SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
☒ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2019
☐ 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)
|(State of Incorporation)||(I.R.S. Employer Identification No.)|
|870 North Commons Drive||60504|
|(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:
|Title of each class||Trading Symbol(s)||Name of each exchange on which registered|
|Common Stock, $0.001 par value||CCMP||The NASDAQ Stock Market LLC|
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x
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 x No o
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definition of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
|Large accelerated filer||x||Accelerated filer|
|Smaller reporting company|
|Emerging growth company|
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No x
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, 2019, as reported by the NASDAQ Global
Select Market, was approximately $3,221,306,626. For the purposes hereof, "affiliates" include all executive officers and directors of the registrant.
As of October 31, 2019, the Company had 29,104,190 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 4, 2020, are incorporated by reference in Part III of this Annual Report on Form 10-K to the extent stated herein.
This Annual Report on 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 Annual Report on Form 10-K.
CABOT MICROELECTRONICS CORPORATION
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2019
ITEM 1. BUSINESS
Cabot Microelectronics Corporation ("Cabot Microelectronics'', "the Company'', "us'', "we'', or "our''), which was incorporated in the state of Delaware in 1999, is a leading global supplier of consumable materials to semiconductor manufacturers and pipeline and adjacent industry customers. On November 15, 2018 (“Acquisition Date”), we completed our acquisition of KMG Chemicals, Inc. (“KMG”), which produces and distributes specialty chemicals and performance materials for the semiconductor industry, pipeline and adjacent industries, and industrial wood preservation industry (“Acquisition”). The Acquisition extended and strengthened our position as one of the leading suppliers of consumable materials to the semiconductor industry and expanded our portfolio with the addition of KMG’s electronic chemicals and performance materials businesses, the latter of which we believe enables us to be a leading global provider of performance products and services to customers in pipeline and adjacent industries.
Subsequent to the Acquisition, we have operated our business within two reportable segments: Electronic Materials and Performance Materials. The Electronic Materials segment consists of our heritage chemical mechanical planarization (CMP) slurries and polishing pads businesses, as well as the KMG’s heritage electronic chemicals business. In our Electronic Materials segment, we serve customers in the semiconductor industry across the United States, Europe and Asia, and are the leading global supplier of CMP slurries, and a leading global supplier of electronic chemicals (also known as “high-purity process chemicals”), and CMP pads. We develop, produce, and sell CMP slurries for polishing many of the conducting, insulating and isolating materials used in integrated circuit (IC) devices, and for polishing the disk substrates and magnetic heads used in hard disk drives. We also develop, manufacture, and sell CMP polishing pads, which are used in conjunction with slurries in the CMP process. In our electronic chemicals business, we produce and sell high-purity process chemicals through the formulation, purification, and blending of acids, solvents, and other wet chemicals used to etch and clean silicon wafers in the production of semiconductors, photovoltaics (solar cells), and flat panel displays.
Our Performance Materials segment includes KMG’s heritage pipeline performance and wood treatment businesses, and our heritage QED business. We are a leading global provider of products, services, and solutions for optimizing pipeline throughput and maximizing performance and safety. Our pipeline performance products include drag-reducing agents (“DRAs”), valve lubricants, cleaners and sealants, and related equipment supporting pipeline and adjacent industries. We also provide routine and emergency maintenance services as well as training for customers in the pipeline and adjacent industries worldwide. Through KMG’s subsidiary, KMG-Bernuth, Inc. (KMG-Bernuth), we manufacture and sell our wood treatment preservatives, based on pentachlorophenol (“penta”), to wood treatment customers who use these products to extend the useful life of wood utility poles and crossarms, but we recently have announced that we intend to no longer invest in this business and will not construct a new consolidated manufacturing facility when we close the two existing facilities by the end of 2021. See below, and Note 10 of “Notes to the Consolidated Financial Statements” included in Item 8 of Part II of this Annual Report on Form 10-K. In our QED business, we serve the precision optics industry with capital equipment, consumables and services. For additional information on our segment reporting, refer to Note 22 of “Notes to the Consolidated Financial Statements” included in Item 8 of Part II of this Annual Report on Form 10-K.
IC DEVICE MANUFACTURING
IC devices, or "chips", are components in a wide range of electronic systems for computing, communications, manufacturing and transportation. Consumers most frequently encounter IC devices in mobile internet devices (MIDs) such as smart phones and tablets, microprocessors, application processors and memory chips in their desktop or laptop computers, and in automotive applications, gaming devices, and digital televisions. The multi-step manufacturing process for IC devices typically begins with a circular wafer of pure silicon, with the first manufacturing step referred to as a "wafer start". Many identical IC devices, or dies, are manufactured on each wafer at the same time. The initial steps in the manufacturing process build transistors and other electronic components on the silicon wafer. These components are isolated from each other using a layer of insulating material, most often silicon dioxide, to prevent electrical signals from bridging from one transistor to another. These components are then wired together using conducting materials such as aluminum or copper in a particular sequence to produce a functional IC device with specific characteristics. Once the conducting wiring on one layer of the IC device is completed, another layer of insulating material is added. The process of alternating insulating and conducting layers is repeated until the desired wiring within the IC device is achieved. At the end of the process, the wafer is cut into the individual dies, which are then packaged to form individual chips.
CMP SLURRIES AND PADS
Demand for CMP consumables products, including slurries and pads, used in the production of IC devices is primarily based on the number of wafer starts by semiconductor manufacturers and the type and complexity of the IC devices they produce. To enhance the performance of IC devices, IC device manufacturers have progressively increased the number and density of electronic components and wiring layers in each IC device. This is typically done in conjunction with shrinking the key dimensions on an IC device from one technology generation, or "node," to another. As a result, the number of transistors, wires and discrete wiring layers have increased, increasing the complexity of the IC device and the related demand for CMP consumables products. Furthermore, as semiconductor technology has advanced and performance requirements of IC devices have increased, the percentage of IC devices that utilize CMP in the manufacturing process has increased steadily over time. We believe that CMP is used in most IC devices made today, and we expect that the use of CMP will continue to increase in the future.
In the CMP polishing process, CMP consumables are used to remove excess material that is deposited during the IC manufacturing process, and to level and smooth the surfaces of the layers of IC devices, via a combination of chemical reactions and mechanical abrasion, leaving minimal residue and defects on the surface, with only the material necessary for circuit integrity remaining. CMP slurries are liquid solutions generally composed of high-purity deionized water and a proprietary mix of chemical additives and engineered abrasives that chemically and mechanically interact at an atomic level with the surface material on the wafer. 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. Grooves are formed into the surface of the pad to facilitate distribution of the slurry. The CMP process is performed on a CMP polishing tool. During the CMP process, the wafer is held on a rotating carrier, which is pressed down against a CMP pad. The CMP pad is attached to a rotating polishing table that spins in a circular motion in the opposite direction from the rotating wafer carrier. A CMP slurry is continuously applied to the polishing pad to facilitate and enhance the polishing process. Hard disk drive and silicon wafer manufacturers use similar processes to smooth the surface of substrate disks.
An effective CMP process is achieved through technical optimization of the CMP consumables in conjunction with an appropriately designed CMP process. Prior to introducing new or different CMP slurries or pads 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 confirm that the CMP consumable product will function properly within the customer's overall manufacturing process. These tests and evaluations may require minor changes to the CMP process or the CMP slurry or pad. While this qualification process varies depending on numerous factors, it is generally quite costly and may take six months or longer to complete. IC device manufacturers usually assess the cost, time required, and impact on production when they consider implementing or switching to a new CMP slurry or pad.
CMP enables IC device manufacturers to produce smaller, faster and more complex IC devices with a greater density of transistors and other electronic components. With smaller IC devices, IC device manufacturers can increase the number of IC devices that fit on a wafer, which increases their throughput, or the number of IC devices that can be manufactured in a given time period. CMP also helps reduce the number of defective or substandard IC devices produced, which increases the device yield. Producing more complex and higher performing IC devices increases the value of the wafers processed. Improvements in throughput, yield and value per wafer improve the return on an IC device manufacturer's significant investment in manufacturing capacity, which is a high priority. More broadly, sustained growth in the semiconductor industry traditionally has been fueled by enhanced performance and lower unit costs, making IC devices more affordable in an expanding range of applications. We believe CMP remains a critical process in leading-edge semiconductor technology, enabling IC device manufacturers to efficiently produce complex chips, particularly where higher performance may now be accompanied by higher unit costs.
Through our electronic chemicals business, we formulate, purify and blend acids, solvents and other wet chemicals used to etch and clean silicon wafers in the production of semiconductors, photovoltaics (solar cells) and flat panel displays. Our products include sulfuric, phosphoric, nitric and hydrofluoric acids, ammonium hydroxide, hydrogen peroxide, isopropyl alcohol, other specialty organic solvents and various blends of chemicals. Our customers rely on us to provide products with very low levels of contaminants and particles. We purchase raw material chemicals from various suppliers and at our facilities blend, purify and package them for distribution to our customers. We are responsible for product purity levels and analytical testing, and in our view, our ability to maintain high purity levels throughout the supply chain process is a competitive advantage. We believe the production of high-purity process chemicals is critical to our customers’ businesses, as they demand an increasing level of purity to enable more advanced technology nodes and increase yields. We believe demand for electronic chemicals will continue to increase as the semiconductor industry migrates to smaller nodes, which require additional processing steps.
PIPELINE PERFORMANCE PRODUCTS; DRAG REDUCING AGENTS ("DRAs")
Through the Acquisition, we acquired KMG’s pipeline performance business, which has enabled us to become a leading global provider of performance products and services to pipeline companies. Through this business, we supply DRAs, valve lubricants, cleaners and sealants, and related services and equipment, including routine and emergency valve maintenance services and training, to customers in the pipeline and adjacent industries. Our pipeline performance products and services provide value-added specialty products that optimize pipeline efficiency, lower operating costs, and enhance safety. Through the Acquisition, we acquired KMG’s pipeline performance business, which includes the DRA business operated through Flowchem LLC (“Flowchem”), a wholly-owned subsidiary of KMG, as well the valve lubricants and related services businesses. We operate facilities for the manufacture, formulation and distribution of our pipeline performance products in the United States and Canada. We believe demand for DRAs is driven by both production levels within current pipeline infrastructure, as well as future additional pipeline capacity coming online. In our view, aging of existing pipeline infrastructure should create additional demand, as DRAs allow pipeline customers to maximize throughput while meeting maximum pipeline pressure regulations.
In the wood treatment preservatives business, KMG-Bernuth supplies penta to industrial customers who use this preservative to pressure treat wood products, primarily utility poles and crossarms, to extend their useful life by protecting against insect damage and decay. Early in the fourth quarter of fiscal 2019, we had announced that, as a result of the Mexican government’s required compliance with certain international environmental regulations and the resulting requirement that KMG-Bernuth cease producing penta in Mexico by the end of 2021, we planned to close both the Matamoros, Mexico and Tuscaloosa, Alabama facilities by such time, with the intention to consolidate operations in a new plant. However, later in the fourth quarter of fiscal year 2019, as we assessed our capital expenditure priorities for fiscal year 2020 and beyond, we made a decision to further focus our future capital investments on our high-growth core businesses, such as pipeline performance products, CMP slurries and pads and electronic chemicals. As a result, we also decided to cease future investment in the wood treatment business and to not construct a new production facility to replace current operations in Matamoros and Tuscaloosa. In the interim, prior to the closure of the Matamoros and Tuscaloosa facilities, we intend to continue to operate the existing facilities and provide our customers with quality penta products to treat and extend the useful life of wood utility poles and crossarms. We are considering various options regarding this business. See Note 9 and Note 10 of “Notes to the Consolidated Financial Statements” included in Item 8 of Part II of this Annual Report on Form 10-K.
Our wholly-owned subsidiary, QED Technologies International, Inc. (QED), is a leading provider of deterministic finishing and advanced measurement technology for the precision optics industry. Many of the production processes currently used in precision machining and polishing have been based on traditional, labor-intensive techniques, which are being replaced by computer-controlled, deterministic processes. Through our QED subsidiary, we are applying our technical expertise in polishing techniques to demanding applications in other industries where shaping, enabling, and enhancing the performance of surfaces is critical to success, such as for precision optics. We believe precision optics are pervasive, serving several large existing industries such as semiconductor equipment, aerospace, defense, biomedical, research and digital imaging.
CMP CONSUMABLES FOR IC DEVICES AND FOR SUBSTRATE MATERIALS
We develop, produce and sell CMP slurries for polishing a wide range of materials that conduct electrical signals, including tungsten, copper, tantalum (commonly referred to as "barrier"), which is used in copper wiring applications, and aluminum. Slurries for polishing tungsten are used in essentially all chip manufacturing processes containing CMP, with growth driven by increased utilization and higher performance demands in advanced logic, DRAM and 3D NAND devices. Tungsten slurries are also used in advanced logic devices for a multitude of end use applications including MIDs such as smart phones and tablets, gaming devices, and in high-performance computing and artificial intelligence, as well as in legacy logic applications such as those used in automobiles and connected communication devices. In addition, Tungsten slurries are also used in some of the most advanced technologies, such as 3D memory and FinFET for advanced logic IC devices. Slurries for polishing copper and barrier materials are used in the production of advanced IC logic devices such as microprocessors for computers, and devices for graphic systems, gaming systems and communication devices, as well as in the production of advanced memory devices. These products include different slurries for polishing the copper film and the thin barrier layer used to separate copper from the adjacent insulating material. Slurries for polishing aluminum are used in certain advanced transistor gate structures. We offer multiple products for each technology node to enable different integration schemes depending on specific customer needs.
We also develop, manufacture and sell slurry products used to polish the dielectric insulating materials that separate conductive layers within logic and memory IC devices. Some of our slurry products for these materials are used in mature, high volume polishing applications called Interlayer Dielectric, or ILD, in the production of both logic and memory devices. Our more advanced dielectrics products are designed to deliver higher throughput, improved defectivity, and lower cost of ownership than required in traditional ILD applications, as well as to meet the more stringent and complex performance requirements of lower-volume, more specialized dielectrics polishing applications at advanced technology nodes. Some of the applications for advanced dielectrics slurries include shallow trench isolation (STI), "stop on poly" or "stop on nitride" isolation, bulk oxide polishing, and polishing of various dielectrics in advanced transistor designs.
We develop, produce and sell CMP polishing pads, which are consumable materials that work in conjunction with CMP slurries in the CMP polishing process. We believe that CMP polishing pads represent a natural adjacency to our CMP slurry business, since both technologies are required by our customers to deliver their intended result and utilize the same technical and sales infrastructure. Our polishing pad product portfolio includes pads utilizing both thermoset and thermoplastic polyurethane pad material. We produce and sell pads that can be used on a variety of polishing tools, over a range of applications, including tungsten, copper, and dielectrics, over a range of technology nodes, and on both 300mm and 200mm wafers.
In addition, we develop, produce and sell CMP slurries for polishing certain substrate related materials that are used in the production of hard disks and IC devices used in various electronics applications, which represent 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 substrates, resulting in better performance, such as greater storage capacity, higher speed or better power efficiency, of electronics and their applications.
ELECTRONIC CHEMICALS PRODUCTS FOR IC DEVICES AND FOR SUBSTRATE MATERIALS
Our electronic chemicals products include sulfuric, phosphoric, nitric and hydrofluoric acids, ammonium hydroxide, hydrogen peroxide, isopropyl alcohol, other specialty organic solvents and various blends of chemicals. These products are used in multiple process steps throughout the semiconductor fab. Customers demand an increasing level of purity to enable more advanced technology nodes and increase yields. Our electronic chemicals products currently have purity levels up to 20 parts per trillion levels.
In our Flowchem business, we provide polymer-based DRAs for light, medium, and heavy crude oil transmission. We have several product offerings to meet specific customer needs depending on the physical properties of the crude being pumped and various geographic climate conditions. Our products provide benefit by reducing the pressure loss in a pipeline due to the turbulent flow. This allows pipeline operators to maximize product flow while maintaining safe operating pressure and reducing energy consumption.
In our Valve Products and Services business, we develop, manufacture, and sell products used for maintaining and extending the operational lifespan of lubricated isolation valves. We also service valves inline and under pressure through our field services division, and provide accredited training to customers in the pipeline and adjacent industries globally.
WOOD TREATMENT PRODUCTS
Penta products include solid blocks and concentrated solutions. The solid penta blocks are manufactured at our facility in Matamoros, Mexico. DT-40 (penta concentrate liquid) is processed at KMG-Bernuth’s plant in Tuscaloosa, Alabama. See above and below, and Note 9 and Note 10 of “Notes to the Consolidated Financial Statements” included in Item 8 of Part II of this Annual Report on Form 10-K regarding our decision to cease future investment in the wood treatment business and to not construct a new production facility to replace current operations in Matamoros and Tuscaloosa.
