Ultra Clean Holdings, Inc. (UCTT) Q1 2008 Earnings Report, Transcript and Summary

Welcome to the Ultra Clean Technology’s first quarter financial results conference call. (Operator Instructions) I would now like to turn the call over to Chief Financial Officer, Jack Sexton. Jack Sexton – Chief Financial Officer: Welcome to our first quarter financial results conference call. My name is Jack Sexton, Chief Financial Officer, of Ultra Clean Holdings, and with me today is our Chairman and Chief Executive Officer, Clarence Granger. A few moments ago we issued a press release reporting financial results for the first quarter of 2008. The press release can be accessed from the Investor Relations section of Ultra Clean’s website at uct.com. In addition, we have arranged for a taped replay of this call, which may be accessed by phone. This replay will be available approximately one hour after the call’s conclusion and will be accessible for two weeks. The dial-in access number for this replay is 888-561-5097 for domestic callers and 706-679-7569 for international dialers. The pass code is 42484125 for both domestic and international callers. This call is also being webcast live with a web replay also available for 14 days from the Investor Relations section of our website at uct.com. Together with our recently issued press release, this conference call enables the company to comply with the SEC regulations for fair disclosure. Therefore, investors should accept the contents of this call as the company’s official guidance for the second quarter of fiscal 2008. Investors should note that only the CEO and CFO are authorized to provide company guidance. If at any time after this call we communicate any material changes in guidance it is our intent that such updates will be done officially via public forum such as a press release or publicly announced conference call. Matters that we discuss today include forward-looking statements as defined in the U.S. Securities Private Litigation Reform Act of 1995 related to matters including our future financial performance, new product orders and shipments, consolidation of activities in the U.S. and expanded production at our China facilities. Investors are cautioned that forward-looking statements are neither promises nor guarantees but involve risks and uncertainties that may cause actual results to differ materially from those projected in the forward-looking statements. Some of those risks and uncertainties are detailed in our filings with the Securities and Exchange Commission, including our most recent Form 10-K filed for the year ended December 28, 2007. The company disclaims any obligation to publicly update or revise any such forward-looking statements or to reflect events or circumstances that occur after this call. Now here are the first quarter results. Revenue for the first quarter of 2008 was $92.4 million, effectively flat with prior period revenue of $92.8 million for the quarter ended December 28, 2007, and a decrease of 17% compared to revenue of $110.8 million in the same period a year ago. The sequential decrease was due to reduced demand for nearly all semiconductor capital equipment customers. The first quarter revenue was slightly below the midpoint of our guided range of $90 million to $97 million. Gross margin for the first quarter was 13.1%, up