Good day, and welcome to the Ultra Clean Fourth Quarter and Full Year 2022 Conference Call. [Operator Instructions] This event is being recorded. I would now like to turn the conference over to Ronda Bennetto, Investor Relations. Please go ahead.

Thank you, operator. Good afternoon, everyone, and thank you for joining us. With me today are Jim Scholhamer, Chief Executive Officer; and Sheri Savage, Chief Financial Officer. Jim will begin with some prepared remarks about the business, and Sheri will follow with the financial review, and then we'll open up the call for questions. Today's call contains forward-looking statements that are subject to risks and uncertainties. For more information, please refer to the Risk Factors section in our SEC filings. All forward-looking statements are based on estimates, projections and assumptions as of today, and we assume no obligation to update them after this call. Discussion of our financial results will be presented on a non-GAAP basis. A reconciliation of GAAP to non-GAAP can be found in today's press release posted on our website. And with that, I'd like to turn the call over to Jim. Jim?

Thank you, Rhonda, and good afternoon, everyone. Thank you for joining us for our fourth quarter and full year 2022 conference call and webcast. First, I'm going to highlight a few financial results that Sheri will expand on in her commentary. I'll follow this with an overview of what we are seeing in the semiconductor market in the near term and summarize our plans as we play a more critical, meaningful role in the value chain. Solid execution from our global teams in 2022 resulted in a record year for UCT with revenue growing 13% year-over-year and operating income reaching a new high of $260 million. Looking back on this extraordinary three-year industry ramp, UCT's annual revenue grew almost 123% and earnings per share surged 243%. That's a compound annual growth rate of 31% for revenue and 51% for earnings per share compared to the industry CAGR of 22% in the same period. Late in the fourth quarter, it became apparent that the industry was headed into a downturn as our customers quickly pushed out and canceled orders in rapid response to their customers doing the same. Reductions in end market demand have been felt throughout the value chain and has prompted suppliers and service providers like UCT to make immediate adjustments to near-term production, operations and financial forecasts. Because our customers and their customers are taking actions to bring surplus inventory into balance as quickly as possible, we believe the major step down of orders are reflected in our Q4 results and Q1 forecast. We expect the order stream to stabilize around these new levels. We have not changed our optimistic view that the fundamental drivers of our industry will propel significant growth over the long term. Not surprisingly, after three consecutive years of record WFE growth accelerated by…

Thanks, Jim, and good afternoon, everyone. Thanks for joining us. In today's discussion, I will be referring to non-GAAP numbers only. As Jim noted, 2022 was a record year of UCT for revenue and operating income. During the year, we paid down our debt by $40 million and spent $12.1 million repurchasing shares and prudently invested in projects to support our long-term growth strategy. Total revenue for the fourth quarter came in at $566.4 million compared to $635 million in the prior quarter. Products division revenue was $499.5 million compared to $556.3 million last quarter. And revenue from our Services division was $66.9 million compared to $78.7 million in Q3. The strong demand we saw in the first three quarters of 2022 led to a record revenue of $2.4 billion for the year, up 13% from the prior year. Products generated revenue of $2.1 billion, up 15% year-over-year, and Services contributed $299.6 million, flat with the previous year. Total gross margin for the fourth quarter was 19.5% compared to 20.6% last quarter. Product gross margin was 17.7% compared to 18.3% in the prior quarter, and services was 33.5% compared to 36.9% in Q3. Margins can be influenced by fluctuations in volume, mix in manufacturing region as well as material and transportation costs. So, there will be variances quarter to quarter. Total gross margin for the year was 20.2% compared to 21.4% last year. Operating expense for the quarter was $53.8 million compared with $56.5 million in Q3. As a percentage of revenue, operating expense was 9.5% compared to 8.9% in the prior quarter. For the year, operating expense as a percentage of revenue was 9.3% compared to 9.2% in the prior year. Total operating margin for the quarter was 10% compared to 11.7% in the third quarter. Margin from our…

[Operator Instructions]. And the first question will be from Quinn Bolton from Needham & Company. Please go ahead.

