Ultra Clean Holdings, Inc. (UCTT) Q2 2023 Earnings Call Transcript

Good day, and welcome to the Ultra Clean Technology Q2 2023 Earnings Call and Webcast. Please note, this event is being recorded. I would now like to turn the conference over to Rhonda 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 today. I'll start with a recap of our second quarter performance and provide some commentary on current and long-term industry dynamics before turning the call over to Sheri for a detailed financial review. Then we'll open up the call for questions. During the second quarter, the semiconductor industry remained challenged in certain segments, while other areas remained strong. Trailing edge, servers, and China ordering and taking delivery of tools were bright spots. However, PC and consumer end markets that rely on advanced memory and foundry/logic spending remained weak. Headwinds included elevated inventory levels across the supply chain, macroeconomic and geopolitical instability, including interest rates, fears of recession, inflation, and export controls, all of which are likely to influence our industry for a few more quarters. Product mix and lower utilization at some sites on reduced revenue were the overriding factors that affected our second quarter results. UCT's legacy Products business performed as expected in this dynamic environment with some adjustments to orders but no notable push-outs or cancellations. Although a small percentage of our total Products revenue, our non-semi business saw some unexpected volatility in the second quarter, particularly in the process technology space, where we supply semi-like parts to non-semi businesses in display, industrial, and medical. Lastly, our Service business declined from the first quarter as some customers adjusted their schedules to realign with ongoing end market weakness. As anticipated, the cost reduction initiatives we introduced earlier this year have begun to materialize in our financial results. Inventory decreased and Operating Expenses trended down, resulting in healthy cash flow. Footprint optimization and site efficiencies to adapt to current demand while preparing for the ramp are on track but are much larger in scale, so it takes time for profitability to be fully appreciated. We will continue to reduce inventory and trim expenses throughout the third and fourth quarters and are being extremely prudent and strategic when making investments to align with our long-term capacity with our customers' road maps. A highlight this quarter worth noting is that UCT was awarded Intel's Distinguished Supplier Award, which recognizes partners that exemplify Intel's standard of excellence. To qualify for an Intel EPIC Award, suppliers must not only exceed expectations but meet aggressive performance goals. Receiving this award was a true honor, and I want to thank our team for their world-class commitment to continuous improvement, making UCT widely considered the best of the best. In summary, before turning the call over to Sheri, we are aligned with our customers and industry sentiment that Wafer Fabrication Equipment is at the bottom of the trough and expect our revenue and profitability to fluctuate around these levels for the next few quarters. Our view for our ramp in 2024 remains intact. However, there are too many moving parts today to call the exact timing and shape of the recovery. Overall, based on industry estimates and confirmed by our internal marketing team, we are extremely optimistic about the long-term growth trajectory of our industry and do see a clear path to a $1 trillion chip industry by 2030. I want to thank all of our employees for their relentless drive to succeed in this challenging environment. I also want to thank our shareholders for their patience while we adjust our business during this phase of the cycle to ensure stronger growth and profitability during the next upturn. And with that, I'll turn the call over to Sheri. Sheri?

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, Q2 remained a challenging period in the semi-cycle as companies work to reduce and rebalance inventory levels on weak end demand while navigating persistent macroeconomic and geopolitical headwinds. Total revenue for the second quarter came in at $421.5 million compared to $433.3 million in the prior quarter. Products division revenue was $362.5 million compared to $368.6 million last quarter. And revenue from our Services division was $59 million compared to $64.7 million in Q1. Total gross margin for the second quarter was 16.7% compared to 17.3% last quarter. Products gross margin was 14.5% compared with 14.7% in the prior quarter, and Services was 30.3% compared to 31.7% in Q1. The reduction in margin is due to lower volumes driving decreased efficiencies. As we continue to optimize our footprint and increase efficiencies, we expect to see incremental improvements in gross margin. However, as Jim noted, these initiatives are complex and larger in scale. Therefore, it will take some time for the benefit to be fully realized. Operating expense for the quarter was $49.4 million compared with $52.7 million in Q1 and decreased as a percentage of revenue to 11.7% compared to 12.2% in the prior quarter as some of our initial cost control initiatives began to materialize. Total operating margin for the quarter was relatively flat from the prior quarter at 5% compared to 5.1% in the first quarter. Margin from our Products division was 4.3% compared to 4.1% in the prior quarter, and Services margin came in at 9.3% compared to 10.8% in the prior quarter. The fluctuations in margins were mainly due to decreased efficiency on reduced volume partially offset by lower operating expenses. Efforts are ongoing to align our cost structure with current demand levels. Based on 45 million shares outstanding, earnings per share for the quarter were $0.16 on net income of $7.1 million compared to $0.17 on net income of $7.6 million in the prior quarter. Our tax rate for the quarter was 16%. We expect our tax rate for 2023 to stay in the mid- to high teens. Turning to the balance sheet. Our cash and cash equivalents were $320.8 million at the end of the second quarter compared to $322.1 million last quarter. Cash from operations increased to $36.4 million compared to $28 million in the prior quarter driven primarily by the reduction of inventory and management of cash flows. As we navigate through the current cycle, we will continue to manage our working capital to ensure sustained financial stability. During the quarter, we purchased 337,000 shares at a cost of $9.5 million. For the third quarter, we project total revenue between $405 million and $455 million. We expect EPS in the range of $0.08 to $0.28. And with that, I'd like to turn the call over to the operator for questions.

