Ultra Clean Holdings, Inc. (UCTT) Q4 2016 Earnings Report, Transcript and Summary

Good day and welcome to the Ultra Clean Technologies Fourth Quarter and Fiscal Year 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 are Jim Scholhamer, Chief Executive Officer; and Sheri Brumm, Senior Vice President and Chief Financial Officer. Jim will begin with some prepared 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 fourth quarter and fiscal year 2016. The press release information about the webcast and how to access the replay of the call can be found in the investor relations section of our website at uct.com. Before we begin, let me remind you that today’s call may contain certain forward-looking statements, including the company’s views regarding future financial performance, new product orders and shipments and industry growth. Investors are cautioned that forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from those projected in the forward-looking statements. Information including these risks and uncertainties that is contained in our periodic filings with the SEC, including our most recent Form 10-Q and Form 10-K in the press release relating to today’s call, 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 fourth quarter and fiscal year 2016 earnings conference call. I would like to turn it over to Jim. Jim?

Thank you Annie and good afternoon everyone. Thank you for joining us today for our fourth quarter and full year 2016 conference call. By every measure 2016 was a year of extraordinary growth for UCT. We achieved records in overall revenue, semiconductor revenue, and revenue from outside the U.S. Our strategy to broaden our capabilities well beyond GAAP panels and deepen our exposure within the semiconductor capital equipment market has proven very successful. In total revenue grew 20% over the previous year to $563 million. Semiconductor revenue increased 17% and revenue from outside the U.S. grew 67%. Leveraging these high revenue levels coupled with our commitment to operational excellence and a particular favorable product mix allowed us to meet our target margins in the fourth quarter. Our earnings power was clearly visible as the bottom line outpaced the top line. As a leading outsource manufacturer with a focus on the semiconductor capital equipment industry our success is largely due to our ability to quickly and effectively meet our customer's dynamically changing needs, especially in the current robust environment. Together with our focus on expanding our suite of capabilities UCT is ideally positioned to ensure our customer success and accelerate our growth over the long term. The underlying fundamentals in wafer fab equipment outperformed expectations in 2016. Investments grew, capacity was added, and demand was stronger than ever. These remain the primary drivers for 2017. From an industry perspective these three main factors are behind the growth of our primary markets. First, increasing demand for consumer electronics is fueling the semiconductor capital equipment market as the ramp of 3D NAND and 10 nanometer production forges ahead and foundry and logic spending increases. Second, we are benefiting from our direct exposure to the fastest growing sub segments of the WFE markets, advanced deposition and Edge. In total deposition and Edge grew at a significantly faster pace in the overall industry in 2016. This enabled UCT to significantly outpace the broader WFE market. With our customers leading the migration to a 3D technology and our significant exposure to these segments, we are positioned to continue the trend in 2017. And third, as our customers grow their businesses to keep pace with the industry demand, production capacity is becoming more constrained prompting accelerated outsourcing. This is where UCT's advantaged is clear. Our flexible and global manufacturing capabilities and capacity are reducing our customer’s time to market and maintaining cost competitiveness. We see this trend in outsourcing as a solid longstanding driver for our business. Over the last few years, we have added new modules to our capabilities both organically and inorganically to grow our business and diversify beyond gas panels. By providing additional front-end modules we are expanding our content across our customer’s platforms. Together, with our extensive knowledge of manufacturing processes we have been able to scale in step with the rapidly changing technology requirements in a stressed supply chain environment. As a result a considerable portion of our overall growth, this past year can be tied to new business that has expanded our Sam [ph] significantly and increased our share. All of this has resulted in our ability to outpace the markets we serve. Finally our flat panel display business also saw record revenue for the year, more than doubling over 2015. Investments in OLED are continuing as leading companies begin to ramp the technology. Additionally, the build out of Gen 10.5 for large area TV's is leading to the construction of multiple new fabs in the industry, something we have not seen for many years. As a result, the anticipated investment in the flat panel display equipment market over the next several years should contribute to our non-semi revenues. In summary, we set new performance records in 2016. Our customer relationships have never been stronger and our business is firing on all cylinders. We continue to manufacture for the industry's most exciting and innovative products and solutions. As we look to the first half of 2017 and beyond we see the same main drivers to our business. One, growth in the overall WFE market; two, strength in deposition and Edge; and three, further share gains as we expand our content. In order to achieve long-term revenue and profitability targets we are focused on operational excellence throughout our organization to successfully deliver to our customers and meet their high levels of demand. 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 the call for questions. Sheri?

