012 and we expect that softness will continue through the second quarter of our fiscal 2013.

COST OF GOODS SOLD Total cost of goods sold was $56.5 million for the three months ended December 31, 2012, which represented an increase of 6.9%, or $3.7 million, from the three months ended December 31, 2011. The increase in cost of goods sold was primarily due to $4.6 million from a higher-cost product mix and $2.6 million due to certain production variances. These increases in cost of goods sold were partially offset by a $3.5 million decrease due to increased utilization of our manufacturing capacity associated with the higher sales volume.

Metal oxides, such as silica, are significant raw materials that we use in many of our CMP slurries. In an effort to mitigate our risk exposure to rising raw material costs and to increase supply assurance and quality performance requirements, we have entered into multi-year supply agreements with a number of suppliers. For more financial information about our supply contracts, see "Tabular Disclosure of Contractual Obligations" in this Quarterly Report on Form 10-Q as well as in Item 7 of Part II of our Annual Report on Form 10-K for the fiscal year ended September 30, 2012.

Our need for additional quantities or different kinds of key raw materials in the future has required, and will continue to require, that we enter into new supply arrangements with third parties. Future arrangements may result in costs which are different from those in the existing agreements. In addition, a number of factors could impact the future cost of raw materials, packaging, freight and labor. We expect to continue to invest in our supply chain to improve product quality, reduce variability and improve our manufacturing product yields.

GROSS PROFIT Our gross profit as a percentage of revenue was 47.0% for the three months ended December 31, 2012, as compared to 48.3% for the three months ended December 31, 2011. The decrease in gross profit as a percentage of revenue was primarily due to certain higher manufacturing costs and a lower-valued product mix, partially offset by increased sales volume. We continue to expect our gross profit percentage for full year fiscal 2013 to be in the range of 46% to 48%.

RESEARCH, DEVELOPMENT AND TECHNICAL Total research, development and technical expenses were $15.3 million for the three months ended December 31, 2012, which represented an increase of 11.3%, or $1.6 million, from the three months ended December 31, 2011. The increase was primarily due to $0.9 million in higher staffing-related costs, including costs related to our AIP, and $0.6 million in higher expenses for clean room materials.

22-------------------------------------------------------------------------------- index Our research, development and technical efforts continue to focus on the following main areas: · Research related to fundamental CMP technology; · Development and formulation of new and enhanced CMP consumables products, including collaboration on joint development projects with our customers; · Process development to support rapid and effective commercialization of new products; · Technical support of CMP products in our customers' research, development and manufacturing facilities; and, · Evaluation and development of new polishing and metrology applications outside of the semiconductor industry.

SELLING AND MARKETING Selling and marketing expenses were $7.1 million for the three months ended December 31, 2012, which represented a decrease of 3.1%, or $0.2 million, from the three months ended December 31, 2011.

GENERAL AND ADMINISTRATIVE General and administrative expenses were $11.0 million for the three months ended December 31, 2012, which represented a decrease of 15.1%, or $1.9 million, from the three months ended December 31, 2011. The decrease was primarily due to $2.5 million in lower professional fees, including the absence of $2.4 million in fees associated with our leveraged recapitalization with a special cash dividend completed in March 2012, partially offset by $0.6 million in higher staffing-related costs, including costs associated with our AIP.

INTEREST EXPENSE Interest expense was $1.0 million for the three months ended December 31, 2012, which represented an increase of $0.9 million from the three months ended December 31, 2011. The increase was due to interest expense recorded on the term loan we entered into in fiscal 2012 to partially fund the special cash dividend we paid in fiscal 2012.

OTHER INCOME (EXPENSE), NET Other income was $0.9 million for the three months ended December 31, 2012 compared to $0.1 million during the three months ended December 31, 2011. The increase in other income was primarily due to foreign exchange effects on the settlement or remeasurement of monetary transactions denominated in currencies other than the functional currency, primarily related to changes in the exchange rate of the Japanese yen and the New Taiwan dollar to the U.S. dollar, net of the gains and losses incurred on forward foreign exchange contracts discussed in Note 9 of the Notes to the Consolidated Financial Statements.

PROVISION FOR INCOME TAXES Our effective income tax rate was 41.4% for the three months ended December 31, 2012 compared to a 32.2% effective income tax rate for the three months ended December 31, 2011. The increase in the effective tax rate during the first quarter of fiscal 2013 was primarily due to the recognition of a $1.7 million foreign tax adjustment, as discussed in Note 1 under the heading "Results of Operations". Our effective income tax rate for fiscal 2013 does not yet reflect the reinstatement of the U.S. research and experimentation tax credit retroactively effective January 1, 2012, as the American Taxpayer Relief Act of 2012 was not signed into law until January 2013. Due to the reinstatement of this tax credit, we expect to receive approximately $0.9 million in discrete income tax benefits related to fiscal 2012 and we currently estimate we will receive an additional $1.2 million in tax benefits for full fiscal year 2013, subject to actual qualified research and development spending as defined by the law.

