Ultra Clean Holdings, Inc. (UCTT) Q3 2016 Earnings Report, Transcript and Summary

Good afternoon and welcome to the Ultra Clean Technologies Third Quarter 2016 Conference Call. [Operator Instructions] Please also note that this event is being recorded. I would now like to turn the conference over to Annie Leschin. Please go ahead.

Good afternoon everyone. Thank you for joining us for our call today. With me on today’s call is Jim Scholhamer, Chief Executive Officer; and Sheri Brumm, Senior Vice President and Chief Financial Officer. Jim will begin with some remarks about the business and Sheri will follow with the financial review, after which we will open up the call for questions. Earlier this afternoon, we issued a press release reporting financial results for the third quarter ended September 24, 2016. The press release can be accessed from the investor relations section of our website along with the information for a replay of the live call and a webcast at uct.com. Before we begin, let me remind you that today’s call may contain forward-looking statements, including the company’s views regarding future financial performance, new product or orders and shipments and industry growth. Investors are cautioned that forward-looking statements involve risks and uncertainties that may cause actual results to defer materially from those projected in the forward-looking statements. Information concerning these risks and uncertainties is contained in our periodic filings with the SEC, including our most recent Form 10-K and Form 10-Q and in the press release relating to today’s call, which is available on the investor page of our website. All forward-looking statements are based on management’s estimates, projections, and assumptions as of today. And UCT assumes no obligation to update them. Today’s call also includes non-GAAP adjusted financial measures. Reconciliations to GAAP measures are contained in today’s press release, which is available again on the investor page of our website. Welcome to our third quarter 2016 earnings conference call. I now like to turn the call over to Jim. Jim?

Thank you, Annie. Good afternoon everyone. Thank you for joining us today for our third quarter conference call. At little over a year ago, we undertook strategic initiatives to focus on the semiconductor capital equipment market over the long term and position ourselves to outpace the industry. More than 18 months into this strategy, we are successfully executing on those initiatives and delivering results. Our third quarter was an exceptionally strong one as we exceeded expectations on the top and bottom line. We achieved records in overall revenue, semiconductor revenue, and revenue from outside the U.S. In total, third-quarter revenue grew 19% year-over-year to $146.2 million, while semiconductor revenue increased 15% and revenue from outside the U.S. rose 66%. These revenue levels translated to significantly stronger earnings power as GAAP EPS increased 60% to $0.08 per share and non-GAAP grew 70% to $0.17 per share. These results clearly demonstrate the power of our financial model as revenues grow. As technology inflections in the marketplace progress with new semiconductor device architectures we are seeing strong levels of capital investments, especially in debt position and edge. Our proven ability to keep pace with our customers dynamic needs by providing the best service and supply in our industry as strengthened our customer relationships and is driving our business forward. With the industry's upward momentum, we are increasing our share in the market and are optimistic about our growth opportunities that lay ahead. As part of our overall strategy to improve profitability, we have taken steps to move manufacturing closer to our key customers in more cost-effective geographies. There are two reasons for this important initiative. First, we can better collaborate with our customers to proactively adapt to their changing needs across their entire product life cycle. Second, and perhaps more importantly, we can reduce our customers time to market, while remaining cost competitive. We are seeing this strategy pay off as we have grown our Singapore operations significantly over the last year. Having increased our presence in Asia, we are better positioned now more than ever to broaden our offerings ramp our capacity to enable our customer’s success and fuel sustainable growth for UCT. Industry indicators point to continued semiconductor growth for the remainder of 2016 and into 2017. This is driven by the ramp of 3D NAND, initial 10 nanometer production, and increases in foundry and logic spending. With the increasing need for deposition enhanced for these advanced technologies, our leading capabilities, and direct exposure to these high growth areas position us to outpace the broader market. In addition, with UCT's long-standing position and relationships in the display market, we expect to benefit from the rapid development of OLED technology. OLED is becoming increasingly important, especially in mobile, leading to a stronger display equipment forecast over the long-term. Turning to our fourth quarter outlook, we anticipate revenues of $146 million to $151 million. Operating expenses are projected to be flat with the third quarter. We expect GAAP diluted net income per share of $0.12 to $0.15. Excluding intangible assets, amortization costs of $1.4 million, we expect non-GAAP earnings per share to be in the range of $0.17 to $0.20. In closing, as the need for advanced technology becomes even more essential to our customers, we are broadening our capabilities, while delivering value to our customers and shareholders through strong operational and financial performance over the long-term. Now I would like to turn the call over to Sheri to review our financial results in more detail, after which time we will open up the call for questions. Sheri?

