Ultra Clean Holdings, Inc. (UCTT) Q3 2020 Earnings Call Transcript

Good afternoon and welcome to the Ultra Clean Third Quarter Conference Call. Please note, this event is being recorded. I would now like to turn the conference over to Rhonda Bennetto, Investor Relations. Please proceed.

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 a 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 disclosure 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. We appreciate your time today. I'm going to start with a review of our third quarter performance and then highlight a few of our recent accomplishments. I'll wrap up with our thoughts on the industry and then turn the call over to Sheri for a financial review. Then we'll open up the call for questions. UCT delivered another solid quarter of revenue and profitability thanks to large part to the exceptional commitment and innovation of our team members around the world and ongoing strength in the semiconductor market. All our facilities are running smoothly which enabled us to again exceed customer expectations for quality and on-time delivery. Our products division saw an increase in business for nearly all customers and we secured a sizable new award from one of our main customers as they continue to work with us to meet their outsourcing needs. In addition, we were designated as an improved design and production partner for a major lithography company and continue to secure manufacturing awards for our next-generation tools. This new designation enables UCT to add value early in the design and development process as new systems are being developed. A final highlight for our products business this quarter is our Singapore facility hitting a new milestone reaching record revenue of $100 million. Our service business expanded at IDMs across all device areas and we saw elevated engagement at each of our OEMs. Using the midpoint of our fourth quarter guidance, we will have increased our annual revenue by 30% this year compared to last year, significantly outperforming the overall WFE market for 2020. Our performance these past few quarters underscores the strength, flexibility and resilience of our business model to consistently gain share and deliver growth, all while improving profitability and shareholder value. In early 2016, we embarked on the plan to double our revenue and vastly improve profitability. Focusing on the semiconductor market, we pursued additional capabilities deeper within the value chain that went beyond our primary business. By leveraging existing infrastructure and vertical capabilities in conjunction with a handful of strategic acquisitions, we diversified our offerings by adding multiple new equipment products into our portfolio and introduced a higher-margin service component to our business, readily surpassing our goal. This year, we're on track to achieve annual revenue of approximately $1.4 billion, almost three times our revenue in 2015, while maintaining our share of the gas panel business. Revenue from all other areas of our business now constitutes almost 65% of our total revenue compared to 10% just five years ago. We continue to execute on our multi-year growth strategy by building upon our technology leadership in key areas, further strengthening our competitive advantage. The markets we serve are being driven by a vast set of demand drivers, and UCT's diverse suite of capabilities enables us to play a large and more valuable role with our customers. By optimizing our operations, implementing new processes and procedures, maximizing utilization of our facilities, and strategically expanding our global footprint, we have broadened our presence and increased our sizable lead within our served markets. Our aspirational goal for the next three years is to reach $2 billion in revenue. Since 2015, while the WFE market has grown less than 2x, we have more than doubled revenue from our largest customers and virtually tripled revenue from our second-largest customer while gaining valuable traction within our broader customer base. Another pivotal element of our growth plan is to add a third reportable customer to our products division. This year we have accelerated our efforts and deepened our engagement with one customer in particular, and expect their revenue contribution to yield reportable results within the next few years. Dynamic multi-year industry inflections are driving our business today and creating exciting new opportunities for UCT. We are confident we can maintain our sustainable growth path and outperform the industry. While we expect the fourth quarter to be somewhat flat compared to the third quarter, we are very encouraged by the alignment of the growth drivers for the industry in 2021. Accelerating technology inflections due to the pandemic, robust mobile demand driven by 5G, and new CPU architectures are all enabling higher performing servers, cloud services, AI, and machine learning, all driving semiconductor content enrichment. These trends will support continued demand for advanced memory and logic. Our business is well balanced, with both our products and service businesses having broad exposure across all device types. Additionally, we anticipate a disciplined CapEx schedule as customers build out their fabs at the leading edge, strengthening market conditions and industry profitability next year and beyond. Before handing the call over to Sheri, I want to again thank our employees and our suppliers for their incredibly hard work ensuring our success and the success of our customers. We remain mindful of the macro headwinds that may arise as a result of the pandemic situation, but have proven we can execute at speed, innovate at scale, and successfully navigate under difficult circumstances. And with that, I'll turn the call over to Sheri to review our financial performance. Sheri?

