10-K 1 body.htm CABOT MICROELECTRONICS CORPORATION Cabot Microelectronics Corporation


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2005

or

o 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

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.001 par value

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 (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES þ NO o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act ). YES þNO o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act ). YES o NO þ

The aggregate market value of the registrant’s Common Stock held beneficially or of record by stockholders who are not affiliates of the registrant, based upon the closing price of the Common Stock on March 31, 2005 as reported by the NASDAQ National Market, was approximately $775,000,000. For the purposes hereof, "affiliates" include all executive officers and directors of the registrant.

As of November 30, 2005, the Company had 24,291,035 shares of Common Stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s definitive Proxy Statement for the Annual Meeting of Stockholders to be held on March 7, 2006, are incorporated by reference in Part III of this Form 10-K to the extent stated herein.

This Form 10-K includes statements that constitute “forward-looking statements” within the meaning of federal securities regulations. For more detail regarding “forward-looking statements” see Item 7 of Part II of this Form 10-K.
 


1


FORM 10-K
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2005
 

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PART IV.
     
       
 
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OUR COMPANY

Cabot Microelectronics Corporation ("Cabot Microelectronics'', "the Company'', "us'', "we'', or "our''), which was incorporated in the state of Delaware in 2000, is the leading supplier of high-performance polishing slurries used in the manufacture of advanced integrated circuit (IC) devices within the semiconductor industry, in a process called chemical mechanical planarization (CMP). CMP is a polishing process used by IC device manufacturers to planarize or flatten many of the multiple layers of material that are built upon silicon wafers in the production of advanced ICs. In this polishing process, CMP slurries and pads are used to level, smooth and remove excess material from the surfaces of these layers, while leaving minimal residue or defects on the surface. CMP slurries are liquid solutions generally composed of high-purity deionized water, proprietary chemical additives and engineered abrasives that chemically and mechanically interact with the surface material of the IC device at an atomic level. CMP pads are engineered polymeric materials designed to distribute and transport the slurry to the surface of the wafer and distribute it evenly across the wafer. CMP enables IC device manufacturers to produce smaller, faster and more complex IC devices with fewer defects. We believe CMP will become increasingly important in the future as manufacturers continue to shrink the size of these devices and to improve their performance.

We operate predominantly in one industry segment - the development, manufacture and sale of CMP slurries. Our CMP products are used for a number of applications, such as polishing insulating dielectric layers, tungsten that is used to connect the multiple wiring layers of IC devices through these insulating layers, and copper wiring, including the associated barrier film. We also develop, manufacture and sell CMP slurries for polishing certain components in hard disk drives, specifically rigid disk substrates and magnetic heads, and we believe we are one of the leading suppliers in this area. Further, we are developing and beginning to commercialize CMP polishing pads, which are used in conjunction with slurries in the CMP process.

We believe our core competency lies in our ability to shape, enable and enhance the performance of surfaces. We intend to utilize this capability to strengthen and grow our core CMP business within the semiconductor and hard disk drive industries, and also to leverage our CMP technology and knowledge into other technically demanding polishing applications that are synergistic to our core CMP business. We believe that we have unique capabilities and infrastructure to modify surfaces of materials using chemistry in conjunction with mechanical abrasion, at an atomic level, which may provide improved productivity or previously unseen surface performance. We believe that these unique capabilities can be applied to a range of fine finish polishing applications beyond the semiconductor and hard disk drive industries.


IC DEVICE MANUFACTURING AND CHEMICAL MECHANICAL PLANARIZATION

Advanced IC devices are composed of millions of transistors and other electronic components connected by miles of wiring. The wiring, composed primarily of either aluminum or copper, carries electric signals through the multiple layers of the IC device. Insulating material is used throughout the IC device to isolate the electronic components and the wiring, thereby preventing short circuiting and improving the efficiency of the travel of the electric signal within the device. To enhance performance, IC device manufacturers have progressively increased the number and density of transistors and other electronic components in each IC device. Consequently, the number of wires and the number of layers have also increased.

The multi-step manufacturing process for IC devices typically begins with a circular wafer of pure silicon. A large number of identical IC devices, or dies, are manufactured on each wafer at the same time. The first step in the manufacturing process builds transistors and other electronic components on the silicon wafer. These are then isolated from each other to prevent electrical signals from bridging from one transistor to another. Once the transistors and other electronic components are in place on the silicon wafer, they are usually covered with a layer of insulating material, most often silicon dioxide. These components are then wired together using either aluminum or copper in a particular sequence to produce a functional IC device with specific characteristics. When the wiring on one layer of the IC device is completed, another layer of insulating material is added. The process of alternating insulating and wiring layers is repeated until the desired wiring within the IC device is finished. At the end of the process, the wafer is cut into the individual dies, which are then packaged to form individual chips.


IC devices can be segmented into either logic or memory. Logic devices include chips such as microprocessors, digital signal processors (DSP), microcomponents and microcontrollers. These are normally computing intensive devices that need to perform large numbers of processing steps every second. As a result, these chips, particularly the leading microprocessors and DSPs, usually require use of the latest technology that increases the speed of signal processing. Advanced logic chips use copper wiring to provide that processing speed since copper wiring has lower electrical resistance than aluminum wiring; aluminum wiring is used in chips that do not require this speed, such as logic devices of older technology, because it is more cost-effective. Memory devices, which include flash, DRAM and SRAM chips, function by reading, storing and writing data. Traditionally this segment has been highly cost sensitive and processing speed is not as critical as in logic devices. Therefore, memory devices tend to use aluminum wiring, which represents a lower cost approach than copper. CMP is used for both advanced logic and memory devices. The percentage of semiconductor devices that utilize CMP in the manufacturing process has increased over time due to higher technology and performance requirements by IC device manufacturers. We believe that CMP is used in slightly more than half of all semiconductor devices made today, and we expect that CMP will be used more extensively in the future.

The CMP process utilizes a combination of chemical reactions and mechanical abrasion to planarize the insulating and conductive layers of an IC device and is also used to remove excess materials during the formation of intricate structures within the IC device, leaving only that material necessary for circuit integrity. During the CMP process the wafer is typically held on a rotating carrier, which is pressed down against a rotating polishing table and spun in a circular motion. The portion of the table that comes in contact with the wafer is covered by a textured polishing pad. A CMP slurry is continuously applied to the polishing pad to facilitate and enhance the polishing process. Hard disk drive manufacturers use a process similar to the CMP process described above to smooth the surface of substrate disks before depositing magnetic media.

BENEFITS OF CMP

CMP is an enabling technology that allows IC device manufacturers to produce IC devices that are smaller and of greater density of transistors and other electronic components than was previously possible, both of which improve the performance and capabilities of the device. As IC devices shrink and the density of transistors becomes greater, they require structures with smaller dimensions and tighter spacing within the device wiring. CMP provides the near perfectly smooth and flat surface required to create these intricate wiring patterns.

By enabling IC device manufacturers to make smaller IC devices, CMP also allows them to increase the number of IC devices that fit on a wafer. This increase in the number of IC devices per wafer in turn increases the throughput, or the number of IC devices that can be manufactured in a given time period, and reduces the cost per chip. CMP also helps reduce the number of defective or substandard IC devices produced, which increases the device yield. Improvements in throughput and yield reduce an IC device manufacturer's unit production costs, and reducing costs is one of the highest priorities of a semiconductor manufacturer since return on its significant investment in manufacturing capacity can be enhanced by lower unit costs. More broadly, sustained growth in the semiconductor industry has been fueled by lower unit costs that have made IC devices more affordable in an expanding range of applications.


CMP SLURRIES

The characteristics that are important for an effective CMP process include:

 
§
high polishing rates, which increase productivity and throughput;

 
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selectivity, which is the ability to enhance the polishing of specific materials while at the same time inhibiting the polishing of other materials;

 
§
uniform planarity, which minimizes unevenness as different layers are built on the wafer;

 
§
uniformity of polishing, which means that different surface materials can be polished to the same degree at the same time across the wafer, leading to uniformity of all dies on the wafer;

 
§
low defectivity, which means that the devices have fewer imperfections and therefore produce higher yield; and

 
§
cost, which is important for users to minimize their cost of manufacturing.

These attributes may be achieved through technical optimization of the slurry and the pad in conjunction with an appropriately designed CMP process. These qualities affect and enhance the performance of IC devices and can also improve yield and throughput, thereby lowering unit costs. Prior to introducing new or different CMP slurries into its manufacturing process, an IC device manufacturer generally requires the product to be qualified in its processes through an extensive series of tests and evaluations. These qualifications are intended to ensure that the product will function properly in the manufacturing process, as well as to optimize its application. These tests may require changes to the CMP process or the CMP slurry. While this qualification process varies depending on numerous factors, it is not unusual for it to be very costly and to take six or more months to complete. IC device manufacturers usually take the cost, time delay and impact on production into account when they consider implementing or switching to a new CMP slurry.


OUR PRODUCTS

CMP SLURRIES FOR IC DEVICES

We develop and produce CMP slurries of various formulations for polishing a wide range of applications including tungsten and dielectric materials, which currently represent the most common use of CMP in IC device manufacturing. Slurries for polishing tungsten and dielectric are used primarily in memory devices and older generation logic devices. Dielectric slurries are used in legacy inter layer dielectric, or ILD applications, which represent the more mature and cost-sensitive part of the CMP business, as well as in advanced dielectric applications, which require higher performing solutions such as for pre-metal dielectric and direct shallow trench isolation applications.

We also develop and manufacture slurry products for polishing copper, which is used primarily in the wiring of advanced IC logic devices. These products include different slurries for polishing the copper film, as well as the thin barrier metal layer used to separate copper from the adjacent insulating material. We work on continuously improving existing products to enhance their performance, and on developing new, higher performing and higher quality products for more advanced applications in future generation IC devices.

CMP SLURRIES FOR THE DATA STORAGE INDUSTRY

We develop and produce CMP slurries for polishing the magnetic heads and the coating on disks in hard disk drives, which represents an extension of our core CMP slurry technology and manufacturing capabilities established for the semiconductor industry. We believe CMP significantly improves the surface finish of these coatings, resulting in greater storage capacity of the substrates, and also improves the production efficiency of manufacturers of hard disk drives by helping them increase their throughput and yield.


CMP POLISHING PADS
 
CMP polishing pads are consumable materials used in the CMP process that work in conjunction with CMP slurries to facilitate the polishing process. We believe the CMP polishing pad market is currently led by one principal supplier, Rohm and Haas. We believe that CMP polishing pads represent a natural adjacency to our CMP slurry business, and that there is value in co-developing slurries and pads to achieve technically optimized CMP solutions and are currently developing and beginning to commercialize polishing pads utilizing our own and licensed technology.


INDUSTRY TRENDS

The semiconductor industry has experienced rapid growth over the past three decades, but it has also been highly cyclical. During fiscal 2001 through 2003 our revenue continued to grow, despite the protracted semiconductor industry downturn of that time, primarily because CMP was used in only the most advanced IC devices and the most advanced technology continued to grow even though the overall semiconductor industry contracted. Now that CMP is being used more broadly within the IC industry, another semiconductor industry downturn in fiscal 2005 affected us, and served as a primary cause of our revenue decline in this year. As we enter into fiscal 2006 we are cautiously encouraged by what we believe are indicators of improving business trends. On a geographic basis, the Asia Pacific region continues to be the fastest growing region for IC manufacturing, as well as for our business, and we expect this trend to continue in the future.

We anticipate the worldwide market for CMP consumables used by IC device manufacturers will grow in the future as a result of expected increases in the number of IC devices produced, the percentage of IC devices produced that require CMP and the number of CMP polishing steps used to produce these devices. We believe that the increased emphasis on memory technology and the incorporation of advanced memory products into digital consumer devices will continue to be a key growth driver in the industry over the long term and will parallel the industry’s traditional emphasis on microprocessors for personal computers.

