Ultra Clean Holdings Inc (UCTT) 2006 Q3 法說會逐字稿

Welcome to the Ultra Clean Technology's third-quarter results conference call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded Monday, October 23, 2006. I would now like to turn the conference over to Jack Sexton, Chief Financial Officer. Please go ahead, sir.

Good afternoon and welcome to our third-quarter financial results conference call. My name is Jack Sexton, Chief Financial Officer of Ultra Clean Holdings, and with me today is our Chief Executive Officer, Clarence Granger.

A few moments ago, we issued a press release reporting financial results for the third-quarter 2006. Press release can be accessed from the investor relations section of Ultra Clean's website at uct.com.

In addition, we have arranged for a tape replay of this call which may be accessed by phone. This replay will be available approximately one hour after the call's conclusion and will be accessible for two weeks. The dial-in access number for this replay is 800-633-8284 for domestic callers and 402-977-9140 for international colors. The pass code is 21305979 for both domestic and international dialers.

This call is also being webcast live with the Web replay also available for 14 days from the investor relations section of our website at uct.com.

Together with our recently issued press release, this conference call enables the Company to comply with the SEC regulations for fair disclosure. Therefore, investors should accept the contents of this call as the Company's official guidance for the fourth quarter of fiscal 2006. Investors should note that only the CEO and CFO are authorized to provide Company guidance.

If at anytime after this call we communicate any material change in guidance, it is our intent that such updates will be done officially via public forum, such as a press release or publicly announced conference call.

The matters that we discuss today include forward-looking statements as defined in the U.S. Private Securities Litigation Reform Act of 1995 related to matters including our future financial performance, Sieger integration efforts, new product orders and shipments, and expanded production at our China facility.

Investors are cautioned that forward-looking statements are neither promises nor guarantees, but involve risks and uncertainties that may cause actual results to differ materially from those projected in the forward-looking statements. Some of those risks and uncertainties are detailed in our filings with the Securities and Exchange Commission, including our most recent Form 10-Q filed for the quarter ended June 30, 2006. The Company disclaims any obligation to publicly update or revise any such forward-looking statements or to reflect events or circumstances that occur after this call.

Now here are the third-quarter results. Revenue for the third quarter of 2006 was $104.1 million, a sequential increase of 52%, due primarily to the addition of Sieger Engineering, compared to revenue of $68.5 million for the quarter ended June 30, 2006, and an increase of 278% compared to revenue of $27.5 million in the same period a year ago. Our third-quarter revenue was above our guided range of 92 to $100 million.

Gross margin for the third quarter was 14.7%, a decrease from 15.6% in the prior quarter and an increase from 9.3% in the same period a year ago. The sequential decrease was due largely to the addition of Sieger, which as expected had a dilutive effect on our gross margin as a percent of revenue.

Operating expenses in the third quarter were $7.4 million, compared to $5.5 million for the prior quarter, an increase of 35%. The sequential increase of $1.9 million is due to a non-cash charge for the amortization of intangible assets associated with the acquisition of Sieger Engineering of approximately $737,000; increased G&A costs associated with a full quarter of activity for Sieger of approximately $700,000; legal and consulting charges related to Sarbanes-Oxley compliance work, patent infringement litigation, and general corporate matters, totaling approximately $300,000; and increased sales commissions, bonuses, profit-sharing accruals, and FAS 123(R) related charges of approximately $200,000.

Interest and other net expense increased $474,000 over prior quarter, due primarily to interest charges on debt put in place in support of the Sieger acquisition. Our effective tax rate for the first three quarters of 2006 and our expected effective tax rate for the balance of the year is 25%, flat with prior period.

Net income for the third quarter was $5.6 million, increasing from net income of $4 million in the second quarter of 2006, and increasing from a net loss of $566,000 in the same period a year ago.

Diluted earnings per share for the third-quarter 2006 was $0.25, at the high end of our guided range of $0.21 to $0.25, despite a $0.02 per-share charge for the amortization of Sieger related intangible assets referenced earlier. This $0.02 charge was not included in our third-quarter guidance due to the fact that the purchase accounting valuation work on the acquisition was not completed at the time the third-quarter guidance was issued.

For purposes of your financial modeling, the $737,000 amortization charge or $0.02 per-share charge after-tax will be unchanged for the fourth quarter of 2006. Starting in the first quarter of 2007, the amortization will decrease to $337,000, $0.01 per-share after-tax, and will remain at this level for effectively 10 years.

Turning to the balance sheet, cash of $18.9 million decreased $0.1 million during the period. Third-party debt of $33.4 million decreased $1.4 million during the third quarter, as a result of principal payments on our term loans and a reduction of the outstanding revolver.