Thanks Jim and good afternoon, everyone. Thanks for joining us. In today's discussion I'll be referring to non-GAAP numbers only. Total revenue for the quarter was $363.3 million, up 5.4% from the prior quarter. Our products division grew 5.9% to $294.4 million, driven by increased demand from nearly all our customers. Our services business contributed $68.9 million, up 3% on increased activity across the board from our IDM and OEM customer base. Total gross margin remains at the higher end of our model at 21% compared to 22% last quarter. The change was primarily due to increased material and maintenance needs for our services business to meet demand, offset by favorable direct labor expenses in both businesses. Products gross margin was 17.5% compared to 17.8% last quarter, and services margin was 36% compared to 39.3% last quarter. Margins can be influenced by customer concentration, geography, product mix, and volume, so you can expect to see variances quarter-to-quarter. Operating expenses were $34.3 million, down from $35.4 million last quarter. As a percentage of revenue, operating expenses decreased to 9.4% compared to 10.3% in the prior quarter. Total operating margin for the quarter stayed flat at 11.6% compared to 11.7% in the second quarter. Margins from our product division improved to 10.8% versus 10.5% in the prior quarter, above our current model of 8% to 10% due to increased volumes and lower operating expenses. Margins from our services division were 14.9% versus 17.1% in the prior quarter and remains at the high end of our current model of 12% to 15%. The change was primarily due to an increase in expenses for materials to meet demand. Based on 41.1 million shares outstanding, earnings per share for the quarter were $0.73 on net income of $29.9 million compared to $0.75 on net income of $30.5 million in the prior quarter. Our tax rate for the quarter was 18.1% compared to 18.8% last quarter. We expect our tax rate for 2020 to remain in the high-teens. Turning to the balance sheet, our cash and cash equivalents were $176.1 million this quarter compared to $214.4 million last quarter. Cash from operations was $19.7 million, up from $17.5 million in the prior quarter. In addition to our regular payments, we made an additional voluntary Term B loan payment of $7.8 million, bringing our total Term B payment to $10 million for the quarter. Additionally, we paid off the balance of our revolver in the amount of $40 million. We've made significant progress paying down our Term B loan over the past couple of years and continue to look at ways to ensure that our overall capital structure supports our growth objectives. While demand remains steady, we continue to risk-adjust our guidance to account for numerous uncertainties surrounding the COVID-19 pandemic, including unexpected changes in demand and possible supply chain interruptions. We anticipate revenue for the fourth quarter to be between $345 million and $375 million, and EPS in the range of $0.63 to $0.77. And with that, I'd like to turn the call over to the operator for questions.

Our first question comes from Krish Sankar with Cowen. Please go ahead.

This is Steven calling in on behalf of Krish. My first question is about the guidance range. I see that you are still offering a relatively wide range due to various uncertainties. Looking beyond the pandemic, has there been any change in visibility or feedback from customers and OEMs over the past 90 days, or is it still similar to what it was a quarter ago?

Hi Steven, this is Jim. I think things have definitely become a bit more predictable, and we have a solid understanding of our supply chain. We had a good idea of where we would end up, although it was always uncertain how our customers and other suppliers might perform. However, we're starting to see that performance tighten as well. The range is now down to $30 million, whereas at one point it was as wide as $40 million. We're beginning to narrow that range. Things are definitely smoothing out regarding any potential second wave or new disruptions. We see things more clearly now compared to a few quarters ago.

Got it, thanks for that. As a follow-up, I had a question related to China. As your currency opens stand, I guess how much of your sales is exposed to Chinese domestic semiconductor companies versus through your OEM customers? Just trying to understand from your guidance perspective, if there are still continuing risks related to U.S. administration taking any actions against Chinese domestic companies?

Yes, the actions regarding China trade have largely unfolded as we anticipated. The primary concern is around the logic foundry and its logic chips, which have pretty much played out. They generally operate with a wafer fabrication expense of $3 billion to $5 billion. This year, it's slightly higher, so we do have some exposure, but it's relatively moderate.

Okay, thanks Jim.