PRECISION OPTICS PRODUCTS
Through QED, we design and produce precision polishing and metrology systems for advanced optics applications that allow customers to attain near-perfect shape and surface finish on a range of optical components such as mirrors, lenses and prisms. QED's polishing systems use Magneto-Rheological Finishing (MRFTM), a proprietary surface figuring and finishing technology that employs magnetic fluids and sophisticated computer technology to polish a variety of shapes and materials. QED's metrology systems use proprietary Subaperture Stitching Interferometry (SSI) technology, which captures precise metrology data for large and/or strongly curved optical parts. QED's products also include MR polishing fluids, consumables, spare and replacement parts, as well as optical polishing services and other customer support services.
We collaborate closely with our customers to develop and manufacture products that offer innovative and reliable solutions to our customers' challenges, and we strive to consistently and reliably deliver and support these products around the world through what we believe is a robust global infrastructure and supply chain. We continue to focus on the execution of our primary strategies related to technology leadership, customer collaboration, and supply chain excellence.
STRENGTHENING AND GROWING OUR ELECTRONIC MATERIALS BUSINESS
Delivering Innovative and High-Performing Solutions: We believe that technology and innovation are vital to success in our Electronic Materials business, primarily in the area of CMP consumables, and we devote significant resources to research and development. We focus our research and development activity to deliver innovative CMP consumables products for advanced applications for our technology-leading customers.
We believe an example of our ability to deliver innovative products for advanced applications is the revenue generated from our tungsten and dielectrics slurry products used in 3D memory and tungsten slurry products for FinFET in advanced logic, as well as growth in revenue from our CMP pads products. We believe our focused effort on advanced technologies with technology-leading customers will enable us to provide more compelling new products as technology continues to advance. In addition, we believe our CMP pads product area represents a promising opportunity for continued growth. We believe that our array of pad technology and products enables us to better serve the needs of our customers on a global basis, including the ability to offer performance-differentiated CMP slurry and pad consumable sets. For our electronic chemicals products, we believe increasing levels of purity and achieving lower levels of variation are required to enable these next-generation IC technologies. We continue to work to develop industry leading metrology methods to measure the purity levels achieved.
Close Collaboration with Our Customers: We believe that building close relationships with our customers is essential to achieving long-term success in our business. We collaborate with our customers to identify and deliver new and improved CMP solutions, to integrate our products into their manufacturing processes, and to assist them with supply, warehouse and inventory management. Our customers demand a highly reliable supply source, and we believe we have a competitive advantage because of our ability to timely deliver high-quality products and service from the early stages of product development through the high-volume commercial use of our products. We have strategically located our research and development and clean room facilities, manufacturing operations, and related technical and customer support teams to be responsive to our customers' needs, and believe they provide us with a competitive advantage. These facilities are located in the United States, South Korea, Japan, Taiwan, Singapore, France, Italy, and the United Kingdom.
We believe the several supplier excellence awards we have received from our customers over the past decade, which recognize our product quality and reliability, technology leadership, and customer support capabilities, are evidence of our commitment to, and success in, delivering high-performing and high-quality products to our customers through close collaboration with them. Our global business teams are focused on a range of projects with our customers to address specific business opportunities for advanced technologies.
Robust Manufacturing Process and Global Supply Chain: We believe that product and supply chain quality are critical to success in our business. Our customers demand continuous improvement in the performance of our products, in terms of product quality and consistency. Thus, we strive to reduce variation in our products and processes in order to increase quality, productivity and efficiency, and improve the uniformity and consistency of performance of our CMP consumables and high-purity electronic chemicals products. Variability reduction becomes more important to our customers as technology advances. Our global manufacturing sites are managed to provide the people, training and systems needed to support stringent industry demands for product quality. To support our quality initiative, we use Six Sigma, a systematic, data-driven approach and methodology for improving quality by reducing variability, across our Company. We believe our use of Six Sigma has contributed to lower variability in our products and sustained improvement in productivity in our operations.
We also believe that continuous improvement and variation reduction in our global supply chain are critical to our success and the success of our customers. We believe our capabilities in supply chain management and quality systems differentiate us from our competitors, and that our worldwide CMP consumables manufacturing plants and global network of suppliers also provide supply chain flexibility as needed.
EXPANDING OUR PERFORMANCE MATERIALS BUSINESS
Delivering High Quality Pipeline Products. For our DRA business, our Flowchem subsidiary focuses on providing superior customer service to our customers while delivering consistent, high quality DRA products at a competitive price. We intend to continue to serve current customers as they bring new capacity online and to grow our business through attracting and serving new customers. In addition, we continue to develop other products focused on the pipeline transmission area for which DRAs can serve currently unmet needs.
In our Valves Products and Services business, we continue to work to drive demand for our products by promoting valve best practices to energy industry operators that align with current and trending global regulations. Our primary focus is the promotion of our high-margin critical sealing products as an alternative to more costly mechanical solutions for achieving isolation in aged infrastructure.
Wood Treatment Transition. Early in the fourth quarter of fiscal 2019, we had announced that, as a result of the Mexican government’s required compliance with certain international environmental regulations and the resulting requirement that KMG-Bernuth cease producing penta in Mexico by the end of 2021, we planned to close both the Matamoros, Mexico and Tuscaloosa, Alabama facilities by such time, with the intention to consolidate operations in a new plant. However, later in the fourth quarter of fiscal year 2019, as we assessed our capital expenditure priorities for fiscal year 2020 and beyond, we made a decision to further focus our future capital investments on high-growth core businesses, such as pipeline performance products, CMP slurries and pads and electronic chemicals. As a result, we also decided to cease future investment in the wood treatment business and to not construct a new production facility to replace operations in Matamoros and Tuscaloosa. In the interim, prior to the closure of the Matamoros and Tuscaloosa facilities by the end of 2021, we intend to continue to operate the existing facilities and provide our customers with quality penta products to treat and extend the useful life of wood utility poles and crossarms. We are considering various options regarding this business. See above and below and Note 10 of “Notes to the Consolidated Financial Statements” included in Item 8 of Part II of this Annual Report on Form 10-K.
Driving Demand for Precision Optics.
Through our QED subsidiary, we develop and provide products for demanding polishing applications for precision optics, and QED continues to be the technology leader in deterministic finishing in the industry. QED’s polishing and metrology technology enables customers to replace manual processes with automated solutions that provide more precise and repeatable results.
We believe the semiconductor industry continues to exhibit various trends. Demand within the semiconductor industry is driven by MIDs, personal computers (PCs), and a wide range of other electronic applications including high-performance computing and artificial intelligence. The semiconductor industry has shown fluctuation in the overall industry demand, as a result of numerous factors, including changing mix of demand drivers, semiconductor fab utilization, pressure to reduce costs, and slower pace of technology advancement.
We have discussed the significant shift in semiconductor industry demand over the past several years from IC devices for PCs to MIDs. Demand for MIDs is largely consumer-based, versus more enterprise-based demand for PCs, and this shift introduced fluctuations in semiconductor industry demand, along with various macroeconomic and geopolitical conditions. There are several factors that could drive future industry growth, such as the: ongoing transition from traditional planar, or 2D, memory to advanced 3D memory for mobile, server, and PC applications; expected need for advanced semiconductor devices for high performance computing, virtual and augmented reality, smart phone applications, artificial intelligence, and 5G; demand for greater connectivity with wearables, peripherals, and the internet of things; increased semiconductor content in automobiles; and semiconductor industry development in China. While demand conditions may fluctuate, and periodically be softer, which we experienced in fiscal year 2019, we continue to believe that semiconductor industry demand will grow over the long term based on increased usage of IC devices in existing applications, as well as future applications.
Over the past several years, we have seen the customer base within the semiconductor industry consolidate as larger semiconductor manufacturers have generally grown faster than smaller ones, through mergers and acquisitions as well as through alliances among and between different companies. Costs to achieve the required scale in manufacturing within the semiconductor industry continue to rise, along with the related costs of research and development, and larger manufacturers generally have greater access to the resources necessary to manage their businesses. This trend is particularly evident in capital spending within the industry, as the largest semiconductor companies account for an increasingly large portion of total capital spending in the industry compared to the past.
As demand for more advanced and lower cost electronic devices grows, there is continued pressure on IC device manufacturers to reduce their costs. Many manufacturers reduce costs by pursuing ever-increasing scale in their operations, while seeking to reduce their production costs by increasing their production yields, regardless of their scale. Thus, they look for electronic materials products, such as CMP consumables and electronic chemicals products, with quality and performance attributes that can help them reduce their overall cost of ownership, pursue ways to use smaller amounts of CMP materials, and aggressively pursue price reductions for these materials. Electronic chemicals products also require increased levels of purity and, like CMP consumables products, lower levels of variation, which contributes to our pursuit of cutting-edge metrology methods to measure purity levels achieved.
Manufacturers also have historically reduced cost, and simultaneously improved device performance, by migrating to smaller technology nodes. However, as the industry continues to shrink dimensions, leading edge technology node transitions are becoming more challenging due to technical and physical obstacles, and the pace of technology change has slowed. To achieve performance and cost improvements, semiconductor manufacturers are placing greater emphasis on new device architectures, including 3D memory and FinFET. Industry commentary suggests that approximately two-thirds of the NAND market has been converted to 3D memory, and while the industry transition is almost complete, we expect additional incremental volume in the memory area associated with more vertical layers. In addition, while during our fiscal 2019 the semiconductor industry experienced weakness in overall DRAM and NAND demand that led to what we believe is a short-term reduction in wafer starts, industry expectations remain that overall demand for these devices, and the related need for increased wafer starts, should continue in the coming years. We believe semiconductor manufacturers will continue to depend upon highly engineered materials in these new architectures, requiring innovative CMP solutions. Further, as wafer starts and the subsequent number of processing steps used on each wafer continue to grow, we see the demand for our high purity electronic chemicals products as also likely to increase.
ELECTRONIC MATERIALS DEMAND
Demand for our CMP consumables and electronic chemicals products is primarily driven by wafer starts, so the electronic materials sector reflects semiconductor industry demand patterns in terms of growth, cyclicality and seasonality and varying demand for specific device types. Consistent with other participants in the semiconductor industry, we have experienced relatively soft demand conditions in the semiconductor industry starting in our second fiscal quarter of 2019 and continuing past the end of the fiscal year, although some signs of stabilization are becoming apparent. Over the long term, we anticipate worldwide demand for CMP consumables and electronic chemicals used by IC device manufacturers will grow as a result of expected long-term growth in wafer starts, and the trend to more advanced technologies. With respect to CMP consumables, we believe there will continue to be an associated increase in the number of CMP polishing steps required to produce these advanced devices, and the introduction of new materials that are expected to require CMP. With respect to electronic chemicals, we believe there will be increasing demand as customers are requiring a higher level of purity, which requires an increasing number of processing steps used on each wafer. In addition, as customers introduce smaller technology nodes and new architectures, they require higher purity chemicals with fewer and fewer impurities.
We expect the anticipated long-term growth in demand will be partially mitigated by continued efficiency improvements in electronic materials usage as customers seek to reduce their costs. As discussed above, semiconductor manufacturers look for ways to lower the cost of CMP consumables and electronic chemicals in their production operations. As an example, for CMP consumables, these can include customer improvements in technology, dilution of slurry, use of concentrated slurry products, or reduction of slurry flow rate, to reduce the total amount of slurry used, and to extend pad life. In addition, CMP demand also depends upon the specific mix of IC device demand, since the intensity of CMP usage varies by IC device type.
We believe that CMP technical solutions are becoming more complex, with advanced technologies generally requiring greater customization of CMP slurry products by customer, tool set and process integration approach. As a result, we generally see customers selecting suppliers earlier in their development processes and maintaining preferred supplier relationships through production. Therefore, we believe that close collaboration with our customers early in the development cycle offers the best opportunity for optimal CMP solutions. We also believe that research and development programs with customers and suppliers continue to be vital to our success as we develop and commercialize innovative, high-performing and more cost-effective CMP solutions.
PERFORMANCE MATERIALS DEMAND
Pipeline Products and Services
Demand for our pipeline performance products and services may be impacted by changes in the utilities and/or oil and gas industries. Volatility in oil and natural gas prices may impact our customers’ activity levels, including production and spending on our pipeline products and services. Expectations about future prices and price volatility are important in determining future spending levels for customers of our pipeline performance products and services. Historically, worldwide oil and natural gas prices and markets have been volatile and may continue to be so in the future. Prices for oil and natural gas are subject to wide fluctuations in response to relatively minor changes in the supply of and demand for oil and natural gas, market uncertainty, and a variety of additional factors that are beyond our control. These factors include, but are not limited to, increases in supplies from United States shale production, international political conditions, including uprisings and political unrest, sovereign debt crises, the domestic and foreign supply of oil and natural gas, the level of consumer demand due to economic growth in countries such as China, weather conditions, domestic and foreign governmental regulations and taxes, the price and availability of alternative fuels, the health of international economic and credit markets, the ability of the members of the Organization of Petroleum Exporting Countries and other state-controlled oil companies to agree upon and maintain oil price and production controls, and general economic conditions.
Demand for our wood treatment preservative products, which are used to treat and preserve wood from insect damage and decay, is driven by our customers’ demand for utility poles and railroad crossarms, which may be impacted by factors such as infrastructure improvement projects and weather-related events. See above and below, and Note 10 of “Notes to the Consolidated Financial Statements” included in Item 8 of Part II of this Annual Report on Form 10-K, regarding our decision to cease future investment in the wood treatment business and to not construct a new production facility to replace operations in Matamoros and Tuscaloosa.
Demand for products produced by our QED subsidiary may be impacted by changes in the underlying industries that utilize precision optics, such as semiconductor equipment, aerospace, defense, research, biomedical and digital imaging. Since our primary QED business is the sale of capital equipment, our results may be directly affected by levels of capital spending in these industries. Historically, capital spending is very cyclical, and is impacted by several different factors. These factors include general macroeconomic conditions, government spending and policies, as well as industry-specific trends and dynamics.
We compete in the semiconductor industry, which is characterized by advances in technology and demanding requirements for product quality and consistency, and lower cost of ownership. We face competition from other suppliers of electronic materials. However, as to our CMP consumables business, we believe we are the world’s leading supplier of CMP slurries, and the second largest provider of CMP pads. We believe we continue to be well-positioned to retain and grow our business, and that we have the experience, scale, capabilities and infrastructure that are required for success, as we continue to work closely with technology-leading customers in the semiconductor industry to meet their growing expectations as a trusted business partner.
Our CMP slurry competitors range from small companies that compete with a single product or in a single geographic region, to divisions of global companies with multiple lines of CMP products. 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 solutions for all major applications, with a proven track record of supplying these products globally in high volumes with the requisite high level of technical support services.
With respect to CMP polishing pads, a division of DowDuPont has held the leading position in this area for many years. Several other companies also participate in this area of the CMP consumables business. We believe that our distinctive portfolio of pad technology and products enables us to meet our customers' needs for improved defectivity, greater pad consistency, and longer pad life. In addition, we believe that our full array of polishing pads offerings enables us to better serve our customers on a global basis, including our performance-differentiated slurry and pad consumable sets.
As to electronic chemicals, there are various competitors with whom we compete in different regions. In North America, we believe that we have a significant leadership position, and our principal competitors include Honeywell, Kanto Corporation and Avantor. Outside of the United States, other providers in Europe are BASF, Technic and Honeywell, and in Asia, BASF and Kanto Corporation, among others. We believe our business in Europe is comparable to other providers, and other than in Singapore, at present we do not participate materially in the business in Asia.
In our pipeline performance business, LiquidPower Specialty Products Inc. holds the leading position in DRAs, with Baker Hughes as the other primary provider. For our valve products and services, however, participants include numerous other businesses with none appearing to hold a leadership position.
With respect to our wood treatment business, penta products are and must be registered prior to sale under United States law. See Item 3 of this Annual Report on Form 10-K. As a condition to registration, any company wishing to manufacture and sell these products must provide substantial scientific research and testing data regarding the chemistry and toxicology of the products to the U.S. Environmental Protection Agency (“EPA”). This data must be generated by the applicant, or the applicant must purchase access to the information from other data providers. We believe that the cost of satisfying the data submission requirement serves as an impediment to the entry of new competitors, particularly those with lesser financial resources. While we have no reason to believe that the product registration requirement will be materially modified, we cannot give any assurances as to the effect of such a discontinuation or modification on our business or competitive position.