We expect this anticipated growth will be somewhat mitigated by increased efficiencies in CMP slurry usage, driven by pressure on IC manufacturers to reduce their CMP costs. For example, most IC devices today are manufactured on 200 mm silicon wafers. However, IC industry leaders are in the process of transitioning to the manufacture of some high volume IC devices using 300 mm wafers, in an effort to reduce the cost of making each chip. The larger 300 mm wafers contain more IC devices and typically use less CMP slurry per device. In general, 300 mm wafer manufacturing began in 2002 and this trend is expected to continue in the future for certain applications. However, we believe that economies of 300 mm manufacturing will create lower cost devices, which we expect will spur additional growth of these devices due to greater affordability, consistent with past industry transitions to larger wafer sizes.

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 among, and pricing pressure on, CMP slurry suppliers. In addition, as CMP technology has become more advanced, we believe that CMP technical solutions have become more complex, and leading edge technologies now often require some customization by customer, tool set and process integration approach. Further, 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 and quality in CMP slurry products.


STRATEGY
 
We believe our core competency lies in our ability to shape, enable and enhance the performance of surfaces. We intend to utilize this capability to strengthen and grow our core CMP business within the semiconductor and hard disk drive industries, and also to leverage our CMP technology and knowledge into other technically demanding polishing applications that are synergistic to our core CMP business.

As we strengthen and grow our core CMP business, we intend to execute on the following strategic initiatives:
 
ADVANCE OUR TECHNOLOGY LEADERSHIP
 
We believe that technology is vital to success in the CMP slurry business and we plan to continue to devote significant resources to research and development. We need to keep pace with the rapid technological advances in the semiconductor industry so we can continue to deliver a full line of CMP slurry products, over a range of technologies, that meet or exceed our customers' evolving needs. In October 2005 we opened our Asia Pacific technology center in Geino, Japan, which includes a clean room and provides polishing, metrology and product development capability to support our customers in the Asia Pacific region.

ACHIEVE OPERATIONS EXCELLENCE
 
Our customers demand increasing performance of our products in terms of product quality and consistency and expect a highly reliable supply source. We believe the capacity and the location of our production facilities in the United States, Asia and Europe allow us to provide a dependable and predictable supply chain to meet our customers' CMP slurry requirements in a consistent and timely manner. We intend to continue to advance our strict quality systems in order to improve the uniformity and consistency of performance of our CMP products. To support our operations excellence initiative, we have adopted the concepts of Six Sigma across our company; Six Sigma is a systematic, data-driven approach and methodology for improving quality by reducing variability in processes, across our company. We believe that we have made productivity and efficiency gains through this program in fiscal 2005, and expect more in fiscal 2006. We are now also extending our Six Sigma initiative to include joint projects with customers.

GET CLOSER TO OUR CUSTOMERS
 
We believe that building close relationships with our customers is another cornerstone for long-term success in our business. We work closely with our customers to identify and develop new and better CMP consumables, to integrate our products into their manufacturing processes, and to assist them with supply, warehousing, packaging and inventory management. We have devoted significant resources to enhancing our close customer relationships and we are committed to continuing this effort. As more of our business shifts to the Asia Pacific region, we have reinforced our customer commitment by constructing an Asia Pacific technology center in Geino, Japan, which we believe will enhance our ability to provide optimized CMP solutions to our customers in this region. We have also announced plans to begin selling directly to customers in Taiwan, rather than through a distributor, in order to better serve our customers. In addition, we are moving the portion of our business that serves the hard disk drive market to Singapore, since Southeast Asia is an important manufacturing region for a number of customers in this industry.

EXPAND INTO ENGINEERED SURFACE FINISHES

In addition to strengthening and growing our core CMP business, we also intend to leverage our CMP experience and technology to explore new applications and products to diversify and grow our business, such as we have accomplished with our slurries for data storage polishing applications. Under our engineered surface finishes initiative, we are actively pursuing a variety of surface modification applications where we believe our technical ability to shape, enable and enhance the performance of surfaces at an atomic level may provide improved productivity or previously unseen surface performance. In pursuit of this initiative, we expect to supplement our internal development efforts with some externally acquired technologies and businesses. For example, in October 2005 we acquired the assets of Surface Finishes Co., Inc., a privately-held company established in 1949 which specializes in precision machining techniques at the sub-nanometer level. We expect this acquisition will provide us with commercial finishing capabilities that will present opportunities to facilitate the introduction of our internal technology development to customers beyond the semiconductor industry, and afford access to a variety of markets that benefit from precision surface finish, but that we do not currently serve.


CUSTOMERS, SALES AND MARKETING

Our sales process begins with development teams who collaborate with our customers, using our research and development facilities and capabilities to design CMP products tailored to their precise needs. Next, our applications teams work with customers to integrate our products into their manufacturing processes. Also, as part of our normal sales process, our logistics and sales personnel provide reliable supply, warehousing, packaging and inventory management to our customers. Through our interactive approach, we are able to build close relationships with our customers in a variety of areas.

We also market our products through independent distributors, primarily in Taiwan and China. Over the last few years we have reduced the number of resellers that distribute our products in situations where we have had sufficient business scale to support direct sales and where we have seen strategic benefit. In furtherance of one of our key strategies of getting closer to our customers, in August 2005 we announced our decision to begin selling our products directly to customers in Taiwan, effective April 2006, rather than through Marketech, our distributor. We believe this strategy, which we have developed over time and which we already have successfully implemented in other parts of the world, will allow us to further strengthen our solid relationships with our customers and directly bring to them the full capabilities of our organization.

In response to significant growth in the IC device manufacturing industry in Asia, we have increased our focus in Asia over the last several years by increasing the number of sales and marketing, technical and customer support personnel present in this region. In October 2005 we opened our Asia Pacific technology center, located adjacent to our existing manufacturing facility in Geino, Japan, which includes a clean room and provides polishing, metrology and product development capability to support our customers in this region. Further, we are moving the portion of our business that serves the hard disk drive market to Singapore, since Southeast Asia is an important manufacturing region for a number of customers in this industry.

In fiscal 2005, our five largest customers accounted for approximately 53% of our revenue, with Marketech, our largest customer who is our distributor in Taiwan and China, accounting for approximately 35% of our revenue. In fiscal 2004, our five largest customers accounted for approximately 55% of our revenue, with Marketech accounting for approximately 32% of our revenue.


CABOT CORPORATION AS OUR MAJOR SUPPLIER OF RAW MATERIALS

Fumed metal oxides, such as fumed silica and fumed alumina, are significant raw materials we use in many of our CMP slurries. In an effort to mitigate our risk to rising raw material costs and to increase supply assurance and quality performance requirements, we have entered into multi-year supply agreements with Cabot Corporation for the purchase of fumed silica and fumed alumina. We purchase fumed silica primarily under a fumed silica supply agreement with Cabot Corporation, which runs through December 2009 and will automatically renew unless either party gives certain notice of non-renewal. The fumed silica agreement provides for the cost of fumed silica to increase approximately 4% over the initial six-year term of the agreement, and in some circumstances is subject to certain inflation adjustments and shared cost savings adjustments resulting from our joint efforts. Under this agreement and subject to certain terms and conditions, Cabot Corporation continues to be our primary supplier of certain quantities of fumed silica for products we produced as of January 2004, the effective date of the agreement. For amounts over these quantities, and for products we introduce after the effective date, we have the flexibility to purchase from other parties.


We purchase fumed alumina primarily under a fumed alumina supply agreement with Cabot Corporation that runs through December 2006, and may be renewed at our option for another five-year term. The fumed alumina supply 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 an agreed upon capacity expansion, an agreed upon rate of return on investment, and incentive payments if they produce above a threshold level of fumed alumina per year that meets our specifications. Under this agreement and subject to certain terms and conditions, Cabot Corporation continues to be the exclusive supplier of certain quantities of fumed alumina for products we produced as of December 2001, the effective date of the agreement. For amounts over these quantities, and for products we introduce after the effective date, we have the flexibility to purchase from other parties.

These agreements prohibit Cabot Corporation from selling fumed silica and fumed alumina to third parties for use in CMP applications, as well as engaging itself in CMP applications. If Cabot Corporation fails to supply us with our requirements for any reason, including if we require product specification changes that Cabot Corporation cannot meet, we have the right to purchase products meeting those specifications from other suppliers.


RESEARCH AND DEVELOPMENT

We believe that technology is vital to success in the CMP business as well as in our other initiatives, and we plan to continue to devote significant resources to research and development. With respect to CMP, we believe our leadership position depends in part on our ability to develop CMP applications tailored to our customers' needs, so we have assembled dedicated development teams that work closely with customers to identify their specific technology and manufacturing challenges and to translate these challenges into viable CMP process solutions. Our technology efforts are focused on four main areas: development and formulation of new and enhanced CMP slurry and pad products; research related to fundamental technology such as advanced chemistry and particle technology; process development to support rapid and effective commercialization of new products; and evaluation of new polishing applications outside of the semiconductor and data storage industries.

We operate a research and development facility in Aurora, Illinois, which is staffed by a team that includes experts from the semiconductor industry and scientists from key disciplines required for the development of high-performance CMP products. This facility features a state-of-the-art Class 1 clean room and advanced equipment for product development. We have also invested in 300 mm polishing and metrology capabilities to remain aligned with our technology leading customers and provide us with the ability to replicate their CMP activities in our clean room.

In October 2005 we opened our Asia Pacific technology center, located adjacent to our existing manufacturing facility in Geino, Japan, which includes a clean room and provides polishing, metrology and product development capability to support our customers in this region. We believe this technology center will enhance our ability to provide optimized CMP solutions to our customers in the Asia Pacific region, and underscores our commitment both to continuing to invest in our technology infrastructure to maintain our technology leadership, and to becoming even more responsive to the needs of our customers.

In our research and development laboratories, our skilled technical personnel study different aspects of the CMP process and products. Understanding the chemical reactions on the surface of the polished wafer allows us to formulate slurries with specifically tailored selectivity that interact with one material and then slow or essentially stop planarization as soon as this particular material has been polished. As CMP technology has become more advanced, we believe that CMP technical solutions have become more complex, and leading edge technologies often require significant customization. Since developing a completely customized solution for every customer would be cost prohibitive, our scientists have developed product platforms for the most advanced and next generation applications that can be “tuned” systematically for a particular customer’s needs, including removal rates and selectivity. We believe that this product development approach represents a more effective means of providing highly customized, value-added solutions for our customers for the most advanced applications.


Beyond CMP for the semiconductor and data storage industries, we are also increasing internal research and development efforts related to our engineered surface finishes initiative. We are translating our core technical expertise in CMP technology developed for the semiconductor industry, with which we modify surfaces at an atomic level, into a range of demanding surface modification and polishing applications in other industries where shaping, enabling and enhancing the performance of surfaces is critical to success. We believe that a number of application areas we are currently developing represent natural adjacencies to our core CMP business and technology, and include uses in fields such as optics, optoelectronics, flat panel displays and metal finishing.

We believe competitive advantage lies in technology leadership and that our investments in research and development provide us with leading edge polishing and metrology capabilities to support the most advanced and challenging customer technology requirements on a global basis. In fiscal 2005, 2004 and 2003 we incurred approximately $43.0 million, $44.0 million and $41.5 million in research and development expenses, respectively. Investments in research and development property, plant and equipment are capitalized and depreciated over their useful lives.