Our next question comes from Charles Shi with Needham & Company. Please go ahead.

Jim and Sheri, my first question is really about the third quarter revenue. You talked about the high end of the guidance, and I can see that most of that is coming from the product revenue. I wondered, compared to a quarter ago, where do you see the sources of this significant upside from the product side of the business and is there any product revenue being pulled forward from the fourth quarter to the third quarter. Thank you.

Yes, thanks Charles. We do not see any significant movement between the quarters and definitely nothing fourth quarter to third quarter. We've seen strength across the board. Obviously, TSMC has been spending quite a bit with their successes on moving forward with 7 nanometer, and Samsung has been investing very heavily in their fab. So we've seen a pretty strong performance across the board. I wouldn't say things have changed too much in that regard.

Okay, thanks. So maybe a little bit looking forward to the first quarter. And I know you don't provide guidance, but from your conversations with the OEM customers on their view plan, what's the general feel about the first quarter next year at this moment?

You're right, we certainly don't give that kind of granularity. All of our customers are pretty strong in their forecast for the entire year of 2021. I think they are all looking at around a 10% growth rate, and in any given quarter there can be movement around that number. So it's too early for a bottoms-up forecast to really talk about the first quarter. But there's certainly nothing to suggest that there would be any significant change from the industry ramp that we're in today.

Got it, thank you. So maybe the next question is a little bit about the service side of the business. Definitely there's a very good sequential growth for the second and third quarter. I mean, probably driven by slightly higher utilization rate of your IDM customers, and you also mentioned some strength on the OEM customers. I wonder on the IDM side, looking into the fourth quarter, just a lot of concerns about whether the memory side of the fab utilization could soften. What's your outlook there and how would that affect service business revenue for the fourth quarter?

Yes, we don't guide by division. But we don't see any weakening in the memory space on fab utilization at this point, nor do we expect it. We do expect a temporary drop in utilization at one of the major logic foundries that are switching over from 14 nanometer to 10 nanometers, so there's going to be a small drop in utilization at that very large logic fab, where we have a significant presence. We see a temporary drop there in the service business, which should resume back to full utilization in the first quarter as they finish their conversion. That's really the only change that we see for the service side in the fourth quarter.

Great, thanks so much for the color Jim and congratulations on the results. Thank you.

Our next question comes from Patrick Ho with Stifel. Please go ahead.

Jim, maybe first off on the product side of the business. Given that you've been able to deliver to your customers above expectations. You've managed the capacity well. But as business trends continue to be healthy and potentially grow as we go into 2021, how do you look at your current capacity situation on the products? And secondly, do you need to build any inventory given some of the comments from your customers that they're building inventory?

Thanks Patrick. Regarding the second part, most of the products we make are not really like inventory-type products; they're customized equipment that is very customer specific. So I don't see a lot of that. We definitely can temporarily increase capacity significantly above the current levels. It's not sustainable to go up 20% or 30%, but we certainly have that capability. We'll start to see our Malaysia facility adding capacity in the third quarter of next year, so we're very comfortable with our ability to meet any demand increases that we expect next year.

Great, that's helpful. And maybe as my follow-up question for you, Jim. In terms of the services business and the parts cleaning side of things. As you know, etch and deposition are very capital intensive in 3D NAND. They go through a lot of parts, and that probably helps your business as utilization rates pick up. Is that something that you're monitoring closely as we go into 2021 with a potential recovery in the NAND FLASH market? How can that incrementally benefit that side of your business?

Yes Patrick, we definitely monitor all that carefully. That's really where the large footprint we have in that business pays off. We're adding capacity in some of those sites to support some of those increases. In particular, we are in discussions with our majority-owned JVs and adding capacity in certain areas right now, as well as replacing a building that burned down in Korea. That building is coming online, and capacity is increasing there to support Samsung and Kyontech. In North America, we have such a broad footprint that we work with our customers to move around capacity to our fabs which currently have available capacity. For example, as our factories in Arizona and Oregon get closer to full capacity, we can divert some of that to our Charleston factory, where we haven't seen that demand yet. So we're keeping a close watch on all those factories as we prepare for capacity to meet our customers' needs, and we're in great shape.