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

Thanks for taking my question. Jim, the first question I had is I understand you said revenue profitability to bounce around these levels for the next few quarters, which kind of makes a lot of sense. I'm just trying to triangulate this with some of your customers have spoken about reducing their inventory levels. So how do you kind of handicap that given the fact that as they reduce their inventory level, it's kind of a slight negative for you in the short term? And then I have a couple of follow-ups.

I think we have been fairly consistent in our communications during these calls. We currently have a substantial amount of inventory and deferred revenue involving our customers. As we projected, we are noticing a slight improvement as we head into the next quarter, but inventory levels remain elevated, reaching heights we haven't encountered for quite some time, following the challenges of the post-COVID supply chain. This is why we are taking a cautious approach and anticipate it will take a few more quarters to resolve this situation. Nonetheless, I'm hopeful that conditions may improve sooner rather than later.

Got it. I have one other question for you and then one for Sheri. Jim, my second question is about the China semi-cap companies like AMEC or Piotech. I'm curious if you can still ship to them and if they remain part of your customer base. Any information you can provide would be helpful. Then I have a follow-up for Sheri.

Yes. We have been able to ship to them on more of the trailing edge investment that's going on in China. So we have seen some pretty good movement there. It actually was relatively strong. So we were initially concerned that it was kind of inventory hoarding because they were afraid of new restrictions. But I think we've now confirmed that they're actually just seeing more business at the trailing edge. So we've actually seen our business with AMEC and Piotech continue to be strong.

Thank you, Jim. I have a final question for Sheri. You've done a great job managing costs during this challenging time. If revenues reach these levels, then profitability should also be around these levels. How easy is it to adjust operations if the situation improves or worsens moving forward?

Yes, we have certain cost initiatives in place, so we're prepared to scale down if necessary, and we continually assess our cost structure. Scaling up can be equally challenging, as it involves hiring quickly and ensuring we have the right capacity in place to meet customer demand. We're considering both scenarios because both Jim and I believe the situation can change rapidly, based on our past experiences. Therefore, we will continue to evaluate both options to ensure we can respond effectively to either situation.

Our next question comes from Quinn Bolton with Needham & Company. Please go ahead.

Jim, I guess, I just wanted to follow up on Krish's question. Lam last night talked about canceling purchase orders to a number of its component vendors, and in the near term, they were having to take some excess component inventory to cancel those orders. But it certainly made it sound like beyond the September quarter, they may be taking significantly lower deliveries from component vendors to try to work down the inventory. And I guess, one, are you seeing that? And two, is that sort of incorporated in your outlook for stable revenue through the year-end and maybe even into early next year?

So one, we have been seeing that actually for Q1 and Q2. We have been dealing with that. And there are a lot of puts and takes, but their inventory isn't always what they need for whatever is being ordered. So obviously, they're still ordering things. And that's why when I say flattish for the rest of the year, bouncing around these levels, maybe up a bit, we've already taken that into account, but we do think there is opportunity for upside as these things start to clear out.

