Ultra Clean Holdings, Inc. (UCTT) Q4 2018 Earnings Report, Transcript and Summary

Good day, everyone, and welcome to the Ultra Clean Technology’s Fourth Quarter and Full Year 2018 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]. After today’s presentation, there will be an opportunity to ask question. [Operator Instructions]. Please note that today’s 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 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. Then we’ll open up the call for questions. The press release issued earlier this afternoon, along with the information about the webcast and how to access a replay of this call, can be found on the Investor Relations section of our website at www.uct.com. Today’s call contains forward-looking statements. Investors are cautioned that those statements involve risks and uncertainties that may cause actual results to differ materially from those discussed on this call. Information concerning these risks and uncertainties is contained in our periodic filings with the SEC, including our most recent Form 10-Q and 10-K and in the press release relating to today’s call. All forward-looking statements are based on management’s estimates, projections and assumptions as of today, and UCT assumes no obligation to update them after today’s call. Also on today’s call, we will be referring to non-GAAP adjusted financial measures, and reconciliations to GAAP can be found in today’s press release. 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 for our fourth quarter and full year 2018 conference call and webcast. First, I’m going to highlight a few financial results, then Sheri will expand on it in her commentary. I will follow this with an overview of how we see in a short-term and long-term semiconductor market landscape and outlook. And conclude by outlining some deliberate actions we are taking to become more profitable and increase the value we deliver to our customers and our shareholders. With the addition of Quantum’s first full quarter of revenue, we were able to report top-line results for the fourth quarter of just over $257 million, at the end of our guided range. These results capped off a strong year for us with 18.6% revenue growth year-over-year despite an uncertain and dynamic second half. Acquiring Quantum has proven to be an extremely valuable contributor to UCT and the diversified and complementary capabilities have already begun to transform our financial profile. In the fourth quarter UTC’s non-GAAP gross margin improved 300 points over the third quarter. Operating margin improved slightly from 6.4% to 6.5% quarter-over-quarter, indicating there is work to be done and I will expand on exactly how we plan to accelerate our profitability in a moment. First, I would like to talk about the semiconductor landscape in general and describe what we're seeing from our position in the value chain both short and longer-term, then I will describe what we’re doing to offset industry uncertainty by elaborating on cost improvements we’re undertaking to right size our business. I will start with the idea where our service business plays a significant role. The semiconductor business is defined by rapid technological changes and the need to maintain high levels of investments for new materials and innovative manufacturing processes for increasingly complex chip design. Top-tier IDMs admitted they did not perceive the magnitude of the economic deceleration in the second half of 2018, especially in China, resulting in IDMs posting year end results well below expectation. Intensifying competition in the smartphone business, mounting macro uncertainty and lackluster demand for memory chips were cited as the primary reason for the slow down and have resulted in a softer outlook for 2019. Despite this Quantum holds a very distinct competitive advantage and is expected to grow mid to high single-digits in 2019, even though wafer fab equipment spending is expected to decline. We benefit in two distinct ways. First, we receive a recurring revenue stream from our ongoing service within the growing installed base where we hold a leading position. Second, we work with our top tier IDM customers as they invest in new fab requiring highly technical cleaning and analytical solution. We add value by partnering closely with our customer helping them extract increased technical capability and higher productivity from existing and new assets within advanced product. As wafer start to increase, so does our service business. This gives us great confidence in our ability to sustain stronger performance than our peers who rely solely on WFE spend. Taking a step down the value chain, OEMs struggling with the trickle-down effect from the push out announced by the IDM. Industry fundamentals, especially within the memory segment are showing weakness as both NAND and DRAM continues to contract, resulting in excess inventory in the system. We anticipate these elevated inventory levels to normalize over the next few quarters, which bodes well for a more favorable 2020. Non-memory sentiment is slightly more optimistic and is predicted by some to grow in 2019, albeit slightly. Regardless of this near-term headwind industry investment remains rational and disciplined and poised to deliver very attractive long-term growth opportunities. And that brings us to our products and solutions business. UCT delivered highly integrated one stop hand-to-hand solution for our OEM customers. Unlike the majority of Quantum’s business with IDM, UCT’s custom manufacturing offerings are driven by primarily by WFE capital equipment spends. Our direct visibility based on customers’ orders is limited and can change significantly even within quarter. Based on what we’ve seen and heard so far this year from IDMs and OEMs, together with our internal marketing intelligence, the industry is taking a much more muted tone and we believe we could see weakness continue throughout the year. While we hope that we’re wrong and a recovery does materialize in the second half of this year, we are restructuring our business now to be more profitable in either scenario. With that summary of the backdrop we felt it was imperative to initiate a series of rigorous cost improvement initiatives to increase profitability without compromising or constraining our capacity to react quickly when the industry growth resume. While we did reduce expenses in the second half of last year as the equipment market softened, they were not sufficient to take us through what we now believe is an extended period of reduced demand. Our product and solutions business and our service business are designed to drive operational excellence companywide, both underwent an exhaustive analysis and brought forward a list of objectives that meet to improve profitability and drive higher returns for our shareholders over the longer term. Our restructuring plan includes consolidating and eliminating, sites moving additional production to Asia, the elimination or postponement of certain planned capital expenditures and a meaningful reduction in workforce. While some of these initiatives are underway, others will be rolled out over the coming quarters. We anticipate cost improvements along the way. However, the majority will be realized in the second half of the year. Expected annualized cost savings from the restructuring plan will be in the $15 million to $20 million range once completed. UCT has successfully managed through several industry cycles as recently as latest 2016 and has emerged a much stronger company when those discussions began. We are working very closely with our customers to position us for significant growth when the industry rebounds. As we navigate these short-term uncertainties, we’re confident that we will be in a much stronger position to benefit from the multi-year technology inflections and leading-edge logic, foundry and memory as well as the increased requirements in semi more broadly. The semiconductor industry is set to benefit from ongoing next-generation innovation and development in home and industrial automation system, wearable devices, advanced software, data center, cloud computing, Internet connected devices and artificial intelligence, just to name few. Increasing consumption of electronic components in our ever expanding automated and connected world will further contribute to growth in the industry. For comparative purposes, our non-semi business was approximately 7% of total revenue in the fourth quarter, of which display made up roughly have. We are seeing display investment timing delays resulting from a softer market outlook. Although we believe spending in display equipment will remain muted over a longer period, the display market remains appealing and technology transitions accelerate creating meaning opportunities during the coming year. In summary, we are very confident in the long-term prospects of the semiconductor industry with ever increasing application. We view the current downturn as an opportunity to materially improve our bottom-line, while ensuring that we protect our revenues and optimize our capabilities to secure long-term growth. I would like to thank our employees and our shareholders for their continued support and I look forward to updating you on our next call. With that I'll turn the call over to Sheri.