from 12.4% recorded in the fourth quarter, and a decrease from 15.1% in the same period a year ago. The 70 basis point sequential improvement in gross margin is due to efficiency improvements as we adjusted to the difficult market environments and increased activity in our original Shanghai facility, which has a favorable impact on our consolidated gross margin. Operating expenses in the first quarter were $9 million, up less than $100,000 compared to the prior quarter. The sequential increase of approximately $100,000 is due to a one-time FAS 123R charge related to the retirement of Larry Misinski and increased rent expense associated with our new Hayward facility, partially offset by reduced outside services and other discretionary spending. Interest and other net expense of $344,000 was flat sequentially and lower interest income offset lower interest expense on reduced debt levels. This debt was originally put in place in support of the Saegar acquisition. Our effective tax rate for the quarter and our estimate for the fiscal year 2008 is 29%, as per the prior projection. The effective tax rate is up slightly from prior year due primarily to the effect of foreign operations as the impact of increased profitability in China is offset by an increase in the effective tax rates in China. As a reminder, the effective tax rate in our first China entity moves from 0% in 2007 to approximately 9% in fiscal year 2008 as a result of the transition of our tax holiday on that first entity. Net income for the first quarter was $1.9 million, decreasing from net income of $2.1 million in the fourth quarter, as $400,000 improved operating income was offset by $600,000 unfavorable movement in income tax provision. Our fourth quarter 2007 results included a $500,000 tax savings on the final year-end provision. Diluted earnings per share for the first quarter 2008 were $0.09 on a GAAP basis, within our guided range of $0.08 to $0.14. The $0.09 EPS includes a $0.01 per share charge for amortization of intangible assets related to the Saegar acquisition and a $0.04 charge related to SFAS 123R. Turning to the balance sheet. During the first quarter cash of $25 million decreased $8.4 million sequentially while third-party debt decreased $0.8 million to $21.4 million. Taken together, cash net of or third-party debt decreased $7.6 million during the period due to increased account receivables offset by net income and non-cash charges during the period. Account receivables of $47.8 million increased $13 million at 37% due to slower collections as customers slowed payments at quarter end. Days sales outstanding increased 13 day to 47 days at the end of the first quarter. We are stepping up our collection efforts to return to normal levels of DSO. Net inventory of $48.4 million decreased $900,000, or 2%, due to decreased activity levels. Days inventory on hand, calculated on a forward-looking basis, increased to 77 days at the end of the first quarter as a decrease in projected activity levels is not yet reflected in reduced inventory levels. Accounts payable of $38.3 million increased approximately $1.4 million, or 4%, during the period. Days sales outstanding increased one day to 50 days. Now Clarence will discuss our operating highlights for the first quarter and provide guidance for the second quarter of 2008.

