Ultra Clean Holdings, Inc. (UCTT) Q3 2022 Earnings Call Transcript

Good day, and welcome to the Ultra Clean's Third Quarter 2022 Conference Call. Please note this event is being recorded. I would now like to turn the conference over to Ms. Rhonda Bennetto, Investor Relations. Please go ahead, ma'am.

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?

Thanks, Rhonda, and thank you all for joining us today. I'm going to start with a brief review of our third quarter results and provide some insight into how we feel the rest of the year will play out. I'll also share our thoughts regarding 2023 and beyond and provide some additional commentary on our capital allocation strategy. After that, I'll turn the call over to Sheri for a financial review, and we will open up the call for questions. Solid operational execution and modest supply chain improvements contributed to a strong third quarter. Although the supply chain continues to present challenges, enhanced collaboration amongst our global teams, our suppliers, and our customers has alleviated most constraints, and we expect to see incremental improvements in the coming quarters. While some customers continue to prioritize and reconfigure their delivery schedules, we have seen only limited cancellations relating to the new export regulation for U.S. semiconductor technology sold in China. If we use the midpoint of our fourth quarter guidance, we expect full year revenue to be up roughly 16% over 2021. After several years of unprecedented growth, we are anticipating a decrease in demand fundamentals and believe there will be a pullback as chip makers and their customers draw down inventory and realign their investment plans. UCT is much larger and more diversified now than ever before, and our operating model enables us to quickly flex and buffer the effects of a broader industry pullback. With over 30 years of experience adjusting to these ups and downs, we are confident in our ability to perform well in a broad range of market scenarios. Long term, we remain very bullish on the industry as a whole. Demand for products powered by semiconductors is accelerating, driven by multiple end applications from smart electric cars and mobile devices to communication infrastructure, AI, and IoT devices. UCT has taken deliberate strategic steps to ensure we are well positioned to outperform as these new applications shift to volume manufacturing. The expansion of our capabilities with resources strategically close to our customers has deepened our collaboration and will enable us to accelerate production with greater operational efficiency. Our new Malaysia facility is a great example of how we have become more globally diverse, taking our operations to a whole new level in terms of scale, efficiency, supply chain infrastructure, and automation. Our Malaysia site is ramping to schedule, and we are seeing strong engagement as customers look to secure a long-term outsourced manufacturing partner. This site has become another key driver of our share gains, and as geopolitical events unfold, it will become even more important as we continue to outgrow the industry. The extended outlook for semiconductors remains robust, and UCT is ideally positioned to capitalize on future opportunities. In addition to prioritizing investments supporting our growth strategy, we also recognize our commitment to deploy capital that drives the greatest return for our shareholders. Given our strong cash flow, we believe now is the time to initiate a share repurchase program. This new program will enable us to act opportunistically when conditions are right, while maintaining a disciplined approach to capital allocation, including debt repayment while maintaining our healthy balance sheet. Our conviction in our growth strategy and business model has never been stronger, and this program provides another avenue to return meaningful value to our investors. In summary, we see sustainable strength in our markets as large powerful trends drive fundamental expansion in the demand for semiconductors. In the short term, we will focus on implementing operational efficiencies and optimizing our global footprint. Longer term, we expect to capture an even larger share of our addressable market. And with that, I'll turn the call over to Sheri for a review of our financial results. Sheri?

Thanks, Jim, and good afternoon, everyone. Thanks for joining us. In today's discussion, I will be referring to non-GAAP numbers only. Solid execution, supported by ongoing demand for our products and services resulted in total revenue for the third quarter of $635 million compared to $608.7 million in the prior quarter. Products division revenue was $556.3 million compared to $532 million last quarter, and revenue from our Services division was $78.7 million compared to $76.7 million in Q2. Total gross margin for the third quarter was 20.6% compared to 20.3% last quarter. Products gross margin was 18.3% compared to 17.8% in the prior quarter, and Services was 36.9% compared to 37.2% in Q2. Margins can be influenced by fluctuations in volume and mix, materials and transportation costs, and manufacturing regions, so there will be variances quarter-to-quarter. Operating expense for the quarter was $56.5 million compared with $55.9 million in Q2. As a percentage of revenue, operating expense was 8.9% compared to 9.2% in the prior quarter. Total operating margin for the quarter was 11.7% compared to 11.1% in the second quarter. Margin from our Products division was 10.8% compared to 10.2% in the prior quarter, and Services margin was 18.2% compared to 16.9% in the prior quarter due to reduced spending. Based on 45.6 million shares outstanding, earnings per share for the quarter was $1.06 on net income of $48.6 million compared to $1.04 on net income of $47.4 million in the prior quarter. Our tax rate for the quarter was 17.9% compared to 15.2% last quarter. We expect our tax rate for 2022 to stay in the mid- to high teens. Turning to the balance sheet, our cash and cash equivalents were $453.5 million at the end of the third quarter compared with $421.4 million last quarter. Cash from operations was $71.7 million compared with $81.8 million in the prior quarter due to timing of cash collections and payments. We made an additional debt payment of $11 million in the quarter. During the third quarter, we finalized the divestment of our third non-core, non-semi subsidiary that came with the Ham-Let acquisition, resulting in a $20.8 million pretax loss. The impact of this divestiture is reflected in our third quarter GAAP financial results. Given the current global macroeconomic and geopolitical uncertainty, including the effects of the new export regulations for U.S. semiconductor technology sold in China, we are keeping our guidance range wide. We project total revenue for the fourth quarter of 2022 between $600 million and $650 million. We expect EPS in the range of $0.94 to $1.14. As we announced today, the Board has recently approved a stock buyback program up to $150 million over a three-year period. We intend to be opportunistic with our purchases; however, we have not factored this into our fourth quarter guidance. And with that, I'd like to turn the call over to the operator for questions.