Thank you, Jim. Across the board 2016 was an exceptional year for UCT. Total revenue for the year grew 20% to reach $562.8 million but more importantly our non-GAAP EPS more than doubled demonstrating the power of our business model. Successful integration of our recent acquisitions, identifying opportunities to streamline our business, and leveraging low cost region manufacturing are only some of the initiatives we've executed on to improve the operating capacity of our business and increase profitability. I will now turn to the quarterly financials. Revenue for the fourth quarter was a record $174.5 million, an increase of 19.4% from the prior quarter and a 68.8% increase when compared to the same period in 2015. Fourth quarter semiconductor revenue reached an all time high of 156 million, a sequential increase of 20.6%. This strong growth was a result of strong industry momentum and additional drop in orders from our key customers. Semiconductor revenue was 89.4% of total revenue compared with 88.6% last quarter. Non-semiconductor revenue grew in the fourth quarter to 18.5 million up 10.7% from the third quarter. This was due mainly to an elevated level of growth in flat panel display which should continue into 2017. As a result of the increase in semiconductor revenue as a percent of sales non-semi revenue was slightly lower at 10.6% of total revenue compared with 11.4% last quarter. Continuing our strategy to maintain our presence close to our customers, revenue from outside the U.S. reached a record high of $89.9 million or 52% of total revenue compared to 72.7 million or 50% in the third quarter. Higher revenue and increased factory utilization lead to higher gross margins in the fourth quarter of 17% on a GAAP basis and 17.4% on a non-GAAP basis versus GAAP gross margin of 16.1% in the third quarter and 12.9% in the same period last year. Our fourth quarter non-GAAP gross margin included approximately 700,000 related to the impairment of equipment and inventory associated with our 3D printing business in Singapore. We expect to remain in our targeted gross margin range of 15% to 18% for the first quarter of 2017. Operating expenses for the quarter were 17 million or 9.8% of revenue compared to 16.8 million or 11.5% in the third quarter, and 16.7 million or 16.1% a year ago. We continue to focus on optimizing costs and leveraging our business model as we drive top line growth. During the quarter we incurred pretax charges of 1.4 million for intangible assets amortization, 100,000 related to cost on the closure of one of our facilities, and approximately 400,000 related to the impairment of our 3D printing business. Excluding these charges non-GAAP operating expenses for the fourth quarter were 15.1 million or 8.7% of revenue compared to 14.5 million or 9.9% in the third quarter, and $13.8 million or 13.4% for the same period last year. Operating income for the quarter was 12.7 million or 7.3% before interest expense and income taxes. This compares to $6.7 million or 4.6% for the third quarter and an operating loss of 3.3 million or 3.2% for the same period last year. Fourth quarter non-GAAP operating income was $15.2 million or 8.7% before interest expense and income taxes. This compares to 9 million or 6.1% for the third quarter and a loss of 500,000 or 0.5% for the same period last year. These improvements were due primarily to increases in revenue and operational efficiencies. Fourth quarter tax expense was $2.5 million including the impact of the valuation allowance on our U.S. deferred tax assets. Excluding the impact of the valuation allowance position the non-GAAP tax rate for the fourth quarter would have been 20.7%. For the first quarter of 2017 we expect a non-GAAP tax rate of approximately 24%. Interest expense for the fourth quarter was $585,000, a decrease of 28,000 compared to the prior quarter and an increase of 14,000 from the same period last year. Fourth quarter net income was $10 million or $0.30 per share. This compares to 2.6 million or $0.08 per share for the third quarter and a loss of 15.8 million or $0.49 per share for the same period last year. Fourth quarter non-GAAP net income was 12 million or $0.36 per share compared to 5.7 million or $0.17 per share in the third quarter and breakeven for the same period last year. Diluted shares outstanding were 33.5 million for the fourth quarter, an increase of 426,000 shares from the prior quarter. Non-cash charges for the fourth quarter were 1.6 million related to stock compensation, 1.7 million related to depreciation, and 1.4 million related to amortization of intangibles. Turning to the balance sheet, net liquidity increased 6.7 million during the quarter. Cash increased 5.2 million to 52.5 million primarily due to cash generated from operating activities. Outstanding debt was 67.8 million, a decrease of 1.5 million from the previous quarter. We expect net cash to be relatively flat in the first quarter. Accounts receivables were 74.7 million in the fourth quarter, an increase of 8.9 million from the prior quarter. Day sales outstanding fell to 38 days in the fourth quarter from 41 days at the end of the third quarter. Accounts payable was 71.2 million, an increase of 19.2 million over the prior quarter which resulted in our days payable outstanding increasing to 44 days from 38 days at the end of the third quarter. Net inventory was $103.9 million, an increase of 14.8 million over the prior quarter. We expect inventory level to increase in the first quarter to meet demand expectations. That concludes our prepared remarks. Operator, I'd like to open the call for questions. Thank you.

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

Great, thank you and congratulations on a very strong quarter and outlook. Say Jim in your comments you mentioned first half kind of being driven by the same drivers as you've seen for the second half of 2016. You know with the strong guidance for Q1, can you give us any qualitative comments what you might be expecting or thinking about for the second quarter?