Thanks, Jim. And good afternoon, everyone. Thanks for joining us. In today’s discussion, I will be referring to non-GAAP numbers only. I will begin with a short recap of 2018, then guide into our fourth quarter results. For the full year 2018 total revenue was $1.1 billion, an increase of 18.6% over the prior year. Gross margin averaged 16.5% compared to 18.1% in 2017. Operating expenses as a percentage of revenue increased by less than 1% over the prior period totaling $94.9 million. Operating margin came in at 7.8% compared to 10.3% in the prior year. Diluted earnings per share of $1.66 on net income of $64.7 million compared to $2.34 and $80.3 million in 2017. And lastly for the full year we generated cash from operations of $45.4 million compared to $48.9 million in the previous year and exited 2018 with $144.1 million of cash and cash equivalent. Now let met turn to fourth quarter results. Our semiconductor services business performed better than expected, offsetting the seen weakness in our product and solutions business. This resulted in total revenue of $257.4 million, up 10% quarter-over-quarter and at the high end of our guidance range. Total semiconductor revenue was $239.7 million which included $58.4 million from Quantum. Non-semiconductor revenues which include display, generated $17.8 million or 6.9% of revenue. Total non-GAAP gross margin rose to 18.7%, a dramatic improvement from 15.7% in the third quarter. This increase reflected a full quarter of our high margin services business. As we shared before, margins can be influenced by number of factors including costumer concentration, geography, product mix and volumes, and you should expect to see these variances quarter-to-quarter. Operating expense as a percentage of revenue increased to 12.2% as expected due to the Quantum acquisition. Operating margin for the fourth quarter was 6.5%, up slightly from 6.4% in the prior quarter. While heading in the right direction it’s clearly not where we want to be. Restructuring that is underway will improve efficiency and further reduce cost. By taking decisive action now we’re preparing UCT to manage through an unpredictable environment while improving longer term results and increasing our value for customers and shareholders. Based on 39 million shares outstanding, earnings per share for the fourth quarter were $0.23, derived from net income of $8.7 million. This compares to $11.9 million net income and $0.30 per share last quarter. Our tax rate for the quarter was 17.2% compared to 14.6% last quarter. Going forward, we expect our tax rate to be in the middle to high teens but as always you’re going to expect to see variances quarter-to-quarter. Turning to the balance sheet, we ended the quarter at $144.1 million in cash and cash equivalents, a decrease of $16.2 million over the prior quarter. We used $30 million to payoff joint venture debt related to the Quantum acquisition. Cash from operations was $30.1 million, an increase of $2.8 million over the prior quarter. Inventory decreased by $12.5 million during the quarter and we will continue to optimize our inventory level to closely match customer demand. Our first quarter outlook reflects what a lot of our peers and customers have reported already and continued softening in our semiconductor products and solutions business. However, we do expect to see slight increase in our services revenue. We’re assuming total revenue for the first quarter to be between $230 million to $250 million. While we expect to see upside on our bottom-line as a result of the aggressive restructuring strategy we’re undertaking, the benefit of that process will take some time to fill through and be fully realized. For the first quarter we’re projecting non-GAAP EPS to be between $0.09 and $0.19. And with that, I’d like to turn the call over to the operator for questions.

