Ultra Clean Holdings Inc (UCTT) 2007 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Ultra Clean Technology third quarter results conference call. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded Monday, October 22, 2007. 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 Chairman and Chief Executive Officer, Clarence Granger.

A few months ago we issued a press release reporting financial results for the third quarter 2007. The press release can be accessed from the Investor Relations section of Ultra Clean's website at uct.com. In addition, we have arranged for it a taped 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 number of for this replay is 800-952-6697 for domestic callers and 212-231-2901 for international callers. The pass code is 21352079 for both domestic and international dialers. This call is also being webcast live with a 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 2007. Investors should note that only the CEO and CFO are authorized to provide Company guidance.

If at any time after this call we communicate any material changes in guidance it is our intent that such updates will be done officially via a 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, new product orders, and shipments, and expanded production at our China facilities.

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 29, 2007 and Form 10-K filed for the year ended December 29, 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 2007 was $95.5 million, a sequential decrease of 9% compared to revenue of $104.7 million for the quarter ended June 29, 2007, and a decrease of 8% compared to revenue of $104.1 million in the same period a year ago.

The sequential decrease was due to reduced demand from nearly all semiconductor capital equipment customers, with industry demand becoming progressively weaker toward the end of the quarter. As a result, our third quarter revenue was at the low end of our guided range of $95 million to $103 million.

Gross margin for the third quarter was 14%, down from the 15.1% recorded in the second quarter, and a decrease from 14.8% in the same period a year ago. The sequential reduction in gross margin is due to reduced factory utilization as a result of lower industry demand.

Operating expenses in the third quarter were $7.8 million compared to $8.3 million for the prior quarter, a decrease of 6%. The sequential decrease of approximately $500,000 is due to reduced legal cost associated with our patent infringement lawsuit, partially offset by increased sales and marketing expenses.

Interest and other net expense of $460,000 was effectively flat with prior period. These charges relate primarily to interest expense on debt put in place in support of the Sieger acquisition.

Our effective tax rate through the third quarter and the rate projected for the full fiscal year 2007 is flat with prior periods at approximately 29%.

Net income for the third quarter was $3.5 million, decreasing from net income of $5.1 million in the second quarter of 2007.

Diluted earnings per share for the third quarter 2007 was $0.16, also at the low end of our guided range of $0.16 to $0.22. The $0.16 earnings per share includes a $0.01 per share charge for amortization of intangible assets related to the Sieger acquisition and a $0.03 per share charge related to FAS 123R.

Turning to the balance sheet, during the third quarter cash of $28 million increased $8.1 million sequentially, while third-party debt decreased $900,000 to $28 million. Taken together net liquidity, now at zero with cash equal to third-party debt, improved $9 million during the period. Accounts receivable of $42.9 million decreased $7 million or 14% due to improved collections at lower revenue -- and low revenue during the period. Day sales outstanding decreased two days to 41 days at the end of the third quarter.

Net inventory of $51.2 million increased $2.8 million or 6% due to approximately $4.5 million in raw material brought in at the end of the third quarter in support of a new system implementation, which I will discuss later in the call. Days inventory on hand calculated on a forward-looking basis, and after adjusting out the exceptional increase in inventory, was flat at 52 days at the end of the third quarter.

Accounts Payable of $33.6 million increased approximately $600,000 or 2% during the period. Days payable outstanding increased 4 days to 43 days.

Finally I'm please to report that UCT has successfully implemented a new fully distributed enterprise resource planning, or ERP system, at all of our U.S.-based locations. At the beginning of the current month we successfully transitioned three U.S. sites to the same version of standardized ERP software. We plan to complete the China portion of this implementation in the first quarter of 2008.

We expect to realize significant efficiencies over the next several quarters by moving to an updated centralized ERP platform. This also completes one of the final stages of Sieger's integration into UCT by bringing all U.S. operations onto a common Company ERP system.

Now Clarence will discuss our operating highlights for the third quarter and provide guidance for the fourth quarter of 2007.

The third quarter of 2007 was a challenging period for the industry in which we saw a progressive softening of demand from nearly all of our customers. Despite this challenging environment, we managed to deliver relatively strong operating performance, while continuing to make significant progress on our key strategic initiatives.

During the quarter we secured orders from three new customers, Axcelis Technologies, Photon Dynamics, and a new Korean customer, IPS. In addition, we completed construction of a second facility in Shanghai, China, and we signed a lease on a new facility in the Silicon Valley, which will allow us to consolidate our operations here.

At the same time, we continued to execute on the new product awards announced in the first half of this year. Making significant advances like these during periods of reduced industry demand is one of the attributes that allows UCT to consistently outgrow the industry.