Our QED subsidiary operates in the precision optics industry. There are few direct competitors of QED and we believe its technology is unique and provides a competitive advantage to customers in the precision optics industry, which still relies heavily on traditional artisanal methods of fabrication.
CUSTOMERS, SALES, AND MARKETING
Within the semiconductor industry, our customers are generally producers of logic or memory IC devices, or providers of IC foundry services. Some logic customers, and so-called "fabless" companies, outsource some or all the production of their devices to foundries, which provide contract manufacturing services, in order to avoid the high cost of process development, construction and operation of a fab, or to provide additional capacity when needed.
We believe the primary influences of our customers' electronic materials buying decisions are: overall cost of ownership, which represents the cost to purchase, use and maintain a product; product quality and consistency; product performance and its impact on a customer's overall yield; engineering support; and, supply assurance. We believe that greater customer expertise within the processes that utilize our CMP consumables and electronic chemicals, more challenging integration schemes, additional and unique polishing materials, and cost pressures will continue to increase demands on suppliers like us.
We use a collaborative approach to build close relationships with our customers in a variety of areas, and we have customer-focused teams in each major geographic region. Our sales process begins long before the actual sale of our products and occurs on numerous levels. Due to the long lead times from research and development to product commercialization and sales, we have research teams that collaborate with technology-leading customers on emerging applications years before the products are required by the market. For CMP consumables, we also have development teams that interact closely with these customers, using our research and development facilities and capabilities to design products tailored to their needs. Next, our applications engineers work with customers to integrate our products into their manufacturing processes. Finally, as part of our sales process, our logistics and sales personnel provide supply, warehouse and inventory management services for our customers, which is also the case for our electronic chemicals customers.
We market our CMP slurry and pad products primarily through direct sales to our customers, although we use distributors in certain areas. We believe this strategy of primarily direct sales provides us an additional means to collaborate with our customers and provides our customers with the most efficient means by which to procure our products.
For our electronic chemicals products, we market through a combination of an internal sales force and distributors organized by geographic region.
Pipeline Products and Services
Through our Flowchem subsidiary, we provide DRAs to several major mid-stream pipeline transmission companies both domestically and internationally. We have a U.S.-based and global sales team, a wholly-owned transportation and logistics company and a network of distributors and agents to manage the sales and delivery of our products. Our main marketing approach is through our membership in industry-based professional organizations, trade shows and publications.
In our Valve Products & Services business, we market and sell to pipeline and adjacent industry customers, such as service companies, and major utility distribution companies via direct sales and channel partners. We actively participate as industry experts in global industry trade shows and forums through technical presentations and white papers.
The principal wood preserving chemicals for industrial applications are penta, which is the base for our products, creosote and chromated copper arsenate, or CCA. We only supply penta to customers in the United States and Canada. We do not have other products or business. We are the only manufacturer of penta-based preservatives in North America. Penta is used primarily to treat electric, telephone and other utility poles, to protect them from insect damage and decay, thus extending their useful life by many years. We estimate that approximately two million treated wood utility poles are purchased each year by utility companies in the United States. Of that amount, we estimate approximately 50% are treated with penta. The remaining poles are treated primarily with creosote or CCA.
Our QED subsidiary supports customers in the semiconductor equipment, aerospace, defense, research, biomedical, and digital imaging industries. QED counts among its worldwide customers leading precision optics manufacturers, major semiconductor original equipment manufacturers, research institutions, and contractors to the United States and other governments.
For additional information on our customers, refer to Note 2 of “Notes to the Consolidated Financial Statements” included in Item 8 of Part II of this Annual Report on Form 10-K.
RESEARCH, DEVELOPMENT AND TECHNICAL
We believe that technology is vital to success in our businesses, primarily in the area of CMP consumables, and we plan to continue to devote significant resources to research, development and technical support (“R&D”), and balance our efforts between shorter and longer-term industry needs. Here, we focus our R&D efforts on product innovation at leading-edge applications for our technology-leading customers. We develop new and enhanced CMP solutions tailored to these customers' requirements using our expertise in chemical formulation, materials science, product engineering and manufacturing technology. We work closely with these customers at their facilities to identify their specific technology and manufacturing challenges and to translate these challenges into viable CMP process solutions.
Our Research, development and technical efforts are focused on the areas of research related to fundamental CMP technology; development of new and enhanced CMP consumables products, including collaboration on joint development projects with technology-leading customers and suppliers; process development to support rapid and effective commercialization of new products; technical support of our CMP products in our customers’ research, development and manufacturing facilities; and, development of polishing and metrology application outside of the semiconductor industry.
Our research in CMP slurries and pads addresses a breadth of complex and interrelated performance criteria that relate to the functional performance of IC devices, our customers' manufacturing yields, and their overall cost of ownership. We design slurries and pads that are capable of polishing one or more materials of differing hardness, sometimes at the same time, that comprise the semiconductor circuitry. In addition, our slurries and pads products must achieve the desired surface conditions at high polishing rates, high processing yields and low consumables costs in order to provide acceptable cost of ownership for our customers. Meanwhile, our electronic chemicals products are subject to increased high purity demand to enable more advanced technology nodes and increase yields. These market expectations require us to continue to develop industry leading metrology methods in order to measure the purity levels achieved. As technology advances and materials and designs increase in complexity, these challenges require significant investments in R&D.
We believe that our technology provides us with a competitive advantage, and that our investments in R&D provide us with polishing and metrology capabilities that support the most advanced and challenging customer technology requirements.
Our global R&D team includes experts from the semiconductor industry and scientists from key disciplines required for the development of high-performance CMP consumable products. We operate an R&D facility in Aurora, Illinois, that features a Class 1 clean room and advanced equipment for product development, including 300mm polishing and metrology capabilities;; a facility in Taiwan that includes a clean room with 200mm polishing capability; a facility in South Korea that provides slurry formulation capability and 300mm polishing capability; and, an R&D laboratory in Singapore that provides polishing, metrology and slurry development capabilities for the data storage industry. We also operate R&D facilities in the United States, Europe, and Singapore pertaining to our electronic chemicals business. Our slurry, pads, and electronic chemicals facilities underscore our commitment to continuing to invest in our technology infrastructure to maintain our technology leadership and to be responsive to the needs of our customers.
For our pipeline performance products, in our Flowchem business, we employ several resources and facilities to perform research and development activities. We focus on both improving existing product performance as well as developing new products/technologies to serve our customers’ needs for DRAs.
We also commit R&D resources to our QED subsidiary. These activities are primarily focused on the development of new polishing and metrology capabilities, in support of our MRF and SSI product lines, as well as additional capabilities for our polishing services group. This work is done in our facilities in Rochester, New York.
RAW MATERIALS SUPPLY
Engineered abrasive particles are significant raw materials we use in many of our CMP slurries and pads. Our strategy is to secure various sources of different raw materials, as appropriate, to enable the desired performance of our products, and monitor those sources as necessary to provide supply assurance. Also, we have entered into multi-year supply agreements with several suppliers for the purchase of raw materials in the interest of supply assurance and to control costs. For additional information regarding these agreements, refer to "Tabular Disclosure of Contractual Obligations", included in "Management's Discussion and Analysis of Financial Condition and Results of Operations," in Item 7 of Part II of this Annual Report on Form 10-K. In our electronic chemicals business, we rely on a variety of suppliers for our raw materials, some of which we purchase on open account and others which we purchase under supply contracts. The number of suppliers is often limited, particularly as to the specific grade of raw material required by us to supply high purity products to our customers.
For both our pipeline performance products and our wood treatment products, we depend on outside suppliers for all the raw materials needed to produce our products and are subject to fluctuations in the price of those materials. We purchase raw materials for these businesses from a limited number of suppliers. Most of our QED subsidiary’s business relates to capital equipment, thus, there are minimal raw material supply issues that we face within this business unit.
We believe our intellectual property is important to our success and ability to compete, and we also differentiate our products and technology by their high quality and reliability, and our quality systems, global supply chain and logistics. As of October 31, 2019, we had 1,317 active worldwide patents, of which 284 United States patents, and 357 pending worldwide patent applications, of which 51 are in the United States.
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 businesses. Our patents have a range of duration. We refresh our intellectual property on an ongoing basis through continued innovation. As an example, we have had patent coverage that was important to some of our legacy CMP slurry business and continue to have significant other patents that protect this technology and other legacy and advanced technology with a range of duration. We attempt to protect our intellectual property rights through a combination of patent, trademark, copyright and trade secret laws, use of certain manufacturing technologies, exclusive contractual arrangements with suppliers, and with employee and third party-nondisclosure and assignment agreements. We vigorously protect and defend our intellectual property and have been successful in this regard.
Most of our intellectual property has been developed internally, but we also may acquire intellectual property from others to enhance our intellectual property portfolio. These enhancements may be via licenses or assignments or we may acquire certain proprietary technology and intellectual property when we make acquisitions. We believe these technology rights can enhance our competitive advantage by providing us with future product development opportunities and expanding our intellectual property portfolio.
Our facilities and operations are subject to various environmental, safety, and human health laws and regulations, both at a federal and state or local level, including those relating to air emissions, wastewater discharges, chemical manufacture and distribution, the handling and disposal of solid and hazardous wastes, storage and disposal, and various other occupational safety and health matters. Governmental authorities can to enforce compliance with their regulations, and violators may be subject to civil, criminal, and administrative penalties, injunctions, or both. We believe that our facilities are in substantial compliance with applicable environmental laws and regulations. Our major operations in the United States, Japan, Singapore, South Korea, Taiwan, France, Italy, and the United Kingdom are certified under current ISO 14001 Environmental and OHSAS 18001 Safety and Health standards, which requires that we implement and operate according to various procedures that demonstrate waste reduction, energy conservation, injury reduction and other environmental, health and safety objectives. We have achieved certification under the revised ISO 14001 standards and are now actively pursuing certification under revised OHSAS 18001 standards that will transition to ISO 45001 standards over the next three years. We have incurred, and will continue to incur, capital and operating expenditures and other costs in complying with environmental, safety and health laws and regulations in the United States and other countries in which we do business, but we do not expect these costs will be material. See “Item, 1A. Risk Factors.”, Item 3 “Legal Proceedings”, and Note 20 of “Notes to the Consolidated Financial Statements” included in Item 8 of Part II of this Annual Report on Form 10-K.
We believe our employees are the foundation of our success. As of October 31, 2019, we employed 2,047 individuals, including 1,385 in operations, 249 in research and development and technical, 413 in sales, general and administration. In general, our employees are not covered by collective bargaining agreements, but we do have some workers who are subject to such agreements, part of works councils, or similar arrangements, primarily in Europe, Mexico, Singapore. We have not experienced any work stoppages and consider our relations with our employees to be good.
FINANCIAL INFORMATION ABOUT GEOGRAPHIC AREAS
We sell our products worldwide. We believe our geographic coverage allows us to utilize our business and technical expertise from a diverse, global workforce, strategically located in close proximity to our customers. As a result of the Acquisition, our geographic mix has changed. For example, in fiscal 2019, our North America revenue as a percentage of total revenue has increased from 13% to 36% compared to fiscal 2018. While approximately 50% of our global revenue is still being generated in Asia Pacific, our dependency on revenue from Asia Pacific has decreased as a result of the Acquisition. For more financial information about geographic areas, see Note 23 of “Notes to the Consolidated Financial Statements” included in Item 8 of Part II of this Annual Report on Form 10-K.
Our Electronic Materials business experiences some seasonality, mostly related to fluctuations in consumer demand for MID’s around the December and lunar new year holidays, and back to school periods, but over the past several years seasonality has appeared more muted, tempered by the broader array of factors affecting demand, such as 5G, Cloud computing, and AI. In our Performance Materials business, demand for our pipeline performance products such as DRAs appears to have some seasonality linked to weather, with demand for DRAs increasing in the colder months, yet demand from additional pipeline capacity coming online has made this less apparent.
Our annual reports on Form 10-K, quarterly reports on Form 10-Q, definitive proxy statements on Schedule 14A, current reports on Form 8-K, and any amendments to those reports, as well as any other filings with the SEC, 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 regarding beneficial ownership of our securities by our executive officers and directors are made available on our Company website following the filing of such with the SEC. In addition, the SEC's website (http://www.sec.gov) contains reports, proxy statements, and other information that we file electronically with the SEC.
ITEM 1A. RISK FACTORS
RISKS RELATING TO OUR BUSINESS
DEMAND FOR OUR PRODUCTS FLUCTUATES AND OUR BUSINESS MAY BE ADVERSELY AFFECTED BY WORLDWIDE ECONOMIC AND INDUSTRY CONDITIONS
Our business is affected by economic and industry conditions and the majority of our revenue derives from our Electronic Materials segment, which is primarily dependent upon semiconductor industry demand. With respect to our Electronic Materials segment, historically, semiconductor industry demand has fluctuated due to economic and industry cycles and seasonal shifts in demand, which can affect our business, causing demand for our electronic materials products to fluctuate. For example, we have experienced relatively soft demand conditions in the semiconductor industry starting in our second fiscal quarter of 2019 and continuing past the end of the fiscal year, although some signs of stabilization are becoming apparent. Previously, we had experienced the strengthening of demand conditions in the semiconductor industry from the second half of fiscal 2016 through fiscal 2018, following relatively soft demand conditions during the first half of fiscal 2016. Furthermore, competitive dynamics within the semiconductor industry may impact our business. Our limited visibility to future customer orders makes it difficult for us to predict industry trends. If the global economy or the semiconductor industry weakens, whether in general or as a result of specific factors, such as macroeconomic factors, or unpredictable events such as natural disasters or geopolitical events, we could experience material adverse impacts on our results of operations and financial condition. Some additional factors that may affect demand for our electronic materials products include: demand trends for different types of electronic devices, such as logic versus memory IC devices, or digital versus analog IC devices; the various technology nodes at which those products are manufactured; customers' efficiencies in the use of CMP consumables and/or high-purity process chemicals (“electronic chemicals”); customers' device architectures and specific manufacturing processes; the short order to delivery time for our products; quarter-to-quarter changes in customer order patterns; market share and competitive gains and losses; and pricing changes by us and our competitors.
As to our Performance Materials segment, which continues to be an area of potential continued growth for us, our business may be impacted by changes in the utilities and/or oil and gas industries. Volatility in oil and natural gas prices may impact our customers’ activity levels, including production, and spending on our performance materials products and services. Expectations about future prices and price volatility are important in determining future spending levels for customers of our pipeline performance products and services. Historically, worldwide oil and natural gas prices and markets have been volatile, and may continue to be so in the future. Prices for oil and natural gas are subject to wide fluctuations in response to relatively minor changes in the supply of and demand for oil and natural gas, market uncertainty and a variety of additional factors that are beyond our control. These factors include, but are not limited to, increases in supplies from U.S. shale production, international political conditions, including uprisings and political unrest, sovereign debt crises, the domestic and foreign supply of oil and natural gas, the level of consumer demand due to economic growth in countries such as China, weather conditions, domestic and foreign governmental regulations and taxes, the price and availability of alternative fuels, the health of international economic and credit markets, the ability of the members of the Organization of Petroleum Exporting Countries and other state-controlled oil companies to agree upon and maintain oil price and production controls, and general economic conditions.
Further, adverse global economic and industry conditions could have other negative effects on our Company. For instance, we could experience negative impacts on cash flows due to the inability of our customers to pay their obligations to us, or our production processes could be harmed if our suppliers cannot fulfill their obligations to us. As a result of these or other conditions, we also might have to reduce the carrying value of goodwill and other intangible assets, which could harm our financial position and results of operations.
WE MAY PURSUE ACQUISITIONS OF, INVESTMENTS IN, AND MERGERS OR STRATEGIC ALLIANCES WITH OTHER ENTITIES, WHICH COULD DISRUPT OUR OPERATIONS AND HARM OUR OPERATING RESULTS IF THEY ARE UNSUCCESSFUL, OR WE MAY ENCOUNTER UNANTICIPATED ISSUES IN IMPLEMENTING THEM
We expect to continue to make investments in technologies, assets and companies, either through acquisitions, mergers, investments or alliances, in order to supplement our organic growth and development efforts. Acquisitions, mergers, and investments, including our acquisitions of KMG, which we completed in November 2018, and NexPlanar, which we completed in October 2015, involve numerous risks, including the following: difficulties and risks in integrating the operations, technologies, products and personnel of acquired companies; difficulties and risks from unanticipated issues arising subsequent to a transaction related to the other entity; potential disruption of relationships with third parties such as customers or suppliers; diversion of management's attention from normal daily operations of the business; increased risk associated with foreign operations; potential difficulties and risks in entering markets or industries in which we have limited or no direct prior experience and/or where competitors have stronger positions; potential difficulties and unexpected situations arising in operating new businesses with different business models; facilities and operations; potential difficulties with regulatory or contract compliance in areas in which we have limited or no experience; 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 or merger with, or asset or other acquisition of, or investments in, other entities. Transactions such as our acquisitions of KMG and NexPlanar could and in some cases have had negative effects on our results of operations, in areas such as contingent liabilities, gross margins, amortization charges related to intangible assets and other effects of accounting for the purchases of other business entities. Investments in and acquisitions of technology-related companies or assets are inherently risky because these businesses or assets may never develop, and we may incur losses related to these investments.
