Ultra Clean Holdings, Inc. (UCTT) Q3 2013 Earnings Report, Transcript and Summary

Good afternoon. My name is LaShanda, and I will be your conference operator today. At this time, I would like to welcome everyone to the Ultra Clean Technology Third Quarter Financial Results Conference Call. [Operator Instructions] Joining us today is Ms. Sheri Brumm, Vice President of Finance; Mr. Casey Eichler, Chief Financial Officer; and Mr. Clarence Granger, Chairman and Chief Executive Officer. I will now turn the call over to Ms. Brumm. You may begin your conference.

Thank you, operator. Welcome to our third quarter financial results conference call. Presenting today are Clarence Granger, Ultra Clean's Chairman and Chief Executive Officer; and Casey Eichler, Ultra Clean's Chief Financial Officer. We will begin by presenting the financial results for our third quarter, and Clarence will follow with some remarks about the business. A few moments ago, we issued a press release reporting financial results for the third quarter ended September 27, 2013. The press release can be accessed from the Investor Relations section of Ultra Clean's website, along with the information for the tape delay and replay of the live webcast 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 fourth quarter of fiscal 2013. 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 a publicly announced conference call. The matters that we discuss today include forward-looking statements as defined in the U.S. Private Securities Litigation Reform Act of 1995 related to matters including our future financial performance, new product orders and shipments and industry growth. Investors are cautioned that forward-looking statements 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. 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 is Casey to present the third quarter results.

Thank you, Sheri, and good afternoon. Revenue for the third quarter was $107.2 million, a decrease of approximately 2.7% from the prior quarter and an increase of 6.3% when compared to the same period a year ago. Semiconductor revenue for the third quarter was $94.8 million, which is flat with Q2 of 2013. And non-semiconductor revenue was $12.4 million, a decrease of 17% when compared to the second quarter. Semiconductor revenue was 88% of total revenue for the quarter. Revenue outside the U.S. was 33% in the quarter compared to 30% in the prior quarter. 3 customers had revenues over 10% for the quarter, and gas delivery systems represent 57% of our revenue for the third quarter. Gross margin for the third quarter increased to 14.8% compared to 14.6% in the second quarter. We are extremely pleased that we were able to increase our gross margin quarter-over-quarter, while revenue declined slightly. Operating expenses were $10.9 million, or 10%, excluding amortization of intangibles, as compared to $11 million, or 10%, in Q2. Our operating expenses as a percentage of revenue will continue to decline in the fourth quarter. We had operating income of $3.4 million, or 3.2%, before interest expense and income taxes compared to an operating income of $3.6 million or 3.3% in the second quarter. Excluding amortization of intangibles, our operating income was $4.9 million or 4.6% in the third quarter. Interest expense for the quarter was $633,000, a decrease of approximately $101,000 quarter-over-quarter. The effective tax rate for the third quarter was 15.5% or an expense of $375,000. The tax rate for the fourth quarter should be modeled at 20%. Third quarter net income was $2 million or $0.07 per share. Excluding amortization expense related to the merger with AIT, third quarter net income was $3.3 million or $0.12 per share compared to $0.12 per share in the second quarter. The diluted share count was 29 million, up 200,000 shares compared to the prior quarter. Non-cash charges for the third quarter were $1.1 million related to FAS 123R, $833,000 related to depreciation and $1.5 million related to amortization of intangibles. Turning to the balance sheet. Cash was $65.9 million, a decrease of $5.4 million from the prior quarter. Net cash, however, increased $6.5 million during the period. In managing our cash balances, we paid down the debt during the quarter by $12 million, thereby taking our outstanding debt down to $56.5 million from $68.3 million in the second quarter. We anticipate that gross cash will be up slightly next quarter with net cash once again rising as a result of continued debt repayment. Accounts receivable was $49.7 million, up $2.7 million from the second quarter. And days sales outstanding increased to 42 days from 38 days at the end of the second quarter. Accounts payable of $37.8 million increased approximately $7.7 million quarter-over-quarter. Days payable outstanding at the end of the third quarter increased to 37 days from 29 days at the end of the second quarter. Net inventory was $50.3 million, an increase of $1.6 million over the prior quarter. The increase in inventory is a result of our fourth quarter forecast and the need for inventory ahead of the start of the quarter. Inventory levels are projected to stay flat during the fourth quarter of 2013. In summary, I'm exceptionally proud of our team, the entire team, for delivering continued improvement in operational and financial performance. Now, Clarence will discuss our operating highlights for the third quarter. Clarence?