I will now provide further detail on these accomplishments. During the quarter we began shipments of Gas Delivery Systems to a new customer, Axcelis Technologies. We anticipate that this relationship will grow and eventually extend into process modules.

We also were awarded process module business from another new customer, Photon Dynamics, which provides test equipment to the flat-panel industry. This is UCT's first extension into the test equipment industry. We expect to ship the first Photon Dynamics process module in Q1 2008 from one of our U.S. facilities, and then transfer the manufacturing of this module to our new Shanghai facility in Q2 of 2008. We remain focused on expanding further into process modules and other nongas delivery subsystems.

We estimate the incremental worldwide market opportunity for these modules to exceed $2.4 billion, and as of today only 20 to 30% of these modules have been outsourced. We believe our customers will continue to outsource these modules at a rapid pace, and that we are well-positioned to serve this market, given our engineering expertise, industry knowledge, and capabilities in the area of low-cost system integrations in an environment of rapid change.

Additionally, I'm pleased to announce that UCT has signed a seven-year lease on a 100,000 square foot facility here in Silicon Valley, which we plan to occupy starting in April 2008. This new facility will allow us to vacate our Menlo Park facilities and a significant portion of our South San Francisco facilities, centralizing both subsystem assembly operations under one roof. The new facility will also serve as our headquarters office. We are confident that we will realize significant savings by centralizing our Silicon Valley-based assembly operations into a single facility.

Another major UCT strategic initiative is focused on continuing to expand our Asian-based operations. During this quarter we have continued this effort by beginning volume shipments of a major gas delivery product that is transitioning to Shanghai from one of our U.S. facilities by adding a new Korean-based customer and by completing a second major manufacturing facility, in Shanghai.

This second facility in Shanghai is a new 80,000 square foot facility in very close proximity to our first Shanghai facility, which was opened in March of 2005. This new facility is intended to support large module manufacturing, such as large CMP modules or the test modules I described earlier.

In addition, we will add machining capability to this facility, utilizing the expertise we have developed at our South San Francisco machining center. We anticipate initial shipments from the new Shanghai facility to begin in Q4 of 2007.

Looking ahead to next quarter, we project a further decline in industry demand. We expect revenue for the fourth quarter of 2007 to range between $87 million and $95 million, and net income per share to range between $0.08 and $0.14.

To summarize the highlights for the third quarter, UCT achieved revenue and earnings per share within our guided range in a challenging quarter for the industry. We added two new U.S.-based customers, Axcelis Technologies and Photon Dynamics. We started shipping Gas Delivery Systems to Axcelis during the quarter, and we are scheduled to begin shipping process modules to Photon Dynamics beginning in Q1 of 2008.

We signed a lease on a new facility in the Silicon Valley which will allow us to consolidate operations here. And we week continued expanding our China operation by transitioning new products from our U.S. facilities to our China facilities, adding a new Korean customer, and opening a second facility for machining and large module manufacturing.

In closing, we remain optimistic about our market position and our continued ability to grow faster than the industry.

With that, operator, we would now like to open the call for questions.

(OPERATOR INSTRUCTIONS). Jay Deahna, JP Morgan.

Two questions to get the ball rolling. The first one is I am little been surprised that you are not seeing a little bit more new process module momentum from your core customer base, the big semiconductor equipment OEMs that you have been working with for a long time. So I am wondering where that all stands. And you indicated that 20 to 30% of modules are being outsourced already. Are you not getting your fair share relative to the big contractor manufactures? If you could give me an update on that then I have got one follow-on.

Sure. With regard to the new process module momentum, again a lot of this happens at our customer's speed, so our customers are continuing to be anxious to move -- outsource more of these modules, but we have not seen actual transitions at this point in time. We absolutely believe that we're continuing to get our share. Actually we believe -- we have been led to believe by our customers that we're actually gaining market share in terms of overall revenue with our prospective customers. We absolutely don't believe we're losing any momentum or any market share. We just believe it is a matter of how quickly our customers transition to outsource these modules.

If you look at the big guys, these two out of three I believe you have done some level of process chamber work with them. Are they just essentially looking to see a little more data on how well you execute on that, or are you having to deal with different divisions working at different times? When do we see the dike break on getting more mandates from some of the big guys? That is the follow-up.

And then the other question is Lam Research indicated in their call two weeks ago that they expect shipments of Etch systems to increase in the first half of '08 versus the second half '07. And they indicated that their orders bottomed in 3Q and should be up in 4Q, which means their shipments should be up in 1Q. Based on what you're looking at with your business does 4Q feel like the bottom for shipments from a cyclical perspective? And then you got some new business scaling in the early part of next year from mandates this year. Does that imply that 4Q should be the bottom for you guys cyclically? And that's it.