In summary, net liquidity improved $1.3 million during the quarter, after funding UCT's legal and consulting costs associated with the Sieger transaction.

Accounts receivable of $47.1 million decreased $4.9 million or 9% due to improved collections. Days Sales Outstanding, restated to incorporate Sieger for prior periods, decreased nine days to 41 days at the end of the third quarter.

Net inventory of $49.4 million increased $4.3 million or 10% due primarily to increased inventory levels in our China facility. Days inventory on hand, restated to incorporate Sieger for prior periods and calculated on a forward-looking basis, increased one day to 51 days at the end of the third quarter.

Accounts payable of $39.8 million decreased $4.5 million or 10% during the period, largely due to a reduction in Sieger accounts payable and the settlement during the period of legal and consulting accounts payable pertaining to the Sieger transaction.

Now Clarence will discuss our operating highlights for the third quarter and provide guidance for the fourth quarter of 2006. Clarence?

Thanks, Jack. I'm pleased to report that the third quarter of 2006 was another quarter of strong operating performance for UCT and that once again we made significant progress on all of our key strategic initiatives.

Specifically, we grew UCT non-gas delivery revenue by 51% sequentially, ramping the two new contract awards we had previously announced to full production, and winning a new major follow-on contract award.

We increased the revenue derived from our Shanghai, China, facility by 38% sequentially. We shipped production orders to our new U.S.-based gas delivery system customer. We made significant progress in integrating the newly-acquired Sieger Engineering.

Additionally, UCT improved net liquidity and achieved record financial results both for revenue and earnings per share. During the third quarter, we grew our revenue for the fourth consecutive quarter; and we exceeded the top end of our revenue guidance by $4.1 million or 4.1%.

Earnings per share of $0.25 was at the high end of our guided range of $0.21 to $0.25 despite a $0.02 per-share charge for the amortization of intangible assets which, as Jack discussed earlier, was not in our third-quarter guidance. Absent this charge, the EPS for the quarter would have exceeded the high end of our guided range.

Additionally, improving our net liquidity by $1.3 million in the first quarter after the acquisition was a great accomplishment. I look forward to continued strong cash generation in the coming quarters.

During the just-completed quarter, UCT continued the smooth shipment of customer orders for both of the major subsystem contracts that were announced in the fourth quarter of 2005. This enabled a 51% sequential increase of UCT's non-gas delivery system revenue during the quarter. I'm pleased to say that we have now met our full-year 2006 targeted growth objective in this area.

In addition, we are pleased to announce that we have received a major award for a new follow-on product from one of the same customers. We anticipate prototype shipments of this process module in late Q4 and ramping to full volume production by the end of Q1 2007.

We estimate that expanding into process modules and other subsystems increases in our total addressable market by 3 to 4 times. We believe that, together with Sieger Engineering, we are well positioned to serve this market, given our combined engineering expertise, industry knowledge, and capabilities in the area of low-cost system integration in an environment of rapid change.

Also this quarter, we achieved the highest level of revenue from our Shanghai facility since its opening in March of 2005, increasing revenue by 38% from second-quarter 2006 levels. As expected, we successfully transitioned another of our key customers' product lines to the Shanghai facility in the third quarter.

As with non-gas delivery subsystems, our Shanghai operation is achieving the growth objectives we set at the beginning of this year. Additionally, we are moving ahead with plans to transition more UCT products and some of our newly-acquired Sieger capabilities to Shanghai.

Growing our base in China is key to enhancing our competitive position and improving our profitability. Additionally, we feel that having a manufacturing presence in Asia will, over the longer term, aid us in penetrating new OEM customers in Asia.

Another UCT strategic initiative is focused on expanding our U.S. customer base. During our last earnings call, we announced that we had received initial production orders for gas delivery systems from a new U.S.-based customer. I'm pleased to say that we successfully fulfilled these orders and received follow-on orders during the third quarter. We are also now involved in several new design projects with this significant new customer.

Regarding the integration of Sieger Engineering, we have successfully completed all of our initial integration tasks, and we are on schedule to complete all of our major integration activities by January 1, 2007. We are also moving quickly to expand the engineering content of the Sieger offering, as well as targeting new business opportunities by leveraging Sieger's machining capabilities.

Our initial efforts have been well received by customers. We remain very optimistic about our short- and mid-term prospects for winning new module awards and increasing the Company's share of the rapidly-growing outsourced subsystem market.

Looking ahead into the next quarter, demand levels are flattening. However, we expect that our continued growth in non-gas delivery subsystems revenue will offset any pockets of market-based declines. We expect revenue for the fourth quarter of 2006 to range between $100 million and $108 million, and net income share to range between $0.23 and $0.28.