Thanks, Casey. During the third quarter of 2013, we achieved revenue slightly above the midpoint of our guidance range. As a result, we were extremely pleased in our gross margin performance at 14.8% versus 14.6% in the second quarter. Although revenue declined from Q2, we achieved better gross margins quarter-over-quarter. As Casey previously stated, our revenue for Q3 was $107.2 million, and our adjusted earnings per share were $0.12, excluding amortization charges. On our previous earnings call, we had guided to Q3 revenue of $103 million to $110 million and $0.06 to $0.12 adjusted earnings per share. We're pleased that we were able to achieve revenue at the midpoint of our guidance and earnings per share at the top end of our guidance range. I'll now review highlights of our activities for the third quarter. In the third quarter, we increased our net liquidity by $6.5 million to $9.4 million. With a continued focus on inventory and operational efficiency, we have been able to generate cash consistently for the last 5 quarters. We're very confident that, as a result of our operational execution, we will continue to generate cash, reduce our debt and reduce our inventory balances. In Q3, the percent of revenue coming from our Asian operations continued to rise. The third quarter saw 33% of our total revenue come from our Asian manufacturing operations, an increase from 30% of total revenue in Q2. As mentioned in previous calls, AIT's heavily U.S.-based manufacturing led to an increase in the percentage of our overall U.S. manufacturing shortly after the acquisition. We are now starting to see increased manufacturing as a percentage of total sales within Asia. We anticipate this trend to continue having a favorable impact on UCT's margins and profitability. Another major accomplishment for the quarter was our gross margin achievement. During the third quarter, we saw a slight decrease in revenue, yet we were still able to maintain a healthy gross margin of 14.8% compared to 14.6% in Q2. As mentioned previously, these margins were achieved through our continued focus on operational efficiency, as well as our mix of revenue being shipped from outside of the U.S. and continued integration activities with AIT. As stated numerous times previously, our margin goal is to achieve gross margins in the 15% to 18% range, and we anticipate reaching this goal in the fourth quarter of 2013. On the new business front, this quarter, we added a new customer, whose primary products are crystal growth tools, serving multiple markets including consumer electronics, solar and semiconductor industries. This new customer will generate approximately $2 million of revenue for UCT in Q4 2013 and $10 million to $15 million in 2014. This win represents another important milestone in our strategy to expand our served markets, as well as to add new customers. In addition to our superior on-time and quality performance, this new customer was drawn to our engineering design capabilities and our global footprint. We are very excited about this significant new opportunity. I'd now like to shift to our guidance for the fourth quarter of 2013. UCT is seeing a significant revenue ramp within the semiconductor sector of our business for the fourth quarter. As a result, we anticipate an overall revenue increase during the quarter. Our revenue guidance for the fourth quarter is $120 million to $125 million, and our Q4 earnings guidance is for earnings per share to be in the range of $0.18 to $0.22, excluding amortization charges. As Casey discussed earlier, the tax rate for the fourth quarter should be modeled at 20%. In summary, during the third quarter of 2013, we had several major achievements. We saw our net cash balance go up significantly, our gross margins were maintained at a healthy level quarter-over-quarter and we anticipate them to increase again next quarter. Finally, UCT added a significant new customer that will generate approximately $2 million in revenue in Q4 and will have continued revenue increases during fiscal 2014. In closing, we remain confident that UCT's future is very bright, both from a long-term growth and an operational execution perspective. With that, operator, we would now like to open the call for questions.