Congratulations on a record 2022. I know the environment has changed, but great to see those results. I guess, Jim, I wanted to ask your thoughts. In your script, you talked about the majority of the step-down in orders you think has taken place in Q4 of '22 and this quarter here in '23. And you talked about seeing or expecting orders to sort of stabilize. And so, as you look out to 2023, how do you see the revenue profile for the year? I know you've got that $30 million that comes out of Q1 and likely gets captured in Q2. But should we be thinking about -- it feels like the first quarter level without that $30 million impact would be close to $450 million at the midpoint. Is that kind of the revenue level you see where things are stabilizing? Or do you see a different level?

Hi. Quinn, no, I think you have it exactly right. Yes, that's true. It would have been around $450 million would have been what we would have been projecting. And yes, I think we see it stabilizing at that level or maybe slightly higher and being -- bouncing around roughly those numbers throughout the year. We're obviously hopeful that the second half could be more positive as some of our customers and peers have commented that they're looking to see if there's something improves in the second half, but our assumption at this time is bouncing around the number that you put out there and some recovery in the second quarter, assuming that the supplier that's impacting us and many people right now is able to recover as well. So yes, that's exactly the right way to think about it.

Perfect. You mentioned, Jim, the number of actions you're taking to streamline operations now including sort of reduced overtime, getting rid of some of the variable employee costs. But where do you see OpEx sort of shaking out in the near term as you take those actions? And then you also mentioned facility consolidation. Is this downturn giving you the opportunity to bring more business into Malaysia from some of the other sites around the world?

Yes, I think there are several parts to that, Quinn. Yes, we've been through multiple of these cycles. And so, taking down the variable cost, especially in the COGS area, we're pretty experienced at that. And I think you'll see us sustain higher gross margins through this cycle than we have in the past also with our broader company portfolio that we've assembled since the last downturn. So, on the OpEx side, there are a few headwinds. I'll let Sheri talk about that in a second. Those take a while to really move down. And some of the consolidation actions, of course, those are consolidating where you have two sites relatively to close proximity or business has moved from one region to another and a site is kind of unbalanced as a result of the last surge of the industry where we rebalance that and consolidate those sites. Those actions take roughly a year to put in place before you start seeing the benefit of those. We won't see a lot of that impact of those longer-term cost reductions until next year. But those will obviously help us become leaner and hit better numbers in the next upturn, just like we did in the last one. But Sheri, maybe you can talk about some of the other specifics?

Yes. So, we came in at 9.5% for Q4. We will see that go up in Q1 and partially in next year as we move through it. But we do have quite a few reduction initiatives in place, especially surrounding controllable spending within OpEx, whether that be travel or other discretionary spending as well as looking at our headcount and obviously, looking at footprint that does play into that as well. So, we are continuing to look at that quite heavily and see that cost hopefully come down as we move through the year as well.

Sure. Should we be thinking maybe OpEx somewhere between, say, 10% and 11% of sales? Or do you think it could go even higher just given the magnitude of the quarterly change in revenue in March?

Yes. We've seen it, I think in the past, when we've gone through downturns anywhere between 10% and 12%. So, I would assume that it would be around that -- within that range depending upon the revenue level. So obviously, Q1 has come down. Some as a result of this cyber-attack along with just the industry coming down. So, I anticipate that it's going to be probably a little higher as a percentage of revenue for Q1. But as we move through the year, I think it will come up to a more normalized range.

Thank you.

The next question is from Krish Sankar from Cowen. Please go ahead.

Hi, thank you for taking my question. This is Stephen calling on behalf of Krish. I guess, Jim or Sheri, just a quick question first on Q4 and some of the impact from, I guess, production limitations in China that you guys previously highlighted. I guess relative to that $60 million delta between what you reported for Q4 and your original guidance midpoint, how much of an impacted production restriction have? And how is that situation here in Q1 so far?