To summarize the highlights for the third quarter, we achieved record levels of both revenue and earnings per share. This is the fourth consecutive quarter of growth for our business. We continue to grow our non-gas delivery subsystems revenue and our Shanghai revenue, consistent with our objectives.

We maintain a strong pipeline of customer qualifications for product transfers to our Shanghai facility. We began production shipments to our significant new U.S.-based customer. We completed a full quarter of smooth integration efforts with Sieger, and we remain optimistic about our continued ability to grow our business in the fourth quarter of 2006 and beyond.

Operator, we would now like to open the call for questions.

(OPERATOR INSTRUCTIONS) Jay Deahna from JPMorgan.

Congratulations on your continued excellent strategic execution. A couple of questions here. The first one is, Clarence, within the gas delivery system business, if we look at your recent mandate with the follow-on order, does this materially change the market share picture in any way, shape, or form, or what? Just kind of give us an update on the share trends in GDS and the stability or growth of that business for you.

Then the second question is, within your new product offerings, in terms of the process module business, it looks like you have got two core customers there, one where you got a nice follow-on order. Just wondering where you stand in terms of the sales process, in terms of broadening that out. Then I have got a quick follow-on to the second part.

Okay, the first question was with regard to our gas delivery business and share trends. I would say, within our existing customer base, the shares are fairly stable at this point in time. We do see some minor fluctuation based on individual performance. We believe our individual performance is very good.

But we don't expect to see significant share shifts within existing customers. But there are still opportunities to pick up new customers, smaller customers, in the United States. We are actively pursuing those at this point in time. As obviously, we have mentioned in this call, we do have another significant-sized U.S.-based customer where we think there is an excellent opportunity for us to capture significant market share.

Is that enough to move the needle, Clarence? Like what is your overall GDS market share, and how much can that change it by?

Probably 2 to 3% change. So we believe we are now the largest supplier of gas delivery systems in the United States. We believe this has the potential of moving that market share by 2 to 3%. So relatively small in terms of overall, but it is still significant to us.

Okay, then on your process module business?

Sure. The second question was related to the process module opportunities and where do we stand in general in the sales process in that? Virtually all of our major customers are interested in outsourcing more and more of their process modules.

We think by virtue of not only our size and our relationships, we are one of the largest suppliers to all of our key customers. Now that we have acquired Sieger, we are even a larger supplier to all of our key customers. We believe that puts us in a very good position to expand our process module business.

We have just announced this major win with one of our largest customers. We believe there are very good opportunities for future wins in the process module arena, although we are not announcing any others at this point in time.

Okay, then the follow-on question relative to your process control business. There's two. Number one, is your new mandate greater than 10% of your business? Number one.

Then number two, are any of your existing process module customers taking process modules from your factory, and shipping them directly to chipmaker fabs, and putting their systems together at their customer, without bringing them into their facility to test them first?

Okay. On the first question, is the new mandate greater than 10%? I assume you mean the new order that we are talking about.

Yes.

Yes, that is going to be on the order of a 15 to $20 million incremental order once we ramp to full-volume production. So it is not -- our combined Company is now roughly obviously a $400 million Company. So it is not greater than 10%, but it is not insignificant, either.

So that is for calendar '07, 15 to $20 million?

Yes, once we ramp to full volume. Our target is to ramp to full volume by the end of Q1; and that is incremental.

The other question with regard to shipping directly to the fabs, we are not to that point yet, but we're very close. It is one of our customers' targeted objectives. So I would expect to see that happening, if not before the end of the year, certainly by Q1 of next year.

Great, thank you.

Robert Maire, Needham

By the way, congratulations on some really nice numbers. Great execution.

Thank you, Robert.

Thanks, Robert. Good afternoon.

A couple questions. You know, on your printed-out or your released comments, you're guiding $0.23 to $0.25 inclusive of a $0.02 charge. So that if we backed the charges back in, that is really $0.28 to $0.30. If we back the charges back into this quarter, it is $0.27. Is that correct?

That is correct. I think just to be clear, the printed guidance is $0.23 to $0.28, just to make sure that I was clear. I don't know if you misspoke earlier.

Yes, that's correct. $0.23 to $0.28; and that is including the charges. If we put the charges -- if we discount the charges, it is really $0.28 to --?

It would be $0.25 to $0.30.

Right, got it. Okay. In terms of ongoing absorption of Sieger, could you tell us what kind of savings you are expecting over sort of what period of time? What should we be modeling in terms of our SG&A? If we held at similar revenue levels, what could we expect going forward in terms of the model as it comes together?