Yes, I guess the first part of your question was again how quickly are our customers migrating to outsourcing major modules, and when do we see the dam breaking. It is still very, very difficult for us to project that. Again, we announced a total of five major modules in the first half of this year. We are adding another one, although -- albeit it is not from one of our major customers.

Again, we see this as a continual consistent move on the part of our customers. It is part of their major strategy. Our major customers have publicly announced that outsourcing, and outsourcing of larger subassemblies, is a major part of their strategy. So in terms of the timing that is really up to them. We keep trying to accelerate that and they do try to accelerate it as well, but of course there's always some challenges in actually making these things happen.

Again, we remain very confident. We are moving. I would like to be moving faster but we are moving at a reasonable pace.

The second question related to Lam Research's comments, and again and I don't want to overlay our comments with their comments, but certainly what we have heard is consistent from all of our customers. Again, my visibility beyond one quarter is pretty limited. I have demonstrated that based on one of my comments in a previous call. But we would obviously expect, if our customers start to see increased shipments in Q1, we would certainly expect to be a significant participant in that.

Just one so I'm clear, did you indicate that your sense from talking to several customers is that their outlook is similar to what Lam articulated? Is that what you are insinuating?

Those are our internal discussions, and our customers do tend to remain optimistic, more than one.

Jesse Pichel, Piper Jaffray.

What is the dollar value of the new programs from Axcelis and the Photon Dynamics?

We have tried to anticipate that, and again we think it could lead to some significantly larger opportunities, but the two opportunities that we have specifically described based on the orders that we have and the projections that we have from them in the near future for just these particular products are somewhere in the $5 million to $10 million range for 2008.

Does that bring up your total new programs for '08 to be in the range of about $45 million to $65 million?

Actually I did the math myself. I think it came up to $45 million to $70 million.

$45 million to $70 million. Right. And then are there -- I always like to ask this, the value of any end of life programs that you are aware of?

I am not aware of any major end of life programs. You mean expenses or costs that we would have associated with end of life programs?

No, no. I am just trying to base an '08 revenue number based on the new wins, and I want to offset that with anything that is coming end of life.

I see. These are incremental wins. These are not tied to any other projects that would have end of life. There are other ongoing projects that will have end of life, and at the same time they will have new generation products associated with them. So I would say that would be relatively neutral. Our expectation is that this is incremental.

We always suggest in terms of incremental wins. So as you go back and check your nuts, it is always in that mode. It is never this much coming in without discussing what is falling off. We always discuss incrementally.

How should we think of gross margin next quarter? And especially in light of I guess two new facilities that are going up, will that have a further drag on gross margins?

The volume impact -- we basically lost 110 basis points going from Q2 to Q3 and about 70 basis points of that was volume related. We have got a little bit less of a decline expected in Q4, but we will see maybe a 50 basis point drop as a result of that.

The cost of the new facility in China is already baked into our number, so we have pretty much starting a starting cost level of expenditures in Q3 for the new Shanghai facility, the second machining facility, so I don't see any further drag from that.

What is the revenue generating capacity of the second Shanghai facility?

We've got a capacity -- our first Shanghai facility has a capacity of about $150 million annually. And the second facility is actually a little bit larger and does larger modules than the first, so it is actually incrementally above that. I would say somewhere between $150 million and $200 million annually.

I just have to asked ask this question. At the end are you seeing any quoting activity for your services in the solar tool market or photovoltaic tool market with any of your customers or potentially new customers?

We are already shipping to that market in very low volume. But as you know, one of our major customers is a major participant in this business, and obviously it is still at an early stage, but we will be a beneficiary from that as one of their major suppliers. And so we are going to try and start looking at ways that we can quantify that a little better. But we are already starting to see some growth in that area. And we are also going to target that as one of our future growth areas as well.

Tim Summers, Stanford Financial Group.

As you guys look at the third and the fourth quarter, third quarter revenue actuals and the fourth quarter outlook, are there a certain productline or customers that are doing materially better or worse then either you expected or relative to each other?

Yes, certainly we wouldn't want to get into that by customer by productline. That would be very disruptive for us from our customer relationship standpoint. But I guess what I would say was, it did get worse throughout the quarter. We did start to see more cancellations and put outs throughout -- as we progressed towards the end of the quarter. And it did seem to be by and large the majority of our customers -- virtually all of our customers. There were one or two of the smaller customers where we're just trying to gain penetration where we're still able to offset what happens with the industry by doing -- picking up some new business. But of our Big Three customers it is very similar.

As we model the fourth quarter, is it reasonable to assume that we should be taking down our revenue expectations for the process module business, Sieger, and the GDS business kind of equally, or are there certain pockets of weakness that might be -- might see greater declines in 4Q?

I would assume basically everything down in a very similar way. We're not really seeing pockets of strength, just a consistent slide in the wrong direction.