Yes. In Q4, the major impact was actually the industry downturn and a lot of canceled and delayed orders. The COVID impact turned out to be much smaller than we first feared. I think it was roughly $8 million or $5 million. And that factory is up and operating normally right now. What was the second part of your question on that?

Yes. Is there any -- I guess you [indiscernible] the answer, I guess there's no follow-on impact here in Q1. Is that correct?

No. The only unexpected impact in Q1 was one of the key suppliers for the industry. and the issue that they're having with the cyber-attack. Those components are used in multiple areas of the tools by many of us.

All right. Got it. My follow-up question is regarding sort of your, I guess, your memory exposure. I think in your slide deck, you show your exposure on a revenue basis from your largest customer is holding steady around 40% in Q4 relative to Q3. Just kind of wondering, just given some of the talk in the industry over the past couple of weeks about memory makers or suppliers potentially not cutting CapEx significantly this year as originally expected, I guess, how do you see that, if any, at this time flowing through to your outlook for the second half of the year?

Yes. It's hard to predict what impacts. I think obviously, we're seeing Samsung looking to spend a little bit through the cycle more than some of the other memory or foundry makers as well. So, it's really hard to say if that's going to -- what that's going to look like or if there are any further cuts from the memory makers. So, I think that's why we're taking the view of not expecting a recovery in the second half of the year, but obviously, a pleasant -- positive surprise is possible.

Thank you.

And the next question is from Christian Schwab from Craig-Hallum Capital Group. Please go ahead.

Great. Jim, after you take the variable cost of COGS out, I'm just wondering, do we -- what your utilization rate of labor is? And then -- more importantly, as we look to the eventual recovery at a $450 million run rate business quarterly, plus or minus. What is your utilization rate then on tools and facilities?

Yes. The utilization on labor with some time lag, we tend to keep up not at 100%, but pretty close to even through the down cycles when we're not able to achieve it through normal means of overtime, and we carry a large temporary workforce sometimes up to 35%, 40% during the upturn. So, when we're not able to meet those utilizations and we utilize other things like shutdowns, which we're doing in this quarter and other methods as well. So, we keep the labor utilization very high. So, we expect to be able to keep the gross margins up. Obviously, the footprint and the tools and the costs and COGS is harder to cover. I couldn't give you an exact number on the utilization, but I think if you assume we were 100% utilized at the 630 million, do the math on the number, which is 65% of that, I think you'd be somewhere roughly around there. We were not 100% utilized in the Malaysian footprint, but we were 100% utilized in the workforce there. So, we maybe put it at around 60% or so.

Okay. No, that's great. And then can you just remind us on the product mix, the end markets that you serve. Can you -- between memory, mature, advanced logic, where the vast majority of your shipments to your two leading customers end up being utilized by end customers' fabs. Does that make sense?

Yes. It's actually hard for us to track on a running basis is when we ship a tool to our customers, again, that same tool can go or the same module can go to any application. So, it's not something I can really forecast. But I think you'd expect it to follow exactly where the capital is being spent right now. So, memory is clearly going to be down as more of the tools are going to foundry and Samsung as well. So, I think you'll see a shift that way. But I couldn't give you a new pie chart on memory versus logic foundry at this point. But definitely, it's going to be moving towards less memory, as you would expect.

Great. And then should we assume that gross margins improve sequentially in Q2 and then the kind of flat line at those type of levels given labor will be fixed quickly. And then is that the way we should be thinking about that?

Yes. I would assume that it would be able to level out at the Q2 level. And then hopefully, depending upon what happens in the second half, we would see it stay around that range as we move through the rest of the year.

Great. And then my last question is remind us, if you could, what lead times were pre-pandemic or pretty strong three years however you want to do it. What they were during the strong three years and what you expect them to be on the backside of this?