Thank you. We will now begin the question-and-answer session. [Operator Instructions]. Our first question comes from Quinn Bolton of Needham & Company. Please go ahead.

Congrats on the nice gross margin improvement in the fourth quarter. I guess I first want to start with your outlook for 2019. It sounds like you are taking a fairly conservative approach and not expecting any sort of recovery in WFE throughout the year. I just wanted to -- to want to confirm that if that’s the way you're thinking about it? The second question I have is, where do you think we are in the inventory reduction process and when you think we would sort of potentially come back to levels of underlying consumption in 2019?

Yes. Hi, Quinn. I will take the first part and I will turn it over to Sheri for the second. So 2019, the outlook, I think obviously the second half is uncertain as I mentioned on the call. We don’t have visibility for the second half. I think in this situation we don't know if the second half is going to recover like the initial consensus was out there a few months ago. And I think given the uncertainty instead of banking on a recovery, I think it’s in our best interest. We will be able to manage a recovery in the second half. But given that we have at least two quarters of runway, it’s a good time for us to embark on some of the longer-term costs reduction that some time to implement in the lower period. I guess I will continue on with the inventory, we've been aggressively working the inventory down. We’re not yet at the level that we'd like to be. We would like to be our turns up one or two more turns a year. But I think as we finally -- as the revenue declines or slow down or stop on the equipment side, we will have some time to catch up. We’ve been reducing the inventory, but we haven't been able to reduce it as fast as the revenue has been dropping but now that things have stabilize, I think over the next several quarters we will be able to recover it to normal levels.

Sorry, Jim my question on the inventory was really meant for what you think your customers’ inventories, are they buying sort of at a rate lower than what they are actually shipping or do you think their shipments are fairly well aligned with an underlying demand at this point?