COMPETITION

We compete in the CMP consumables industry, which is characterized by rapid advances in technology and demanding product quality and consistency requirements. We believe that customers make supplier decisions based on three factors, in this order of priority: first, product performance; second, supply assurance, including the ability to reliably deliver a high level of consistency and quality in CMP slurry products; and third, product price. There are several other manufacturers of CMP consumables with commercial sales of CMP slurries for IC devices, although we believe we have more CMP slurry business than each of our competitors. In our view, we are the only CMP slurry supplier today that serves a broad range of customers by offering and supporting a full line of CMP slurry products for all major applications over a range of technologies, and has a proven track record of supplying these products globally in high volumes with the attendant required high level of technical support services. Due to our success to date and the attractive demand outlook for the CMP industry, we expect competition will continue and other potential competitors may attempt to enter this market. We anticipate that competitive activity will also continue due to customer desires to gain purchasing leverage and lower their costs through leveraging alternative sources of supply.

We may also face competition in the future from customers that currently have, or that may develop, in-house capability to produce their own CMP products, and from significant changes in technology or emerging technologies.
 
 
INTELLECTUAL PROPERTY

Our intellectual property is important to our success and ability to compete. As of November 30, 2005, we have 87 active U.S. patents and 95 pending U.S. patent applications. In most cases we file counterpart foreign patent applications. Many of these patents are important to our continued development of new and innovative products for CMP and related processes, as well as for new business initiatives, such as engineered surface finishes. Our patents have a range of duration and we do not expect to lose any material patent through the expiration of such patent in the next seven years. 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.


ENVIRONMENTAL MATTERS

Our facilities are subject to various environmental laws and regulations, including those relating to air emissions, wastewater discharges, the handling and disposal of solid and hazardous wastes, and occupational safety and health. We believe that our facilities are in substantial compliance with applicable environmental laws and regulations. We have incurred, and will continue to incur, capital and operating expenditures and other costs in complying with these laws and regulations in both the United States and abroad. However, we currently do not anticipate that the future costs of environmental compliance will have a material adverse effect on our business, financial condition or results of operations.


EMPLOYEES

As of November 30, 2005, we employed 650 individuals, including 311 in operations, 183 in research and development, 80 in sales and marketing and 76 in administration. None of our employees are covered by collective bargaining agreements. We have not experienced any work stoppages and in general consider our relations with our employees to be good.


FINANCIAL INFORMATION ABOUT GEOGRAPHIC AREAS

Our revenue from customers in the United States totaled $60.0 million, $78.1 million and $79.9 million, and total revenue in other geographic locations totaled $210.4 million, $231.3 million and $171.8 million for fiscal 2005, 2004 and 2003, respectively. Revenue from Taiwan and Japan each accounted for more than ten percent of our total revenue. Our revenue from customers in Taiwan totaled $77.4 million, $86.3 million and $63.8 million for fiscal 2005, 2004 and 2003, respectively. Our revenue from customers in Japan totaled $38.6 million, $44.9 million and $40.3 million for fiscal 2005, 2004 and 2003, respectively. Revenue attributable to foreign regions are based upon the customer location and not the geographic location from which our products were shipped.

Net property, plant and equipment in the United States totaled $87.4 million, $94.8 million and $102.8 million and net property, plant and equipment in other geographic locations totaled $48.4 million, $33.0 million and $30.9 million at September 30, 2005, 2004 and 2003, respectively. More than ten percent of our net property, plant and equipment is located in Japan, having a net book value of $44.3 million, $30.2 million and $28.1 million at September 30, 2005, 2004 and 2003, respectively.

For more financial information about geographic areas, see Note 19 of Notes to the Consolidated Financial Statements included in Item 8 of Part II of this Form 10-K.


AVAILABLE INFORMATION

Our annual reports on Form 10-K, quarterly reports on Form 10-Q, definitive proxy statements on Form 14a, current reports on Form 8-K, and any amendments to those reports are made available free of charge on our company website, www.cabotcmp.com, as soon as reasonably practicable after such reports are filed with the Securities and Exchange Commission (SEC). Statements of changes in beneficial ownership of our securities on Form 4 by our executive officers and directors are made available on our company website by the end of the business day following the submission to the SEC of such filings. In addition, the SEC’s website, www.sec.gov, contains reports, proxy statements, and other information regarding reports that we file electronically with the SEC.



Our principal U.S. facilities that we own consist of:

 
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a global headquarters and research and development facility in Aurora, Illinois, comprising approximately 200,000 square feet;
 
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a commercial dispersion plant and distribution center in Aurora, Illinois, comprising approximately 175,000 square feet;
 
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an office building in Aurora, Illinois, comprising approximately 48,000 square feet;
 
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an additional 13.2 acres of vacant land in Aurora, Illinois, to accommodate the possibility of future growth; and
 
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a facility in Addison, Illinois, comprising approximately 15,000 square feet.

Our principal foreign facilities that we own consist of:

 
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a commercial dispersion plant in Geino, Japan, comprising approximately 113,000 square feet;
 
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a research and development facility in Geino, Japan, comprising approximately 20,000 square feet.

Our principal foreign facilities that we lease consist of:

 
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a commercial manufacturing plant in Singapore, comprising approximately 24,000 square feet;
 
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a commercial dispersion plant in Barry, Wales, comprising approximately 22,000 square feet;
 
§
an office and laboratory in Hsin-Chu, Taiwan, comprising approximately 8,000 square feet; and
 
§
an office in Tokyo, Japan, comprising approximately 3,000 square feet.

We believe that our current facilities are suitable and adequate for their intended purpose and provide us with sufficient capacity and capacity expansion opportunities and technological capability to meet our current and expected demand in the foreseeable future.



We are not currently involved in any material legal proceedings.



None.



Set forth below is information concerning our executive officers and their ages as of November 30, 2005.

NAME
 
AGE
 
POSITION
 
           
William P. Noglows
 
47
 
Chairman of the Board, President and Chief Executive Officer
 
H. Carol Bernstein
 
45
 
Vice President, Secretary and General Counsel
 
Victoria J. Brush
 
53
 
Vice President of Human Resources
 
Jean Pol Delrue
 
58
 
Vice President of Global Sales
 
Julie A. Hensel
 
47
 
Vice President of Global Quality
 
William S. Johnson
 
48
 
Vice President, Chief Financial Officer and Treasurer
 
Daniel J. Pike
 
42
 
Vice President of Corporate Development
 
Stephen R. Smith
 
46
 
Vice President of Marketing and Business Management
 
Clifford L. Spiro
 
51
 
Vice President, Research and Development
 
Adam F. Weisman
 
43
 
Vice President of Operations
 
Daniel S. Wobby
 
42
 
Vice President of Asia Pacific Region
 
Thomas S. Roman
 
44
 
Principal Accounting Officer and Corporate Controller
 

WILLIAM P. NOGLOWS has served as our Chairman, President and Chief Executive Officer since November 2003. Mr. Noglows had previously served as a director of our company from January 2000 until April 2002. Prior to joining us, Mr. Noglows served as an Executive Vice President of Cabot Corporation from 1998 to June 2003. Prior to that, Mr. Noglows held various management positions at Cabot Corporation including General Manager of Cabot Corporation’s Cab-O-Sil Division, where he was one of the primary founders of Cabot Microelectronics when its business was a division of Cabot Corporation, and was responsible for identifying and encouraging the development of the CMP application. Mr. Noglows received his B.S. in Chemical Engineering from the Georgia Institute of Technology.

H. CAROL BERNSTEIN has served as our Vice President, Secretary and General Counsel since August 2000. From January 1998 until joining us, Ms. Bernstein served as the General Counsel and Director of Industrial Technology Development of Argonne National Laboratory, which is operated by the University of Chicago for the United States Department of Energy. From May 1985 until December 1997, she served in various positions with the IBM Corporation, culminating in serving as an Associate General Counsel, and was the Vice President, Secretary and General Counsel of Advantis Corporation, a joint venture between IBM and Sears Roebuck and Co. Ms. Bernstein received her B.A. from Colgate University and her J.D. from Northwestern University; she is a member of the Bar of the states of Illinois and New York.


JEAN POL DELRUE has served as our Vice President of Global Sales since April 2005. His previous position was Vice President of European Business Region since July 2004. He also served as our European Business Manager from June 2001 to July 2004. Prior to joining us, Dr. Delrue worked for Ebara Precision Machinery Europe from January 1995 to June 2001, culminating in serving as the Vice President of CMP Europe. Prior to that, he served as the Business and Technical Development Director and Member of the Management Board at Riber Instruments SA. Dr. Delrue holds an Executive M.B.A. from the Centre de Perfectionnement des Affaires in Paris, France, a Ph.D. in Physical Chemistry from Belgium's University of Mons, and has performed post doctorate work in chemical engineering at Stanford University.


JULIE A. HENSEL has served as our Vice President of Global Quality since October 2005 and previously as our Director of Global Quality since March 2004. Prior to joining us, Ms. Hensel served as a Six Sigma consultant from 2003 to 2004. From 2000 to 2003, she held an executive management role with Datacard Corporation. She received a B.S. in Manufacturing Engineering from the Milwaukee School of Engineering and an M.S. in Manufacturing Systems Engineering from the University of St. Thomas.

WILLIAM S. JOHNSON has served as our Vice President, Chief Financial Officer and Treasurer since April 2003. Prior to joining us, Mr. Johnson served as Executive Vice President and Chief Financial Officer for Budget Group, Inc. from August 2000 to March 2003. Before that, Mr. Johnson spent 16 years at BP Amoco in various senior finance and management positions, the most recent of which was President of Amoco Fabrics and Fibers Company. Mr. Johnson received his B.S. in Mechanical Engineering from the University of Oklahoma and his M.B.A. from the Harvard Business School.

DANIEL J. PIKE has served as our Vice President of Corporate Development since January 2004 and prior to that was our Vice President of Operations from December 1999. Mr. Pike served as our Director of Global Operations from 1996 to 1999. Prior to joining us, Mr. Pike worked for FMC Corporation as a Marketing Manager. Mr. Pike received his B.S. in Chemical Engineering from the University of Buffalo and his M.B.A. from the Wharton School of Business of the University of Pennsylvania.

STEPHEN R. SMITH has served as our Vice President of Marketing and Business Management since April 2005 and previously was our Vice President of Marketing and Sales since October 2001. Prior to joining us, Mr. Smith served as Vice President, Sales & Business Development for Buildpoint Corporation from 2000 to October 2001. Prior to that, Mr. Smith spent 17 years at Tyco Electronics Group, formerly known as AMP Incorporated, in various management positions. Mr. Smith earned a B.S. in Industrial Engineering from Grove City College and an M.B.A. from Wake Forest University.

CLIFFORD L. SPIRO has served as Vice President, Research and Development since December 2003. Prior to joining us, Dr. Spiro served as Vice President of Research and Development at Ondeo-Nalco from 2001 through November 2003. Prior to that, Dr. Spiro held research and development management and senior technology positions at the General Electric Company from 1980 through 2001, the most recent of which was Global Manager - Technology for Business Development. Dr. Spiro received his B.S. in Chemistry from Stanford University and his Ph.D. in Chemistry from the California Institute of Technology.


DANIEL S. WOBBY has served as our Vice President of Asia Pacific Region since September 2005. Prior to that, Mr. Wobby served as Vice President of Greater China and Southeast Asia starting in February 2004. Mr. Wobby previously served as Corporate Controller and Principal Accounting Officer from 2000 to 2004. From 1989 to 1997, Mr. Wobby held various accounting and operations positions with Cabot Corporation culminating in serving as Director of Finance. Mr. Wobby earned a B.S. in Accounting from St. Michael’s College and an M.B.A. from the University of Chicago’s Graduate School of Business.

THOMAS S. ROMAN has served as our Corporate Controller and Principal Accounting Officer since February 2004 and previously served as our North American Controller. Prior to joining us in April 2000, Mr. Roman was employed by FMC Corporation in various financial reporting, tax and audit positions. Before that, Mr. Roman worked for Gould Electronics and Arthur Andersen LLP. Mr. Roman is a C.P.A. and earned a B.S. in Accounting from the University of Illinois and an M.B.A. from DePaul University’s Kellstadt Graduate School of Business.