In addition, we may be required to impair the carrying value of these acquisitions or investments to reflect other than temporary declines in their value. The carrying value of goodwill represents the fair value of acquired businesses in excess of identifiable assets and liabilities as of the acquisition date. The carrying value of other intangible assets represents the fair value of customer relationships, tradenames and other acquired intangible assets as of the acquisition date. Goodwill and other acquired intangible assets expected to contribute indefinitely to our cash flows are not amortized, but must be evaluated for impairment by management at least annually. If the carrying value exceeds the implied fair value of goodwill, the goodwill is considered impaired and is reduced to fair value via a non-cash charge to earnings. If the carrying value of an indefinite-lived intangible asset is greater than its fair value, the intangible asset is considered impaired and is reduced to fair value via a non-cash charge to earnings. If the value of goodwill or other acquired intangible assets is impaired, our results of operations and financial condition could be adversely affected. Examples of asset impairment charges we recently incurred include the charge we took in the fourth quarter of fiscal year 2019 related to the KMG wood treatment business. Absent a sale of the wood treatment business, as we approach the announced closure date of the Matamoros and Tuscaloosa facilities and there are fewer estimated future cash flows, there is ongoing potential for further impairments of long-lived assets and impairment of goodwill. While the timing and amounts of any further impairments are unknown, our results of operations and financial condition could be adversely affected. See Notes 9 and 10 of “Notes to the Consolidated Financial Statements” included in Item 8 of Part II of this Annual Report on Form 10-K for a more detailed discussion of this impairment.
Furthermore, the integration of the recently acquired KMG business into our operations is a complex and time-consuming process that may not be successful. Our Company has a limited history of integrating a significant acquisition into its business and the process of integration may produce unforeseen operating difficulties and expenditures. The primary areas of focus for successfully combining the business of KMG with our operations may include and has included, among others: retaining and integrating key employees; realizing synergies; aligning customer and supplier interface, and operations across the combined business; integrating enterprise resource planning and other information technology systems; and managing the growth of the combined company. Even if we successfully integrate the business of KMG into our operations, there can be no assurance that we will realize the anticipated benefits of the Acquisition.
WE HAVE A CONCENTRATED PRODUCT RANGE WITHIN EACH OF OUR SEGMENTS AND OUR PRODUCTS MAY BECOME OBSOLETE, OR TECHNOLOGICAL CHANGES MAY REDUCE OR LIMIT INCREASES IN THE CONSUMPTION OF OUR PRODUCTS
Although our product offerings have expanded with the Acquisition, our business remains substantially dependent on products in our Electronic Materials segment, such as CMP slurries, pads and electronic chemicals, which account for the majority of our revenue. We have identified our Performance Materials segment as another area of potential continued growth and the product offerings in our Performance Materials segment are similarly concentrated. As such, 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 industries in which we operate, particularly the semiconductor industry, and to adapt, improve and customize our products in response to evolving customer needs and industry trends. Since its inception, the semiconductor industry, which is the largest industry in which we operate, has experienced technological changes and advances in the design, manufacture, performance and application of IC devices. Our customers continually pursue lower cost of ownership and higher quality and performance of materials consumed in their manufacturing processes, including CMP slurries and pads and electronic chemicals, as a means to reduce costs, increase the yield in their manufacturing facilities, and achieve desired performance of the IC devices they produce. We expect these technological changes, and this drive toward lower costs, higher quality and performance and higher yields, will continue in the future. Potential technology developments in the semiconductor industry, as well as our customers' efforts to reduce consumption of CMP consumables, including through use of smaller quantities, 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 THESE CUSTOMERS OR BUSINESS FROM THEM
Our customer base is concentrated among a limited number of large customers in each of our segments. Currently, our principal business is to supply electronic materials primarily to the semiconductor industry. The semiconductor industry has been consolidating as the larger semiconductor manufacturers have generally grown faster than the smaller ones, through business gains, mergers and acquisitions, and strategic alliances. Industry analysts predict that this trend will continue, which means the semiconductor industry will continue to be comprised of fewer and larger participants in the future if their prediction is correct. In addition, our customer base in our pipeline-related businesses is also somewhat concentrated, with large entities predominant, and outside of the United States, these entities frequently are state-owned or sponsored, and limited in number per country, as described more above. One or more of these principal customers could stop buying products from us or could substantially reduce the quantity of products purchased from us. Our principal customers in both of our segments also hold considerable purchasing power, which can impact the pricing and terms of sale of our products. Any deferral or significant reduction in the quantity or price of products sold to these principal customers could seriously harm our business, financial condition and results of operations.
ANY PROBLEM OR DISRUPTION IN OUR SUPPLY CHAIN, INCLUDING SUPPLY OF OUR MOST IMPORTANT RAW MATERIALS, OR IN OUR ABILITY TO MANUFACTURE OR DELIVER OUR PRODUCTS TO OUR CUSTOMERS, COULD ADVERSELY AFFECT OUR RESULTS OF OPERATIONS
We depend on our supply chain to enable us to meet the demands of our customers. Our supply chain includes the raw materials we use to manufacture our products, our production operations and the means by which we deliver our products to our customers. Our business could be adversely affected by any problem or interruption in the supply of the key raw materials we use in our products, including raw materials that do not meet the stringent quality and consistency requirements of our customers, any problem or interruption that may occur during production or delivery of our products, such as weather-related problems, natural disasters, or geopolitical, trade or labor-related issues, or any difficulty in producing sufficient quantities of our products to meet growing demand from our customers. In particular, severe weather conditions have the potential to adversely affect our operations, damage facilities and increase our costs, and those conditions may also have an indirect effect on our operations by disrupting services provided by service companies or suppliers with whom we have a business relationship. Additionally, some of our full-time employees are represented by labor unions, works councils or comparable organizations, particularly in Mexico and Europe. As our current agreements expire, we cannot provide assurance that new agreements will be reached at the end of each period without union action, or that a new agreement will be reached on terms satisfactory to us. An extended work stoppage, slowdown or other action by our employees could significantly disrupt our business. Future labor contracts may be on terms that result in higher labor costs to us, which also could adversely affect our results of operations. Our supply chain may also be negatively impacted by unanticipated price increases due to supply restrictions beyond the control of our Company or our raw materials suppliers.
We believe it would be difficult to promptly secure alternative sources of key raw materials 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 us and our customers. In addition, new contract terms, forced production or manufacturing changes, contractual amendments to existing agreements with, or non-performance by, our suppliers, including any significant financial distress our suppliers may suffer, could adversely affect us. Also, if we change the supplier or type of key raw materials we use to make our products, in particular our electronic materials products, 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 products for their manufacturing processes and products. The requalification process could take a significant amount of time and expense to complete and could occupy technical resources of our customers that might otherwise be used to evaluate our new products, thus delaying potential revenue growth, or motivate our customers to consider purchasing products from our competitors, possibly interrupting or reducing our sales of products to these customers, especially sales of our electronic materials products to our semiconductor industry customers, but also with respect to our pipeline performance products to our pipeline and adjacent industry customers.
OUR BUSINESS COULD BE SERIOUSLY HARMED IF OUR COMPETITORS DEVELOP COMPETITIVE PRODUCTS, OFFER BETTER PRICING, SERVICE OR OTHER TERMS, OR OBTAIN OR ASSERT CERTAIN INTELLECTUAL PROPERTY RIGHTS
Competition from other electronic materials or performance materials manufacturers or any new entrants could seriously harm our business and results of operations, and this competition could continue to increase. Competition has and will likely continue to impact the prices we are able to charge for our products, as well as our overall business. In addition, our competitors could have, obtain or assert intellectual property rights that could affect or restrict our ability to market our existing products and/or to innovate and develop new products, thus increasing our costs of doing business, could attempt to introduce products similar to ours following the expiration of our patents, or could attempt to introduce products that do not fall within the scope of our intellectual property rights.
WE ARE SUBJECT TO RISKS ASSOCIATED WITH OUR FOREIGN OPERATIONS
We currently have operations and a large customer base outside of the United States. Approximately 64% of our revenue was generated by sales to customers outside of the United States for the full fiscal year ended September 30, 2019. We may encounter risks in doing business in certain foreign countries, including, but not limited to, adverse changes in economic and political conditions, both in foreign locations and in the United States with respect to non-U.S. operations of U.S. businesses like ours, geopolitical and/or trade tensions, fluctuation in exchange rates, changes in international trade requirements and sanctions and/or tariffs that affect our business and that of our customers and suppliers, compliance with a variety of foreign laws and regulations and related audits and investigations, as well as difficulty in enforcing business and customer contracts and agreements, including protection of intellectual property rights. We also may encounter risks that we may not be able to repatriate additional earnings from our foreign operations, derive anticipated tax benefits of our foreign operations or recover the investments made in our foreign operations, whether due to regulatory or policy changes in the U.S. or in the countries outside of the U.S. in which we do business, or other factors.
In particular, China continues to be a fast-developing market for the semiconductor industry, and an area of potential growth for us. As business volume between China and the rest of the world continues to grow, there is risk that geopolitical, regulatory, trade and political matters could adversely affect business for companies like ours based on the complex relationships among China, the United States, and other countries in the Asia Pacific region or elsewhere, which could have a material adverse impact on our business. In addition, there are risks that the Chinese government may, among other things, require the use of local suppliers, compel companies that do business in China to partner with local companies to conduct business, or, provide incentives to government-backed local customers to buy from local suppliers rather than companies like ours, all of which could adversely impact our business, including our results of operations.
In addition, we have operations and customers located in the United Kingdom, where voters have approved an exit from the European Union (“Brexit”), which is supposed to occur by January 31, 2020. The United Kingdom and the European Union have agreed to operate under transitional provisions under which most European Union law would remain in force in the United Kingdom until the end of December 2020, however, this transitional period remains subject to the successful conclusion of a final withdrawal agreement between the parties. In the absence of such an agreement, there would be no transitional provisions and a “hard” Brexit would occur. Although it is unknown what the terms of such an agreement, assuming it is reached, will be, it is possible that there will be greater restrictions on imports and exports between the United Kingdom and European Union countries, a fluctuation in currency exchange rates and increased regulatory complexities. These changes may adversely affect our operations and financial results. While such changes in laws, regulations and conditions have not had a material adverse effect on our business or financial condition to date, we cannot provide assurances regarding the future effect of any such changes.
WE ARE SUBJECT TO EXTENSIVE ENVIRONMENTAL LAWS AND REGULATIONS AND MAY INCUR COSTS THAT HAVE AN ADVERSE EFFECT ON OUR FINANCIAL CONDITION AS A RESULT OF VIOLATIONS OF OR LIABILITIES UNDER THEM
Like other companies involved in environmentally sensitive businesses, our operations and properties are subject to extensive and stringent federal, state, local and foreign environmental, health and safety (EHS) laws and regulations, including those concerning, among other things:
• the marketing, sale, use and registration of our chemical products, such as pentachlorophenol (“penta”), which is part of the wood treatment business in our Performance Materials segment;
• the treatment, storage and disposal of wastes;
• the investigation and remediation of contaminated media including but not limited to soil and groundwater;
• the discharge of effluents into waterways;
• the emission of substances into the air; and
• other matters relating to environmental protection and various health and safety matters.
The EPA and other federal and state agencies in the United States, as well as comparable agencies in other countries where we have facilities or sell our products, have the authority to promulgate regulations that could have a material adverse impact on our operations. These EHS laws and regulations may require permits for certain types of operations, require the installation of expensive pollution control equipment, place restrictions upon operations or impose substantial liability for pollution and other EHS concerns resulting from our operations. Compliance with EHS laws and regulations has resulted in ongoing costs for us and could restrict our ability to modify or expand our facilities, continue production, require us to install costly pollution control equipment, or incur significant other expenses, including remediation costs. We are currently involved in investigation and remediation activities at certain sites, such as at KMG-Bernuth's Tuscaloosa, Alabama facility as described in Note 10 of “Notes to the Consolidated Financial Statements” included in Item 8 of Part II of this Annual Report on Form 10-K. We have incurred, and expect to continue to incur, significant costs to comply with EHS laws or to address liabilities for contamination resulting from past or present operations. Federal, state and foreign governmental authorities may seek fines and penalties, as well as injunctive relief, for violation of EHS laws and regulations, and could, among other things, impose liability on us to cleanup or mitigate environmental, natural resources or other damages resulting from a release of pesticides, hazardous materials or other chemicals into the environment. We maintain insurance coverage for sudden and accidental environmental damages. We do not believe that insurance coverage for environmental damage that occurs over time is available at a reasonable cost. Also, we do not believe that insurance coverage for the full potential liability that could be caused by sudden and accidental incidences is available at a reasonable cost. Accordingly, we may be subject to an uninsured or under-insured loss in such cases; although unknown at present, the KMG-Bernuth warehouse fire may be such an instance.
The distribution, sale and use of our products is subject to prior governmental approvals and thereafter ongoing governmental regulation: Our products are subject to laws administered by federal, state and foreign governments, including regulations requiring registration, approval and labeling. The labeling requirements restrict the use and type of application for our products. More stringent restrictions could make our products less desirable which would adversely affect our sales and profitability. All venues where our penta products are used also require registration prior to marketing or use.
Governmental regulatory authorities have required, and may require in the future, that certain scientific testing and data production be provided on our products. Under the Federal Insecticide, Fungicide and Rodenticide Act (“FIFRA”), EPA requires registrants to submit a wide range of scientific data to support U.S. registrations. This requirement significantly increases our operating expenses, and we expect those expenses will continue in the future. Because scientific analyses are constantly improving, we cannot determine with certainty whether or not new or additional tests may be required by regulatory authorities. While good laboratory practice standards specify the minimum practices and procedures that must be followed in order to ensure the quality and integrity of data related to these tests submitted to the EPA, there can be no assurance that the EPA will not request certain tests or studies be repeated. In addition, more stringent legislation or requirements may be imposed in the future. Recent changes to the Toxic Substances Control Act (“TSCA”) could result in increased regulation and required testing of chemicals we manufacture and could increase the costs of compliance for our operations. We can provide no assurance that the cost of such compliance will not adversely affect our profitability. Our products could also be subject to other future regulatory action that may result in restricting or completely banning their use which could have an adverse effect on our performance and results of operations.
1. The Registration, Evaluation and Authorization of Chemicals (“REACH”) legislation may affect our ability to manufacture and sell certain products in the European Union: REACH requires chemical manufacturers and importers in the European Union to prove the safety of their products. We were required to pre-register certain products and file comprehensive reports, including testing data, on each chemical substance, and perform chemical safety assessments. Additionally, substances of high concern are subject to an authorization process. Authorization may result in restrictions on certain uses of products or even prohibitions on the manufacture or importation of products. The full registration requirements of REACH are phased in over several years. We will incur additional expense to cause the registration of our products under these regulations. REACH may also affect our ability to import, manufacture and sell certain products in the European Union. In addition, other countries and regions of the world already have or may adopt legislation similar to REACH that affect our business, affect our ability to import, manufacture or sell certain products in these jurisdictions, and have required or will require us to incur increased costs.
2. The classification of penta as a Persistent Organic Pollutant (“POP”) under the Stockholm Convention may adversely affect our ability to manufacture or sell our penta products: The Conference of the Parties (“COP”) accepted the recommendation of the United Nations Persistent Organic Pollutant Review Committee that the use of penta should be banned except that its use for the treatment of utility poles and crossarms could continue for an extended period of five to ten years. KMG-Bernuth supplies penta to industrial customers who use it primarily to treat utility poles and crossarms. The U.S. is not bound by the determination of the COP because it did not ratify the Stockholm Convention treaty. Canada and Mexico are governed by the treaty. KMG-Bernuth's sole penta manufacturing facility is located in Matamoros, Mexico, and its processing facility is located in Tuscaloosa, Alabama. As a result of the classification of penta as a POP, the Mexican government requires KMG-Bernuth to cease producing penta in Mexico by the end of 2021. In July 2019, KMG-Bernuth had communicated plans to close both the Matamoros and Tuscaloosa facilities by such date and to consolidate into and build a new facility. However, in November 2019, we communicated that we will not build a new facility, and that we intend to explore various options for the wood treatment business. We have taken a restructuring charge and asset impairment charges in our fourth fiscal quarter related to the decision to close the Matamoros and Tuscaloosa facilities and to not build a new plant. No assurance can be given that we will not incur significant expenditures in connection with closing the facilities, or that the ultimate action of the COP and our related decisions will not adversely impact on our financial condition and results of operation.