Got it. Thanks for that additional color. And then I guess, in terms of your Services business revenue, looks like it was weak just as utilization rates have been throttled back. Based on the latest information you have, do you think those utilization rates are now at sort of a trough level in the Services business? Might we start to see a rebound in the second half of the year as utilization rates begin to recover? Or do you think we're going to stay at this lower utilization rate and therefore, Services revenue in the second half is probably going to be around that $59 million level that you saw in Q2 for the rest of the year?

Yes, Quinn. I would say we don't imagine them going any lower. We've certainly seen weakness in Korea, which we hadn't seen until the second quarter. Korea had remained strong in the first quarter. We've seen a lot of delays on node changes in North America. If I were to characterize it, we're assuming it doesn't move from this level. We're assuming it's going to be flat, maybe slightly up, but we think there might be some potential for it to move up a little bit more by the end of the year.

Excellent. And then, Sheri, the gross margins at 16.7% seem to be a little bit lower than what we were thinking without a meaningful change in the revenue. So I guess anything in particular to call out? Was there a particular mix shift? It looks like both Product and Service margins were lower this quarter. Just wondering, when do you think – do you think margins kind of stay at these levels to the extent that revenue is flattish? Is sort of a flattish gross margin the right way to be thinking about gross margin until revenue recovers?

Yes. I think the key thing that affected this quarter was really the Services side, as you mentioned earlier. Obviously, that has a very nice margin profile. So as a result of that, that really assisted with the margin coming down a little bit as well as our Ham-Let Fluid Solutions business was also lower than anticipated. So those feed into the overall margin on the Products side, the Fluid Solutions/Ham-Let and then obviously, Services. I think as we start to see those recover over the course of the year, as Jim mentioned, surrounding Services, we should be able to see some of that margin come up as a result of that, along with the fact that we have cost initiatives in place that we're looking at as well to hopefully affect that, depending upon how long this cycle goes, so that we can ensure that we manage our margin as we move forward.

Our next question comes from Christian Schwab with Craig-Hallum Capital Group. Please go ahead.

I guess more on the optimistic side when we come out of this. We have a very large footprint that you expanded in Asia during the upturn. Should we assume that you're out there aggressively looking to capture market share? These cycles always run the same. We order too much. We take a pause and then all of a sudden, as you talked about, it turns on faster than people think and everyone's scrambling again, inventory correction to strong growth. So should we assume on the back side of this that you think you might have more market share than you did going into the downturn? Or should we not think that?

Yes, Christian, you've followed us for a long time. We've gained market share on both the upside and the downside. In almost all accounts, we're either maintaining or improving our share even during this downturn. A significant part of that is due to many of the OEMs shifting to Southeast Asia, where we've positioned ourselves effectively. We're experiencing numerous new program wins, although it typically takes two to three quarters for these to translate into revenue as we transition operations to those sites. We're performing well at this stage, particularly in areas like etch and CMP. Litho is also doing quite well for Wafer Fabrication Equipment, although we haven't established the largest presence there yet. Currently, we face some disadvantages in total Wafer Fabrication Equipment since the segments where we're stronger are slightly down. However, regarding program and market share wins, we're actually performing exceptionally well. Another point to note is that as part of our cost reduction strategy while consolidating and relocating factories, we are effectively pursuing two goals simultaneously, which has been our strategy for many years. We're consolidating factories into larger facilities, which will enhance our capacity and efficiency by centralizing operations in locations like Texas, Arizona, and Malaysia. This dual approach is designed to increase our efficiency while also preparing for the next significant growth phase. In short, to answer your question, we're doing exceptionally well with our accounts.

Great. And then, Jim, looking at the upturn in the CHIPS Act here in the United States and some of your very large customers expanding manufacturing capacity here. Do you think you'll get any government funds to help in expanding or growing different facilities where the customers want them, in Texas, for example?

Yes. Not in the near term. We have people working on this, but the funds have not yet been allocated towards the supply chain. Those investments have been primarily focused on R&D or large fabs. We haven't seen any of that yet. However, I believe that when Intel starts building a fab in Ohio in '25 or '26 to support them, that will present our opportunity. Currently, the CHIPS Act is not providing any benefits to sub-suppliers. Nonetheless, it is definitely something we are exploring.

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

So thank you, everyone, for attending today's conference call, and we look forward to speaking to you again next quarter.

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