Our common stock has traded publicly on the NASDAQ National Market under the symbol "CCMP" since our initial public offering in April 2000. The following table sets forth the range of quarterly high and low closing sales prices for our common stock on the NASDAQ National Market.

   
HIGH
 
LOW
Fiscal 2004
       
 
First Quarter
61.61
 
48.00
 
Second Quarter
57.54
 
40.50
 
Third Quarter
44.19
 
26.88
 
Fourth Quarter
38.29
 
26.86
Fiscal 2005
       
 
First Quarter
40.80
 
30.58
 
Second Quarter
38.37
 
30.43
 
Third Quarter
31.77
 
27.39
 
Fourth Quarter
33.10
 
27.74
Fiscal 2006 First Quarter (through November 30, 2005)
31.57
 
28.26

 
As of November 30, 2005, there were approximately 1,097 holders of record of our common stock. No dividends were declared or paid in either fiscal 2005 or fiscal 2004 and we have no current plans to pay cash dividends in the future.

ISSUER PURCHASES OF EQUITY SECURITIES

Period
 
Total Number
of Shares
Purchased
 
Average
Price Paid
Per Share
 
Total Number of Shares
Purchased as Part of
Publicly Announced
Plans or Programs
 
Approximate Dollar Value
of Shares that May Yet Be
Purchased Under the Plans
or Programs (in thousands)
 
July 1 through
July 31, 2005
   
   
   
 
$
3,468
 
Aug. 1 through
Aug. 31, 2005
   
118,150
 
$
29.35
   
118,150
   
 
Sept. 1 through
Sept. 30, 2005
   
   
   
   
 
                           
                           
Total
   
118,150
 
$
29.35
   
118,150
   
 

In July 2004 we announced that our Board of Directors had authorized a share repurchase program for up to $25.0 million of our outstanding common stock and we completed this program during our fourth quarter of fiscal 2005. Shares were repurchased from time to time, depending on market conditions, in open market transactions, at management’s discretion. We funded share repurchases from our existing cash balance. The program was primarily intended to diminish earnings dilution from the issuance of stock from the exercise of stock options under our equity incentive plan and purchases under our employee stock purchase plan.

In October 2005 we announced that our Board of Directors had authorized another share repurchase program for up to $40.0 million of our outstanding common stock under terms and conditions similar to those of the July 2004 share repurchase program. The program may be suspended or terminated at any time, at the Company’s discretion. We view the program as an attractive and flexible means to return cash to shareholders.



The following selected financial data for each year of the five-year period ended September 30, 2005 has been derived from the audited consolidated financial statements.

The information set forth below is not necessarily indicative of results of future operations and should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the consolidated financial statements and notes to those statements included in Items 7 and 8 of Part II of this Form 10-K.


 
CABOT MICROELECTRONICS CORPORATION
SELECTED FINANCIAL DATA - FIVE YEAR SUMMARY
(Amounts in thousands, except per share amounts)
 
   
Year Ended September 30,
 
   
2005
 
2004
 
2003
 
2002
 
2001
 
Consolidated Statement of Income Data:
                     
Revenue
 
$
270,484
 
$
309,433
 
$
251,665
 
$
235,165
 
$
227,192
 
Cost of goods sold
   
141,282
   
156,805
   
124,269
   
113,067
   
108,419
 
 Gross profit
   
129,202
   
152,628
   
127,396
   
122,098
   
118,773
 
                                 
Operating expenses:
                               
Research and development 
   
43,010
   
44,003
   
41,516
   
33,668
   
25,805
 
Selling and marketing 
   
16,989
   
16,225
   
11,221
   
9,667
   
8,757
 
General and administrative 
   
25,172
   
22,351
   
18,225
   
17,458
   
21,054
 
Litigation settlement 
   
-
   
-
   
-
   
1,000
   
-
 
Amortization of intangibles 
   
255
   
340
   
340
   
345
   
718
 
 Total operating expenses
   
85,426
   
82,919
   
71,302
   
62,138
   
56,334
 
Operating income
   
43,776
   
69,709
   
56,094
   
59,960
   
62,439
 
 
                               
Other income (expense), net
   
2,747
   
139
   
(27
)
 
763
   
1,049
 
Income before income taxes
   
46,523
   
69,848
   
56,067
   
60,723
   
63,488
 
Provision for income taxes
   
14,050
   
23,120
   
18,334
   
20,038
   
21,586
 
 Net income
 
$
32,473
 
$
46,728
 
$
37,733
 
$
40,685
 
$
41,902
 
 
                               
Basic earnings per share
 
$
1.32
 
$
1.89
 
$
1.55
 
$
1.68
 
$
1.76
 
 
                               
Weighted average basic shares outstanding
   
24,563
   
24,750
   
24,401
   
24,160
   
23,824
 
 
                               
Diluted earnings per share
 
$
1.32
 
$
1.88
 
$
1.53
 
$
1.66
 
$
1.72
 
 
                               
Weighted average diluted shares outstanding
   
24,612
   
24,882
   
24,665
   
24,565
   
24,327
 
 
                               
Cash dividends per share
 
$
-
 
$
-
 
$
-
 
$
-
 
$
-
 
 
   
As of September 30,
 
   
2005
 
2004
 
2003
 
2002
 
2001
 
Consolidated Balance Sheet Data:
                     
Current assets
 
$
245,807
 
$
229,681
 
$
179,112
 
$
123,283
 
$
96,454
 
Property, plant and equipment, net
   
135,784
   
127,794
   
133,695
   
132,264
   
97,426
 
Other assets
   
5,172
   
5,816
   
2,810
   
2,838
   
2,801
 
Total assets 
 
$
386,763
 
$
363,291
 
$
315,617
 
$
258,385
 
$
196,681
 
                                 
Current liabilities
 
$
35,622
 
$
32,375
 
$
28,916
 
$
30,571
 
$
26,366
 
Long-term debt
   
-
   
-
   
-
   
3,500
   
3,500
 
Other long-term liabilities
   
12,057
   
15,294
   
14,928
   
10,808
   
528
 
Total liabilities 
   
47,679
   
47,669
   
43,844
   
44,879
   
30,394
 
Stockholders' equity
   
339,084
   
315,622
   
271,773
   
213,506
   
166,287
 
Total liabilities and stockholders' equity 
 
$
386,763
 
$
363,291
 
$
315,617
 
$
258,385
 
$
196,681
 
 

The following "Management's Discussion and Analysis of Financial Condition and Results of Operations", as well as disclosures included elsewhere in this Form 10-K, 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-K are forward-looking. In particular, the statements herein regarding future sales and operating results, company and industry growth and trends, growth of the markets in which the company participates, international events, product performance, new product introductions, development of new products, technologies and markets, the acquisition of or investment in other entities, the construction of new 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 "Factors Affecting Future Operating Results" describes some, but not all, of the factors that could cause these differences.

The following discussion and analysis should be read in conjunction with our historical financial statements and the notes to those financial statements which are included in Item 8 of Part II of this Form 10-K.


OVERVIEW

Cabot Microelectronics Corporation ("Cabot Microelectronics'', "the Company'', "us'', "we'', or "our'') is the leading supplier of high-performance polishing slurries used in the manufacture of advanced integrated circuit (IC) devices within the semiconductor industry, in a process called chemical mechanical planarization (CMP). CMP is a polishing process used by IC device manufacturers to planarize or flatten many of the multiple layers of material that are built upon silicon wafers in the production of advanced ICs. In this polishing process CMP slurries and pads are used to level, smooth and remove excess material from the surfaces of these layers, while leaving minimal residue or defects on the surface. CMP slurries are liquid solutions generally composed of high-purity deionized water, proprietary chemical additives and engineered abrasives that chemically and mechanically interact with the surface material of the IC device at an atomic level. CMP pads are engineered polymeric materials designed to distribute and transport the slurry to the surface of the wafer and distribute it evenly across the wafer. CMP enables IC device manufacturers to produce smaller, faster and more complex IC devices with fewer defects. We believe CMP will become increasingly important in the future as manufacturers continue to shrink the size of these devices and to improve their performance.

We operate predominantly in one industry segment - the development, manufacture and sale of CMP slurries. Our CMP products are used for a number of applications, such as polishing insulating dielectric layers, tungsten that is used to connect the multiple wiring layers of IC devices through these insulating layers, and copper wiring, including the associated barrier film. We also develop, manufacture and sell CMP slurries for polishing certain components in hard disk drives, specifically rigid disk substrates and magnetic heads, and we believe we are one of the leading suppliers in this area. Further, we are developing and beginning to commercialize CMP polishing pads, which are used in conjunction with slurries in the CMP process.

We believe that demand for our products is primarily based on the number of wafers, or “wafer starts”, of advanced devices produced by semiconductor manufacturers. Revenue for fiscal 2005 was $270.5 million, which was down 12.6% from the $309.4 million reported for fiscal 2004. Following a period of strong semiconductor demand in the second half of fiscal 2004, our revenue during the first three quarters of fiscal 2005 was adversely impacted in part by a subsequent downturn in the semiconductor industry, which we believe was partially driven by a reduction in wafer starts by some semiconductor manufacturers to reduce excess inventories of certain semiconductor devices. In addition, our fiscal 2005 revenue was adversely affected by the remaining impact of one large customer transitioning to another supplier of CMP slurry for polishing copper interconnects at 130 nanometer technology, as well as continued competition and pricing pressure resulting in selected price reductions. However, revenue for our fourth quarter of fiscal 2005 increased by 13.6% from the prior fiscal quarter, possibly signifying a semiconductor industry recovery. While some industry experts appear to be cautiously optimistic about the near term outlook for the semiconductor industry, there are several factors that make it difficult for us to predict future revenue trends for our business, including: the cyclical nature of, and continued uncertainty in, the semiconductor industry; short order to delivery time for our products and the associated lack of visibility to future customer orders; and the effect of competition. For example, it is uncertain what impact higher energy costs may have on consumers’ disposable income, which may affect consumer demand for electronic devices and, in turn, demand for IC devices.


On a geographic basis, the Asia Pacific region continues to be the fastest growing region for IC manufacturing as well as for our business, and we expect this trend to continue in the future. In furtherance of our strategic initiatives to advance our technology leadership and to get closer to our customers, we have opened our Asia Pacific technology center, located adjacent to our existing manufacturing facility in Geino, Japan, which includes a clean room and provides polishing, metrology and product development capability to support our customers in the region. In addition, we are moving the portion of our business that serves the rigid disk market to Singapore, since a number of important customers are located in Southeast Asia. This will include establishing manufacturing operations, as well as relocating our commercial and technical teams. Additionally, we have announced plans to sell directly to our customers in Taiwan, rather than through a distributor, which we believe will allow us to further strengthen our solid relationships with our customers there. As part of the transition, we anticipate an adverse impact on our revenue for the second quarter of fiscal 2006 of approximately $11.5 million as our distributor sells its remaining inventory of our products to our customers and we begin building inventory required to begin servicing these customers directly. Following this transition period, we believe our sales volumes will return to the prior level.

Gross profit expressed as a percentage of revenue for fiscal 2005 was 47.8%, which represents a decrease from the 49.3% reported for fiscal 2004. The decrease in gross margin as a percentage of revenue was primarily driven by selected price reductions, partially offset by higher yields in our manufacturing operations and a higher valued product mix. We believe that through the execution of our operations excellence initiative, including the implementation of Six Sigma methods, we made notable productivity improvements in fiscal 2005. These improvements have allowed us to maintain gross margin as a percentage of revenue within a range of 48%, plus or minus 2%, in spite of increased competitive activity and pricing pressure, and we expect this to continue into fiscal 2006.