I guess what I would say -- the only thing I would say is that we are starting to see an upturn in the flat-panel. That business was very slow for a long time, and we're finally trying to see that come back.

Is that a material percent of your business right now?

It is. It is in the low single -- middle single digits I would say, 3, 4%.

(OPERATOR INSTRUCTIONS). Jay Deahna, JP Morgan.

Clarence, usually when the semiconductor equipment OEMs are busy in the active part of an up cycle, it is hard to get their attention for new programs and new outsourcing modules, things of this nature. Now that we are in a slow period, one would think that their bandwidth to have these types of discussions would be a little bit bigger. And ultimately that plants the seeds for new mandates to come at a faster rate.

I'm a little bit surprise that the magnitude of new mandates right now is actually, as of 3Q, a little bit slower than it was in 1Q and 2Q when things were busier. How do we think about that?

I guess we are seeing continual activity in this area. We just don't have any wins to announce. And another thing that we are also seeing that is also very significant is we are seeing that our customers are spending a fair amount of their energy also focusing on how they can migrate more of their products to low-cost regions.

So I think, again, we haven't got anything official to announce at this point in time, but we're pretty optimistic that our customers are going to be spending quite a bit more time looking at ways to transition things to low-cost regions, which we believe will be a significant benefit to us as a result of now having two facilities operational in Shanghai.

Then a follow-up on that notion with Jack. Jack, you said in the past that when you guys come out of this thing you're going to have leverage effect. I am just kind of curious if that leverage effect is being muted based on the new facilities, particularly the new one in Silicon Valley that we haven't heard of before. That is part one.

Part two, you said in the past that every $10 million of new revenue in China, number one primarily I guess, would be 1 full point of gross margin for the overall Company. Is that still the case?

Yes, both of those tenets pretty much they stand firm. Just to clarify the new facilities, we don't expect a step function increase in our expenditures as a result of this Silicon Valley facility. This will be basically a consolidation of efforts and resources into a single facility here in Silicon Valley. So we don't see that as being a drag on our margins. If anything, it should be moving in the other direction.

And the new Shanghai facility, the machining operation we have out there, the same math. In fact the math on that facility is a little bit greater in terms of the differential we realize producing a machined part or a machined assembly than these larger assemblies in Shanghai versus the cost of those in the U.S. So, no, we're not moving in any way away from those two fundamental changes.

This is Clarence again. I would just like to reiterate Jack comments on the new facility in Silicon Valley. We view this as a very significant strategic step forward. When we acquired Sieger obviously they had assembly operations in South San Francisco. UCT had assembly operations in Menlo Park. And we have been looking at logical ways to improve our overall efficiency, and we determined that the most significant way we can benefit efficiencies is by combining those two operations and ultimately eliminating some redundancy. Our lease -- we will begin a month-to-month lease in our Menlo Park facility at that point in time. So as soon as we move out of Menlo Park we will be able to eliminate that cost and --.

And similarly we've got a multisite facility in South San Francisco with leases expiring, which allow us to move out of those and then shrink significantly the footprint in South San Francisco and move things nicely into this new facility.

We may have a very brief time where there is some overlapping of cost, but obviously you can anticipate that with combining two operations into one, we should have some significant efficiencies and potential economies. That is our strategy behind this. This is not perceived as an incremental addition, this is perceived on our part as an incremental consolidation and reduction of our expenses in the U.S.

That was detailed and very clear explanation. The only follow-up I have is will the majority of the brief time of cost overlap the 1Q?

Yes. We looked at it, the expense of transitioning is minimal. We did spend a lot of time negotiating this lease, and we think we got a very solid deal. So there might be one quarter of minimal transition cost, but then lower expenses from there.

Assuming 2Q is a better quarter for revenue, and you're pretty much fully consolidated into the new facility in Silicon Valley, should we be modeling a little bit more upside gross margin leverage effect in 2Q than 1Q?

We have basically indicated a drive up to 18% gross margin in the fourth quarter of '08. And that number stands. That incorporate some level of efficiencies. It is a number I wouldn't alter from your model. Because we have known for some time where we were going to go through this level of consolidation.

Lastly here, what is your utilization in China as of the end of 3Q?

It is right -- just as of 50%.

Just south of what?

50% of the existing -- the first facility.

Is that up sequentially?

A little bit, a little bit. But nothing dramatic, but a couple of percent, yes.

So we will see some good growth in that in Q4?

There are no further questions at this time. Please proceed.

I would like to thank everybody for joining the call. We look forward to speaking to you at an upcoming investor conference or event. Please check our website at uct.com for the schedule of those upcoming conferences. With that, operator, I will return it to you.

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines. Have a great day everyone.