The first quarter of 2008 was another challenging period for the industry, in which we saw a fourth consecutive quarterly decline in industry demand. As anticipated UCT realized efficiency improvement compared to the fourth quarter of 2007 and benefited from a further transition to China, resulting in sequential increase in gross margin of 70 basis points on slightly lower revenue. With respect to commercial and operational highlights during the quarter, we made progress on several fronts. First, as was announced in our press release, we secured three significant new product orders from two existing major customers, including a new process module on a solar tool. Separately, we increased our non-semiconductor revenue by 45% sequentially to 14% of total sales in the first quarter of 2008. This included shipping our initial turn-key flat-panel testers to Photon Dynamics and also increasing our robotic medical device revenues by 9% sequentially. Additionally, we increased the percentage of revenue to rise from our Shanghai operation to 19% of total sales. And finally, we made significant progress on our new facility in Silicon Valley. I will now provide further details on these accomplishments. During the quarter we secured three new orders from two existing key customers. From one major customer we won a new process module award for a solar tool which is projected to have high usage beginning in the fourth quarter of this year. This module ships at the same production volume as solar gas delivery modules and will more than double our revenue potential on thin film solar lines. As with the solar gas delivery systems that we currently provide to the same customer, this newly awarded module will be manufactured in our Shanghai, China, facilities and delivered directly to the customer in Asia. We anticipate shipping our first module in Q3 and to ramp to volume production in Q4. A second order with the same customer is for an integrated process module for EPI applications. It contains a gas delivery system, frame assembly, precision machining assemblies, and electrical assemblies. This module is currently being built in-house by our customer and this order is an indication of their continued commitment to move toward outsourcing during the current industry slow down. The third order is with one of our oldest major customers. It is a new module assembly design similar in many respects to machining assemblies currently built in our South San Francisco facility. Incremental revenue from these three new product awards is estimated to be $3 million-$4 million in 2008 and $20 million-$30 million in 2009. These new wins reflect continued success toward our stated objective to grow faster than the semiconductor capital equipment industry, in part by increasing a portion of our revenue derived from the adjacent markets of the solar, flat-panel, and medical devices industries. Additionally, we continue to make progress on previously announced orders. We shipped our first turn-key tools to Photon Dynamics from our South San Francisco facility and remain on track to transfer production of these systems to our second Shanghai facility at the beginning of the third quarter of 2008. This will be a significant step toward our goal of achieving profitability in our new Shanghai facility in Q3. During this quarter we increased our China-based revenue by 14% to 19% of total company revenue. We also began production level shipments from our second facility in Shanghai. This new facility opened in November 2007, is an 80,000 s.f. building, in very close proximity to our first Shanghai building. We intend to use this new facility for precision machining and large module manufacturing. The first modules produced in this facility will be large flat-panel inspection tools for Photon Dynamics. Subsequently, we will manufacture the new solar sub-systems announced earlier in this call at this site. With these additions we are confident that we will achieve our goal of reaching profitability in this new facility in the third quarter of 2008. Growing our base in China is key to enhancing our competitive position and improving our profitability. Also, I am pleased to announce that in the first quarter we increased our sales to the solar, flat-panel, and medical device industries by 45% and they now represent 14% of our total sales. We anticipate further growth throughout 2008, particularly towards the end of the year. And we are now revising our goal of exceeding 15% of revenue from these sources by Q4 of 2008 to exceeding 20% of our revenue from these sources by Q4 of 2008. In other areas, the remodel/construction that I recently announced, 100,000 s.f. facility here in Silicon Valley, is proceeding on schedule. We plan to occupy this facility starting late in the second quarter of 2008. This new facility will allow us to vacate our Menlo Park facilities and a significant portion of our South San Francisco facilities, combining three assembly facilities into one. The new facility will also serve as our headquarters office. We are confident that we will realize significant savings through this consolidation. Finally, in response to slowing market conditions, we have completed another reduction in force in April reducing our U.S.-based work force by an additional 7%. We believe this further stream-lining was necessary to optimize our operating effectiveness. Looking ahead to next quarter, we project a significant drop in semiconductor equipment industry demand, partially offset by continued growth in the flat-panel, solar, and medical device market. We expect revenue or the second quarter of 2008 to range between $67 million to $74 million and net income per share to range between ($0.03) to $0.03. This EPS estimate includes an expected $0.01 per share charge for amortization of intangibles, a $0.03 charge related to SFAS 123R, and a $0.02 per share charge for employee severance payments. To summarize the highlights for the first quarter, UCT achieved revenue and earnings per share within our guided range in a very challenging quarter for the industry. We received three new product orders from two existing major customers, including a new solar process module and our pipeline of new products remains very strong. We made significant progress on our recently announced order with Photon Dynamics. We grew our revenue in China to 19% of total revenue and we streamlined our business in preparation for yet another quarter of declining semiconductor capital equipment industry demand. In closing, we remain optimistic about our market position, our flexible business model, and our continued ability to grow faster than the industry. With that we would now like to open the call for questions.