We will adopt Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004), "Share-Based Payment" (SFAS 123R) effective October 2005 using the modified prospective method, which we believe will have a material impact on our consolidated results of operations and earnings per share. We will continue to use the Black-Scholes model to approximate grant date fair value, and we expect to recognize approximately $10.0 million of pre-tax share-based compensation expense for full fiscal 2006, assuming we apply our historical approaches to paying long-term incentives and determining fair value. This expense will be recognized in our income statement either in cost of goods sold or in operating expenses, based upon the functional area in which the recipient of the share-based compensation works. We expect that the majority of our share-based compensation expense will be recognized as general and administration expense. Other factors may also impact future share-based compensation expense including the attribution of the awards to the service period, the vesting period of stock options, the timing and number of additional grants of stock option awards, fluctuations in and volatility of our stock price, expected term of the grants, expected risk-free rate of interest and estimated forfeiture rates.


CRITICAL ACCOUNTING POLICIES AND ESTIMATES

This "Management's Discussion and Analysis of Financial Condition and Results of Operations", as well as disclosures included elsewhere in this Form 10-K, are based upon our audited consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingencies. On an ongoing basis, we evaluate the estimates used, including those related to bad debt expense, warranty obligations, inventory valuation, assets impairments, share-based compensation, income taxes and contingencies. We base our estimates on historical experience, current conditions and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources, as well as identifying and assessing our accounting treatment with respect to commitments and contingencies. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies involve significant judgments and estimates used in the preparation of our consolidated financial statements.


ALLOWANCE FOR DOUBTFUL ACCOUNTS

We maintain an allowance for doubtful accounts for estimated losses resulting from the potential inability of our customers to make required payments. Our allowance for doubtful accounts includes both a general reserve based on historical experience and an additional reserve for individual accounts when we become aware of a customer’s inability to meet its financial obligations, such as in the case of bankruptcy filings or deterioration in the customer’s operating results or financial condition. While historical experience may provide a reasonable estimate of uncollectible accounts, actual results may differ from what was recorded. As of September 30, 2005 our allowance for doubtful accounts represented 1.3% of gross accounts receivable. If we had increased our estimate of bad debts by 1.0%, to 2.3% of gross accounts receivable, our general and administrative expense would have increased by $0.4 million.

WARRANTY RESERVE

We maintain a warranty reserve that reflects management’s best estimate of the cost to replace product that does not meet customers’ specifications and performance requirements, and costs related to such replacement. The warranty reserve is based upon a historical product replacement rate applied against sales made in the current quarterly period, plus an additional amount related to any specific known conditions or circumstances. Should actual warranty costs differ substantially from our estimates, revisions to the estimated warranty liability may be required. As of September 30, 2005 our warranty reserve represented 1.9% of the current quarter revenue. If we had increased our estimate of general warranty reserve by 1.0%, to 2.9% of the current quarter revenue, our cost of goods sold would have increased by $0.7 million.

INVENTORY VALUATION

We value inventory at the lower of cost or market and write down the value of inventory for estimated obsolescence or if inventory is deemed unmarketable. An inventory reserve is maintained based upon a historical percentage of actual inventory written off applied against inventory at the end of the period, plus an additional amount for known conditions and circumstances. We exercise judgment in estimating the amount of inventory that is obsolete. Should actual product marketability and raw material fitness for use be affected by conditions that are different from those projected by management, revisions to the estimated inventory reserve may be required. Also, the purchase cost of one of our key raw materials from one supplier may change significantly based upon the total quantity of in-specification product that we purchase in a given fiscal year. During interim periods we determine inventory valuation and the amount charged to cost of goods sold for this raw material from this supplier based on the expected average cost over the entire fiscal year using our current full year forecast of purchases of this raw material from this supplier.

IMPAIRMENT OF LONG-LIVED ASSETS

SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (SFAS 144), requires us to assess the recoverability of the carrying value of long-lived assets whenever events or changes in circumstances indicate that the assets may be impaired. We must exercise judgment in assessing whether an event of impairment has occurred. For purposes of recognition and measurement of an impairment loss, long-lived assets are grouped with other assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. We must exercise judgment in this grouping. SFAS 144 requires that if the sum of the undiscounted future cash flows expected to result from the identified asset group is less than the carrying value of the asset group, then an impairment must be recognized in the financial statements. The amount of the impairment to be recognized is calculated by subtracting the fair value of the asset group from the reported value of the asset group. Determining future cash flows and estimating fair values requires significant judgments and is highly susceptible to change from period to period because it requires management to make assumptions about future sales and cost of sales generally over a long-term period.


INVESTMENT IMPAIRMENTS

In July 2004 we entered into a strategic alliance with, and purchased stock of, NanoProducts Corporation, and we account for this investment using the equity method of accounting. We evaluate the estimated fair value of our equity investment annually or more frequently if indicators of potential impairment exist, to determine if an other-than-temporary impairment in the value of our investment has taken place. No write down was recorded in fiscal 2005.

STOCK-BASED COMPENSATION

In accordance with the provisions of SFAS No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure” (SFAS 148), and No. 123, "Accounting for Stock-Based Compensation" (SFAS 123), we have elected to account for share-based compensation in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25), and related interpretations. We disclose the summary of pro forma effects to reported net income as if we had elected to recognize compensation cost based on the fair value of share-based compensation to employees of Cabot Microelectronics as prescribed by SFAS 123. In calculating such fair value, there are certain estimates that we use such as expected volatility, expected term and expected risk-free rate of interest.

In December 2004 the FASB issued Statement No. 123 (revised 2004), “Share-Based Payment” (SFAS 123R), which requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Under SFAS 123R, the pro forma disclosure alternative permitted under SFAS 123 and SFAS 148 is no longer allowable. We will adopt SFAS 123R in the first quarter of fiscal 2006.

ACCOUNTING FOR INCOME TAXES
 
We account for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes” (SFAS 109), which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. SFAS 109 also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that a portion of the deferred tax asset will not be realized. We have determined that it is more likely than not that our future taxable income will be sufficient to realize our deferred tax assets.
 
COMMITMENTS AND CONTINGENCIES

We have entered into unconditional purchase obligations, which include noncancelable purchase commitments and take-or-pay arrangements with suppliers. We review our agreements and make an assessment of the likelihood of a shortfall in purchases and determine if it is necessary to record a liability. In addition, we are subject to the possibility of various loss contingencies arising in the ordinary course of business such as a legal proceeding or claim. An estimated loss contingency is accrued when it is probable that an asset has been impaired or a liability has been incurred and the amount of the loss can be reasonably estimated. We regularly evaluate current information available to us to determine whether such accruals should be adjusted and whether new accruals are required.


EFFECTS OF RECENT ACCOUNTING PRONOUNCEMENTS

In December 2004 the FASB issued Statement No. 123 (revised 2004), “Share-Based Payment” (SFAS 123R), which replaces SFAS 123 and supersedes APB 25. SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values, and the pro forma disclosure alternative permitted under SFAS 123 and SFAS 148 is no longer allowable under SFAS 123R. We will adopt SFAS 123R effective October 2005 using the modified prospective method, and we believe the adoption of SFAS 123R will have a material impact on our consolidated results of operations and earnings per share. We intend to continue to use the Black-Scholes model to approximate grant date fair value, and we expect to recognize approximately $10.0 million of pre-tax share-based compensation expense for full fiscal 2006, assuming we apply our historical approaches to paying long-term incentives and determining fair value. Other factors may also impact future share-based compensation expense including the attribution of the awards to the service period, the vesting period of stock options, the timing and number of additional grants of stock option awards, fluctuations in and volatility of our stock price, expected term of the grants, expected risk-free rate of interest and estimated forfeiture rates.


In May 2005 the FASB issued FASB Statement No. 154, “Accounting Changes and Error Corrections” (SFAS 154), which replaces Accounting Principles Board Opinion No. 20 “Accounting Changes” and FASB Statement No. 3, “Reporting Accounting Changes in Interim Financial Statements”. SFAS 154 is effective for fiscal years beginning after December 15, 2005 and requires retrospective application to prior period financial statements of voluntary changes in accounting principle, unless it is impractical to determine either the period-specific effects or the cumulative effect of the change. Our consolidated financial position, results of operations or cash flows will only be impacted by SFAS 154 if we implement a voluntary change in accounting principle or correct accounting errors in future periods.

In March 2005 the FASB issued Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations” (FIN 47) which is effective for fiscal years ending after December 15, 2005 and is an interpretation of FASB Statement No. 143, “Accounting for Asset Retirement Obligations”. FIN 47 requires recognition of a liability for the fair value of a conditional asset retirement obligation when incurred if the fair value of the liability can be reasonably estimated. We do not expect the adoption of FIN 47 to have a material impact on our consolidated financial position, results of operations or cash flows.

In December 2004 the FASB issued FASB Statement No. 153, “Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions” (SFAS 153), as part of its short-term international convergence project with the International Accounting Standards Board (IASB). Under SFAS 153, nonmonetary exchanges are required to be accounted for at fair value, recognizing any gains or losses, if their fair value is determinable within reasonable limits and the transaction has commercial substance. SFAS 153 is effective for fiscal years beginning after June 15, 2005. We do not expect the adoption of SFAS 153 to have a material impact on our consolidated financial position, results of operations or cash flows.

In November 2004 the FASB issued FASB Statement No. 151, “Inventory Costs, an amendment of ARB No. 43, Chapter 4” (SFAS 151), which adopts wording from the IASB’s IAS 2, “Inventories”, in an effort to improve the comparability of cross-border financial reporting. The new standard indicates that abnormal freight, handling costs and wasted materials are required to be treated as current period charges rather than as a portion of inventory costs. Additionally, the standard clarifies that fixed production overhead should be allocated based on the normal capacity of a production facility. SFAS 151 is effective for fiscal years beginning after June 15, 2005. We do not expect the adoption of SFAS 151 to have a material impact on our consolidated financial position, results of operations or cash flows.


RESULTS OF OPERATIONS

The following table sets forth, for the periods indicated, the percentage of revenue of certain line items included in our historical statements of income:

   
Year Ended September 30,
 
   
2005
 
2004
 
2003
 
               
Revenue
   
100.0
%
 
100.0
%
 
100.0
%
Cost of goods sold
   
52.2
   
50.7
   
49.4
 
Gross profit
   
47.8
   
49.3
   
50.6
 
                     
Research and development
   
15.9
   
14.2
   
16.5
 
Selling and marketing
   
6.3
   
5.2
   
4.5
 
General and administrative
   
9.3
   
7.2
   
7.2
 
Amortization of intangibles
   
0.1
   
0.1
   
0.1
 
Operating income
   
16.2
   
22.6
   
22.3
 
Other income (expense), net
   
1.0
   
-
   
-
 
Income before income taxes
   
17.2
   
22.6
   
22.3
 
Provision for income taxes
   
5.2
   
7.5
   
7.3
 
                     
Net income
   
12.0
%
 
15.1
%
 
15.0
%



YEAR ENDED SEPTEMBER 30, 2005 VERSUS YEAR ENDED SEPTEMBER 30, 2004

REVENUE

Revenue was $270.5 million in 2005, which represented a 12.6%, or $38.9 million, decrease from 2004. Of this decrease, $23.3 million was due to a decrease in sales volume and $15.7 million was due to a decrease in weighted average selling price, primarily resulting from selected price reductions partially offset by a higher valued product mix. Revenue for fiscal 2005 would have been $0.7 million lower had the average exchange rates for the Japanese Yen and Euro during the period held constant with the prior year’s average rates.

In August 2005 we announced plans to sell directly to our customers in Taiwan, rather than through a distributor, in pursuit of our initiative to get closer to our customers. As part of the transition, we anticipate an adverse impact on our revenue for the second quarter of fiscal 2006 of approximately $11.5 million as our distributor sells its remaining inventory of our products to our customers and we begin building inventory required to begin servicing these customers directly. Following this transition period, we believe our sales volumes will return to the prior level and our revenue may increase slightly to the extent we are able to gain a portion of our distributor’s margin.