Yes, thanks Dick. I think as we’ve stated several times we’re pretty excited with the momentum that we're seeing right now through the first quarter. And as we go out further we’re looking at more of the same kind of top down indicators that you are looking at which is what the Streets is talking about what the momentum might be throughout the year. I think lot of the forecast from the marginally -- from the first half of the year will be somewhat stronger than the second half of the year.

Okay and you mentioned a capacity issues at your customers, at this level 200 million in a quarter, what does this do to your capacity capabilities, I mean are you running into any constraints, where you need to be spending some CAPEX to expand?

No, nothing significant up to these levels. We're very well setup both globally and locally to meet the customers need as far as capacity. Any additional capacity we need to add is something that we at minor levels of capital investment.

Okay and in the non-semi side can you breakout what display was either for the quarter or how that ended for the year?

Yeah, display was up. I think we have talked about it before Dick, this is Sheri. Up traditionally it has been in the 2 million to 3 million range and it was up three to four times. So we saw that it was up year-over-year and we think that it will continue to be strong in 2017.

Great, thank you.

Welcome.

Our next question comes from Edwin Mok of Needham & Company. Please go ahead.

Great, thanks for taking my question. So first just curious why you decided to shut down the 3D printing business and are you getting to get any savings out there?

Yeah, hi Edwin. First of all we didn't shutdown our 3D printing business. You know there were two components to that business when we invested in business to business, B2B and B2C and I think what we found as we have gotten into that business is that the B2B business is very strong and that is what we are focusing on. And the B2B is something where we are moving in broad way moving forward.

And should we expect any savings or in costs related to I guess R&D side for your financial model?

Yeah, there will be some modest small savings but it is not probably material.

Okay, that's helpful. In the semi space we obviously heard from your customer and also from you guys and some of your peers that demand is very strong right now, I understand historically to large counter manufacturer like flex or [indiscernible] also play in space, have you seen them coming back and start looking at semi capital space and decide to come back and build more presence in the space, have you seen any change in competition or do you anticipate any change in competition for those large counter manufacturer?

Well we haven't seen any change. The ecosystem as a whole needs more companies like ourselves in that space. So, we have not seen and especially since outsourcing has accelerated we haven't seen any dramatic changes towards either new entrants or any dramatic shift of people moving out. We have a very healthy business in the counter manufacturing space and that is a good thing for us.

Okay, that's helpful. On the non-semi side you mentioned display was doing quite well, more than double this year. If my math is correct your non-semi business outside of display also grew this year, I am just curious what drove that growth, any new efforts you guys are putting that is driving that growth or anything that you can point to?

Yeah, the non-semi space is highly fragmented and very, very lumpy. It tends to be more one time or two time events that happened in that area. Display has been stronger longer-term, consistent level of revenue in the non-semi and even though as display can be a little bit lumpy it is becoming a more -- a larger dip in those segments by far.

And this is Sheri, you are right, it is was up year-over-year but it was on the flat panel but we did see some lumpiness with post metal [ph] customers that is so true as well during the year but most of it is flat panel.

I see okay, last question I have and I will let the other guys ask, so it looks like your cash is improving and you are like paying off your debt now. So, any thoughts about doing an R&D now or are you still completely focused on driving that down first, just got one down this end because you're thinking, you mentioned that there's not much CAPEX need, just wanted to understand if your business stayed in this level or similar level you probably be generating decent cash flow over the next year or two, just wanted to understand longer-term what is the strategy or how do you think about the cash?

We're always looking at other options driving this. But right now I think the thought is to continue to pay down our debt as it is necessary to do over the next couple of quarters. So again we're always looking at it. I don't -- there's no immediate plans at this point to change our strategy turning now.

Okay great. That is all I have, thank you.

Thanks Edwin.

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

Great, fabulous quarter. As we think about the year should we so we are all kind of relatively on the same page, should we think about 60:40, do you have any idea of how you see the business as far as the first half being greater than the second half as we model that out as far as mix?

Yeah hi Christian, thanks for the compliment. Yeah, obviously we see the first half very strong and that what's right in front of us. We're looking at a lot of the things as you are which is really many quotes from some of the larger OEM are around something like 55 to 45 or slightly down or other kind of more qualitative language. So I think when you start to look at the second half we are not looking at the same kind of information that you're looking at but obviously right now in front of us we see some very, very strong momentum.

Yes, exactly great. And then I guess my last question a follow up to an earlier question, can you quantify for us what the facilities could support in quarterly revenue, I know you guys said that you have plenty of capacity let's say 200 million, do we peak out at 250, how should we be thinking about that?