23-------------------------------------------------------------------------------- index NET INCOME Net income was $9.7 million for the three months ended December 31, 2012 which represented a decrease of 6.8%, or $0.7 million, from the three months ended December 31, 2011. The decrease was primarily due to the previously noted tax adjustment and higher interest expense, partially offset by higher revenue, foreign exchange gains and lower operating expenses.

LIQUIDITY AND CAPITAL RESOURCES We generated $6.2 million in cash flows from operating activities in the first three months of fiscal 2013, compared to $11.0 million in cash from operating activities in the first three months of fiscal 2012. Our cash flows provided by operating activities in the first three months of fiscal 2013 originated from $9.7 million in net income, $12.6 million in non-cash items and a $16.1 million decrease in cash flow due to a net increase in working capital. The decrease in cash flows from operating activities compared to the first three months of fiscal 2012 was primarily due to changes in the timing and amount of accounts receivable collections, accounts payable and accrued expense payments, including payments related to AIP, and decreased net income.

In the first three months of fiscal 2013, cash flows used in investing activities were $3.0 million for purchases of property, plant and equipment. In the first three months of fiscal 2012, cash flows used in investing activities were $7.0 million for purchases of property, plant and equipment, including payments to complete our manufacturing facility in South Korea, which we opened in fiscal 2011. We estimate our total capital expenditures in fiscal 2013 will be between $20.0 million and $25.0 million.

In the first three months of fiscal 2013, cash flows used in financing activities were $10.8 million. We used $10.0 million to repurchase common stock under our share repurchase program and $1.3 million to repurchase common stock pursuant to the terms of our Second Amended and Restated Cabot Microelectronics Corporation 2000 Equity Incentive Plan (EIP) and our 2012 Omnibus Incentive Plan (OIP) for shares withheld from award recipients to cover payroll taxes on the vesting of restricted stock granted under the EIP and OIP. We also used $4.4 million to repay long-term debt. We received $4.2 million from the issuance of common stock related to the exercise of stock options granted under our EIP and the sale of shares to our employees under our 2007 Employee Stock Purchase Plan, as amended and restated January 1, 2010, and we received $0.6 million in tax benefits related to exercises of stock options and vesting of restricted stock granted under our EIP. In the first three months of fiscal 2012, cash flows used in financing activities were $13.1 million. We used $13.0 million to repurchase common stock under our share repurchase program and $1.5 million to repurchase common stock pursuant to the terms of our EIP for shares withheld from employees to cover payroll taxes on the vesting of restricted stock granted under the EIP. We received $1.0 million from the issuance of common stock related to the exercise of stock options granted under our EIP and the sale of shares to our employees under our 2007 Employee Stock Purchase Plan, as amended and restated January 1, 2010, and we received $0.4 million in tax benefits related to exercises of stock options and vesting of restricted stock granted under our EIP.

In November 2010, our Board of Directors authorized a share repurchase program for up to $125.0 million of our outstanding common stock, which became effective on the authorization date. We repurchased 320,647 shares for $10.0 million during the first quarter of fiscal 2013 and we repurchased 321,000 shares for $13.0 million during the first quarter of fiscal 2012 under this program. As of December 13, 2011, we had $82.9 million remaining under this share repurchase program. In conjunction with our capital management initiative that we announced in December 2011, on December 13, 2011, our Board of Directors authorized an increase in the amount available under our share repurchase program to $150.0 million. With this increased authorization, as of December 31, 2012, $120.0 million remains outstanding under our share repurchase program.

Share repurchases are made from time to time, depending on market conditions, in open market transactions, at management's discretion. To date, we have funded share purchases under our share repurchase program from our available cash balance, and anticipate we will continue to do so.

24-------------------------------------------------------------------------------- index We entered into a Credit Agreement in February 2012, which provided us with a $175.0 million Term Loan and a $100.0 million Revolving Credit Facility, with sub-limits for multicurrency borrowings, letters of credit and swing-line loans.

The Term Loan and Revolving Credit Facility are referred to as the "Credit Facilities". The Credit Agreement provides us an uncommitted accordion feature that allows us to request the existing lenders or, if necessary, third-party financial institutions to provide additional capacity in the Revolving Credit Facility, in an amount not to exceed $75.0 million. The Term Loan has periodic scheduled principal repayments; however, we may prepay the loan without penalty.