Our revenue in the first three quarters of fiscal 2005 was adversely affected in part by a semiconductor industry downturn, which we believe was partially driven by a reduction in wafer starts by some semiconductor manufacturers to reduce excess inventories of certain semiconductor devices. While some industry experts appear to be cautiously optimistic about the near term outlook for the semiconductor industry, there are several factors that make it difficult for us to predict future revenue trends for our business, including: the cyclical nature of, and the continued uncertainty in, the semiconductor industry; short order to delivery time for our products and the associated lack of visibility to future customer orders; and the effect of competition on pricing.


COST OF GOODS SOLD

Total cost of goods sold was $141.3 million in 2005, which represented a decrease of 9.9%, or $15.5 million, from 2004. Of this decrease, $11.8 million was due to lower sales volume and $3.7 million was due to lower average costs per gallon, primarily due to improved manufacturing yields partially offset by higher fixed costs.

Fumed metal oxides, such as fumed silica and fumed alumina, are significant raw materials that we use in many of our CMP slurries. In an effort to mitigate our risk to rising raw material costs and to increase supply assurance and quality performance requirements, we have entered into multi-year supply agreements with a number of suppliers. We purchase fumed silica under a fumed silica supply agreement with Cabot Corporation, which provides for the cost of fumed silica to increase approximately 4% over the initial six-year term of the agreement, and in some circumstances is subject to certain inflation adjustments and shared cost savings adjustments resulting from our joint efforts. This agreement runs through December 2009, and will automatically renew unless either party gives certain notice of non-renewal. We purchase fumed alumina primarily under a fumed alumina supply agreement with Cabot Corporation that runs through December 2006, and may be renewed at our option for another five-year term. The fumed alumina supply 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 an agreed upon capacity expansion, an agreed upon rate of return on investment and incentive payments if they produce above a threshold level of fumed alumina 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. In addition, rising energy costs may also impact the cost of raw materials, packaging and freight costs. We also expect to continue to invest in our operations excellence initiative to improve product quality, reduce variability and improve product yields in our manufacturing process.


GROSS PROFIT

Our gross profit as a percentage of revenue was 47.8% in 2005 as compared to 49.3% in 2004. The 1.5 percentage point decrease in gross profit margin resulted primarily from selected price reductions and lower utilization of our manufacturing capacity due to the lower level of sales, partially offset by a higher valued product mix. We continue to experience competition and pricing pressure, but expect to be able to continue to achieve productivity improvements in our manufacturing operations through ongoing execution of our operations excellence initiative. Therefore, we expect our gross profit as a percentage of revenue for fiscal 2006 to be in the range of 48%, plus or minus 2%.


RESEARCH AND DEVELOPMENT

Total research and development expenses were $43.0 million in 2005, which represented a decrease of 2.3% or $1.0 million, from 2004. The decrease is primarily related to $1.1 million in lower expenses for clean room materials and laboratory supplies, $0.8 million in lower technical service and analysis fees and $0.5 million in lower facilities costs. These decreases were partially offset by $0.6 million in higher depreciation expense related to equipment purchased in 2004 for our CMP polishing and metrology clean room in Aurora, Illinois, and $0.4 million in higher staffing costs. Our research and development efforts are focused on four main areas: development and formulation of new and enhanced CMP slurry and pad products; research related to fundamental technology such as advanced chemistry and particle technology; process development to support rapid and effective commercialization of new products; and evaluation of new polishing applications outside of the semiconductor and data storage industries, such as our engineered surface finishes initiative.

We expect that the opening of our new Asia Pacific technology center will result in increased research and development expense in fiscal 2006, which we intend to partially offset over time by decreased costs in our Aurora facility as we transition certain research and development capabilities to Asia.


SELLING AND MARKETING

Selling and marketing expenses were $17.0 million in 2005, which represented an increase of 4.7%, or $0.8 million, over 2004. The increase resulted primarily from higher staffing costs of $0.9 million and higher facility costs of $0.5 million. These increases were partially offset by decreased consulting fees of $0.4 million and lower product sample costs of $0.4 million. In furtherance of one of our key strategic initiatives of getting closer to our customers, we announced our decision to begin selling directly to customers in Taiwan, effective April 2006, rather than through a distributor. Therefore we expect our selling and marketing expenses to increase slightly in fiscal 2006.


GENERAL AND ADMINISTRATIVE

General and administrative expenses were $25.2 million in 2005, which represented an increase of 12.6%, or $2.8 million, from 2004.  The increase resulted primarily from $1.7 million in higher staffing costs and $1.0 million of increased professional fees primarily related to meeting the requirements of Sarbanes-Oxley Section 404.


AMORTIZATION OF INTANGIBLES

Amortization of intangibles was $0.3 million in 2005 and 2004.


OTHER INCOME, NET

Other income was $2.7 million in 2005, compared to $0.1 million in 2004. The increase in other income is primarily due to $2.0 million greater interest income from higher interest rates and our larger balance of cash and short-term investments, as well as a $0.7 million increase in foreign exchange gains.


PROVISION FOR INCOME TAXES

Our effective income tax rate was 30.2% in 2005 and 33.1% in 2004. The decrease in the effective tax rate was primarily due to higher tax-exempt interest income and the increased effect of extraterritorial income tax credits related to export sales from North America. We expect our effective tax rate in fiscal 2006 to be approximately 31.2%.


NET INCOME

Net income was $32.5 million in 2005, which represented a decrease of 30.5%, or $14.3 million, from 2004 as a result of the factors discussed above.


YEAR ENDED SEPTEMBER 30, 2004 VERSUS YEAR ENDED SEPTEMBER 30, 2003

REVENUE

Revenue was $309.4 million in 2004, which represented a 23.0%, or $57.8 million, increase from 2003. Of this increase, $56.7 million was due to an increase in sales volume and $1.1 million was due to an increase in weighted average selling price resulting from both a higher valued product mix and favorable foreign exchange rate changes, which more than offset selective price reductions that were granted to certain customers. Revenue for fiscal 2004 would have been $4.7 million lower had the average exchange rates for the Japanese Yen and Euro during the period held constant with the prior year’s average rates.  Also, in June 2003, we began selling directly to customers in Europe, Singapore and Malaysia rather than through a distributor. During the transition to selling directly to customers, we experienced an adverse revenue impact of $3.7 million during the third quarter of fiscal 2003 as we discontinued sales to our distributor while it drew down its inventory of our products.


COST OF GOODS SOLD

Total cost of goods sold was $156.8 million in 2004, which represented an increase of 26.2%, or $32.5 million, from 2003. Of this increase, $27.3 million was due to higher sales volume. An additional $8.1 million was due to higher average costs per gallon resulting from increased fixed manufacturing costs, higher costs from lower yields in our manufacturing operations associated with meeting our customers’ more stringent product quality requirements, as well as transition costs associated with the termination of a polishing pad distribution agreement. These increases were partially offset by the absence of $2.9 million of expense incurred in fiscal 2003 related to a raw material supply agreement for a polishing pad technology that was previously under development but is no longer being pursued.


GROSS PROFIT

Our gross profit as a percentage of revenue was 49.3% in 2004 as compared to 50.6% in 2003. The 1.3% decrease in gross profit expressed as a percentage of revenue resulted primarily from increased costs from lower yields in our manufacturing operations associated with meeting customer requirements for higher product quality.


RESEARCH AND DEVELOPMENT

Total research and development expenses were $44.0 million in 2004, which represented an increase of 6.0% or $2.5 million, from 2003. Research and development expense increased primarily due to $2.4 million in higher staffing costs, $1.2 million in higher depreciation expense related to the purchase of equipment for our CMP polishing and metrology clean room in Aurora, Illinois, and $0.5 million in higher technical service fees. These increases were partially offset by a decrease in laboratory supplies of $2.1 million.


SELLING AND MARKETING

Selling and marketing expenses were $16.2 million in 2004, which represented an increase of 44.6%, or $5.0 million, over 2003. The increase resulted primarily from higher staffing costs of $2.7 million, increased office expenses of $0.6 million, higher travel costs of $0.6 million, increased consulting fees of $0.5 million and $0.3 million in employee separation costs. The higher selling and marketing expenses resulted from our increased customer support initiatives including our transition in June 2003 to selling direct to customers in Europe, Singapore and Malaysia, rather than through a distributor. Increases in selling and marketing expenses also resulted from the transition to a Global Business Team structure to provide a single point of accountability for each major product area.


GENERAL AND ADMINISTRATIVE

General and administrative expenses were $22.4 million in 2004, which represented an increase of 22.6%, or $4.1 million, from 2003.  The increase resulted primarily from $2.5 million in higher staffing costs, $0.5 million of increased professional fees, $0.3 million due to higher insurance premiums and $0.2 million in employee separation costs.


AMORTIZATION OF INTANGIBLES

Amortization of intangibles was $0.3 million in 2004 and 2003.


OTHER INCOME (EXPENSE), NET

Other income was $0.1 million in 2004, compared to being negligible in 2003. The increase in other income was primarily due to higher interest income and lower interest expense, offset by increased foreign exchange losses.


PROVISION FOR INCOME TAXES

Our effective income tax rate was 33.1% in 2004 and 32.7% in 2003. The increase in the effective tax rate was primarily due to the decreased effect of tax credits from research and experimentation activities.


NET INCOME

Net income was $46.7 million in 2004, which represented an increase of 23.8%, or $9.0 million, from 2003 as a result of the factors discussed above.


INFLATION

We believe that inflation has not had a material effect on our revenues and net income for the last three fiscal years.


LIQUIDITY AND CAPITAL RESOURCES

We had cash flows from operating activities of $48.0 million in 2005, $64.2 million in 2004 and $47.6 million in 2003. Our cash provided by operating activities in 2005 originated from net income from operations of $32.5 million and noncash items of $20.9 million, which were partially offset by a net change in working capital of $5.4 million.

In 2005 cash flows used in investing activities were $35.7 million. Purchases of property, plant and equipment, primarily for the construction of our Asia Pacific technology center and manufacturing projects, were made with $21.1 million in cash and $8.2 million in accrued liabilities. In addition, $12.6 million was used for net purchases of short-term auction rate securities and $1.9 million was used for the final payment for our acquisition of a minority equity ownership interest in NanoProducts Corporation. In 2004 cash flows used in investing activities were $126.8 million, of which $114.0 million was used for net purchases of auction rate securities, which were previously presented as cash and cash equivalents (see Note 2 to the consolidated financial statements). In addition, $11.0 million was used for capital spending, including purchases of land in Geino, Japan, manufacturing equipment and research and development equipment. Finally, we invested $1.8 million as partial payment for a minority equity ownership interest in NanoProducts Corporation. In 2003 cash flows used in investing activities were $14.5 million, primarily due to $16.4 million in purchases of manufacturing equipment, and a 300 mm polishing tool and metrology tools to support increased polishing capacity in our clean room in Aurora, Illinois. These capital expenditures were partially offset by $1.9 million in cash received from the sale of assets, of which $1.8 million related to the January 2003 sale of our distribution center and land in Ansung, South Korea. We estimate that our total capital expenditures in fiscal 2006 will be approximately $20.0 million.

In 2005 cash flows used in financing activities were $10.9 million, primarily as a result of $17.0 million in repurchases of common stock under our share repurchase program and $0.9 million in principal payments under capital lease obligations. These outflows were partially offset by the issuance of common stock of $7.0 million from the exercise of stock options under our equity incentive plan and purchases under our employee stock purchase plan. In 2004 cash flows used in financing activities of $5.4 million were also largely a result of repurchases of $8.0 million of common stock under our share repurchase program and $0.8 million in principal payments under capital lease obligations. These outflows were partially offset by the issuance of common stock of $3.4 million from the exercise of stock options under our equity incentive plan and purchases under our employee stock purchase plan. In 2003 cash flows from financing activities of $8.5 million resulted from the issuance of common stock of $12.8 million for the exercise of stock options under our equity incentive plan and purchases under our employee stock purchase plan. These cash inflows were partially offset by a $3.5 million loan repayment, which is described below, and principal payments of $0.7 million made under capital lease obligations.