Robert, when we initially made this acquisition, we indicated that it was more of a -- the value in it was combining the capabilities, and there wasn't a big portion of cost synergies.

That being said, we have combined very quickly the back-office functions. We have accounting centralized here in Menlo Park. HR is combined. We have a little bit of a presence still in South San Francisco. So we have already realized some level of savings, and we will continue to participate in that going forward.

If your question is -- is there a big shoe to fall? The answer is no. The savings sort of happen naturally and they happen fairly quickly. Then we are not looking to factor in a big chunk of improvement moving forward.

Okay, yes, I was just trying to gauge it. I realized it was accretive from the start.

In terms of the new 15 to $20 million in additional revenue, you say that is going to start to roll in in Q1. So for modeling purposes, if we kind of add that in, would that be appropriate?

Yes, I would drop that it in pretty -- almost a full quarter of that number, into first quarter. Because as we said, we are starting beta production in the fourth quarter, and we think we will be ramped up pretty quickly in Q1.

Okay. In terms of the softness you had mentioned earlier in your comments, is that specific to any customer or any process? Or is that just sort of a general across the board?

Is that softness reflected in orders, or just your customers' commentary coming back, or are they working down a little bit of inventory, or what? Maybe you could give us a little more detail on those comments.

Robert, I think Clarence used the word flattening. We're really seeing a flattening. In some areas, the flattening will mean a small bump; in some areas, a small bump down. It is nothing significant. We wouldn't use the word softness to describe the market environment.

Okay.

What we are saying there is we are indicating our guidance. The midpoint of our guidance is basically flat, $104 million. We are saying we are continuing to grow at a good pace the non-gas delivery side of the UCT core business.

So of course there is some level of reductions offsetting that, based on the midpoint of our guidance. But really it is a more of a flattening and very limited areas of reduction sort of offsetting that.

Okay, great. That sounds good. One other question. In terms of other projects that might be similarly situated or similar in size to this incremental 15 to $20 million contract. Any others that are sort of on the horizon over the next six months to a year? Or others of similar size that you're getting closer to execution on?

Certainly we would hope within a year there would be other opportunities of a similar nature. We're not making any announcements at this point in time. This is a pretty big one, but there's obviously lots of others that we are working on.

Okay. One last question. In terms of customers' reaction to the Sieger, combination, I am assuming that is relatively positive. What sort of opportunities have customers presented now that you are sort of a larger critical mass company? Anything show up because of that?

Yes, sure, Robert. This is Clarence. Two specific areas. The first relates to Sieger. Sieger has traditionally not done engineering related to the projects they have been involved in. So one of our largest customers has asked us to participate now in an engineering activity that Sieger traditionally would not have participated in. So that is getting us involved earlier in some of the larger projects and gives us a stronger opportunity.

Second area is machining capability. This relates more to the traditional UCT side. UCT has not traditionally had precision machining capability. So our customers are now interested -- the customers that Sieger had not served before -- are now very interested in this as part of UCT's extended capability.

So we think both of these areas offer significant additional revenue and growth opportunities to UCT going forward.

Great, congrats again.

Tim Summers, Stanford Financial Group.

Good numbers, guys. Just a couple of clarifications here. On the amortization, when you use the word charge, is that just a onetime charge on the amortization? Or should we just view this is ongoing amortization expense quarter after quarter?

No, Tim, we will have two quarters at this level of $737,000. I will give you a bit of background on that.

We attributed some of that value in what we purchased to the trade name Sieger. But we intend to operate entirely as Ultra Clean Technology starting January 1 of '07. So we're taking an asset which was about $800,000 and amortizing it over two quarters.

So that is why you see this $400,000 drop off from Q4 of '06 to Q1 of '07. It drops down to $337,000. That really is a customer relationship which amortizes over 10 years.

Okay, good. Secondly on the Sieger opportunities going forward, it sounds like you're beginning to focus their expertise and machining capabilities to new customers. Can you take the current Sieger Engineering product line, which I think is primarily CMP, and leverage that either into new customers or expand that into current products with your existing customers?

The CMP product line, obviously, there are other customers that UCT supports the manufacture CMP tools, so there is some potential to extend our expertise from Sieger into other customers.

But the precision machining capability, that is a very narrow and specific area. We do think there is that opportunity with regard to CMP. But the broader area is in the precision machining. All of our customers in all of their product lines are looking for more precision machining capability. So, we view that as being a bigger opportunity to bring to all of our existing customers as we move forward with the Sieger integration.

Then on the reverse side, on the CMP, Sieger has traditionally done fairly limited engineering activity associated with that. We are hoping to bring more of the UCT engineering expertise to some of that product design.