[Operator Instructions] Your first question comes from the line of Edwin Mok with Needham & Company. Y. Edwin Mok - Needham & Company, LLC, Research Division: So first question on your guidance on the fourth quarter. Remember last quarter, you talked about DWFritz, one of your customer, is pretty lumpy. Do you expect that would impact your non-semi business, in other words, baked in your guidance are you guiding for non-semi to be down a little bit in the fourth quarter?

Yes. DWFritz will go down a little bit in the fourth quarter, but this other new customer I mentioned will be coming up in the fourth quarter. But most -- all of our growth will be in the semiconductor side. So our non-semi side will be down a little bit in the fourth quarter. Y. Edwin Mok - Needham & Company, LLC, Research Division: I see. Great. That's very helpful. So talk about this new customer. You mentioned that they're in the crystal growth area. I suspect it's probably sapphire. But my understanding is the sapphire supplier base has been pretty -- kind of oversupplied. Are you worried that this customer might not end up ramping in '14? And any kind of color you can provide in terms of what kind of revenue opportunity you'll get for [indiscernible] actually can give us?

Yes. It's -- there's not too much guidance. It is crystal grower. Some of it is sapphire, some of it is semiconductor, silicon. So we do have an actual order for on the order of $2 million in Q4, and we certainly seem, based on the additional opportunities -- the order in Q4 is for 1 specific program, 1 product for 1 program, and we have had opportunities to quote on multiple programs. So it seems fairly solid to us in the $10 million to $15 million range in 2014. Y. Edwin Mok - Needham & Company, LLC, Research Division: I see. So basically, they have multiple programs. This is just 1 particular program and the $10 million to $15 million, based on assumption, that you might win. There is some of the incremental opportunity. Is that a fair way to think about it?

That is correct. The Q4 opportunity is 1 specific order for 1 specific product, and the 2014 numbers are assuming some additional new business wins, which we think we will achieve. Y. Edwin Mok - Needham & Company, LLC, Research Division: Okay. That's very helpful. And then, moving -- shifting gear to the semi side, ultimately very strong, partially because the sector is coming back, right? How much visibility do you guys have beyond this quarter? Are you worried that it's kind of a 1 quarter blip and things kind of moderate? And in terms of the 3 10% customers, are they all semi customers?

Yes, our 3 10% customers are all semi customers. With regard to visibility, as you know, we have pretty good visibility for 3 months, and we have some less clear or more limited visibility for the subsequent 3 months. But it certainly feels right now like certainly 2014 should be a good year, and it certainly should start off as a good year. Y. Edwin Mok - Needham & Company, LLC, Research Division: Great. 1 last question. So if I look at OpEx based on your guidance, it's kind of implying a 9% type of revenue, OpEx as a percentage of revenue. That seems low compared to your kind of target, right? Do we expect OpEx to kind of come back up as you get into 2014? Or would that -- is this quarter [indiscernible] because of the ramp, you might have a little bit lower than normal OpEx? How do you guys think about that?

Yes -- no. I mean, I'm targeting where -- if we can get OpEx down over a little longer period of time. Obviously, it's very volume dependent. To around 8%, that would be a good target long term for us to get the OpEx. Right now, because volume is just ramping a little bit and we continue to combine some of our functions, it's running at about 9%, which isn't bad but I'd like to see it come down a little more going forward. But that 9% that you've referenced, that's in the right ZIP code for us right now. Y. Edwin Mok - Needham & Company, LLC, Research Division: Great. Actually, I -- let me squeeze one more in. You mentioned that now that you have integrated AIT you're able to leverage your Asian facility and start to produce more. Any way you can kind of quantify that, how much incremental benefit you get out of that? Any kind of help you can get -- give us for that?