3. If our products are not re-registered by the EPA or are re-registered subject to new restrictions, our ability to sell our products may be curtailed or significantly limited: KMG-Bernuth's penta product registrations are under continuous review by the EPA under FIFRA. KMG-Bernuth has submitted and will submit a wide range of scientific data to support its U.S. registrations. To satisfy the registration review, KMG-Bernuth is required to demonstrate, among other things, that its products will not cause unreasonable adverse effects on human health or the environment when used according to approved label directions. In September 2008, the EPA announced that it had determined that penta was eligible for re-registration, but the EPA proposed new restrictions on the use of penta that have required KMG-Bernuth's customers to incur substantial additional costs and to revise certain operating procedures. In December 2014, the EPA issued a registration review work plan that required penta registrants to provide additional research and testing data respecting certain potential risks to human health or the environment as a further condition to continued registration. KMG-Bernuth conducted required testing. but cannot tell you when or if the EPA will issue a final decision concluding that the conditions of re-registration for its penta products and all additional testing requirements have been satisfied. We cannot assure you that KMG-Bernuth's products will not be subject to use or labeling restrictions that may have an adverse effect on our financial position and results of operations. The failure of KMG-Bernuth's current or future-acquired products to be re-registered, to satisfy the registration review by the EPA, or the imposition of new use, labeling or other restrictions in connection with re-registration could have an adverse effect on our financial condition and results of operations.
4. Our use of hazardous materials exposes us to potential liabilities: Our manufacturing and distribution of chemical products, such as our electronic chemicals, involves the controlled use of hazardous materials. Our operations, therefore, are subject to various associated risks, including chemical spills, discharges or releases of toxic or hazardous substances or gases, fires, mechanical failure, storage facility leaks and similar events. Our suppliers are subject to similar risks that may adversely impact the availability of raw materials. While we adapt our manufacturing and distribution processes to the environmental control standards of regulatory authorities, we cannot completely eliminate the risk of accidental contamination or injury from hazardous or regulated materials, including injury of our employees, individuals who handle our products or goods treated with our products, or others who claim to have been exposed to our products, nor can we completely eliminate the unanticipated interruption or suspension of operations at our facilities due to such events. We may be held liable for significant damages or fines in the event of contamination or injury, and such assessed damages or fines could have an adverse effect on our financial performance and results of operations.
FUTURE CLIMATE CHANGE REGULATION COULD RESULT IN INCREASED OPERATING COSTS AND REDUCED DEMAND FOR OUR PRODUCTS
Although the U.S. has not ratified the Kyoto Protocol, a number of federal laws related to “greenhouse gas” or “GHG” emissions have been considered by Congress. Because of the lack of any comprehensive legislation program addressing GHGs, the EPA is using its existing regulatory authority to promulgate regulations requiring reduction in GHG emissions from various categories of sources, such as when a permit is required due to emissions of other pollutants. In addition, various state, local and regional regulations and initiatives have been enacted or are being considered related to GHGs.
Member States of the European Union each have an overall cap on emissions, which are approved by the European Commission, and implement the EU Emissions Trading Directive as a commitment to the Kyoto Protocol. Under this Directive, organizations apply to the Member State for an allowance of GHG emissions. These allowances are tradable so as to enable companies that manage to reduce their GHG emissions to sell their excess allowances to companies that are not reaching their emissions objectives. Failure to purchase sufficient allowances will require the purchase of allowances at a current market price.
Any laws or regulations that may be adopted to restrict or reduce emissions of GHGs could cause an increase to our raw material costs, require us to incur increased operating costs, and have an adverse effect on demand for our products and our financial performance and results for our business.
OUR PRODUCTS MAY BE RENDERED OBSOLETE OR LESS ATTRACTIVE BY CHANGES IN INDUSTRY REQUIREMENTS OR BY SUPPLY-CHAIN DRIVEN PRESSURES TO SHIFT TO ENVIRONMENTALLY PREFERABLE ALTERNATIVES
Changes in regulatory, legislative and industry requirements, or changes driven by supply-chain pressures, may shift current customers away from products using penta, products containing hazardous materials, or certain of our other products and toward alternative products that are believed to have fewer environmental effects. The EPA, foreign and state regulators, local governments, private environmental advocacy organizations and a number of large industrial companies have proposed or adopted policies designed to decrease the use of a variety of chemicals, including penta and others included in certain of our products, such as those containing hazardous materials. Our ability to anticipate changes in regulatory, legislative, and industry requirements, or changes driven by supply-chain pressures, affects our ability to remain competitive. Further, we may not be able to comply with changed or new regulatory or industrial standards that may be necessary for us to remain competitive.
We cannot assure you that the EPA, foreign and state regulators or local governments will not restrict the uses of penta or certain of our other products or ban the use of one or more of these products or the raw materials in them. Similarly, companies who use our products may decide to reduce significantly or cease the use of our products voluntarily. As a result, our products may become obsolete or less attractive to our customers.
BECAUSE WE RELY ON OUR INTELLECTUAL PROPERTY, OUR FAILURE TO ADEQUATELY OBTAIN OR PROTECT IT COULD SIGNIFICANTLY HARM OUR BUSINESS
Protection of intellectual property is particularly important in our industry because we develop complex technical formulas and processes for products that are proprietary in nature and differentiate our products from those of our 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. In addition, we protect our product differentiation through various other means, such as proprietary supply arrangements for certain raw materials, and use of certain manufacturing technologies. Due to our international operations, we pursue protection in different jurisdictions, which may provide varying degrees of protection, and we cannot provide assurance that we can obtain adequate protection in each such jurisdiction. Our failure to obtain or maintain adequate protection of our intellectual property rights for any reason, including through the patent prosecution process or in the event of litigation related to such intellectual property, could seriously harm our business. In addition, certain types of intellectual property, such as patents, expire after a certain period of time, and products protected by our patents then lose such protection, so we refresh our intellectual property portfolio on an ongoing basis through continued innovation, and failure to do so could adversely affect our business. Also, the costs of obtaining or protecting our intellectual property could negatively affect our operating results.
OUR INABILITY TO ATTRACT AND RETAIN KEY PERSONNEL COULD CAUSE OUR BUSINESS TO SUFFER
We utilize and rely upon a global workforce. 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. We compete worldwide with other industry participants for qualified personnel, particularly those with significant experience in the semiconductor industry. The loss of services of key employees, or our inability to obtain or maintain visas or other travel or residency documents on their behalf with respect to our business needs, could harm our business and results of operations. Periodically, we engage in succession planning for our key employees, and our Board of Directors reviews succession planning for our executive officers, including our chief executive officer, on an annual basis.
BECAUSE WE HAVE LIMITED EXPERIENCE IN BUSINESS AREAS OUTSIDE OF ELECTRONIC MATERIALS AND PERFORMANCE MATERIALS, EXPANSION OF OUR BUSINESS INTO OTHER PRODUCTS AND APPLICATIONS MAY NOT BE SUCCESSFUL
An element of our strategy has been to leverage our customer relationships, technological expertise and other capabilities and competencies to expand our business. For example, we have made acquisitions to expand beyond CMP consumables into other electronic materials product areas, as well as into performance materials product areas in which we have limited experience. Expanding our business into new product areas could involve technologies, production processes and business models in which we have limited experience, and we may not be able to develop and produce products or provide services that satisfy customers' needs, or we may be unable to keep pace with technological or other developments. Or, we may decide that we no longer wish to pursue these new business initiatives. Also, our competitors may have or obtain intellectual property rights that could restrict our ability to market our existing products and/or to innovate and develop new products.
TAX INCREASES OR CHANGES IN TAX RULES MAY ADVERSELY AFFECT OUR FINANCIAL RESULTS
As a company conducting business on a global basis, we are exposed, both directly and indirectly, to effects of changes in United States, state, local and foreign tax rules. In December 2017, comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the "Tax Act") was enacted in the United States. Known and certain estimated effects based upon current interpretation of the Tax Act have been incorporated into our financial results. As additional clarification and implementation guidance is issued on the Tax Act, it may be necessary to adjust our income tax estimates, as we experienced in our second fiscal quarter of fiscal 2019 with respect to our previously reported Transition Tax describe in Note 19 of “Notes to the Consolidated Financial Statements” included in Item 8 of Part II of this Annual Report on Form 10-K. Adjustments to income tax amounts could be material to our results of operations and cash flows. In addition, there is a risk that state or foreign jurisdictions may amend their tax laws in response to the Tax Act, which could have a material impact on our future results of operations and cash flows.
CERTAIN CRITICAL INFORMATION SYSTEMS COULD BE SUSCEPTIBLE TO CYBERSECURITY AND OTHER THREATS
We maintain and rely upon certain critical information systems for the effective operation of our business. These information systems include, but are not limited to, telecommunications, the Internet, our corporate intranet, various computer hardware and software applications, network communications, and email. These information systems may be owned and maintained by us, our outsourced providers, or third parties such as vendors, contractors, and Cloud providers. All of these information systems are subject to disruption, breach or failure from various sources including, but not limited to, attacks, degradation, and failures resulting from potential sources, including viruses, malware, denial of service, destructive or inadequate code, power failures, and physical damage. Confidential and/or sensitive information stored on these information systems, or transmitted to or from Cloud storage, could be intentionally or unintentionally compromised, lost, and/or stolen. While we have implemented security procedures and virus protection software, intrusion prevention systems, access control, and emergency recovery processes to mitigate risks like these with respect to information systems that are under our control, they are not fail-safe and may be subject to breaches. Further, we cannot assure that third parties upon whom we rely for various IT services will maintain sufficient vigilance and controls over their systems. Our inability to use or access these information systems at critical points in time, or unauthorized releases of personal or confidential information, could unfavorably impact the timely and efficient operation of our business, including our results of operations, and our reputation, as well as our relationships with our employees or other individuals whose information may have been affected by such cybersecurity incidents.
In addition, regulatory authorities have increased their focus on how companies collect, process, use, store, share and transmit personal data. New privacy security laws and regulations, including the United Kingdom's Data Protection Act 2018 and the European Union General Data Protection Regulation 2016, and similar laws in countries such as Korea and Taiwan, among others, pose increasingly complex compliance challenges, which may increase compliance costs, and any failure to comply with data privacy laws and regulations could result in significant penalties.
OUR ABILITY TO RAISE CAPITAL IN THE FUTURE MAY BE LIMITED, WHICH COULD PREVENT US FROM GROWING, AND OUR EXISTING CREDIT AGREEMENT COULD RESTRICT OUR BUSINESS ACTIVITIES
We may in the future be required to raise capital through public or private financing or other arrangements. Such financing may not be available on acceptable terms, or at all, and our failure to raise capital when needed could harm our business. Our Credit Agreement contains financial and other covenants that may restrict our business activities or our ability to execute our strategic objectives, and our failure to comply with these covenants could result in a default under our Credit Agreement. Furthermore, additional equity financing may dilute the interests of our common stockholders, and debt financing, if available, may involve restrictive covenants that could further restrict our business activities or our ability to execute our strategic objectives and could reduce our profitability. If we raise or borrow funds on acceptable terms, we may not be able to grow our business or respond to competitive pressures.
In addition, borrowings under our Credit Facilities generally bear interest based on (a) a London Inter-bank Offered Rate (“LIBOR”), subject to a 0.00% floor, or (b) a base rate, in each case plus an applicable margin of, in the case of borrowings under the Term Loan Facility, 2.25% for LIBOR loans and 1.25% for base rate loans and, in the case of borrowings under the Revolving Credit Facility, initially, 1.50% for LIBOR loans and 0.50% for base rate loans. On July 27, 2017, the Financial Conduct Authority (the authority that regulates LIBOR) announced that it intends to stop compelling banks to submit rates for the calculation of LIBOR after 2021. In the United States, the Alternative Reference Rates Committee (“ARRC”), the working group formed to recommend an alternative rate to LIBOR, has identified the Secured Overnight Financing Rate (“SOFR”) as its preferred alternative rate for USD LIBOR. When LIBOR ceases to exist after 2021, any calculation of interest based upon the Alternate Base Rate (or any comparable or replacement formulation), may result in higher interest rates. To the extent that these interest rates increase, our Interest expense will increase, which could adversely affect our financial condition, operating results and cash flows.
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, geopolitical, political and stock market conditions generally and specifically as they may impact participants in the semiconductor and related industries; changes in financial estimates and recommendations by securities analysts who follow our stock; earnings and other announcements, and changes in market evaluations, by securities analysts, investors, market participants or others, of or related to, us or participants in the semiconductor and related industries; changes in business, trade 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; changes in our capital deployment strategy, issuances of shares of our capital stock or entering into a business combination or other strategic transaction; and trading volume of our common stock.
ANTI-TAKEOVER PROVISIONS UNDER OUR CERTIFICATE OF INCORPORATION AND BYLAWS MAY DISCOURAGE THIRD PARTIES FROM MAKING AN UNSOLICITED BID FOR OUR COMPANY
Our certificate of incorporation and bylaws, and various provisions of the Delaware General Corporation Law may make it more difficult or expensive to effect a change in control of our Company. For instance, our amended and restated 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.
We have adopted change in control arrangements covering our executive officers and other key employees. These arrangements provide for a cash severance payment, continued medical benefits and other ancillary payments and benefits upon termination of service of a covered employee's employment following a change in control, which may make it more expensive to acquire our Company.
ITEM 1B. UNRESOLVED STAFF COMMENTS
ITEM 2. PROPERTIES
The material properties owned by the Company consist of the following:
▪ a global headquarters and research and development facility in Aurora, Illinois, comprising approximately 200,000 square feet, which serves both of our segments;
▪ a commercial slurry manufacturing plant and distribution center in Aurora, Illinois, comprising approximately 175,000 square feet, which serves our Electronic Materials segment;
▪ an electronic chemicals manufacturing plant and distribution center in Pueblo, Colorado, comprising approximately 1,629,000 square feet, which serves our Electronic Materials segment;
▪ a pipeline performance materials manufacturing plant and distribution center in Waller, Texas, comprising approximately 1,742,000 square feet, which serves our Performance Materials segment;
▪ a commercial slurry and pad manufacturing plant, automated warehouse, research and development facility and offices in Kaohsiung County, Taiwan, comprising approximately 190,000 square feet, which serves our Electronic Materials segment;
▪ a commercial slurry manufacturing plant and distribution center, and a development and technical support facility in Geino, Japan, comprising approximately 165,000 square feet, which serves our Electronic Materials segment; and
▪ a commercial slurry manufacturing plant, development facility and offices in Oseong, South Korea, comprising approximately 110,000 square feet, which serves our Electronic Materials segment.
The material properties leased by the Company consist of the following:
▪ a commercial pad manufacturing plant and offices in Hillsboro, Oregon, comprising approximately 140,000 square feet, which serves our Electronic Materials segment;
▪ a commercial slurry manufacturing plant, research and development facility and offices in Singapore, comprising approximately 24,000 square feet, which serves our Electronic Materials segment;
▪ an electronic chemicals manufacturing plant and distribution center in Singapore, comprising approximately 213,000 square feet, which serves our Electronic Materials segment; and
▪ an electronic chemicals manufacturing plant and distribution center in Riddings, UK, comprising approximately 183,000 square feet, which serves our Electronic Materials segment.
We also own and lease space in various locations worldwide for manufacturing, distribution, technical support, sales, training, and general administrative purposes. We believe that our 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 intend to expand certain of our Electronic Materials and Performance Materials facilities to meet our anticipated business needs.
ITEM 3. LEGAL PROCEEDINGS
We periodically become a party to legal proceedings, arbitrations, and regulatory proceedings (“contingencies”) arising in the ordinary course of our business operations. The ultimate resolution of these contingencies is subject to significant uncertainty, and should we fail to prevail in any of them or should several of them be resolved against us in the same reporting period, these matters could, individually or in the aggregate, be material to our consolidated financial statements. One of these contingencies, related to Star Lake Canal, which we assumed in connection with the Acquisition, is discussed below. The ultimate outcome of these matters, however, cannot be determined at this time, nor can the amount of any potential loss be reasonably estimated, and as a result except where indicated no amounts have been recorded in our consolidated financial statements. The Company records legal costs associated with loss contingencies as expenses in the period in which they are incurred.