Clarence, can you size the precision machining opportunity that you foresee now with Sieger?

Well, eventually, although we haven't formally committed to this, we are evaluating moving some of Sieger's capabilities to China. That was one of our reasons in doing the acquisition. One of the opportunities that we are considering is migrating some significant portion of the machining to China.

If we do that, we think the precision machining opportunity is very large. It is difficult to quantify in millions of dollars. But it would certainly be, if not approaching $100 million, it would be a very significant number.

Okay, great. Thanks, Clarence.

(OPERATOR INSTRUCTIONS) Jesse Pichel, Piper Jaffray.

Sieger has 2, 3 points lower gross margin. I am wondering what could the cost savings be from transferring some of their manufacturing to China? With that, could you give us some gross margin guidance there for Q4 and how you see that progressing?

Sure, Jesse. The transition from the U.S. to China actually has a larger accretive effect in machining than it does in the assembly business. Because there is a fairly high concentration of direct labor and setup time, etc,. associated with the machining operation. So we actually see a bigger bang in moving machining to China than the assembly.

In terms of quoting that, the actual -- the machining tends not to have the same volume impact. It is easier to ramp significant volumes on the assembly than it is in machining. But from a percent profitability standpoint, it is actually richer and then stronger margins than in the assembly operation.

Your margin guidance there for Q4, the range?

For Q4, basically, we are in a mode of -- we have given our range. If you put into your model a little bit of a continued increase in operating expenses, probably another $200,000; and that is mainly driven by Sarbanes-Oxley charges. We are in the heat of the battle with respect to finalizing our 404 certification. Basically what falls out there is a margin in the range of 15%.

Okay. And could you give --?

And sorry, the effective tax rate is basically 25%. We were expecting it to maintain itself at 25%.

Okay. Could you give us a new end market breakout, including the new medical and CMP divisions? Or you don't have that yet?

Sorry, what do you mean by new market breakout?

Well, including Sieger, I am just wondering how you define your end markets at this point. What percent of revenues from, say, medical display, CMP?

We haven't done that, but I can tell you in general. The medical still represents a very small percentage of our overall revenue, probably on the order of 2 or 3%. Flat panel is a larger percentage, probably on the order of 8%. Solar is fairly small percentage, again on the order of 1 to 2%.

The rest of it is in semiconductor capital equipment. So we are still very heavily focused on semiconductor capital equipment.

AMEC has been in the news of late. Are AMEC and companies like [Seven Star] potential customers or competitors?

No, no. AMEC is -- those guys -- AMEC is an equipment manufacturer, so they would be a potential customer.

Potential customer. Yes, I think they're doing quite a lot of machining there in China.

AMEC? A-M-E-C?

That's correct.

No, they are not doing any machining.

Really? I thought they were doing precision machining for PECEVD chambers for a [sigs] process on solar. But that is something I just heard of late.

Speaking of solar, AMEX is shooting for $500 million of solar sales in a few years. We think that is kind of conservative. What are your opportunities in solar? Is it (multiple speakers) applied, or are there other relationships there that are abutting?

We are very early in the solar side, Jesse. So I would say that is something that would make sense for us to be a target market in the longer term. But at this point, our customer base is pretty limited. So we have not yet had an opportunity to focus on that very heavily, but I'm sure we will going forward.

Then lastly, just housecleaning. Jack, could you give us the actual revenue number for gas panels, non-gas panels, and China? Just so we are on the same page.

What is the difference in gross margin points between the U.S. and China at this point? Thank you. Nice quarter.

We have stopped giving China as a percent of the UCT revenue. We are basically in the vicinity of $13 million currently out of China.

We finished last quarter with 55% of our business coming from gas delivery systems. That was on a combined basis, combined with Sieger. That number is not going to move too much quarter-to-quarter -- or we are in the same vicinity at this time.

Gross margin variance between U.S. versus China?

We are still indicating the same. We have a nice gain as we build more and more of our product in China. I hesitate to give an exact delta there. But if we didn't get the gain, we would not be moving over there. So we do get a nice bump by being in China. But I'm not going to articulate that in any more detail.

Great, thank you.

Tim Summers of Stanford Financial Group.

Just two things. Was the upside in the revenue this quarter driven from Sieger or the traditional UCT?

It was driven more by the traditional you UCT, Tim. This is Clarence.

Okay, great. That was it. Thanks.

(OPERATOR INSTRUCTIONS) There are no other questions at this time.

Okay, I would like to thank everybody for joining the call, particularly of course our shareholders. We look forward to speaking with you either on the road or during next quarter's conference call. Thanks again. Operator?

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your line.