(Operator Instructions) Your first question comes from Edwin Mok – Needham & Company. Edwin Mok – Needham & Company: Based on your guidance, do you expect semi to actually grow sequentially in the second quarter?

Yes, it will. Edwin Mok – Needham & Company: So if you back that out, that means you expect your semi business to be down almost 40% sequentially on the second quarter. Do you think this is maybe a short term event and maybe going into the quarter you have a rebound, because that sounds lower than what some of your customers have reported for the coming quarter, basically.

Our projection is 23.7% down for the second quarter and so yes, you’re right, if we offset that by the growth in the non-semi business that would obviously, we’re seeing greater than 24% decline on the semiconductor side, probably closer to 30%. But we have not lost any market share on the semiconductor side with any of our customers. So this is truly a reflection of what we’re seeing in the market, based on declining demand from our customers. Edwin Mok – Needham & Company: Then for your non-semi piece, you mentioned that you have won some business with an existing customer. And you talked about that piece growing. Is it growing in all three customers that you talked about before or is it like one bigger customer that will be carrying the growth in the coming quarter?

Well, in the coming quarter it’s a little bit of everybody. We’ve seen, as we said, sequential growth of 9% last quarter in our medical device, which is almost exclusively intuitive surgical. We’re also seeing, as we said, ramping to volume production on Photon Dynamics. But the largest percentage of growth that we’ll probably see next quarter is going to come, or at least starting in the third quarter, is going to come from the new solar opportunities with applied material. Edwin Mok – Needham & Company: And then the semi piece that you mentioned was baked into your guidance. Before you had talked about these designs back in 2007 and first quarter of winning, and you summed that up as $50+ million in terms of revenue. Do you think that number might be too aggressive?

Yes, Edwin. You’re exactly correct. So what’s happened is we were given those estimates by our customers. We are now qualified and shipping virtually all of those products, they’re just shipping in significantly smaller volume that we had originally anticipated and than our customers had originally anticipated. So it’s probably about half of that revenue that we had originally projected. Edwin Mok – Needham & Company: For the coming quarter do you expect to have some [inaudible] as you are guiding for possibly a loss in the coming quarter? And what was the stock comp expense for the first quarter?

The stock comp expense was indicated $0.04 per share, Edwin. Edwin Mok – Needham & Company: So for the coming quarter you are guiding for possibly having a loss. I was wondering if there was a minimum tax that you have to pay for giving international operations that we should bake into our model.

No, there’s no minimum tax. We are targeting a break even, so basically a flat zero tax. But there’s no minimum tax that you should bake into your model.

Your next question comes from Jay Deahna - JP Morgan. Jay Deahna – JP Morgan: Increasing your expectation of revenue from non-semi to 20% in Q4, how much of that is a function of doing less semi versus more of the other? Or is it some combination?

Well, obviously in Q1 we were flat with regard to Q4 so the increase that we saw this time is an absolute increase. In Q2 we will benefit from the total revenue being down. By Q4, although we certainly don’t give guidance that far out, we would expect to be at or above our Q1 revenue. So the 20% should be on revenues at least as high as our Q1 revenues. Jay Deahna – JP Morgan: And remind me what non-semi was in Q1’s percentage of the total.

It was 14%.

It was 10% in Q4 and 14% in Q1. Jay Deahna – JP Morgan: And then you’re saying 20%, but in the December quarter so obviously there’s a pick up there.

Right. Jay Deahna – JP Morgan: On the new solar mandate, is that a gas delivery system or something else?

It’s something else. We’re not allowed to say what it is yet. But it is something else. Jay Deahna – JP Morgan: And is that on a mainstream CBD system?

Yes, it is. And it’s the same volume usage that would be for gas panels. Although the revenue is slightly higher than for gas panels. Jay Deahna – JP Morgan: Can you say if it’s chamber-related or not?

No, it’s not chamber. Jay Deahna – JP Morgan: On the EPI opportunity, is that an entire system that you’re building or some chunky sub-system that the customer was formerly building internally?

Well, it’s not a complete tool, if that’s what you mean. But it’s a very major portion of the tool. And yes, the customer was building that internally. Is still, as of today, building that internally. We think it’s a very good indication, they’ve talked to us for a long time, about outsourcing larger modules such as this and this is the first move that we’ve seen in a while to actually do that. Jay Deahna – JP Morgan: So is this something you actually haven’t built before? This type of module?

That’s correct. Now, the gas delivery system does attach to this module so we’ve built the gas delivery system that goes onto this module before. Jay Deahna – JP Morgan: So this is one of these sub-modules, perhaps?

Yes, it is. Jay Deahna – JP Morgan: Do you think that there’s more mandates like that as that customer increasingly does more outsourcing with their entire semiconductor-related product line?

Yes, I absolutely believe that’s the case. They’ve indicated that they’re moving more towards this merging transient model and more toward taking delivery of sub-systems in Asia. As that occurs then we’re going to be in a strong position to capture more of those sub-modules, which they would like to have us manufacture in Asia. Jay Deahna – JP Morgan: Do you see more opportunities to do solar-related sub-systems, whether it’s from your existing customers or others?