And the first question will come from Quinn Bolton with Needham & Company.

Congratulations on the strong results. It’s clear that the demand environment is changing rapidly, particularly in 2023. Recently, one of your large customers predicted that WFE could decline by over 20% year-on-year, reaching the low $70 billion range. Given that possibility, how do you foresee 2023? Do you anticipate that your revenue might decrease on the product side in line with WFE? Is there a chance you could outperform without acquisitions? Could you provide any guidance as you consider 2023?

Yes, Quinn, thanks. Yes, we don't see it down more than 20% at this point. But to your question about outperforming typically over the last five years or so, we've outperformed in an organic way outside of M&A by an average of 5 points above WFE. And we see that, we continue to have good momentum in that space on winning share incrementally, and we see that this should continue.

So Jim, if I'm just thinking about the product side of the business, if WFE stays down 20%, you guys outperformed by 5%. Thinking about your products down in the range of 15%, does that make sense as an initial sort of view into next year?

Yes, that's right, Quinn. That's our view.

Got it. And if that's the top line framework, Jim, how do you think about managing OpEx? I mean you've got a lot of skilled labor that you may not want to let go if you think it's relatively short duration downturn. But obviously, if you don't cut OpEx, you could see a bigger swing on earnings. So how are you thinking about managing OpEx through a potential downturn in '23?

Yes. Maybe I'll address like all spending. A huge part of our cost structure is materials and direct labor. Those we can flex; it sometimes takes about a quarter to flush through, but we can flex those pretty quickly along with revenue. We've done this before after 30 years. We've been through many of these. So on the OpEx side, you're exactly right, it's always a balancing act like we did in 2019 to keep the infrastructure in place and the continuous improvement in place through a downturn, which we don't see any reason why it would be extended outside of any large macro events. So we make that balance. We did that in 2019. And we came out even stronger. We take that time to really also clean up after a pretty crazy few years. We do things like consolidate sites and put in initiatives that make us stronger and more nimble as we go forward. So on the OpEx side, obviously, we will be adjusting the spending there, but there are some critical programs that we will obviously keep in place for the longer term.

And the last one, it sounds like from that comment about perhaps optimizing where you're manufacturing. It sounds like this downturn might be an opportunity for you to bring even more to Malaysia to continue to ramp that facility, as it's lower cost than some of the other global facilities in your footprint?

Yes, that's exactly right. Malaysia is ramping up pretty much on schedule and it is our lowest-cost site. With some of the local geopolitical events, I think the entire industry will be looking towards Southeast Asia, specifically. So we really like that out there.

The next question will come from Krish Sankar with Cowen and Company.

This is Steven calling on behalf of Krish. I guess, Jim, first one for you, just in terms of the near-term guidance. Just given some of the comments about improvements in the supply chain, I would imagine that product cycle times are also improving. As a result of that, is it safe to assume that your customers might also be reducing the inventory levels that they have at their end? Or do you see any indications from the customers that they're still working strong and want to maintain some buffer inventory that they've been maintaining in recent quarters?

Yes, probably a question better suited for them. But I think everyone in the industry is going to be reducing their inventory levels to some extent. The supply chain crisis is nearly abated, not only for us but for everyone. So I think, obviously, everybody is flushing through their backlog in this last quarter. I'm sure there will be inventory adjustments due to some short-term softening in the industry. But I haven't seen that yet in the fourth quarter.