Are you talking about tool lead times from our customers to theirs?

Yes, lead times to customers.

From us to our customers?

Yes.

Okay. Yes. depending on what part of our portfolio you're looking at, the fluid solutions, the former Ham-Let, those lead times are relatively -- have been relatively short, and a lot of that is vendor managed inventory. If you're talking about some of the other, like, let's call it, integrated module piece of our business that was stretching out to two to three months in many cases. and sometimes even longer during the upturn. And obviously, they're a lot faster now or, in some cases, immediately ready for shipment should the customers require them.

Fair. Okay. So as far as since the lead times are relatively short, kind of what you implied your visibility of two and -- how many other quarters of digestion at these type of levels, last cycle, I think you suggested it was five quarters really, it will be determined by the dialogue and the direction that we hear from AMAT and lab. Is that fair?

yes. For years leading up to this last up cycle, where the demand without stripping the supply for everyone in the industry, we were -- that's when we were seeing a very unusual fourth quarter bookings that was pretty easy to forecast. We're more back in the normal state where we can see one quarter out relatively clearly except for certain force majeure events like we've been experiencing like COVID and cyber. So, I think we're back to kind of seeing one quarter out and with a little bit even more blurriness because frankly we have to keep track of typically, there's not much inventory between us and our customers. But as the orders fall off pretty sharply at the end of 2022 and further in the first quarter, some inventory built up between us and our customers, which is not a typical state. So, we also have to try to figure out what -- even when we look at end demand and what's going on there, we have to also try to piece together what will actually [indiscernible] an order book for us.

Yes. And then just a follow-up on that. It will be my last question. Do you have an idea of how much aggregate dollar amount of inventory is sitting between you and the customer that historically is not there?

No. We don't -- again, many of the things that we make we don't own 100% share of that modules. Sometimes we're 50% or 60% or 70% share. So, we don't know what they're holding of the same type of thing that we make that may be a competitor made as well. So, all we know is that the warehouses of many of our customers are very full to the point where we even -- in the case here or there, we may have to even hold on to something for them. So, it's pretty big right now, and that's why you might see when they report less dramatic drops in revenue. There's a couple of factors there. One is they're working through their deferred revenue for things that they've already shipped. And two is because they do have a lot in their inventory right now. But I think that will burn off at some point. But I think we're pretty confident. When we put all those different pieces together, the headwinds and the tailwinds, the number that I think Quinn was talking about make a lot of sense.

and the next question is a follow-up question from Quinn Bolton from Needham & Company. Please go ahead.

Sheri, just a quick follow-up for you. If we're thinking about revenue down roughly 25% or about $600 million year-on-year, and I'm getting to that $1.8 billion just by annualized -- or yes, annualizing the $450 million quarterly run rate we've been sort of speaking about. Can you give us some sense, what do you see the incremental margin fall through on that lower revenue is? I mean, should we be modeling like a 25% incremental margin? Or is there a better figure to be thinking about just as we think through the gross margin trend for the year?

Yes. I think -- I mean, the gross margin I don't see major decline in gross margin. I mean there's going to be a point or two, but it's not as much as what we've seen in previous downturns. But I think First off, I think the mix might be a little bit different, but also, we've done a very good job of making sure that we can shift certain assemblies to lower-cost regions as well as bringing our direct labor down very quickly. So that one is not as much of an impact. I think obviously making adjustments to OpEx is harder because there's more fixed cost there, but we see that as, like I mentioned before, leveling out to some degree. And obviously, we want to make sure that we're ready for the next upturn is the key thing for all those categories.

Got it. So, a trough gross margin in the 7.5% range feels like a decent place to be.

Yes, I think that's probably a low point probably.

Okay. Got it. Thank you.

Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to Mr. Scholhamer for any closing remarks.

Thank you, everyone, for joining us today, and we look forward to speaking with you at our next earnings conference next quarter. Thank you.

And thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.