Yes. Well, I mean, there's benefits in 2 ways. One is we're going to get a lot of revenue opportunities that the companies individually didn't get in the past. For us, leveraging our international capabilities and supply chain is helpful to AIT in giving us opportunities that they might not have seen. For us, some of the vertical integration of their full systems experience as well as the frame and the sheet metal gives us some opportunities we might not have seen. So from a revenue perspective, we're going to pick that up. Obviously, leveraging our supply chain and our global approach across AIT and then continuing to build that for UCT gives us some margin improvement as well. Kind of quantifying the number really has a lot of components to it, so it's hard to do but you can see, I think, in what we've been doing over the last few quarters we're very focused on those opportunities, both from an operational and a finance standpoint, and I think we're delivering on that and we're going to continue to be focused on that to try to see what else we can get.

Your next question comes from the line of Dick Ryan with Dougherty. Richard A. Ryan - Dougherty & Company LLC, Research Division: Say, when you look at -- kind of following up on the moving manufacturing to Asia, are you seeing some of the AIT -- the opportunity of moving AIT or is that still kind of being evaluated by the customers?

Well, what we're trying to do is we're trying to get new business as a result of the AIT's capabilities in Asia. So some of their customers have a significant presence in Singapore, and we've been trying to capture more of that Singaporean business. So I wouldn't say a significant portion of the business in the U.S. is migrating to Singapore or to Asia, but I would say we're being given more opportunities in Singapore and in Asia in general that we didn't have before because UCT didn't have relationships with those customers. Richard A. Ryan - Dougherty & Company LLC, Research Division: Okay. On the non-semi side, I think there was a kind of maybe a focus for your new business development group. Can you give us a sense of the pipeline of opportunities there and what you're seeing on the non-semi side?

Well, our frustration, I guess, is every time we seem to get a little wind something seems to slow down somewhere else. But we continue to drive the non-semi side. I would say 70% to 80% of our new business opportunities are in non-semi. We keep driving those very hard. We've got a dedicated team of about 7 people that's focused -- almost is focused exclusively on new business opportunities that we don't handle currently, and most of that is outside of semi. So it does feel like we've got a reasonably full pipeline. Some of them are larger players that could lead to longer-term contracts like this one I just described on the crystal growing. Some of them are smaller players like the DWFritz, and 1 or 2 others where they have tend to be more on the consumer electronics side and tend to have drop-in orders where we can get $2 million or $3 million maybe 1 quarter and then nothing happen for 6 months and another $2 million or $3 million. So I think we're getting a pretty good mix of all of these. Again, it still remains a challenge, but that's where we've got our focus for future growth. Richard A. Ryan - Dougherty & Company LLC, Research Division: Okay. And just on the LED side, is that still a minimal contribution? And any change in the outlook there?

Not for -- there's no change in the outlook for UCT. We've got very minimal revenue coming from that side.

And your next question comes from the line of Jagadish Iyer with Piper Jaffray.

Two questions. First on the semi side of the business, if I look at how -- what consensus thinking is for 2014, I know you have very little visibility beyond 1 quarter. But how should we be thinking about if industry spending is going to be up, say, over 10% now that you've consolidated AIT as well, is that a fair assessment that your semi business could potentially grow? Is there any puts and takes to that in terms of share shift or something going forward as you look at the next 12 months?

Yes. I would say -- I think what I said a little bit in our last earnings call, too, is that the share shifts and what have you seems -- obviously, we mentioned losing business to -- for one of our major customers over a year ago now. That all seems to be reaching an equilibrium point or a point of stability. So I would say, yes, there's nothing negative that's going to cause us to lose market share or decline. Our expectation at this point would be to grow at whatever rate the industry grows or a little higher. We are also penetrating -- as we've mentioned before, we're penetrating some new segments within the semiconductor side. We're starting to make atmospheric robots for 1 of our major customers, and that business is starting to grow to around $2 million a quarter and it looks like there's some additional opportunities there. So I would expect us to grow at whatever rate the semiconductor industry grows plus a little bit for new opportunities.