On May 31, 2019, a fire occurred at the warehouse of the facility of KMG’s subsidiary, KMG-Bernuth, in Tuscaloosa, Alabama, which processes penta for sale to customers in the United States and Canada. The warehouse fire, which we believe originated from non-hazardous waste materials temporarily stored in the warehouse for recycling purposes, caused no injuries and was extinguished in less than an hour. Company personnel investigated the incident, and KMG-Bernuth commenced cleanup with oversight from certain local, state and federal authorities. The carrying value of the warehouse and the affected inventory are not material. Applying the accounting guidance under ASC 410-30, Environmental Obligations and ASC 450, Contingencies, we determined that since we have environmental obligations as of the date of the fire, costs for the fire waste cleanup and disposal should be recognized to the extent they are probable and reasonably estimable. We have applied these criteria and recorded an undiscounted amount of $9,494 loss contingency regarding disposal costs that can be reasonably estimated at this time. These disposal costs were charged to Cost of sales. There are potential additional disposal and other costs that cannot be reasonably estimated as of this time related to materials in the warehouse or otherwise impacted by the incident. The fire waste cleanup and disposal costs have been and may continue to be significant due to the nature of federally-regulated penta-related waste cleanup and disposal requirements. We will continue to update the estimated losses as new information becomes available.
In addition, we are working with our insurance carriers on possible recovery of losses and costs, but at this point we cannot reasonably estimate whether we will receive, or if so, the amount of, any potential insurance recoveries. As such, no insurance recoveries have been recognized as of September 30, 2019.
Separately, in 2014, prior to the Acquisition, EPA had notified KMG-Bernuth, that the EPA considered it to be a potentially responsible party under the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended (“CERCLA”) by virtue of its relationship with certain alleged predecessor companies, including Idacon, Inc (f/k/a Sonford Chemical Company) in connection with the Star Lake Canal Superfund Site near Beaumont, Texas. The EPA has estimated that the remediation will cost approximately $22.0 million. KMG-Bernuth and approximately seven other parties entered into an agreement with the EPA in September 2016 to complete a remedial design phase of the remediation of the site. The remediation work will be performed under a separate future agreement. Although KMG-Bernuth has not conceded liability, a reserve in connection with the remedial design was established, and as of September 30, 2019, the reserve remaining was $728.
We also may face other governmental or third-party claims, or otherwise incur costs, relating to cleanup of, or for injuries resulting from, contamination at sites associated with this or other past and present operations. We accrue for environmental liabilities when a determination can be made that they are probable and reasonably estimable. Other than as described herein, we are not involved in any legal proceedings that we believe could have a material impact on our consolidated financial position, results of operations or cash flows.
In addition, our Company is subject to extensive federal, state and local laws, regulations and ordinances in the U.S. and in other countries. These regulatory requirements relate to the use, generation, storage, handling, emission, transportation and discharge of certain hazardous materials, substances and waste into the environment. The Company, including its KMG entities, manage EHS matters related to protection of the environment and human health, the cleanup of contaminated sites, the treatment, storage and disposal of wastes, and the emission of substances into the air or waterways, among other EHS concerns. Governmental authorities can enforce compliance with their regulations, and violators may be subject to fines, injunctions or both. The Company devotes significant financial resources to compliance, including costs for ongoing compliance.
Certain licenses, permits and product registrations are required for the Company’s products and operations in the U.S., Mexico and other countries in which it does business. The licenses, permits and product registrations are subject to revocation, modification and renewal by governmental authorities. In the United States, in particular, producers and distributors of penta, which is a product manufactured and sold by KMG-Bernuth as part of the wood treatment business, are subject to registration and notification requirements under the FIFRA and comparable state law in order to sell this product in the United States. Compliance with these requirements may have a significant effect on our business, financial condition and results of operations.
We are subject to contingencies, including litigation relating to EHS laws and regulations, commercial disputes and other matters. Certain of these contingencies are discussed above and in “Notes to the Consolidated Financial Statements” in this Annual Report on Form 10-K. The ultimate resolution of these contingencies is subject to significant uncertainty, and should we fail to prevail in any of them or should several of them be resolved against us in the same reporting period, these matters could, individually or in the aggregate, be material to the consolidated financial statements. The ultimate outcome of these matters cannot be determined at this time, nor can the amount of any potential loss be reasonably estimated, and as a result except where indicated no amounts have been recorded in our consolidated financial statements. The Company records legal costs associated with loss contingencies as expenses in the period in which they are incurred.
ITEM 4. MINE SAFETY DISCLOSURES
INFORMATION ABOUT OUR EXECUTIVE OFFICERS
Set forth below is information concerning our executive officers and their ages as of October 31, 2019.
|David H. Li||46 || ||President and Chief Executive Officer|
|Scott D. Beamer||48 || ||Vice President and Chief Financial Officer|
|H. Carol Bernstein||59 || ||Vice President, Secretary and General Counsel|
|Jeffrey M. Dysard||46 || ||Vice President and President, Performance Materials|
|Colleen E. Mumford||43 || ||Vice President, Communications and Marketing|
|Eleanor K. Thorp||45 || ||Vice President, Human Resources|
|Daniel D. Woodland||49 || ||Vice President and President, Electronic Materials|
|Thomas S. Roman||58 || ||Principal Accounting Officer and Corporate Controller|
DAVID H. LI has served as our President and Chief Executive Officer, and as a director of our Company, since January 2015. From June 2008 through December 2014, Mr. Li served as our Vice President of the Asia Pacific Region. Prior to that role, Mr. Li held various leadership roles throughout our business, including in regional and product line management, operations, supply chain and investor relations since joining us in 1998. Mr. Li received a B.S. in Chemical Engineering from Purdue University and an M.B.A. from Northwestern University.
SCOTT D. BEAMER has served as our Vice President and Chief Financial Officer since January 2018. Prior to joining us, Mr. Beamer served as Vice President and Chief Financial Officer of Stepan Company from August 2013. Before that, he held various senior finance roles over a 16-year career at PPG Industries, Inc., including serving as its CFO – Europe, and as its Assistant Corporate Controller. Mr. Beamer has a B.S. in Accounting from Bloomsburg University, and an M.B.A. from the University of Pittsburgh, and began his career at Ernst & Young.
H. CAROL BERNSTEIN has served as our Vice President, Secretary and General Counsel since August 2000. Prior to joining us, Ms. Bernstein served in various senior leadership roles, including as the General Counsel and Director of Industrial Technology Development of Argonne National Laboratory/the University of Chicago, and as over a thirteen-year career at the IBM Corporation, as an Associate General Counsel of the IBM Corporation, and as the Vice President, Secretary and General Counsel of Advantis Corporation, an IBM joint venture. Ms. Bernstein received her B.A. from Colgate University in History and Political Science, and her J.D. from Northwestern University; she is a member of the Bar of the States of Illinois and New York.
JEFFREY M. DYSARD has served as our Vice President and President, Performance Materials since January 2019, and prior to that had served as the General Manager of CMP Slurries, since October 2017, following serving as the General Manager of CMP Pads, from October 2015. Prior to that, Dr. Dysard held a variety of leadership roles in our R&D and product line organizations since joining us in 2004. Before that, he was a scientist with ExxonMobil. Dr. Dysard received a B.S. in Chemistry from the University of Chicago, and a Ph.D. in Chemistry from the University of California, Berkeley.
COLLEEN E. MUMFORD has served as our Vice President of Communications and Marketing since September 2019. Prior to that, Ms. Mumford served as our Corporate Relations Director since March 2018, responsible for Investor Relations, Corporate Communications and Marketing Communications. Ms. Mumford joined us in 1997, and has held various positions, including as North America Quality Director, among other leadership roles in research and development, operations, and human resources. Ms. Mumford received a B.S. in Ecology, Ethology and Evolution from the University of Illinois.
ELEANOR K. THORP has served as our Vice President, Human Resources since September 2018. Ms. Thorp rejoined our company after serving as the Head of Human Resources and Recruiting at Sephora Digital SEA, from 2015 through 2018, based in Singapore. Prior to that, Ms. Thorp was Cabot Microelectronics' Human Resources Director of Asia Pacific from 2013 through 2015. Before this, she was Head of Human Resources and Recruiting at Frontier Strategy Group, and also spent time in executive search, working across a wide range of industries, based first in London and then in New York. Ms. Thorp graduated from the University of Cambridge (England) with a B.A. in Social and Political Science.
DANIEL D. WOODLAND has served as our Vice President and President, Electronic Materials since November 2018, and prior to that had served as our Vice President and Chief Marketing and Operations Officer since October 2017 and Vice President of Marketing since January 2015. Previously, Dr. Woodland served in various product line, marketing and research and development leadership roles since joining us in 2003. Before joining our Company, Dr. Woodland held management roles at OMNOVA Solutions. Dr. Woodland received a B.A. in Physics from the University of California, Berkeley, and a Ph.D. in Physics from the University of Maine.
THOMAS S. ROMAN has served as our Corporate Controller and Principal Accounting Officer since February 2004, and prior to that served as our North American Controller after joining us in 2000, Before that, he worked for FMC Corporation, Gould Electronics, and Arthur Andersen LLP in various financial reporting, tax and audit positions. 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.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock has traded publicly under the symbol "CCMP" since our initial public offering in April 2000, currently on the NASDAQ Global Select Market, and formerly the NASDAQ National Market. As of October 31, 2019, there were approximately 630 holders of record of our common stock. In January 2016, we announced that our Board of Directors authorized the initiation of a regular dividend program under which the Company intends to pay quarterly cash dividends on our common stock. The declaration and payment of future dividends is subject to the discretion and determination of the Company's Board of Directors and management, based on a variety of factors, and the program may be suspended, terminated or modified at any time for any reason.
ISSUER PURCHASES OF EQUITY SECURITIES
|Period||Total Number of Shares|
|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)
|Jul. 1 through Jul. 31, 2019||15,660 || ||$||114.66 || ||15,000 || ||$||74,554 || |
|Aug. 1 through Aug. 31, 2019||14,978 || ||118.98 || ||14,900 || ||72,781 || |
|Sep. 1 through Sep. 30, 2019||11,033 || ||137.16 || ||11,033 || ||71,268 || |
|Total||41,671 || ||$||122.17 || ||40,933 || ||$||71,268 || |
In January 2016, our Board of Directors authorized an increase in the amount available under our share repurchase program from the previously remaining $75.0 million to $150.0 million. Under this program, we repurchased 88,403 shares for $10.0 million in fiscal 2019. As of September 30, 2019, $71.3 million remains available under our share repurchase program. The manner in which the Company repurchases its shares is discussed in Part II, Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, under the heading "Liquidity and Capital Resources", of this Annual Report on Form 10-K. To date, we have funded share purchases under our share repurchase program from our available cash balance, and currently anticipate we will continue to do so.
Separate from this share repurchase program, we purchased a total of 46,702 shares during fiscal 2019 pursuant to the terms of our Cabot Microelectronics Corporation 2012 Omnibus Incentive Plan, as amended (“OIP”), as shares withheld from award recipients to cover payroll taxes on the vesting of shares of restricted stock or restricted stock units awarded under the OIP.
EQUITY COMPENSATION PLAN INFORMATION
See Part III, Item 12 of this Form 10-K for information regarding shares of common stock that may be issued under the Company's existing equity compensation plans.
STOCK PERFORMANCE GRAPH
The following graph illustrates the cumulative total stockholder return on our common stock during the period from September 30, 2014 through September 30, 2019 and compares it with the cumulative total return on the NASDAQ Composite Index and the Philadelphia Semiconductor Index. The comparison assumes $100 was invested on September 30, 2014 in our common stock and in each of the foregoing indices and assumes reinvestment of the quarterly cash dividends declared in fiscal 2016, 2017, 2018, and 2019. The performance shown is not necessarily indicative of future performance. See "Risk Factors" in Part I, Item 1A above.
COMPARISON OF 5-YEAR CUMULATIVE TOTAL RETURN*
Among Cabot Microelectronics Corporation, the NASDAQ Composite Index
and the PHLX Semiconductor Index
*$100 invested on 9/30/14 in stock or index, including reinvestment of dividends.
Fiscal year ending September 30.
|Cabot Microelectronics Corporation||$||100.00 || ||$||114.16 || ||$||120.55 || ||$||113.66 || ||$||93.46 || ||$||105.62 || ||$||99.14 || ||$||103.04 || ||$||129.20 || ||$||154.69 || ||$||188.12 || |
|NASDAQ Composite||$||100.00 || ||$||105.70 || ||$||109.70 || ||$||111.93 || ||$||104.00 || ||$||113.06 || ||$||110.31 || ||$||110.05 || ||$||121.08 || ||$||123.08 || ||$||135.55 || |
|PHLX Semiconductor||$||100.00 || ||$||108.00 || ||$||109.77 || ||$||108.00 || ||$||96.12 || ||$||106.28 || ||$||108.97 || ||$||112.07 || ||$||135.94 || ||$||148.07 || ||$||165.83 || |
|Cabot Microelectronics Corporation||$||181.78 || ||$||197.32 || ||$||232.74 || ||$||265.93 || ||$||268.02 || ||$||257.08 || ||$||239.63 || ||$||282.44 || ||$||278.78 || ||$||357.62 || |
|NASDAQ Composite||$||141.19 || ||$||149.75 || ||$||159.56 || ||$||163.69 || ||$||174.51 || ||$||187.44 || ||$||155.03 || ||$||181.08 || ||$||188.09 || ||$||188.43 || |
|PHLX Semiconductor||$||170.59 || ||$||193.86 || ||$||208.10 || ||$||221.52 || ||$||220.25 || ||$||230.10 || ||$||195.52 || ||$||237.27 || ||$||249.56 || ||$||267.81 || |
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data for each year of the five-year period ended September 30, 2019 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", "Consolidated Financial Statements" and "Notes to the Consolidated Financial Statements" included in Items 7 and 8 of Part II of this Annual Report on Form 10-K, as well as "Risk Factors" included in Item 1A of Part I of this Annual Report on Form 10-K.