There is significant opportunity with other customers. We’re starting dialogue with other customers at this point. Obviously the challenge is trying to figure out which ones are likely to be the most successful and work closely with them. But we do see significant opportunities with other customers. Additionally with the existing customer, we think there is significant further additional opportunities once we prove ourselves on this second module.

Your next question comes from Wynne Jaffe – [inaudible]. Wynne Jaffe - [inaudible]: Could you break down the revenues, 14% of non-semi revenues, between medical and flat-panel?

Yes. Medical is going to be about 8% of the total. 8% out of that 14% is medical. Wynne Jaffe - [inaudible]: And when you get to 20% can you give us a rough percent of what medical should be?

It will increment, the growth is not going to come primarily from the medical, but it will continue to ramp. It’s on the verge of being 10% in the not too distant future. Wynne Jaffe - [inaudible]: Given the sequential decline in overall corporate revenues, could the non-semi revenue be greater than 20% in either the second or third quarter, and then revert back to 20% in Q4 as the rest of the business ramps up?

That’s not outside the realm of possibility.

Your next question comes from Jenny Noone - JP Morgan. Jenny Noone – JP Morgan: What was your non-gas panel revenue for the quarter?

It’s right around 50/50 now. It was 46% non-gas panel last quarter and we’ve grown it, largely on the strength of this additional solar flat-panel and medical device, so it’s about a 50/50 split. Jenny Noone – JP Morgan: Where do you see that going to by the end of the year?

It will continue to grow. You can do the math. If you get the 20%, assume the process module remains relatively flat and add an additional 6% for this solar flat-panel and medical device, you get to more of a 56% non-gas split.

Your next question comes from Jesse Pichel - Piper Jaffray. Jesse Pichel – Piper Jaffray: The solar win, is that a new tool outsourcing win or is that something that was done internally at your customer’s facility?

Our customer was outsourcing this but in small volumes. But it was being outsourced to a different provider. But they’re expecting a huge ramp in this application. They are not completely satisfied with the current provider and so we’ve been given an opportunity to be either the secondary source or primary source. But then again, how well we do in performance. But the volumes are relatively small at this point and they’re expecting big growth in Q4. Jesse Pichel – Piper Jaffray: Actually, a couple of your existing customers have big solar divisions. Do you think this could be a significant tam for you?

That appears to be a very large tam opportunity for us. It’s hard to quantify it. What we’re seeing is on some of these Samsung solar lines, what we’ve said is when fully populated they will utilize, the CVD tools that we provide gas delivery systems on, on these large solar lines when they’re fully populated there area 4 CVD tools with 7 process modules, each process module utilizes a gas delivery system, so there are 28 gas delivery systems on a complete line. And those have an ASP of about $50,000. So it’s about $1.4 million current revenue opportunity for us, for a complete line. With this new module it’s more than doubling. So, it’s probably going to put us up around $3 million revenue opportunity for the line. Or slightly higher.

Your next question is a follow up question from Edwin Mok - Needham & Company. Edwin Mok – Needham & Company: On Shanghai, you mentioned that you expected to achieve profitability by the third quarter. Can I ask what revenue level you need?

Yes. That’s based on about $3 million. Less than $3 million of revenue in that quarter. That we expect to ramp to eventually $6 million to $7 million by the fourth quarter of this year. Edwin Mok – Needham & Company: So your current revenue level is $3 million?

No. You asked by Q3, when we’re making money what level of revenue. And I said we will be making $3 million out of that particular facility in the third quarter. Edwin Mok – Needham & Company: On accounts receivable, you mentioned slow collection. Do you expect it to stay at this level given the challenging environment in the industry right now?