Okay. Fair enough. Then just as a follow-up, Casey, so now that you're slowly inching towards your 15% target, how should we be thinking about as -- potentially, if this revenue start to move up, are you going to manage your inventory? Or how should we look at in terms of holistically, in terms of the mix given your non-semi portion could also be chugging along? Any thoughts on how you're going to get to that 15% to 18% potentially by sustaining that going into 2014?

Okay. Well, a couple of questions in there. 1 was related to inventory and 1 was related to margins. I think, obviously, as the revenue continues to move up or if the revenue continues to move up, we're going to get the natural uplift that you'd get from that. But I do also think that we're going to have a little extra on top of that because there are more efficiencies that we're continuing to try to drive. I think all the site managers, Gino and his team, supply chain, everyone is really, really working hard and we are from a finance perspective as well. So again, we're not ever going to give up on trying to optimize, but revenue does build the margin and we're going to continue to see that. As Clarence referenced, we would expect to see that hit into our target next quarter or the current quarter, Q4. From an inventory standpoint, I did reference that we brought on a little more inventory at the end of last quarter because of the uplift in revenue this quarter. But I also did say that we thought we're going to keep it flat. So our challenge or our goal is to try to keep revenue growing and try to keep inventory flat, and that's what really gives us the cash leverage, et cetera. So from the inventory standpoint, I would expect it to stay relatively flat, and I was pretty pleased that we only went up a little bit considering we have a pretty good-sized quarter ahead of us.

[Operator Instructions] Your next question comes from the line of Patrick Ho with Stifel, Nicolaus. Patrick J. Ho - Stifel, Nicolaus & Co., Inc., Research Division: First, in terms of the fourth quarter outlook, as it relates to your semiconductor business, you talked about some of the new opportunities on the non-gas delivery side of things. Can you give a little bit of color of -- in terms of what you're seeing in your traditional gas delivery business on the semi side versus some incremental contributions from the non-gas delivery side?

Well, gas delivery overall for UCT was 57% last quarter, so it's still the bulk of what we provide. And many of our new opportunities, the way we kind of get the foot in the door is the gas delivery. This new customer that we're talking about on the crystal grower, that first opportunity is a gas delivery subsystem. So it continues to be our entrée for most people. We would expect to see, overall, our gas delivery growth be in line with our overall customer systems growth. So that's kind of how we feel about it, continues to grow, good part of our business and we use it for an entrée into new business opportunities. Patrick J. Ho - Stifel, Nicolaus & Co., Inc., Research Division: Okay. Fair enough. And then, maybe for Casey, in terms of the -- as it relates to the overall business model impact, as these new opportunities in the non-gas delivery system business picks up momentum, what kind of impact do you think that they'll have on margins, given some of these are new products and typically new products have a ramp-up phase? How do you see some of the levers moving on that front?

Yes. So you're exactly right. Initially, the margins, as you're ramping up and getting experience, can be a little lower. I think that's partially offset that a lot of these projects, one of the things we bring that a lot of people don't bring to the table is engineering expertise, design expertise, product introduction expertise and we tend to get paid for that. So that helps to offset that initially. Once the margins ramp up into maturity, I think they're going to be in the same general area as our other products, which is, as you know, 15% to 18% is kind of what we're targeting. So I think that your observation is right. Initially, that starts a little lower, but we add other content that we get paid for. And then, as things go along, we get better and more experience and we tend to get a little bit better margins. Patrick J. Ho - Stifel, Nicolaus & Co., Inc., Research Division: Great. And final question for me, on your non-semis business, I know it's quite lumpy given some of the marketplaces you participate in. From your vantage point, where do you see, I guess, the potential pickup? From existing customers ramping up their business or some of your new customers, I guess, product releases where you've penetrated, those starting up? Where do you see [indiscernible] I guess, the visibility for pickup in the non-semis business?

So right now, the pickup opportunities in the non-semi side are mostly with new business opportunities. The current customers we have, their business seems to be flat or a little bit down right now. So we're trying to offset that by adding new customers as quickly as we can, and that seems to be our biggest growth opportunities in the non-semi side right now. I'm sure that will change again, where our existing customers will start growing again. But for the moment, the biggest growth opportunity is in new customers.