In July 2004 we announced that our Board of Directors had authorized a share repurchase program for up to $25.0 million of our outstanding common stock and we completed the program during the fourth quarter of fiscal 2005. Shares were repurchased from time to time, depending on market conditions, in open market transactions, at management’s discretion. We funded share repurchases from our existing cash balance. The plan was primarily intended to diminish earnings dilution from the issuance of stock from the exercise of stock options under our equity incentive plan and purchases under our employee stock purchase plan. In October 2005 we announced that our Board of Directors authorized a new share repurchase program for up to $40.0 million of our outstanding common stock, under terms and conditions similar to those of the July 2004 share repurchase program. The program may be suspended or terminated at any time, at the Company’s discretion. We view the program as an effective means by which to return cash to shareholders.

In February 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. The loan had been due in April 2005 and had incurred interest at an annual rate of 4.68%. No gain or loss was recognized with respect to the prepayment. As a result of this prepayment, we have no outstanding long-term debt.


On November 24, 2003, we terminated and replaced our existing unsecured revolving credit and term loan with an amended and restated unsecured revolving credit facility of $50.0 million with an option to increase the facility by up to $30.0 million. Under this agreement, which terminates in November 2006 but can be renewed for two one-year terms, interest accrues on any outstanding balance at either the institution’s base rate or the eurodollar rate plus an applicable margin. A non-use fee also accrues. Loans under this facility are anticipated to be used primarily for general corporate purposes, including working capital and capital expenditures. The credit agreement also contains various covenants. No amounts are currently outstanding under this credit facility and we believe we are currently in compliance with the covenants. We have exercised the first renewal option to extend the currently scheduled termination date by one year to November 24, 2007.

We believe that cash generated by our operations and available borrowings under our revolving credit facility will be sufficient to fund our operations, expected capital expenditures, including merger and acquisition activities, and share repurchases for the foreseeable future. However, we plan to expand our business and continue to improve our technology and, to do so, 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 September 30, 2005 and 2004, 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 September 30, 2005 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
 
$
6.6
 
$
1.2
 
$
2.1
 
$
2.3
 
$
1.0
 
Operating leases
   
1.3
   
0.6
   
0.7
   
0.0
   
0.0
 
Purchase obligations
   
39.4
   
28.5
   
7.3
   
3.2
   
0.4
 
Other long-term liabilities 
   
1.7
   
0.0
   
0.0
   
0.0
   
1.7
 
Total contractual obligations
 
$
49.0
 
$
30.3
 
$
10.1
 
$
5.5
 
$
3.1
 

CAPITAL LEASE OBLIGATIONS

In December 2001 we entered into a fumed alumina supply agreement with Cabot Corporation under which we agreed to pay Cabot Corporation for the expansion of a fumed alumina manufacturing facility in Tuscola, Illinois. The payments for the facility have been treated as a capital lease for accounting purposes and the present value of the minimum quarterly payments resulted in an initial $9.8 million lease obligation and 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 expires in 2011. We also can choose not to renew the agreement subject to certain terms and conditions and the payment of certain costs, after the initial five-year term.


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

We operate under a fumed silica supply agreement with Cabot Corporation under which we are obligated to purchase at least 90% of our six-month volume forecast and to pay for the shortfall if we purchase less than that amount. This agreement has an initial six-year term, which expires in December 2009 and will automatically renew unless either party gives certain notice of non-renewal. We currently anticipate meeting minimum forecasted purchase volume requirements. We also operate under the fumed alumina supply agreement with Cabot Corporation, described above in Capital Lease Obligations, under which we are obligated to pay certain fixed, capital and variable costs. Purchase obligations include $19.0 million of contractual commitments for fumed silica and fumed alumina under these contracts calculated based on the fumed alumina agreement running 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 annual services 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 expired in October 2004, and in November 2004 was renewed for another year under similar terms and conditions. The contract continues to have automatic one-year renewals, and contains a 90-day cancellation clause executable by either party. Purchase obligations related to this agreement are $3.0 million, which includes a termination payment if the agreement is not renewed.

In October 2005, we opened our new Asia Pacific technology center located adjacent to our existing manufacturing facility in Geino, Japan. The new 20,000-square-foot facility includes a clean room and provides polishing, metrology and product development capabilities. Purchase obligations related to this capital expansion are $7.0 million, which include remaining construction payments and equipment purchases.

OTHER LONG-TERM LIABILITIES

Other long-term liabilities include $1.0 million for pension liabilities and $0.7 million for deferred compensation obligations.


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, improve and customize our products for advanced IC applications 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 our customers continually pursue lower cost of ownership of materials consumed in their manufacturing processes, including CMP slurries. We expect these technological changes and advances, and this drive toward lower costs, to continue in the future. Emerging technologies in the semiconductor industry, such as electrochemical mechanical planarization (eCMP), as well as our customers’ efforts to reduce consumption of CMP slurries, could render our products less important to the IC device manufacturing process.


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. Our principal customers also hold considerable purchasing power, which can impact the pricing and terms of sale of our products. Any 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. In fiscal 2005, our five largest customers accounted for approximately 53% of our revenue, with Marketech, our largest customer and also our distributor in Taiwan and China, accounting for approximately 35% of our revenue. In fiscal 2004, our five largest customers accounted for approximately 55% of our revenue, with Marketech, our largest customer, accounting for approximately 32% of our revenue. In August 2005 we announced the modification of our distribution agreement with Marketech, such that we will sell our products directly to customers in Taiwan beginning April 2006. Marketech will continue to distribute our products in China.
 

OUR BUSINESS COULD BE SERIOUSLY HARMED IF OUR EXISTING OR FUTURE COMPETITORS DEVELOP SUPERIOR SLURRY PRODUCTS, OFFER BETTER PRICING TERMS OR SERVICE, OR OBTAIN CERTAIN INTELLECTUAL PROPERTY RIGHTS

Competition from current CMP slurry manufacturers or new entrants to the CMP slurry market 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 has and may continue to impact the prices we are able to charge for our slurry products as well as our overall business. 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.


BECAUSE WE HAVE LIMITED EXPERIENCE IN BUSINESS AREAS OUTSIDE OF CMP SLURRIES, EXPANSION OF OUR BUSINESS INTO NEW PRODUCTS AND APPLICATIONS MAY NOT BE SUCCESSFUL

An element of our strategy has been to leverage our current customer relationships and technological expertise to expand our CMP business from slurries into polishing pads. Additionally, under our engineered surface finishes initiative we are translating our core technical expertise in CMP technology for the semiconductor industry, with which we modify surfaces at an atomic level, into a range of demanding surface modifications and polishing applications in other industries where shaping, enabling and enhancing the performance of surfaces is as critical to success as it is in the semiconductor industry. Expanding our business into new product areas involves technologies and production processes in which we have limited experience, and we may not be able to develop and produce products that satisfy our customers’ needs or we may be unable to keep pace with technological or other developments. 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.


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

Our business would suffer from any problem or interruption in our supply of the key raw materials we use in our CMP slurries, including fumed alumina and fumed silica. For example, we operate under a fumed silica supply agreement and fumed alumina supply agreements with Cabot Corporation. 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 promptly secure alternative sources of key raw materials, including fumed metal oxides, in the event one of our suppliers becomes unable to supply us with sufficient quantities of raw materials that meet the quality and technical specifications required by our customers. In addition, contractual amendments to the existing agreements with, or non-performance by our suppliers 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 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 and could motivate our customers to consider purchasing products from our competitors, possibly interrupting or reducing our sales of CMP slurries to these customers.


WE ARE SUBJECT TO SOME RISKS ASSOCIATED WITH OUR FOREIGN OPERATIONS

We currently have operations and a large customer base outside of the United States. For fiscal 2005, approximately 78% of our revenue was generated by sales to customers outside of the United States. For fiscal 2004, approximately 75% of our revenue was generated by sales to customers outside of 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 difficulty in enforcing business and customer contracts and agreements, including protection of intellectual property rights.


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 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.


WE MAY PURSUE ACQUISITIONS AND STRATEGIC ALLIANCES WHICH COULD DISRUPT OUR OPERATIONS AND HARM OUR OPERATING RESULTS IF THEY ARE UNSUCCESSFUL

We expect to continue to make investments in companies, either through acquisitions, investments or alliances, in order to supplement our internal development efforts. Acquisitions and investments involve numerous risks, including the following: difficulties in integrating the operations, technologies, products and personnel of acquired companies; diversion of management’s attention from normal daily operations of the business; potential difficulties in entering markets in which we have limited direct prior experience and where competitors in such markets have stronger market positions; initial dependence on unfamiliar supply chains or relatively small supply partners; insufficient revenues to offset increased expenses associated with acquisitions; potential loss of key employees of the acquired companies; or inability to effectively cooperate and collaborate with our alliance partners.

Further, we may never realize the perceived or anticipated benefits of a business combination. Future acquisitions by us could have negative effects on our results of operations, such as contingent liabilities and amortization charges related to intangible assets. Investments and acquisitions of high technology and development stage companies are inherently risky because these businesses may never develop, and we may incur losses related to these investments. In addition, we may be required to write down the carrying value of these investments to reflect other than temporary declines in their value, which 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 revenue in the first three quarters of fiscal 2005 was adversely affected in part by a semiconductor industry downturn, which we believe was partially driven by a reduction in wafer starts by some semiconductor manufacturers to reduce excess inventories of certain semiconductor devices. As we enter into fiscal 2006 we are cautiously encouraged by what we believe are indicators of improving business trends, however there are several factors that make it difficult for us to predict future revenue trends for our business, including: the cyclical nature of, and the continued uncertainty in, the semiconductor industry; short order to delivery time for our products and the associated lack of visibility to future customer orders; and the effect of competition on pricing.


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.


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 fluctuated 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 industries; 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 and related industries; changes in business or regulatory conditions affecting us or participants in the semiconductor and related industries; 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.



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 14% 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 FOREIGN EXCHANGE RATE RISK

We have performed a sensitivity analysis assuming a hypothetical 10% adverse movement in foreign exchange rates. As of September 30, 2005, 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.



CABOT MICROELECTRONICS CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE


   
Page
Consolidated Financial Statements:
 
 
Report of Independent Registered Public Accounting Firm
36
 
Consolidated Statements of Income for the years ended September 30, 2005, 2004 and 2003
38
 
Consolidated Balance Sheets at September 30, 2005 and 2004
39
 
Consolidated Statements of Cash Flows for the years ended September 30, 2005, 2004 and 2003
40
 
Consolidated Statements of Changes in Stockholders’ Equity for the years ended September 30, 2005, 2004 and 2003
41
 
Notes to the Consolidated Financial Statements
42
 
Selected Quarterly Operating Results
61
   
 
Financial Statement Schedule:
 
 
Schedule II - Valuation and Qualifying Accounts
62

All other schedules are omitted, because they are not required, are not applicable, or the information is included in the consolidated financial statements and notes thereto.

 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Stockholders and Board of Directors of
Cabot Microelectronics Corporation:

We have completed an integrated audit of Cabot Microelectronics Corporation’s 2005 consolidated financial statements and of its internal control over financial reporting as of September 30, 2005 and audits of its 2004 and 2003 consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.

Consolidated financial statements and financial statement schedule

In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Cabot Microelectronics Corporation and its subsidiaries at September 30, 2005 and 2004, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 2005 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

Internal control over financial reporting

Also, in our opinion, management’s assessment, included in Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A, that the Company maintained effective internal control over financial reporting as of September 30, 2005 based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of September 30, 2005, based on criteria established in Internal Control - Integrated Framework issued by the COSO. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.