Thank you, Jim. Results for the third quarter exceeded our expectations as industry-wide semiconductor capital spending remains strong. Revenue was $146.2 million, an increase of 12.6% from the prior quarter and 19%, compared to the same period in 2015. This was a revenue record quarter for UCT in overall revenue, semiconductor revenue, and revenue from outside the U.S. Semiconductor revenue in the third quarter was $129.4 million, an increase of 10.6% from the last quarter, reflecting the industry-wide strength in growing demand from our capital equipment customers. Semiconductor revenue accounted for 88.6% of total revenue, compared with 90.2% last quarter. Non-semiconductor revenue grew 31% to $16.7 million or 11.4% of total revenue for the third quarter, compared to 9.8% last quarter. This was due mainly to higher growth in flat panel display, which should continue into 2017. In addition, we saw higher demand from the industrial and consumer market, which we expect to return to more normal levels in the fourth quarter. Revenue from outside the U.S. this quarter also reached a record high of $72.7 million or 50% of total revenue, compared to 45% in the second quarter. This reflects our strategy to manufacture closer to our key customers in Southeast Asia. During the quarter, two customers each accounted for more than 10% of total revenue. Higher revenue increased factory utilization and labor efficiency, coupled with lower material costs led to an improvement in our gross margin in the third quarter to 16.1% from 14.7% in the second quarter, and 15.4% in the same period last year. We expect to remain in our targeted gross margin range of 15% to 18% for the fourth quarter. Operating expenses for the quarter were $16.8 million or 11.5% of revenue, compared to $15.3 million or 11.8% of revenue in the second quarter and $15.9 million or 12.9% of revenue a year ago. Improvements in operating expenses, as a percentage of revenue, reflect our ongoing commitment to optimizing costs where possible, and growing revenue faster than OpEx. During the quarter, we incurred pretax charges of $1.4 million for intangible asset amortization, $925,000 for executive transition cost, and a favorable $105,000 for a release of a previously accrued expense related to the closure of one of our facilities. Excluding these one-time charges and amortization of intangibles, non-GAAP operating expenses for the third quarter were $14.5 million or 9.9% of revenue compared to $13.8 million or 10.6% of revenue in the second quarter and $13.9 million or 11.3% of revenue in the same period last year. Operating income was $6.7 million or 4.6%. This compares to $3.7 million or 2.9% for the second quarter and $3.1 million or 2.5% in the same period last year. Non-GAAP operating income was $9 million or 6.1%. This compares to $5.2 million of 4% in the second quarter and $5.1 million or 4.1% in the same period last year. These improvements were due primarily to increases in revenue and operational efficiency. During the third quarter, we incurred a tax expense of $2.8 million. This includes the impact of the evaluation allowance on our U.S. deferred tax assets related to our operating loss carry-forwards. Excluding this impact, the non-GAAP tax rate for the third quarter of fiscal 2016 would have been 25.4%. For the fourth quarter, we expect a non-GAAP tax rate of approximately 27%. Interest expense for the quarter was $613,000, roughly flat with the prior quarter and an increase of $59,000 from the same period last year. Third quarter net income was $2.6 million or $0.08 per share. This compares to $700,000 or $0.02 per share for the second quarter and $1.7 million or $0.05 for the same period last year. Excluding pretax charges for intangible assets amortization executive transition cost and the favorable lease of accrued expenses for our facility disclosure, third quarter non-GAAP net income was $5.7 million or $0.17 per share compared to $3.2 million or $0.10 per share in the second quarter and $3.1 million or $0.10 per share for the same period last year. Diluted shares outstanding were $33.1 million for the third quarter, an increase of 308,000 shares from the prior quarter. Non-cash charges for the third quarter were $1.9 million related to the stock compensation, $1.5 million related to depreciation and $1.4 million related to amortization of intangibles. Turning to the balance sheet, net cash increased $3.9 million in the quarter. We expect net cash to stay relatively flat in the fourth quarter. Cash on hand was $47.3 million, an increase of $3.2 million from the prior quarter, primarily due to cash generated from operating activities. Outstanding debt was $69.2 million, a decrease of $700,000 from the previous quarter. Accounts receivable was $65.8 million, down $7.3 million from the prior quarter. DSOs fell to 41 days from 51 days at the end of the second quarter. Accounts payable were $52 million, a decrease of $12.8 million over the prior quarter. Net inventory was $89 million, a decrease of $1.3 million over the prior quarter. We expect inventory levels to remain relatively flat in the fourth quarter. Periodically, UCT needs to realign our fiscal year end date with the calendar year end. As a result, the fourth quarter will be a 14 week quarter. That concludes our prepared remarks. Operator, I’d like to open the call for questions.