CABOT MICROELECTRONICS CORPORATION
SELECTED FINANCIAL DATA - FIVE YEAR SUMMARY
(Amounts in thousands, except per share amounts)
|Year Ended September 30,|
|Consolidated Statements of Income Data:|
|Revenue||$||1,037,696 || ||$||590,123 || ||$||507,179 || ||$||430,449 || ||$||414,097 || |
|Cost of sales||595,043 || ||276,018 || ||253,050 || ||220,247 || ||201,866 || |
|Gross profit||442,653 || ||314,105 || ||254,129 || ||210,202 || ||212,231 || |
|Research, development and technical||51,707 || ||51,950 || ||54,798 || ||58,532 || ||59,778 || |
|Selling, general and administrative||213,078 || ||102,037 || ||86,483 || ||77,162 || ||77,413 || |
|Asset impairment charges||67,372 || ||— || ||860 || ||— || ||— || |
|Total operating expenses||332,157 || ||153,987 || ||142,141 || ||135,694 || ||137,191 || |
|Operating income||110,496 || ||160,118 || ||111,988 || ||74,508 || ||75,040 || |
|Interest expense||45,681 || ||2,905 || ||4,529 || ||4,723 || ||4,524 || |
|Interest income||2,346 || ||4,409 || ||2,351 || ||949 || ||365 || |
|Other income (expense), net||(4,055)|| ||89 || ||(438)|| ||(296)|| ||316 || |
|Income before income taxes||63,106 || ||161,711 || ||109,372 || ||70,438 || ||71,197 || |
|Provision for income taxes||23,891 || ||51,668 || ||22,420 || ||10,589 || ||15,051 || |
|Net income||$||39,215 || ||$||110,043 || ||$||86,952 || ||$||59,849 || ||$||56,146 || |
|Basic earnings per share||$||1.37 || ||$||4.31 || ||$||3.47 || ||$||2.47 || ||$||2.32 || |
|Weighted average basic shares outstanding||28,571 || ||25,518 || ||25,015 || ||24,077 || ||24,040 || |
|Diluted earnings per share||$||1.35 || ||$||4.19 || ||$||3.40 || ||$||2.43 || ||$||2.26 || |
|Weighted average diluted shares outstanding||29,094 || ||26,243 || ||25,512 || ||24,477 || ||24,632 || |
|As of September 30,|
|Consolidated Balance Sheets Data:|
|Cash and cash equivalents||$||188,495 || ||$||352,921 || ||$||397,890 || ||$||287,479 || ||$||354,190 || |
|Other current assets||320,061 || ||169,860 || ||153,092 || ||149,351 || ||140,318 || |
|Property, plant and equipment, net||276,818 || ||111,403 || ||106,361 || ||106,496 || ||93,743 || |
|Other assets||1,476,392 || ||146,789 || ||176,757 || ||183,904 || ||72,223 || |
|Total assets||$||2,261,766 || ||$||780,973 || ||$||834,100 || ||$||727,230 || ||$||660,474 || |
|Current liabilities||$||171,460 || ||$||101,154 || ||$||91,213 || ||$||65,885 || ||$||60,644 || |
|Long-term debt||928,463 || ||— || ||132,997 || ||146,961 || ||155,313 || |
|Other long-term liabilities||181,466 || ||13,127 || ||14,853 || ||16,736 || ||15,553 || |
|Total liabilities||1,281,389 || ||114,281 || ||239,063 || ||229,582 || ||231,510 || |
|Stockholders' equity||980,377 || ||666,692 || ||595,037 || ||497,648 || ||428,964 || |
|Total liabilities and stockholders' equity||$||2,261,766 || ||$||780,973 || ||$||834,100 || ||$||727,230 || ||$||660,474 || |
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following "Management's Discussion and Analysis of Financial Condition and Results of Operations" (MD&A), as well as disclosures included elsewhere in this Annual Report on 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 Annual Report on Form 10-K are forward-looking and address a variety of subjects including, for example, future sales and operating results; growth or contraction, and trends in the industry and markets in which the Company participates; the acquisition of, investment in, or collaboration with other entities, including the Company’s acquisition of KMG Chemicals, Inc. (“KMG”), and the expected benefits and synergies of such acquisition; divestment or disposition, or cessation of investment in certain, of the Company’s businesses; new product introductions; development of new products, technologies and markets; product performance; the financial conditions of the Company's customers; competitive landscape; the Company's supply chain; natural disasters; various economic or political factors and international or national events, including related to the enactment of trade sanctions, tariffs, or other similar matters; the generation, protection and acquisition of intellectual property, and litigation related to such intellectual property or third party intellectual property; environmental, health and safety laws and regulations, and related compliance; the operation of facilities by Cabot Microelectronics; the Company's management; foreign exchange fluctuation; the Company's current or future tax rate, including the effects of the Tax Cuts and Jobs Act in the United States (“tax act”); cybersecurity threats; financing facilities and related debt, pay off or payment of principal and interest, and compliance with covenants and other terms; and, uses and investment of the Company's cash balance, including dividends and share repurchases, which may be suspended, terminated or modified at any time for any reason by the Company, based on a variety of factors. Statements that are not historical facts, including statements about Cabot Microelectronics’ beliefs, plans and expectations, are forward-looking statements. Such statements are based on current expectations of Cabot Microelectronics’ management and are subject to a number of factors and uncertainties, which could cause actual results to differ materially from those described in the forward-looking statements. Except as required by law, Cabot Microelectronics undertakes no obligation to update forward-looking statements made by it to reflect new information, subsequent events or circumstances. The section entitled "Risk Factors" 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 "Notes to the Consolidated Financial Statements" which are included in Item 8 of Part II of this Annual Report on Form 10-K.
Cabot Microelectronics Corporation ("Cabot Microelectronics'', "the Company'', "us'', "we'', or "our'') is a leading global supplier of consumable materials to semiconductor manufacturers and pipeline companies. As discussed above, on November 15, 2018 (“Acquisition Date”), we completed our acquisition of KMG Chemicals, Inc. (“KMG”), which produces and distributes specialty chemicals and performance materials for the semiconductor industry, pipeline operations and adjacent industries, and industrial wood preservation industry (“Acquisition”). The Acquisition has extended and strengthened our position as one of the leading suppliers of consumable materials to the semiconductor industry and has expanded our portfolio with the addition of KMG’s performance materials business, which enables us to be a leading global provider of performance products and services to the pipeline operations industry. The Consolidated Financial Statements included in this Annual Report on Form 10-K include the financial results of KMG from the Acquisition Date. Subsequent to the Acquisition, we operate our business within two reportable segments: Electronic Materials and Performance Materials. The Electronic Materials segment consists of our heritage CMP slurries and polishing pads businesses, as well as the recently-acquired KMG electronic chemicals business. The Performance Materials segment includes KMG’s heritage pipeline performance and wood treatment businesses, and our heritage QED business. For additional information, refer to Part 1, Item 1, “Business”, in this Annual Report on Form 10-K.
In the Electronic Materials segment, we recorded record revenue in fiscal 2019, primarily due to the Acquisition. We had lower CMP slurries revenue in fiscal 2019 compared to fiscal year 2018, which was partially offset by higher revenue in CMP pads and the addition of revenue in electronic chemicals. We believe this decline in CMP slurries revenue was due to the softness in the semiconductor industry in fiscal 2019, primarily in the memory sector. CMP slurries have a high participation in the memory sector, and were adversely impacted by the decrease in DRAM and NAND production at our customers during our fiscal 2019. In logic applications, the transition to advanced nodes by many of our top customers is driving increased demand for materials, particularly electronic chemicals. We believe that new applications in areas such as mobile, artificial intelligence (AI), and blockchain will continue to drive demand for advanced logic semiconductor devices going forward. In addition, the legacy logic and foundry area of the industry continues to benefit from growth in applications such as internet of things, autonomous driving, industrial automation, cloud and high-performance computing, virtual reality, and 5G. We believe we remain well-positioned to benefit from these long-term demand trends. Despite some industry headwinds that impacted demand for our CMP slurries, performance in CMP pads and the acquired KMG businesses more than offset these headwinds, reflecting the strength of our acquired KMG businesses, the resiliency of our heritage CMP business, and the breadth of our product offerings. Later in fiscal 2019, as channel inventories appeared to be reduced and demand from multiple end markets improved, we began to see signs of stabilization in the semiconductor industry and improvement in demand for our CMP slurries from advanced logic, foundry and memory customers. However, there are many factors that make it difficult for us to predict future revenue trends for our business, including those discussed in Part I, Item 1A entitled “Risk Factors” in this Annual Report on Form 10-K.
In our Performance Materials segment, we recorded record revenue in fiscal 2019, primarily driven by the Acquisition. We have experienced strong demand for our DRAs in our pipeline performance business. These products enable pipeline operators to optimize the efficiency and throughput of oil transport in both United States and international oil production.
Revenue for fiscal 2019 was $1,037.7 million, which represented an increase of 75.8% from the $590.1 million reported for fiscal 2018, primarily due to the Acquisition.
Net income was $39.2 million in fiscal 2019, which represented a decrease of 64.4% or $70.8 million, from $110.0 million in fiscal 2018. Results benefited from the Acquisition, but were more than offset by Acquisition-related expenses, asset impairment charges and a restructuring charge related to wood treatment, increased amortization and depreciation associated with re-valuing KMG assets to fair value, cleanup and disposal costs related to a warehouse fire at our wood treatment facility in Tuscaloosa, Alabama, higher Interest expense resulting from the debt borrowing to finance the Acquisition, and newly issued final regulations related to the United States Tax Cut and Jobs Act ("Tax Act"), which impacted our reserves for uncertain tax positions. For the same reasons, Diluted earnings per share decreased from $4.19 in fiscal 2018 to $1.35 in fiscal 2019. See Note 21 of "Notes to the Consolidated Financial Statements" included in Part II, Item 8 of this Annual Report on Form 10-K.
Adjusted EBITDA was $333.4 million in fiscal 2019. This represents an increase of $143.5 million, or 75.5% from $189.9 million in fiscal 2018. Adjusted EBITDA benefited from the Acquisition of the KMG businesses, partially offset by the softer industry conditions that resulted in lower demand for our heritage CMP products. Refer to the “Use of certain GAAP and Non-GAAP Financial Information” section below for the definition of adjusted EBITDA and a reconciliation of adjusted EBITDA to Net income, the most comparable GAAP financial measure. Adjusted EBITDA margin, which represents adjusted EBITDA as a percentage of revenue, was 32.1% and 32.2% for fiscal 2019 and 2018, respectively.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
This MD&A, as well as disclosures included elsewhere in this Annual Report on 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 business combinations, asset retirement obligations, impairment of long-lived assets, goodwill and other intangible assets, 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 for 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.
We account for our acquisitions under the current standards of accounting for business combinations. These standards require assets and liabilities of an acquired business to be recognized at their estimated fair value. We engage independent third-party appraisal firms to assist us in determining the fair values of assets and liabilities acquired. This valuation requires management to make significant estimates and assumptions, especially with respect to long-lived and intangible assets. Goodwill represents the residual value of the purchase price over the fair value of net assets acquired, including identifiable intangible assets.
Critical estimates in valuing certain of the intangible assets include but are not limited to: future expected cash flows related to customer relationships, trade names, acquired developed technologies, and patents and assumptions about the period of time the technologies will continue to be used in the Company's product portfolio; expected costs to develop the in-process technology into commercially viable products and estimated cash flows from the products when completed; and, discount rates. Management's estimates of value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable. Assumptions may be incomplete or inaccurate, and unanticipated events and circumstances may occur that may cause actual realized values to be different from management's estimates.
ASSET RETIREMENT OBLIGATIONS
Asset Retirement Obligations (AROs) are the obligations associated with the retirement of tangible long-lived assets. The Company recognizes an ARO liability in the period in which it is incurred, including upon acquisition, if a reasonable estimate of fair value can be made. If a reasonable estimate of fair value cannot be made in the period in which the ARO is incurred, the liability shall be recognized when a reasonable estimate of fair value can be made.
The Company recognizes AROs for the removal or storage of hazardous materials, decontamination or demolition of above ground storage tanks (ASTs), and certain restoration and decommissioning obligations related to certain of our owned and leased properties. AROs are initially recorded at an estimate of fair value by discounting to present value the expected future cash flows. In subsequent periods, the Company recognizes accretion expense in Cost of sales increasing the ARO balances, such that the balance will ultimately equal the expected cash flows at the time of settlement.
The Company has multiple production facilities with an indeterminate useful life and there is insufficient information available to estimate a range of potential settlement dates for the obligation. Therefore, the Company cannot reasonably estimate the fair value of the liability.
IMPAIRMENT OF LONG-LIVED ASSETS
We assess the recoverability of the carrying value of long-lived assets to be held and used whenever events or changes in circumstances indicate that the carrying value may not be recoverable. 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 either individually identified or 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. The carrying value of a long-lived asset is considered impaired when the total projected undiscounted cash flows from the use and eventual disposition of the asset or asset group are separately identifiable and are less than its carrying value. In that event, a loss is recognized based on the amount by which the carrying value exceeds the fair value of the long-lived asset. The fair value methodology used is an estimate of fair market value, which is made based on prices of similar assets or other valuation methodologies, including present value techniques. Long-lived assets to be disposed of by means other than sale are classified as held for use until their disposal. Long-lived assets to be disposed of by sale are classified as held for sale and are reported at the lower of carrying amount or fair market value, less the estimated cost to sell. Depreciation is discontinued for any long-lived assets classified as held for sale.
In the fourth quarter of fiscal 2019, we recorded an impairment of $67.4 million of long-lived assets, including a $4.1 million impairment of Property, plant and equipment in the wood treatment asset group. See Note 10 of "Notes to the Consolidated Financial Statements" included in Part II, Item 8 of this Annual Report on Form 10-K for a more detailed discussion of the impairment. We did not record any impairment expense in fiscal 2018. We recorded impairment expense on long-lived assets of $0.9 million in fiscal 2017 related to surplus research and development equipment, which was subsequently sold for a gain.
GOODWILL AND OTHER INTANGIBLE ASSETS
Purchased intangible assets with finite lives are amortized over their estimated useful lives and are evaluated for impairment using a process similar to that used to evaluate other long-lived assets. Goodwill and indefinite lived intangible assets are not amortized and are tested annually in our fourth fiscal quarter or more frequently if indicators of potential impairment exist, using a fair-value-based approach. The recoverability of goodwill is measured at the reporting unit level, which is defined as either an operating segment or one level below an operating segment. A component is a reporting unit when it constitutes a business for which discrete financial information is available and segment management regularly reviews the operating results of the component. Components may be combined into one reporting unit when they have similar economic characteristics. We have six reporting units, all of which had goodwill as of September 30, 2019, the date of our annual impairment test.
The Company’s Electronic Materials segment is comprised of the three following reporting units: CMP slurries, electronic chemicals, and CMP pads. The Company’s Performance Materials segment is comprised of three additional reporting units: pipeline performance, wood treatment, and precision optics.
Accounting guidance provides an entity the option to assess the fair value of a reporting unit either using a qualitative analysis ("step zero") or a quantitative analysis ("step one"). We used a step zero qualitative analysis for the CMP slurries reporting unit in fiscal 2018 and 2019, and for Precision Optics in fiscal 2019. Aside from those previously noted, all other reporting units were assessed for goodwill impairment using a step one approach. The Flowchem trade name, an indefinite-lived intangible asset, was assessed for impairment using a relief from royalty approach.
Factors requiring significant judgment include the selection of valuation approach and assumptions related to future revenue, discount factors, terminal growth rates, and royalty rates, among others. Changes in economic and operating conditions that occur after the annual impairment analysis or an interim impairment analysis that impact these assumptions may result in future impairment charges.
In the fourth quarter of fiscal 2019, the Company performed its annual goodwill impairment assessment, comparing estimated fair values of the reporting units to their carrying amounts. In estimating the fair values, the Company used the average of an income approach, discounting estimated future cash flows, and a market approach based upon relevant market multiples. As a result of asset impairment charges recorded in the fourth quarter of fiscal 2019, the carrying value of the wood treatment reporting unit is equal to its fair value. In this circumstance with no excess of fair value over carrying value, any unfavorable variances from the estimated inputs used in the impairment assessment may result in further impairment of long-lived assets or goodwill. The Company’s Electronic Chemicals reporting unit has goodwill resulting from a recent acquisition, with a greater sensitivity to impairment, due to the extent by which its estimated fair value exceeds its carrying value. Changes to the assumptions requiring significant judgment, noted above, could result in a different outcome for the impairment assessment. Accordingly, the Company performed sensitivity analysis for selected key assumptions.
As a result of the review performed in the fourth quarter of fiscal 2019, and the related sensitivity analysis, we determined that there was no impairment of our goodwill as of September 30, 2019. There was no goodwill impairment recorded in fiscal 2018 or 2017.
While no goodwill impairments were recognized in fiscal 2019, the Company recognized asset impairment charges of $67.4 million, of which $63.3 million related to Other intangible assets, net for the wood treatment reporting unit due to triggering events that occurred in the fourth quarter of fiscal 2019. See Note 10 of "Notes to the Consolidated Financial Statements" included in Part II, Item 8 of this Annual Report on Form 10-K. The Company will continue to monitor the wood treatment asset group for indicators of long-lived asset or goodwill impairment. Absent a sale of the business, as the Company approaches the announced closure date of the facilities and there are fewer estimated future cash flows, there is ongoing potential for further impairments of long-lived assets and impairment of goodwill. While the timing and amounts of any further impairments are unknown, they could be material to the Company’s Consolidated Balance Sheets and to the Consolidated Statements of Income, but they will not affect the Company’s reported Net cash provided by operating activities.
ACCOUNTING FOR INCOME TAXES
Current income taxes are determined based on estimated taxes payable or refundable on tax returns for the current year.
Deferred income taxes are determined using enacted tax rates for the effect of temporary differences between the book and tax
bases of recorded assets and liabilities. The effect on deferred tax assets and liabilities of changes in tax rates is recognized in income in the period that includes the enactment date. Provisions are made for both United States and any foreign deferred income tax liability or benefit. We assess whether or not our deferred tax assets will ultimately be realized, and record an estimated valuation allowance on those deferred tax assets that may not be realized. We recognize the tax benefit of an uncertain tax position only if it is more likely than not that the tax position will be sustained by the taxing authorities, based on the technical merits of the position. In fiscal 2017, we maintained an assertion to permanently reinvest the earnings of all of our foreign subsidiaries. In light of the Tax Act and the associated transition to a modified territorial tax system, we no longer consider our foreign earnings to be indefinitely reinvested. See Note 19 of "Notes to the Consolidated Financial Statements" included in Part II, Item 8 of this Annual Report on Form 10-K for additional information on income taxes.
COMMITMENTS AND CONTINGENCIES
We have entered into certain unconditional purchase obligations, which include noncancelable purchase commitments and take-or-pay arrangements with suppliers. We review our agreements on a quarterly basis 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 information available to us to determine whether such accruals should be adjusted and whether new accruals are required.