A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 
/s/ PRICEWATERHOUSECOOPERS LLP
   
   
   
Chicago, Illinois
 
December 7, 2005
 
 
CABOT MICROELECTRONICS CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)

   
Year Ended September 30,
 
   
2005
 
2004
 
2003
 
               
               
Revenue
 
$
270,484
 
$
309,433
 
$
251,665
 
                     
Cost of goods sold
   
141,282
   
156,805
   
124,269
 
                     
Gross profit
   
129,202
   
152,628
   
127,396
 
                     
Operating expenses:
                   
Research and development
   
43,010
   
44,003
   
41,516
 
Selling and marketing
   
16,989
   
16,225
   
11,221
 
General and administrative
   
25,172
   
22,351
   
18,225
 
Amortization of intangibles
   
255
   
340
   
340
 
Total operating expenses
   
85,426
   
82,919
   
71,302
 
                     
Operating income
   
43,776
   
69,709
   
56,094
 
                     
Other income (expense), net
   
2,747
   
139
   
(27
)
Income before income taxes
   
46,523
   
69,848
   
56,067
 
Provision for income taxes
   
14,050
   
23,120
   
18,334
 
                     
Net income
 
$
32,473
 
$
46,728
 
$
37,733
 
                     
Basic earnings per share
 
$
1.32
 
$
1.89
 
$
1.55
 
                     
Weighted average basic shares outstanding
   
24,563
   
24,750
   
24,401
 
                     
Diluted earnings per share
 
$
1.32
 
$
1.88
 
$
1.53
 
                     
Weighted average diluted shares outstanding
   
24,612
   
24,882
   
24,665
 
 
The accompanying notes are an integral part of these consolidated financial statements.
 
CABOT MICROELECTRONICS CORPORATION
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and par value amounts)

   
September 30,
 
   
2005
 
2004
 
ASSETS
         
Current assets:
         
Cash and cash equivalents
 
$
44,436
 
$
43,308
 
Short-term investments
   
126,605
   
114,010
 
Accounts receivable, less allowance for doubtful accounts of $470 at September 30, 2005 and $598 at September 30, 2004
   
36,759
   
41,347
 
Inventories
   
28,797
   
24,474
 
Prepaid expenses and other current assets
   
5,970
   
3,264
 
Deferred income taxes
   
3,240
   
3,278
 
Total current assets
   
245,807
   
229,681
 
               
Property, plant and equipment, net
   
135,784
   
127,794
 
Goodwill
   
1,373
   
1,373
 
Other intangible assets, net
   
--
   
350
 
Other long-term assets
   
3,799
   
4,093
 
Total assets
 
$
386,763
 
$
363,291
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
             
Current liabilities:
             
Accounts payable
 
$
10,236
 
$
13,080
 
Capital lease obligations
   
1,170
   
1,272
 
Accrued expenses, income taxes payable and other current liabilities
   
24,216
   
18,023
 
Total current liabilities
   
35,622
   
32,375
 
               
Capital lease obligations
   
5,436
   
6,385
 
Deferred income taxes
   
4,967
   
7,374
 
Deferred compensation and other long-term liabilities
   
1,654
   
1,535
 
Total liabilities
   
47,679
   
47,669
 
               
Commitments and contingencies (Note 18)
             
Stockholders’ equity:
             
Common stock:
             
Authorized: 200,000,000 shares, $0.001 par value
             
Issued: 25,198,809 shares at September 30, 2005 and 24,855,495 shares at September 30, 2004
   
24
   
25
 
Capital in excess of par value of common stock
   
145,011
   
136,259
 
Retained earnings
   
218,059
   
185,586
 
Accumulated other comprehensive income
   
1,160
   
1,905
 
Unearned compensation
   
(171
)
 
(153
)
Treasury stock at cost, 774,020 shares at September 30, 2005 and 241,865 shares at September 30, 2004
   
(24,999
)
 
(8,000
)
Total stockholders’ equity
   
339,084
   
315,622
 
               
Total liabilities and stockholders’ equity
 
$
386,763
 
$
363,291
 

The accompanying notes are an integral part of these consolidated financial statements.


CABOT MICROELECTRONICS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
 
   
Year Ended September 30,
 
Cash flows from operating activities:
 
2005
 
2004
 
2003
 
               
Net income
 
$
32,473
 
$
46,728
 
$
37,733
 
Adjustments to reconcile net income to net cash provided by operating activities:
                   
Depreciation and amortization
   
19,072
   
17,611
   
15,732
 
Loss on equity investment
   
330
   
73
   
-
 
Noncash compensation expense and non-employee stock options
   
312
   
67
   
(13
)
Provision for doubtful accounts
   
(65
)
 
44
   
121
 
Stock option income tax benefits
   
1,288
   
967
   
4,822
 
Deferred income taxes
   
(2,417
)
 
1,119
   
4,447
 
Unrealized foreign exchange (gain)/loss
   
1,079
   
(3
)
 
(1,535
)
Raw material supply obligation
   
-
   
-
   
1,959
 
Loss on disposal of property, plant and equipment
   
363
   
58
   
50
 
Impairment of property, plant and equipment
   
657
   
-
   
-
 
Other
   
299
   
(471
)
 
198
 
Changes in operating assets and liabilities:
                   
Accounts receivable
   
3,967
   
(3,210
)
 
(10,855
)
Inventories
   
(4,760
)
 
(326
)
 
(693
)
Prepaid expenses and other assets
   
(2,824
)
 
(308
)
 
(378
)
Accounts payable, accrued liabilities and other current liabilities
   
(2,847
)
 
567
   
(324
)
Income taxes payable, deferred compensation and other noncurrent liabilities
   
1,035
   
1,294
   
(3,680
)
Net cash provided by operating activities
   
47,962
   
64,210
   
47,584
 
                     
Cash flows from investing activities:
                   
Additions to property, plant and equipment
   
(21,137
)
 
(10,968
)
 
(16,396
)
Proceeds from the sale of property, plant and equipment
   
6
   
15
   
1,861
 
Purchases of equity investments
   
(1,930
)
 
(1,820
)
 
-
 
Purchases of short-term investments
   
(141,570
)
 
(184,040
)
 
-
 
Proceeds from the sale of short-term investments
   
128,975
   
70,030
   
-
 
Net cash used in investing activities
   
(35,656
)
 
(126,783
)
 
(14,535
)
                     
Cash flows from financing activities:
                   
Prepayments of long-term debt
   
-
   
-
   
(3,500
)
Repurchases of common stock
   
(16,999
)
 
(8,000
)
 
-
 
Net proceeds from issuance of stock
   
6,983
   
3,385
   
12,761
 
Principal payments under capital lease obligations
   
(869
)
 
(815
)
 
(742
)
Net cash provided by (used in) financing activities
   
(10,885
)
 
(5,430
)
 
8,519
 
                     
Effect of exchange rate changes on cash
   
(293
)
 
(7
)
 
145
 
Increase (decrease) in cash
   
1,128
   
(68,010
)
 
41,713
 
Cash and cash equivalents at beginning of year
   
43,308
   
111,318
   
69,605
 
Cash and cash equivalents at end of year
 
$
44,436
 
$
43,308
 
$
111,318
 
Supplemental disclosure of cash flow information:
                   
Cash paid for income taxes
 
$
14,014
 
$
19,554
 
$
14,420
 
Cash paid for interest
 
$
596
 
$
688
 
$
882
 
Supplemental disclosure of noncash investing and financing activities:
                   
Accrued purchases of property, plant and equipment
 
$
8,204
 
$
-
 
$
-
 
Issuance of restricted stock
 
$
125
 
$
25
 
$
275
 
Assets acquired under capital leases (Note 9)
 
$
-
 
$
-
 
$
114
 

The accompanying notes are an integral part of these consolidated financial statements.

 
CABOT MICROELECTRONICS CORPORATION
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(In thousands)
 
   
Common
Stock, $0.001
Par Value
 
Capital
In Excess
Of Par
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income
 
Comprehensive
Income
 
Unearned
Compensation
 
Treasury
Stock
 
Total
 
                                   
                                   
Balance at September 30, 2002
   
24
   
114,116
   
101,125
   
(1,688
)
       
(71
)
 
-
   
213,506
 
                                                   
Exercise of stock options
   
1
   
11,556
                                 
11,557
 
Tax benefit on stock options exercised
         
4,822
                                 
4,822
 
Amortization of unearned compensation on restricted stock
                                 
18
         
18
 
Issuance of Cabot Microelectronics restricted stock under employee compensation plans
         
265
                     
(199
)
       
66
 
Issuance of Cabot Microelectronics restricted stock under deposit share plan
         
30
                     
(10
)
       
20
 
Forfeiture of Cabot Microelectronics restricted stock
         
(89
)
                   
89
         
-
 
Reverse amortization related to restricted stock forfeited
                                 
(37
)
       
(37
)
Issuance of stock options to non-Cabot Microelectronics employees
         
6
                                 
6
 
Issuance of Cabot Microelectronics stock under Employee Stock Purchase Plan
         
1,207
                                 
1,207
 
Net income
               
37,733
       
$
37,733
                   
Net unrealized gain on derivative intruments
                     
34
   
34
                   
Foreign currency translation adjustment
                     
2,841
   
2,841
                   
Total comprehensive income
                         
$
40,608
               
40,608
 
                                                   
Balance at September 30, 2003
   
25
   
131,913
   
138,858
   
1,187
         
(210
)
 
-
   
271,773
 
                                                   
Exercise of stock options
         
2,232
                                 
2,232
 
Tax benefit on stock options exercised
         
967
                                 
967
 
Amortization of unearned compensation on restricted stock
                                 
76
         
76
 
Issuance of Cabot Microelectronics restricted stock under deposit share plan
         
75
                     
(25
)
       
50
 
Forfeiture of Cabot Microelectronics restricted stock
         
(15
)
                   
15
         
-
 
Reverse amortization related to restricted stock forfeited
                                 
(9
)
       
(9
)
Issuance of Cabot Microelectronics stock under Employee Stock Purchase Plan
         
1,087
                                 
1,087
 
Purchase of treasury stock, at cost
                                       
(8,000
)
 
(8,000
)
Net income
               
46,728
       
$
46,728
                   
Net unrealized loss on derivative intruments
                     
(10
)
 
(10
)
                 
Foreign currency translation adjustment
                     
728
   
728
                   
Total comprehensive income
                         
$
47,446
               
47,446
 
                                                   
Balance at September 30, 2004
 
$
25
 
$
136,259
 
$
185,586
 
$
1,905
       
$
(153
)
$
(8,000
)
$
315,622
 
                                                   
Exercise of stock options
         
5,655
                                 
5,655
 
Tax benefit on stock options exercised
         
1,288
                                 
1,288
 
Amortization of unearned compensation on restricted stock
                                 
106
         
106
 
Issuance of Cabot Microelectronics restricted stock under deposit share plan
         
376
                     
(125
)
       
251
 
Forfeiture of Cabot Microelectronics restricted stock
         
(5
)
                   
5
         
-
 
Reverse amortization related to restricted stock forfeited
                                 
(4
)
       
(4
)
Issuance of Cabot Microelectronics stock under directors' deferred compensation plan
         
374
                                 
374
 
Issuance of Cabot Microelectronics stock under Employee Stock Purchase Plan
         
1,064
                                 
1,064
 
Purchase of treasury stock, at cost
   
(1
)
                               
(16,999
)
 
(17,000
)
Net income
               
32,473
       
$
32,473
                   
Net unrealized gain on derivative intruments
                     
35
   
35
                   
Foreign currency translation adjustment
                     
(780
)
 
(780
)
                 
Total comprehensive income