Thank you. [Operator Instructions] And our first question comes from Edwin Mok of Needham. Please go ahead.

Great. Hey thanks for taking my question and congrats on a great quarter. My first question is, how much was your top two, how much typically you guys have two 10% or 10% less customer can you quantify how much they were for the quarter and/or some color on that?

Hello Edwin. Thank you. Yes, I think as you well know, I think our mix in our number one and number two is pretty much the same as it has been in the past, which is well over 10% for both of them.

Okay that's fine. You mentioned on the call that kind of a strong growth of your revenue from your Singapore operations kind of help drive this growth rate, are you kind of in active program to transition some of your customer products to your Singapore operations that allows you to see that growth? And maybe a question for Sheri, does that help you with your margins, as that facility ramp up?

I’ll take the first part and I’ll have the second part go to Sheri. Yeah Singapore growth has been primarily due as we made share gains. Most of those share gains have occurred in Singapore, but there has also been some transitioning from the United States as well, but that’s kind of secondary at this point. The majority of Singapore growth has been new programs, new products that we're making for our customers that are now out of Singapore as they tend to grow also their Singapore operations.

And Edwin, thank you. In terms of margin having more go through Singapore, obviously it is a lower cost region for us and from a labor perspective it is a little bit cheaper than doing work within the U.S., so as a result it does assist us with our margin. The other piece is the tax benefit that we get by doing more business outside the U.S.

Okay that's helpful. Talk about a space, [indiscernible] pause you have lot of space obviously referred positive data point on the space right, just curious on what customer is telling you or kind of bill plan that you are looking, are you – do you think this growth – and you guys have [indiscernible] nice strong sequential growth over the quarter this year, right, including the fourth quarter piece on your guidance, I was just curious how sustainable do you think that this, do you think you can continue to deliver growth let’s say for a full year of 2017 or at least in the first quarter of 2017, any kind of color you can provide on that?

Sure. I think through 2016 for a total WFE growth using several third-party analysts come anywhere between 4% to 6.6% on WFE for 2016, early indications are 2017, roughly at the higher end of that range through 2017 as an overall annual growth. Within that overall WFE growth space that we're looking at our customers are sitting 1.5 to 2 times growth in areas where they are centered, which is deposition and edge. So, we see a higher growth rate into the last part of 2016 and into 2017, of course we can't - we don't know what the whole year would look like or quarter-by-quarter, but the general industry guidelines is that the higher end of 4% to 6% for 2017 and that the dep and edge potions will come in at roughly 1.5 to 2 times, of course there are many caveats and many other things that could happen, obviously in 2016 the main driver has been 3D NAND. Growth, there has been some 10 nanometer logic which has been said adding some tailwind in 2016, DRAM less than 20 nanometer is just starting as an early hit into 2016, but in 2017 we see 3D NAND as the main driver for growth continuing. We see the 10-nanometer logic picking up, and then we see the less than 20 nanometer DRAM accelerating quarter-by-quarter or how it lays out, those are the overall prognosis that we care, that we see and we will see where it goes from there, but we remain very optimistic. We are well positioned for that growth and our customers are very optimistic about momentum into 2017 as well.