Okay, yes. Sorry about that. Yes, the inventory between us and our customers, the OEM customers is generally not as large of a concern as it is between the original part manufacturers are making more standard on the shelf items. So we did see some of that impacting Q4 of the customers’ finished goods inventory in some of the major modules, I think a significant portion of that has been worked out.

And then for Sheri, I think you mentioned annualized cost savings roughly $15 million to $20 million as you implement these cost savings programs. Can you give us some sense of how much of that hits the OpEx line, how much of that comes into cost of goods?

Most of it is actually cost of goods but we will see some small increments in OpEx. So I would say probably 70% to 80% will flow through COGS and then the rest of it will go through OpEx.

Our next question comes from Karl Ackerman of Cowen and Company. Please go ahead.

Jim or Sheri, just going back to that last question on OpEx. Looking at March OpEx, I think it isn’t that higher than perhaps what I would have thought. But following the implementation of the $15 million to $20 million of cost realignment actions you are taking, how should we think about the absolute level of OpEx spending for the balance of 2019? And secondarily, as you seek to improve manufacturing utilization, how should we think about gross margins for the balance of the year?

So from a OpEx perspective, obviously we’re forecasting out. I think we mentioned last quarter that we thought we would be in about the 12%range, now that QDT is part of our overall company, they have certain level of OpEx as well as we do. So they grow up our percentage up a little bit. That’s something that we’re going to continue to optimize over the course of the year with these cost reductions as well as just obviously optimizing in general what we tend to do. So I would expect that we would be depending upon revenue be in the 11% to 12% range as we have been and then continue to drive down if possible.

As a follow up, while the services business QDT is obviously much more insulated from the year-over-year WFE drop in 2019, I would think that a pullback in wafer starts would likely affect kind of growth this year, at least near-term. And so, I guess the question is, does the growth of your services business for mid high single-digit growth in 2019 imply a massive hockey stick ramp in the second half of this year or would you expect it to be relatively flattish of March levels?

Yes, in the service business we actually have a lot more visibility. Our bottoms up forecast has extended quite a bit more than it is on the equipment side, and that's due to the nature of putting the facilities in place near the fabs and being very tightly bound with the fab -- particular fab start-up. So we’re well-positioned and there's been some fab ramp ups that have been announced and we now see that they are growing especially in Israel for example. And so, we're pretty confident in where we are positioned in the water fab starts that we’ve got to pretty solid forecast in that area.

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

Maybe first off for either Jim or Sheri with regards to the restructuring, can you give a little more color where the restructuring is going to come from, whether it's from your core UCT business systems and products side or on the QDT front? And the reason I’m asking is, a lot of it is on the core UCT side of things. Could this have been done earlier before the acquisition close, so you could get kind of the cost structure and some of the rationalization, does that kind makes sense on a going forward basis?

Yes. The answer to your question is yes, it is on the core equipment side or [SPS] side is what we call it. Obviously we have been making adjustments to that side of the business incrementally as we went along through the year of ‘18. Back in the fall we have a major customer call the bottom and at that time we believed that there would be a pretty quick recovery after only a quarter. So -- and we took steps back then but now that, that period has been a extended period of time. We can do the types of restructuring moves that take a longer period of time and that are more easily achieved when the factories aren’t running at high levels of capacity. So it really -- in order to do a lot of things that we’re doing, we needed a kind of runway that we now see that we have.

Fair enough. And then maybe as a follow-up to that, given -- I mean you’ve been in the equipment industry for a long time now and it's an extremely volatile business, maybe it’s less cyclical than it’s been in the past. With these restructuring moves how confident are you if WFE in the future get’s back to that $50 billion or higher level that you can turn it on and be able to ramp quickly for your customers in those future times. I understand the rationalization today, but if they go back to the high levels that we saw just a few quarters, I guess the sense we should have that to return very quickly?