The Credit Facilities are scheduled to expire on February 13, 2017. The Term Loan was drawn on February 27, 2012 and the Revolving Credit Facility remains undrawn. In connection with the Credit Agreement, we terminated our previously existing $50.0 million unsecured revolving credit facility. The Credit Agreement contains covenants that restrict the ability of the Company and its subsidiaries to take certain actions, including, among other things and subject to certain significant exceptions: creating liens, incurring indebtedness, making investments, engaging in mergers, selling property, paying dividends or amending organizational documents. The Credit Agreement requires us to comply with certain financial ratio maintenance covenants, including a maximum consolidated leverage ratio of 3.00 to 1.00 through June 30, 2013 and a minimum consolidated fixed charge coverage ratio of 1.25 to 1.00. As of December 31, 2012, our consolidated leverage ratio was 1.50 to 1.00 and our consolidated fixed charge coverage ratio was 6.70 to 1.00. The Credit Agreement also contains customary affirmative covenants and events of default. We believe we are in compliance with these covenants. See Note 8 of the Notes to the Consolidated Financial Statements for additional information regarding the Credit Agreement.

As of December 31, 2012, we had $169.6 million of cash and cash equivalents, $31.1 million of which was held in foreign subsidiaries in Singapore and Taiwan where we have made a current election to permanently reinvest the earnings rather than repatriate the earnings to the U.S. If we choose to repatriate these earnings in the future through dividends or loans to the U.S. parent company, the earnings could become subject to additional income tax expense.

We believe that our current balance of cash and long-term investments, cash generated by our operations and available borrowing capacity under our new Credit Facility will be sufficient to fund our operations, expected capital expenditures, merger and acquisition activities and share repurchases for the foreseeable future. However, in order to further expand our business, we may need to raise additional funds in the future through equity or debt financing, strategic relationships or other arrangements. Depending on future conditions in the capital and credit markets, we could encounter difficulty securing additional financing in the type or amount necessary to pursue these objectives.

OFF-BALANCE SHEET ARRANGEMENTS At December 31, 2012, and September 30, 2012, 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.

25-------------------------------------------------------------------------------- index TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS The following summarizes our contractual obligations at December 31, 2012, and the effect such obligations are expected to have on our liquidity and cash flow in future periods.

CONTRACTUAL OBLIGATIONS Less Than 1-3 3-5 After 5 (In millions) Total 1 Year Years Years Years Long-term debt $ 168.4 $ 8.7 $ 28.4 $ 131.3 $ - Interest expense and fees on long-term debt 12.3 3.6 6.0 2.7 - Purchase obligations 180.5 56.0 82.7 41.4 0.4 Operating leases 10.6 4.0 3.9 2.2 0.5 Other long-term liabilities 6.9 - - - 6.9 Total contractual obligations $ 378.7 $ 72.3 $ 121.0 $ 177.6 $ 7.8 During the quarter ended December 31, 2012, we operated under a fumed silica supply agreement with Cabot Corporation, our former parent company which is not a related party, under which we were generally obligated to purchase at least 90% of our six-month volume forecast for certain of our slurry products, to purchase certain minimum quantities every six months, and to pay for the shortfall if we purchased less than these amounts. This agreement expired on December 31, 2012. We did not pay any shortfall under this agreement. We completed the negotiation of a new fumed silica supply agreement with Cabot Corporation that became effective as of January 1, 2013 with an initial term of four years. This new agreement has revised pricing and requires us to purchase certain minimum quantities of fumed silica each year of the agreement, and to pay a shortfall if we purchase less than the minimum. The purchase obligations in the table above reflect management's expectation that we will meet the minimum purchase quantities each year of the new contract. We currently operate under a fumed alumina supply agreement with Cabot Corporation, which expires in April 2013, under which we are obligated to pay certain fixed, capital and variable costs, and have certain take-or-pay obligations. We currently anticipate we will not have to pay any shortfall under these agreements.

Purchase obligations include an aggregate amount of $165.1 million of contractual commitments related to our Cabot Corporation agreements for fumed silica and fumed alumina.

Interest payments on long-term, variable rate debt reflect LIBOR rates in effect at December 31, 2012. Commitment fees are based on our estimated consolidated leverage ratio in future periods. See Note 8 of the Notes to the Consolidated Financial Statements for additional information regarding our long-term debt.

Refer to Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" of Part II of our annual report on Form 10-K for the fiscal year ended September 30, 2012, for additional information regarding our contractual obligations.

26-------------------------------------------------------------------------------- index

[ Back To Technology News's Homepage ]