Okay that’s helpful. One last question and I’ll let the other guys ask, you mentioned on your prepared remarks that on the first quarter you saw strong demand on display as you provide some commentary, but you also said that on the non-semi side you also see demand from industrial and consumer market, which we expect to moderate in the fourth quarter. So, are we talking about your overall non-semi revenue potentially decline a little bit in the fourth quarter and does that break into your guidance?

Materially it is relatively flat. So, what we saw is that in the third quarter we saw some of our more industrial smaller pieces of our business kind of have some one-time spikes, if you would, and then we also saw the beginning of the growth of the OLED and display business start to hit in the third quarter in the non-semi. So, we do not expect the industrial commercial side to continue beyond the size of third quarter, but we see continued growth and momentum in the OLED and display growth. So, we see that the non-semi business will stay materially relatively flat.

Okay, great. That's helpful. Thank you.

And our next question comes from Patrick Ho of Stifel. Please go ahead.

Hello Patrick.

Patrick, is your line on mute?

Sorry about that. Thank you again and I apologize for that. First off in terms of your Singapore operations, given your outlook and the possibility with the potential for a sustained wafer fab equipment spending environment in 2017, how do you feel about your current capacity situation and whether you are flexible enough to meet increased demand or would you need to add additional capacity or labor to meet the demand that’s out there?

Hello Patrick. Good question. We actually expanded our Singapore capacity in the last several quarters, five quarter to prepare for this growth. So, we’re actually in very good position going forward for the foreseeable future. We don't see any need to add at this point unless things become extremely good, which is a good situation.

Right, that's helpful. And Sheri, in terms of the gross margins, I know there is always a lot of moving pieces with that for a company of your size, but looking forward to maintain that 15% to 18% target model that you have, what are going to be the biggest variables, is it just simply revenues and utilization or are there other variables of product mix and things of that nature that can impact, whether it’s at the high end or low end at these more elevated revenue levels?

Yes Patrick, you know it is several variables. Obviously, revenue volume does play a big part of that, but also the jurisdiction in which we are actually shipping our revenue is a piece of it that makes, does play a part of it, obviously shipping more out of Asia and some of our lower-cost regions does assist with our gross margin because it’s a little less expensive to do business there. So, I think those are the two key things that really assist us, as well as mix with our customers. So, just depending upon what we are shipping for our customers that changes each quarter and whether we are able to - with each quarter what products we are actually shipping out to them and right now we are within our target range and we anticipate being able to stay there with the revenue levels we are at.

Great, thank you very much.

And our next question comes from Christian Schwab of Craig-Hallum Capital. Please go ahead.

Hi guys, guess this Tyler on for Christian. Thanks for taking my question. You covered a lot there, but I was hoping maybe you guys could break down even qualitatively how much of a strength you see now and your guidance is industrial driven and how much would you attribute to your own strong execution in market share gains? Thanks.

I’m sorry Tyler, you were a little bit low, could you repeat the question?

Yes sorry. So, I was hoping how much would be the strength seen, would you attribute just to broad industry strength and how much could you attribute to your own strong execution and market share gains that you are seeing?

Yes good question Tyler. So obviously clearly we're seeing the tide go up as many of our peers in the industry are seeing, but I think you are seeing us actually outpace that pretty significantly, which is the second factor behind where we are, which is our market share gains. And then we have a third leg where we are well-positioned in the part of the WFE, so we really have three factors, which is WFE growth, we are in the best space of the WFE area and in addition we have share gains. And so at this point, I think we see all three tailwinds adding to our current strength.

Okay, great. That helps. That's all from me. Great quarter, thanks guys.

Thank you, Tyler.

Thanks Tyler.

[Operator Instructions] Our next question comes from Dick Ryan of Dougherty. Please go ahead.

Great, thank you and congratulations on a good quarter and guidance guys. Sheri just some housekeeping numbers, can you give me depreciation and stock-based comp for the quarter and maybe cash flow?