Your next question comes from the line of Colin Rusch with Northland Capital Markets.

Can we just talk a little bit about incremental margins? It looks like, based on your guidance, that you're talking about incremental gross margins in the mid-20s and incremental operating margins around 20%. And then, you're also talking about a little bit of a drag with these new products. Can you just give us some sense of, as you add revenue to the model, how much leverage there really is?

Well, again, it depends on where that revenue is being added. I'll give you all the caveats of domestic versus international and low-cost region, et cetera. But I think a lot of people at a high level have kind of modeled around 20% on a kind of fall-through at these levels on gross margin. That's not an unreasonable place to start but then you have to impact it with all those different things. As I mentioned, we've got plenty of capacity, et cetera. So from an operating expense standpoint, back into the middle and beginning of last year -- or of this year, I should say, we were running at MTO [ph] and no bonuses, and it was a lean time. In our business, you have to get lean. We now have gotten back to a more normalized business environment. So you've seen a little bit of cost added, but I don't think we have to add a lot of cost on the operating expense line to continue to ramp revenues. So I don't think there are, to your point -- there's a lot of degradation as it falls down through the operating income line. So -- and then, the tax is, as always, as you get down to the end of the year, a bit of a wild card because you have to look at the full year and make adjustments for transfer pricing and all the other things that you do. But I think the 20%, as I referenced, is a pretty fair place to think about it for Q4.

Colin, this is Clarence. One of the things I would add with regard to our improving margin, we are starting -- we are continuing to see a benefit associated with the AIT integration. So some of the margin improvement is, as you mentioned, volume and location-related. But some of it is related to making progress on the integration, utilizing UCT supply chain more, stabilizing the manufacturing teams in AIT and combining the focus on working together more cooperatively. We're starting on the UCT side. We're starting to utilize some frames that are manufactured by AIT, which has helped improving our cost model on some of the frames, and we're starting to utilize the UCT supply chain in Asia and elsewhere to help drive down some of the AIT cost. So I think part of what you're seeing is clearly volume-related, part of it is Asia-related, but another significant component is the success we're having with the integration. And I would say we're probably 70% to 80% complete on the integration at this point.

Okay. So just so I'm really clear, we're talking about roughly 20% operating margin for -- on the incremental revenue or just a touch below that...

I think...

Which is great.

I think that's what people generally use at these levels. And then, like I say, it depends on how much of that is coming in low-cost regions, how much domestic, what the product mix is, et cetera. But that's a reasonable place to start and then work from there.

Let me pin you down next time and actually have it be your opinion. So separately, the cash management, it looks great here. The de-leveraging story is really playing out. Can you talk a little bit about your acquisition strategy as you start to see that cash balance -- or net cash balance rebuild and opportunities that you're seeing out there right now?

Yes. I don't know that we ever turn off or turn on our acquisition strategy. What we do is continually look at opportunities. I -- even when we closed the AIT deal, to do something the next quarter would have been a little challenging probably, but I think there's always opportunities to finance quality combinations, and I think AIT and UCT was a very high-quality combination and I think there are other ones out there. But as we've talked about, we are not a fix-it shop. We're not somebody that's just going to overpay or try to build the top line through an aggressive M&A strategy. We're trying to be thoughtful about rounding out our capabilities not only in semi but outside of semi, and I would just say that I look at things -- Clarence and I look at things constantly, trying to find out where we can get the proverbial 1 plus 1 equals 2 or 2.5 or 3. So we'll continue to do that. And I'm not worried about the cash balance when I think about doing a future acquisition.

Our focus continues to be on driving cash. And if we drive cash, that gives us a lot more opportunities.

[Operator Instructions] And there are no further questions at this time.

Great. Well, I appreciate it. I appreciate everyone who dialed in and have continued to be supportive of the company. We're going to continue to work hard for you, and hope to see some of you during the quarter. Thanks a lot.

This concludes today's conference call. You may now disconnect.