Great, and final question from me, maybe for Sheri in terms of the model. You've done a great job in gross margin and have managed OpEx well. But you did mention that you're adding some expenses in the near term for the business growth that you're seeing. How should we look at that full potential increase? Is it just incremental increases, or is there a potential for a big step up as your revenues reach higher levels?

Hi Patrick, yes, for now I would say it's definitely incremental. We still feel like we'll be at the top end of our operating margin model. So it's just going to be, we're very careful with OpEx to ensure that we only add incrementally and that we get the benefit of additional revenue coming through. So top end of our model still.

Our next question comes from Dick Ryan from an undisclosed source. Please proceed.

Sheri, what Jim is mentioning about aspirational goals of $2 billion over the next few years, is it too early to ask what you think gross margin and operating margins could look like under that sort of scenario?

Yes, it's too early, Dick. I think obviously we feel very comfortable with the model range. But it also depends on where that growth is coming from, whether it's via acquisition or organic growth. It really is dependent on many factors, so it's hard to predict exactly what those margins would be at this point, but we certainly feel comfortable in the model range that we're in right now.

Okay, and what sort of debt payment should we expect in Q4?

We haven't made a final decision yet. But we're continuing to look at paying down some additional debt. So I would say we would probably see a little bit of additional payment like we did last quarter. But I don't have a specific amount at this point.

And Jim, regarding the sizable new wins with an OEM and some new designation with litho customers, are you able to give us a little more color on those two items?

Yes, on one of our existing very high-volume customers, they just haven't built any new brick and mortar capacity, and as you can see, the industry continues to push towards new highs in WFE. Outsourcing has always been part of their strategy. So it's even more important now, as we continue to push to new highs in the industry. As they look to move things out of their factory, we've been bidding on some of those projects, and one of the sizable contracts has come through in the last quarter, so we were happy to report that. Regarding the litho customer, we've been in a long-term engagement with them, really starting about a year ago, with direct work involving our engineers alongside theirs, working on many new tools that are not yet released. Unfortunately, revenue for those takes a while to ramp for us because they need to release the tools and start to see volume. But it's exactly what we want to do, which is to get involved early in the design process and help them get their product to market, and then become the high-volume production house for those products as they roll out. So we are really pleased with our work there, and we're starting to see that investment pay off as we won the status of being a design and production partner for them.

Okay, great. Thank you and congratulations on a strong quarter.

Thank you, Dick.

Our next question comes from Tom Diffely with D.A. Davidson. Please go ahead.

I guess first, what was the timing on the litho engagement? Is that just a 2021 story?

Yes, I think we have current revenue going on released products with the company now, especially through one of their acquisitions made about five or six years ago. That division of their company has been a long-time customer. So we see incremental production here and there on some of the existing tools. But definitely, it's mid-to-late next year when we expect to see the revenue ramp on the new products that they're rolling out, and we are engaged with them on.

Okay, great. I was more surprised when you talked about the logic conversion slowing things down a little bit for a quarter. I always thought when a company went through a transition like that, with a lot of annual or preventive maintenance, it would actually benefit your cleaning business.

I think obviously there's definitely some element of that offsetting, the fact that the fab will be down for the majority of the quarter. So obviously, that reduces many of the etching and the coatings that require our business to come in and clean the tools. So yes, there are definitely some offsets from parts coming out to be pre-managed, but there's also obviously a lot less cleaning cycles when the fab isn’t operating.

Okay, and final question on the new Malaysian facility. Obviously, it increases capacity nicely. But you also talked about cost reductions. Is most of that coming from reducing output from higher-cost regions, or is it more from shipping and logistics cost savings from being closer to your customers and suppliers?

Most of that is coming from reducing manufacturing costs. It is located in a very advantageous logistics area as well. But the majority of the logistics costs for our products, once they leave the facility, are borne by our customers. The inbound logistics are relatively straightforward, so the main factor is that we're transitioning production from higher-cost regions to Malaysia, where labor costs are lower.

Okay, great, and I appreciate your time today.

Thank you, Tom.

This concludes our question-and-answer session. I would like to turn the conference back over to Jim Scholhamer for any closing remarks.

Thank you everyone for joining us, and we look forward to speaking with you again next quarter. Thank you.

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