Got it. Okay. That's helpful. And I guess my follow-up is on your Services business. So just kind of tying it into the earlier questions about calendar '23 WFE coming down based on market expectations of 20%. If WFE does come down too much, what are the implications for your services business, especially since that's more tied to wafer starts and capacity utilization rates? What have you seen there so far? And if the industry is down 15%, 20%, can your service business still grow potentially?

Growth will be a challenge. I think we will see some wafer start soften, and a lot of what's happened in the wafer starts has been in the memory space that started happening today. With the memory fabs, we do not use much in the way of high-tech cleaning and coding and analytics, so that has been a very minor effect for us. However, there have been some logic and foundry slowdowns as well in one or two of the customers. I think we would tend to grow or tend to fall in line with wafer starts. But I do expect wafer starts will fall a bit. However, the swing in revenues, as you’ve seen in the past, is fairly dampened compared to WFE.

Next question will come from Hans Chung with D.A. Davidson.

This is Linda on behalf of Hans Chung. So first of all, congratulations on the quarter. I wanted to ask, in terms of the China export restrictions, obviously, the entire industry is dealing with the impact, but I'd like to see if you might be able to quantify for us how much revenue might have been impacted both in the third quarter as well as any potential impact in the fourth quarter guidance from the regulations?

Yes, Linda, this is Sheri. Nothing has affected us in the third quarter, but we anticipate around a $15 million impact in the fourth quarter for the new export legislation.

Great. I have a follow-up question for Sheri regarding the factors affecting gross margin. You mentioned supply chain issues, inflationary pressures, and volume challenges. Could you provide more details on your plans to address these and how they might influence our expectations for the fourth quarter and the overall calendar year 2023?

Yes. I mean, we're evaluating that right now. Obviously, some of it will depend upon where the revenue is for calendar '23. As things go down, we do see gross margin going down; you can't completely eliminate all factors. But as Jim mentioned, we will be looking at our footprint and other costs associated with our revenue. Materials and labor make up about 55% to 70% of the P&L, so that's something that we are taking into account right away when revenue comes down. We will be looking at that as we go across the year. We're not really giving guidance at this point for the full year, but that's something that we're heavily looking at currently.

That's fair. So lastly, regarding the Malaysia facility, if I remember correctly in the past, you have said that the first phase of the facility could do about $200 million a year and above $50 million a quarter. Am I getting the numbers correctly? And with that, what was the revenue run rate in 3Q? And if you may, what do you expect in 4Q and potentially '23?

Yes, that's right. Phase 1, we mentioned around $200 million run rate for Malaysia, and we're pretty close to that run rate, a little bit shy, but pretty much on schedule. The total capacity of that factory when it's up and running will be $600 million to $800 million. We probably won't need all of that next year, but it's been ramping pretty well.

Yes, in Q3 was about $24 million. So we see that continuing to go up in Q4.

The next question will come from Christian Schwab with Craig-Hallum.

This is Tyler on behalf of Christian. I ask a couple of questions, too. Going back to the Services side of your business, Jim, with the Ham-Let acquisition, you guys have talked in the past about some share gain opportunities and some potentially pretty significant ones. I was just wondering if you could update us on those thoughts as the environment here softens. Does that change your outlook there? Does it maybe even improve your opportunity to pick up some share gains to offset some of the softness? Any thoughts on that would be appreciated.

Yes, definitely market share in the former Ham-Let, which we call Fluid Solutions, continued market share improvements are part of that 5 points outgrowing the market. We've made great strides even this year before a lot of the capital equipment that we've ordered for that business has come in. We've increased the capacity and the output and the revenue from that acquisition pretty substantially, I think over a 30% year-on-year. So yes, absolutely. Going into next year, even with the WFE decline, we see a lot of opportunity there. We've been in a situation where if we can make it, we can sell it. That's where the largest part of our backlog in our business still resides.

That's great. Talking about the Ham-Let, the Fluid Solutions. Many questions have already been addressed. So I thought maybe just from a big picture perspective during a downturn like this. In the past couple of years, when the market has been quite strong, you've mentioned opportunities to gain market share and introduce new modules and nodes with some of your key customers. So fundamentally, what does it look like during a downturn as an opportunity to enhance your engagement with these customers? Any thoughts on that?

Yes, we've been doing a great job of that throughout the year. It has been more challenging with the supply chain somewhat hindered, affecting our programs. However, next year, we will focus more on this. Our customers are expecting improvements in the longer run for 2024 and 2025, but we also face significant challenges in WFE. Therefore, 2023 will be crucial for us and our customers to prepare for the rebound after this year.

This concludes our question-and-answer session. I would now like to turn the conference back over to Mr. Scholhamer for any closing remarks. Please go ahead.

Thank you, everyone, for joining us today, and we look forward to speaking with you again in the new year.

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