It’s a good question. Each of course region is different. Singapore is obviously a great area of growth for us right now. We see a very clear path to 250 with minimal to no investment and even beyond 250, I think lot amount of that will still be relatively small. We have a footprint now established in all the regions that we need. And so I think we can grow compare without a lot of capital needed.

The other thing Christian is that it obviously it really depends on where our customer needs are and what products they need built. So, -- but in general we have a good capacity model for where we're at in terms of the revenue growth that we're seeing.

Great, and is there any, I guess I have one follow up that came to mind, is there any gross margin difference between geographies that we should be kind of monitoring or paying attention as revenue stays so strong, where your pricing might be a little bit better or not or should I not be thinking about it that way?

No, I think the key thing is that where our goal is to stay within our target margin range. Obviously the margin is really dependent on a couple of things and part of it is volume, part of it is the geography of the manufacturing that we're doing because there is a labor component to the cost component within or outside the U.S. areas as well as product mix. So obviously, those three things can really play a factor quarter-over-quarter.

Okay, alright, that’s great. Thank you.

Thanks Christian.

[Operator Instructions]. Our next question comes from Patrick Ho of Stifel. Please go ahead.

Thank you very much and congrats as well. Maybe for Jim or Sheri taking the capacity question a little bit differently, as you look at the supply chain how are you managing that given some of the volatile trends. I mean you saw the rapid rise up, it's going to stay steady at these kinds of levels today but at some point they're going to fall off. How are you managing that where you're not going to be carry "extra inventory" or things of that nature and maybe related to that how fungible are some of the products you have between displays and semi's that they can kind of be interchangeable and now keep your inventories are very manageable levels?

Hi Patrick, thanks. Yeah, I think I’ll reverse that -- your question to answer the second part first and let Sheri answer the first part. There's almost no overlap between display components and semiconductor it's very minor. So there's not a lot of flexibility in that area. I’ll let Sheri make a view or comment on our inventories and how we’re managing them through the upturn and the downturn.

Yes, I mean we're obviously very focused on inventory, making sure that we have the right amount for our customers to keep things that we have been able to deliver quickly to our customers. On time delivery is very important as well as cost and quality. But you mentioned the supply chain being able to execute based on the supply chain that we have and so far we've been able to do that with them that we're seeing. So, I think we're setup in a good area at this point to be able to continue to deal with the levels of revenue that we see.

I think the other part of your question is how to manage on the downturn

Right.

If there was one, obviously UCT having 20 plus years in this industry has -- we have very good practices in place in order to manage the moment there's an inflection and manage how the inventories flow, how the orders go out there, so that we have very, very tight control both through the upturn if you've been very successful which is let's our revenues going up pretty dramatically and very quickly but also those same measures are in place for when things turn the other way that we can make sure that we can shut up the supplies as quickly as we turned it on in the upturn.

Great, that's helpful. And maybe as a follow up question for you Jim, you've seen many of these different cycles over the years, given that your visibility typically is only about a quarter or so, is it fair to assume that your visibility has extended in this current environment where at least qualitatively you're seeing stuff for the June quarter already where typically you don’t get that type of a lead time or are things still -- that three months type of lead times that you typically get?

Yeah, I think that’s a fair statement because the whole supply chain all the way through to the basic OEM components is pretty stretched. There's a lot of visibility just because a lot of the lead times are longer. So we do have a little bit more visibility into the second quarter than we normally would have. One thing that is also clear to us is that the pieces are going to be higher, but the next peak will be higher than this peak and the next valley will be higher than the last valley. And that's very cool. The overall trend is basically as we have pointed at a 30 degree angle or 45 degree angle now and that's something that very clear, very visible to us as we talk to our customers.

Great, thank you very much.

Thank you.

We have a follow up question from Edwin Mok. Please go ahead.

Hey guys, just a quick follow up on the model on your guidance, if I did the math correctly -- are your gross margin in the height of your 15% to 18% range or you are seeing some saving in OPEX, which way if going to sky you can give us some rough idea on how you think OPEX would have come in the quarter and if I'm correct that margin might sort of expand beyond the 17.4% you just reported?

Hi Edwin, yes so from a margin perspective I would assume that we are still going to be in our targeted range. Higher volume doesn't necessarily mean that we would be outside of that particular range. Again it's kind of goes down to the volume, the geography, and the product mix and that can change quarter-over-quarter. From an OPEX perspective, OPEX in Q1 tends to be a little bit higher in general because we have the year-end audit and the year-end activity that occurs. So, I would assume that it's going to be a little bit higher but our range that we typically operate in is the 9% to 10% range or seem that a little bit below that because of our volumes and I would assume that the percentage of revenue will be somewhat similar.

Okay, great. That’s all I have. Thank you.

Thank you, Edwin.

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 for joining us in our record quarter. We set many records this quarter and we look forward to seeing you at upcoming events.