We only saw that at the end of the first quarter, which again, is preceding this very steep drop in Q2 is a lot of customers holding cash and being a little bit reluctant to finalize payment toward the quarter end. So between redoubling our efforts in that area and we just think the customers aren’t going to be as grasping and holding onto their cash at the end of the next quarter. We think we will be able to improve significantly for the DSO we did at the end of Q1. Edwin Mok – Needham & Company: So it sounds like it was more of just a one-quarter event.

Yes. And a little bit just, everybody said things were heading into a tough quarter, the second quarter, they wanted to show as much cash as they could on their balance sheet. And we had tough times getting the collections we normally get at the end of the quarter. Edwin Mok – Needham & Company: And finally inventories, given the drop in revenue level, any drops in inventory?

Basically the three U.S. facilities, our non-South San Francisco facility, all dropped nicely in line with the reducing demand. We had a little bit of an increase in inventory in our two largest growing facilities. One is in Asia where we had some core gas product that was purchases. Basically we didn’t reduce as quickly as we would have like, given the quick decline in demand. That is reusable inventory that we’re not worried about using. And the second increase in inventory was in South San Francisco, which is seeing a nice pretty solid continued demand in that facility and they’ve got a couple of new product lines, particularly in flat-panel and the new PDI opportunity, which is also flat-panel. So it’s a combination of new inventory for those two new projects and just robust demand there that caused that facility to increase. So, to answer your question, no, we’re not concerned that we won’t be able to use the inventory that’s there. It happens to be in our two facilities that are growing the most.

Your next question comes from Adam Meisel - Aquifer Capital.

Could you help a little bit, with all the moving pieces, give us a view of what to think of this company looking like in a more normal cyclical environment. Because I listened to what you’re describing, there’s a lot of expansion of business in solar, an expansion of business in process modules, and a lot of that in the medical devices and other non-gas things. It’s hard to see what all that will look like 6, 12, 18, or even 24 months down the road, when the world becomes more normalized because it’s being obscured by the cyclical down turn. So when you look out and say to investors, they should think of this company in some environment that isn’t cyclically high or low. What does it look like in terms of revenues, earnings, because it’s very hard now to put that together. And anything you do to help would be good.

If we go back to Q1 2007, we did $110.8 million. We have added significant new contracts on top of that. So if the industry would have returned to that demand level, we think we would be in the $130 million to $140 million range, just with the business we’ve already brought on and what we see as more normal activity levels. And there we think we approximate 18% gross margin, about 11.5% operating margin. And one interesting point that your question draws out is this down turn in Q2 and the need to get very lean, and we are, Clarence highlighted the fact that we went through a major reduction in early April, so we are getting very lean, operationally, is effectively good for the business in the sense that you become very efficient and with that subsequent return to growth in the industry, the profit falls through at very healthy levels. That’s what we saw following the Q3 2005 down turn and we expect to see the same as we come out of this most recent down turn.

I would like to elaborate on that. So, again, this is strategically what this company has done numerous times in the past. We’ve seen down turns and down turns like this. It’s a tremendous opportunity for our customers to migrate to more outsourcing. You see us capture new wins. And so what we’re doing is we’re streamlining our operations, as we have in the past. We’re consolidating facilities, we’re increasing our revenue out of our China operations, we’re increasing our China facilities, we’re reducing our headcount. So we’re taking all the action to streamline our operations and as the industry comes back and as we broaden into other industries, we expect to see a dramatic sling shot effect catapulting us to significant profitability going into the future. This is exactly in line with our strategic philosophy and our strategic direction. It has worked for us numerous times. And as the industry grows and as we expand into other industries, we see this happening again in the very near future.

There are no further questions at this time.

I would like to thank everybody for joining the call and remind everybody that we are on the road. We will be at the Cowen Conference in late May. We will also be at the JP Morgan Conference in Boston a little bit earlier in the month in May. I remind everybody that we do like to speak to investors throughout the industry cycle. We think there’s a lot to learn and communicate in both directions whether the industry is in a down turn or an up turn. So we look forward to seeing you on the road and thank you again for joining the call.