Yes. Our confidence level is very high, without going into too much detail about the types of restructuring that we’re doing, we are very confident we will be able to have a very similar if not improved capacity at the end of the restructuring. It will be much more efficient. We have a lot of duplication capabilities, both within the region and then globally. And so there is an opportunity to really get scale in certain areas that make sense and remove duplication from side-to-side.

Great. And a final question from me on the services front. It’s a business that you're projecting to grow again this year, it’s obviously different market dynamics from the product side of things. How are you looking at offering I guess different types of services, analytics, and I guess even more even stickier solutions than the traditional parts cleaning business. How are you looking at new offerings for your customers that will drive revenues over time?

Actually that is definitely a part, we’re not just doing cleaning, we’re actually doing a lot of contamination control and analytics already with our ChemTrace segment of the cleaning division. So that actually is one of the key strategic element of the service Quantum business that we bought and we’re definitely looking at how to leverage that and improve that and it’s definitely one of the selling point of that capability. Second, there’s also a lot of activity technology-wise on surface treatments and surface coatings and texturing, a lot of engineering that goes along. And a lot of work is being done on handling a lot of strange new materials being taken up on periodic table and put into chip. And so we’re definitely as a combined entity we’re -- that the main focus is how to put resources in that area and leverage that because it’s already an effective arm of the service business and definitely something we want to grow.

[Operator Instructions] Our next question comes from David Duley of Steelhead Securities.

Just a couple of clarifications. You mentioned that your Quantum business is going to grow I think high to single-digits. What is the base level, what was Quantum’s revenue in total in ‘18?

I don’t have the -- I have, ‘18 is about 235 million.

Great. And then as far as the size of the WFE market in 2019, for planning purposes, what level are you planning for, I think it was roughly 50 billion last year, how far down do you think it’s going to be this year?

Yes. I don’t think we really backed out or what I would want to get -- be the lone guy predicting WFE not ahead of everyone else. But definitely, definitely not 50 billion. But we did a mixture of bottoms up and a top down kind of analysis that let us to believe that it's going to be down in a similar range that it’s been now and we believe the major movements down from current revenues are kind of over with, but we don't I think more what we see than any further major deterioration. It’s just a lack of sign of recovery in the second half, which may happen, but at this point we don't see it.

Why I guess I’m asking this is, generally I think it’s kind of consensus that it might be down around 42 billion from 50 billion or roughly down high end of that 20% range that people are referring to. But if there is not second half recovery then it would be down more than that and I guess that’s kind what I’m wondering is, if you don’t have visibility into a second half recovery one way or the other, then just trying to figure out what level of planning you’re kind of gearing towards the industry?

Again without trying to bridge down to a new WFE number, I think those are reasonable assumptions to make and I think you could -- we could do our planning from there.

Okay. And then going forward what gross margin expectation should we have for your cleaning business there?

Well for the cleaning side, they are about double what our typical core UCP business has been. So from a combined company standpoint, we really see us been at the higher end of our range if not beyond that as we move in through the course of the year to, how the course of the year goes from a revenue perspective but we’re going to seek that we’re at the higher end of our range for Q4.

And then so, was there a quite large percentage for the business?

No. We’re not providing that at this point, really we’re going to be doing segment reporting starting in Q1 so start to see the half margin for that business going forward when we go into 2019 reporting.

Okay, another question from me is about the cost savings goal, I think you mentioned they really don’t fit to the second half of this calendar year just given the timing of things. As far as the 15 million to 20 million would be kind of guess on a quarterly basis in the second half, how much we might have achieved by the end of Q3 and the end of Q4 let’s say?

Yes. Obviously we don’t want to do a full year forecast, some of the actions have occurred as of very recently. So the actions are occurring as we speak and they will continue through the year. There will be no real material effect that we believe until the second half of the year and obviously if you spread the cost savings of the second half and maybe some of them are going into the first quarter, I think you can just make some assumptions on how that might spread out.

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

Yes. Thank you, for joining us, and we look forward to speaking you again in April.

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