Yes, depreciation was $1.4 million and stock-based comp was $1.9 million.

Okay.

Cash flow from operations was $5.7 million.

And one last one, how much was ERP spend in Q3 and what do you think that might be for Q4?

Yes, it wasn't very significant during the quarter in terms of actually expense hitting the P&L we had a lot of capitalization as part of the process of viewing the project. I think Q4 you are going to start to see some expense, additional expense 200,000 to 300,000 as we talked about previously.

Okay. Jim can you talk about the non-semi, what part of that is related to the OLED spend versus the industrial and consumer side you talked about?

Sure. I think in the non-semi, the display/OLED because we’ve been in display for more than 10 years, 15 years and so what we're seeing is a display uptick because of OLED. That has accelerated from relatively nice share of our non-semi space and now is growing pretty dramatically and we are expected to become a major component of our nonindustrial spend – our non-semi spend, I’m sorry.

So if non-semi was, what I think was 16.7 in Q3, rough percentage maybe, can you give me?

Wasn’t that high, what’s it…

Non-semi?

Non-semi.

Yes it was 31% of total revenue.

No, non-semi?

I’m sorry. It went up 31%, it was 11.4% of total revenue Dick.

Yes.

Yeah, non-semi was 16.7 million right?

Correct. Yes.

I'm sorry, I thought you were speaking of percentage.

So of that 16.7 what rough number would be display/OLED?

We don't break that out. It went from a significant piece of that to a much more significant piece and we see it becoming an even higher significant piece of that.

Okay. What percentage of the semi business is gas paneled now?

It is roughly, I think, I haven't looked - I don't have the numbers in front of me, but I would say it is well over 50% still, but it is becoming a smaller percentage as we have been adding market share over outside of the gas panel area over the last year.

Okay. And that was my next question, it was, the market share is that in the gas panel or is that from the Marchi and the Miconex acquisition contributing to that growth as well?

Sure the Marchi and the Miconex both, you know while we added and also ability to gain share in that space after we acquired them as well as just gaining share gains in more of the model space, which is not related to the gas panel. So the gas panel area is relatively stable and the share gains are in other modules, as well as gaining share in some of the acquisitions that we have made.

Great, thank you.

Thank you, Dick.

Thank you.

And our next question is a follow-up from Patrick Ho of Stifel. Please go ahead.

Yes, thank you. Jim, as a follow-up to some of the OLED commentary you just mentioned, is the pickup in your flat panel display business simply volume as we saw starting to see ramp or is your market opportunity also expanding as the industry moves OLED from LCD?

So, Patrick great question. So the services that we deliver is along the traditional lines of what we delivered to a display - piece of display equipment regardless of whether it’s OLED or typical TFT LCD. What's happening in that industry is that it’s becoming much more capital intensive. So they need more machines to do more layers in order to make the same number of displays. And so what we are seeing as a overall pick up in the capital intensity of that industry, but for us we are delivering more of our standard, not standard but our typical product lines into that industry, it is not a share gain from our point of view. However, it is a lift in the overall, our customers overall lift in their whole display industry in general for capital equipment, as well as others seeing a rising benefit from this transition, it is really an inflection. This technology OLED is similar to what happened in 1998 when LCDs broke out a wave out of the notebook computer and took over monitors and TVs and then it ended up taking over plasma and projection TV and everything else. So there is an inflection going on in this market where you are seeing OLED display really take off and the good news is it requires a lot more equipment to make the same display as for the former TFT LCD equipments. So, we're seeing at this point, we are delivering our product line into this area and their requirements are tighter and harder and reliable customers and suppliers like ourselves are even more important than ever.

All right that's really helpful, thanks again Jim.

You're welcome Patrick. Thank you.

And ladies and gentlemen this concludes our question-and-answer session. I would like to turn the conference back over to management for any closing remarks.

So, thank you for joining us. We are excited about our outlook and what we're seeing in the market trends is we hit in the 2017 and we look forward to speaking to you again. Thank you very much.

Thank you.

And ladies and gentlemen, the conference has now concluded. Thank you for attending today's presentation. You may now disconnect.