EFFECTS OF RECENT ACCOUNTING PRONOUNCEMENTS
See Note 2 of "Notes to the Consolidated Financial Statements" included in Part II, Item 8 of this Annual Report on Form 10-K for a description of recent accounting pronouncements including the expected dates of adoption and effects on our results of operations, financial position and 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,|
|Revenue||100.0 ||%||100.0 ||%||100.0 ||%|
|Cost of sales||57.3 || ||46.8 || ||49.9 || |
|Gross profit||42.7 || ||53.2 || ||50.1 || |
|Research, development and technical||5.0 || ||8.8 || ||10.8 || |
|Selling, general and administrative||20.5 || ||17.2 || ||17.1 || |
|Asset impairment charges||6.5 || ||— || ||0.2 || |
|Operating income||10.7 || ||27.1 || ||22.1 || |
|Interest expense||4.4 || ||0.5 || ||0.9 || |
|Interest income||0.2 || ||0.7 || ||0.5 || |
|Other income (expense), net||(0.4)|| ||0.1 || ||(0.1)|| |
|Income before income taxes||6.1 || ||27.4 || ||21.5 || |
|Provision for income taxes||2.3 || ||8.8 || ||4.4 || |
|Net income||3.8 ||%||18.6 ||%||17.1 ||%|
YEAR ENDED SEPTEMBER 30, 2019, VERSUS YEAR ENDED SEPTEMBER 30, 2018
Revenue was $1,037.7 million in fiscal 2019, which represented an increase of 75.8%, or $447.6 million, from fiscal 2018. The increase in revenue was primarily driven by the Acquisition. Revenue from Cabot Microelectronics' heritage businesses decreased by $3.3 million, or 0.6%, driven by a $30.9 million decrease due to lower sales volume and a $5.6 million decrease due to foreign exchange fluctuations, partially offset by a $30.3 million increase due to a higher value product mix, and $2.9 million increase due to price changes.
COST OF SALES
Total Cost of sales was $595.0 million in fiscal 2019, which represented an increase of 115.6%, or $319.0 million, from fiscal 2018. The increase in Cost of sales was primarily due to the Acquisition. The Cost of sales from Cabot Microelectronics’ heritage businesses decreased by $7.5 million. The decrease was driven by a $6.2 million decrease due to lower sales volume, and a $3.2 million decrease due to foreign exchange fluctuations, partially offset by a $3.0 million increase in freight and packaging costs. Cost of sales included $14.9 million fair value write-up of KMG-acquired inventory sold and $9.5 million related to the KMG-Bernuth warehouse fire.
Our gross margin was 42.7% in fiscal 2019 compared to 53.2% in fiscal 2018. The gross margin was adversely impacted by the inclusion of the KMG businesses, which reduced margin by 11.6%, of which 1.4% was due to the impact of the fair value write-up of acquired inventory sold, 0.9% was due to the costs related to the KMG-Bernuth warehouse fire, and 0.7% was due amortization of Acquisition-related costs. Within Cabot Microelectronics’ heritage businesses, gross margin increased by 1.0%, which was primarily due to a higher value product mix, partially offset by lower volume and higher freight and packaging costs.
RESEARCH, DEVELOPMENT AND TECHNICAL
Total Research, development and technical expenses were $51.7 million in fiscal 2019, which represented a decrease of 0.5%, or $0.2 million, from fiscal 2018. The decrease was primarily due to lower staffing-related costs of $2.4 million, including incentive compensation costs, partially offset by higher supplies and equipment costs used in research and development of $2.1 million.
Our Research, development and technical efforts are focused on the areas of research related to fundamental CMP technology; development of new and enhanced CMP consumable products, including collaboration on joint development projects with technology-leading customers and suppliers; process development to support rapid and effective commercialization of new products; technical support of CMP products in our customers’ research, development and manufacturing facilities; and, development of polishing and metrology applications outside of the semiconductor industry.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative expenses were $213.1 million in fiscal 2019, which represented an increase of 108.8%, or $111.0 million, from fiscal 2018. The increase was primarily due to $45.5 million of amortization expense related to the Acquisition, $38.4 million in incremental KMG-related costs associated with the post-Acquisition period during fiscal 2019, and $34.7 million of Acquisition and integration related costs. These items were partially offset by the absence of executive officer transition costs of $4.2 million that occurred in the first quarter of fiscal 2018.
ASSET IMPAIRMENT CHARGES
Asset impairment charges were $67.4 million in fiscal 2019 due to impairment of the long-lived assets in the wood treatment asset group. See Note 10 of “Notes to the Consolidated Financial Statements” included in Item 8 of Part II of this Annual Report on Form 10-K.
Interest expense was $45.7 million in fiscal 2019, which represented an increase of $42.8 million, from fiscal 2018. The increase resulted from the debt borrowing to finance the Acquisition.
Interest income was $2.3 million in fiscal 2019, which represented a decrease of 46.8%, or $2.1 million from fiscal 2018 due to lower cash balances.
OTHER INCOME (EXPENSE), NET
Other expense was $4.1 million in fiscal 2019, which increased from Other income of $0.1 million in fiscal 2018. The increase was primarily due to higher loss on foreign exchange, the absence of the gain on sale of assets of $1.0 million, and gain on the termination of interest rate swap agreements that occurred in fiscal 2018.
PROVISION FOR INCOME TAXES
Our effective income tax rate was 37.9% in fiscal 2019 compared to 32.0% in fiscal 2018. The increase in the effective tax rate during fiscal 2019 was primarily due to newly issued final regulations related to the Tax Act, which impacted our reserves for uncertain tax positions, unfavorable tax treatment of certain Acquisition-related costs, such as compensation deduction limitations, as well as non-deductibility of certain professional fees. Partially offsetting these adverse items, the Tax Act reduced the corporate income tax rate to 21.0% effective January 1, 2018, resulting in a change in our blended tax rate of 24.5% in fiscal 2018 to 21.0% beginning with our fiscal 2019.
Net income was $39.2 million in fiscal 2019, which represented a decrease of 64.4%, or $70.8 million, from fiscal 2018. The fiscal 2019 Net income was adversely impacted by the asset impairment and restructuring charges related to the wood treatment business of $68.9 million, Acquisition-related expenses of $34.7 million, a charge for fair value write-up of acquired inventory sold of $14.9 million, costs related to the KMG-Bernuth warehouse fire of $9.9 million, and increased tax expense related to newly issued final regulations related to the Tax Act, which impacted the Company’s reserves for uncertain tax positions, offset by the increase due to the addition of KMG businesses.
YEAR ENDED SEPTEMBER 30, 2018, VERSUS YEAR ENDED SEPTEMBER 30, 2017
Revenue was $590.1 million in fiscal 2018, which represented an increase of 16.4%, or $82.9 million, from fiscal 2017. The increase in revenue was driven by a $52.9 million increase due to higher sales volume, a $27.5 million increase due to a higher value product mix, and a $4.4 million increase due to foreign exchange fluctuations, partially offset by a $1.8 million decrease due to price changes. The increase in sales volume was consistent with continued overall strong demand conditions in the global semiconductor industry.
COST OF SALES
Total Cost of sales was $276.0 million in fiscal 2018, which represented an increase of 9.1%, or $23.0 million, from fiscal 2017. The increase in Cost of sales was primarily driven by a $12.4 million increase due to higher sales volume, a $6.6 million increase in fixed manufacturing costs, including higher staffing-related expenses, a $2.9 million increase due to product mix, a $2.0 million increase due to foreign exchange fluctuations, partially offset by a $1.0 million decrease in other variable manufacturing costs, including material costs. Fixed manufacturing costs included $5.2 million of NexPlanar amortization expense compared to $4.8 million in the same period of fiscal 2017.
Our gross margin was 53.2% in fiscal 2018 compared to 50.1% for fiscal 2017. The increase in gross margin from fiscal 2017 was primarily due to higher sales volume and a higher value product mix, partially offset by higher fixed manufacturing costs, including higher staffing-related expenses.
RESEARCH, DEVELOPMENT AND TECHNICAL
Total Research, development and technical expenses were $52.0 million in fiscal 2018, which represented a decrease of 5.2%, or $2.8 million, from fiscal 2017. The decrease was primarily due to lower professional expenses of $1.3 million, lower staffing-related costs of $1.0 million, and lower depreciation and amortization expense of $0.7 million, partially offset by the absence of a gain on equipment disposal of $1.8 million that occurred in fiscal 2017.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative expenses were $102.0 million in fiscal 2018, which represented an increase of 18.0%, or $15.6 million, from fiscal 2017. The increase was primarily due to $4.2 million in costs associated with executive officer transitions, $3.9 million in Acquisition and integration related costs in connection with the Acquisition, higher long-term incentive compensation expenses of $2.5 million, higher staffing-related costs of $1.6 million, and higher professional expenses of $1.5 million.
Interest expense was $2.9 million in fiscal 2018, which represented a decrease of 35.9%, or $1.6 million, from fiscal 2017. The decrease resulted from the payoff of our Term Loan in April 2018.
Interest income was $4.4 million in fiscal 2018, which represented an increase of 87.5%, or $2.1 million, from fiscal 2017. The increase resulted from higher investment balances and higher average interest rates.
OTHER INCOME (EXPENSE), NET
Other income was $0.1 million in fiscal 2018, an increase of $0.5 million from fiscal 2017. The increase was primarily due to the gain on the sale of certain assets of $1.0 million in the second quarter of fiscal 2018.
PROVISION FOR INCOME TAXES
Our effective income tax rate was 32.0% in fiscal 2018 compared to 20.5% in fiscal 2017. The increase in the effective tax rate during fiscal 2018 was primarily due to the unfavorable initial impact of the Tax Act, which was enacted in the first quarter of fiscal 2018, and the absence of benefits of the tax holiday in South Korea, which expired as of October 2017. These items were partially offset by the benefit from the adoption of ASU 2016-09 in fiscal 2018, which requires excess tax benefits of share based exercises to be recorded as a reduction to the Provision for income taxes, rather than an increase to equity. See Note 19 of "Notes to the Consolidated Financial Statements" included in Part II, Item 8 of this Annual Report on Form 10-K for more information on our income tax provision.
Net income was $110.0 million in fiscal 2018, which represented an increase of 26.6%, or $23.1 million, from fiscal 2017. The increase was primarily due to higher revenue and a higher gross margin, partially offset by higher operating expenses and the $18.2 million unfavorable initial impact of the enactment of the Tax Act in December 2017.
Segment data is presented for our two reportable segments for the fiscal year ended September 30, 2019 and 2018. The segment data should be read in conjunction with our Consolidated Financial Statements and related notes included elsewhere in this Annual Report on Form 10-K.
Revenue from external customers by segment and adjusted EBITDA/Margin are as follows:
|Twelve Months Ended September 30,|
|Electronic Materials||$||833,051 || ||$||559,944 || ||$||485,034 || |
|Performance Materials||204,645 || ||30,179 || ||22,145 || |
|Total||$||1,037,696 || ||$||590,123 || ||$||507,179 || |
|Twelve Months Ended September 30,|
|Segment Adjusted EBITDA: || |
| Electronic Materials||$||294,902 || ||$||222,019 || ||$||169,044 || |
| Performance Materials||91,372 || ||7,191 || ||2,516 || |
| Unallocated corporate expenses||(52,856)|| ||(39,266)|| ||(34,050)|| |
| Total||$||333,418 || ||$||189,944 || ||$||137,510 || |
|Twelve Months Ended September 30,|
|Adjusted EBITDA Margin|
|Electronic Materials||35.4 ||%||39.7 ||%||34.9 ||%|
|Performance Materials||44.6 ||%||23.8 ||%||11.4 ||%|
THE YEAR ENDED SEPTEMBER 30, 2019, VERSUS YEAR ENDED SEPTEMBER 30, 2018
The $273.1 million increase in Electronic Materials revenue was primarily driven by the addition of KMG’s electronic chemicals business since the Acquisition. Further increase was driven by higher value product mix and strong organic demand for the Company’s heritage CMP pads product line, which increased 13.8%, primarily on higher sales volume, partially offset by the decrease in Company's heritage CMP slurries products due to the softer industry conditions. The increase in adjusted EBITDA for Electronic Materials increased from the prior year was driven by the addition of KMG’s electronic chemicals, as well as stronger profitability, driven by the leverage achieved on higher sales volume of the Company’s legacy CMP polishing pads product line. The lower adjusted EBITDA margin was primarily due to change in mix of products as a result of the Acquisition.
The $174.5 million increase in Performance Materials revenue was primarily driven by the addition of KMG’s performance materials business post-Acquisition. Performance Materials’ adjusted EBITDA and adjusted EBITDA margin expanded from the prior year due to the addition of KMG’s heritage performance materials business.
USE OF CERTAIN GAAP AND NON-GAAP FINANCIAL INFORMATION
We provide certain non-GAAP financial information, such as adjusted EBITDA and adjusted EBITDA margin, to complement reported GAAP results because we believe that analysis of our financial performance is enhanced by an understanding of these non-GAAP financial measures. We exclude certain items from earnings when presenting our adjusted EBITDA measure because we believe they will be incurred infrequently and/or are otherwise not indicative of a segment's regular, ongoing operating performance. Accordingly, we believe that they aid in evaluating the underlying operational performance of our business, and facilitate comparisons between periods. In addition, adjusted EBITDA is used as a basis of the performance metric for our fiscal 2019 Short-Term Incentive Program (STIP). A similar EBITDA calculation is also used by our lenders for a key debt compliance ratio.
Adjusted EBITDA margin is defined as adjusted EBITDA as a percentage of revenue. Adjusted EBITDA is defined as earnings before interest, income taxes, depreciation and amortization, adjusted for certain items that affect comparability from period to period. These adjustments include items related to the Acquisition, such as expenses incurred to complete the Acquisition and integration related expenses, costs of restructuring and asset impairment related to the wood treatment business, costs related to the KMG-Bernuth warehouse fire, and impact of fair value adjustments to inventory acquired from KMG.
The non-GAAP financial information provided is a supplement to, and not a substitute for, the Company’s financial results presented in accordance with U.S. GAAP. Management strongly encourages investors to review the Company’s consolidated financial statements in their entirety and to not rely on any single financial measure. These non-GAAP financial measures are provided to enhance the investor's understanding about the Company's ongoing operations. Specifically, the Company believes the impact of Acquisition-related expenses and Acquisition-related amortization expenses are not indicative of its core operating results, and thus presents these certain metrics excluding these effects. The presentation of non-GAAP financial information is not meant to be considered in isolation or as a substitute for results prepared and presented in accordance with U.S. GAAP. A reconciliation table of GAAP to non-GAAP financial measures is contained below.
Adjusted EBITDA for the Electronic Materials and Performance Materials segments is presented in conformity with Accounting Standards Codification Topic 280, Segment Reporting. This measure is reported to the chief operating decision maker for purposes of making decisions about allocating resources to the segments and assessing their performance. For these reasons, this measure is excluded from the definition of non-GAAP financial measures under the SEC Regulation G and Item 10(e) of Regulation S-K.
RECONCILIATION OF NET INCOME TO ADJUSTED EBITDA
The table below presents the reconciliation of Net income to adjusted EBITDA. Adjusted EBITDA is not a measurement of our financial performance under GAAP and should not be considered as an alternative to Net income. Adjusted EBITDA may have limitations as an analytical tool and should not be considered in isolation or as a substitute for analysis of our results as reported under GAAP.
|Twelve Months Ended September 30,|
|Segment Adjusted EBITDA|
|Electronic Materials||$||294,902 || ||$||222,019 || ||$||169,044 || |
|Performance Materials||91,372 || ||7,191 || ||2,516 || |
|Unallocated Corporate Expenses||(52,856)|| ||(39,266)|| ||(34,050)|| |
|Total||$||333,418 || ||$||189,944 || ||$||137,510 || |
|Twelve Months Ended September 30,|
|Net income ||$||39,215 || ||$||110,043 || ||$||86,952 || |
|Interest expense||45,681 || ||2,905 || ||4,529 || |
|Interest income||(2,346)|| ||(4,409)|| ||(2,351)|| |
|Income taxes||23,891 || ||51,668 || ||22,420 || |
|Depreciation and amortization||98,592 || ||25,876 || ||25,930 || |
|EBITDA*||205,033 || ||186,083 || ||137,480 || |
|Acquisition and integration related expense||34,709 || ||3,861 || ||— || |
|Charge for fair value write-up of acquired inventory sold||14,869 || ||— || ||— || |
|Cost related to KMG-Bernuth warehouse fire||9,905 || ||— || ||— || |
|Costs related to restructuring of wood treatment business||1,530 || ||— || ||— || |
|Charges related to asset impairment of wood treatment business|