Ultra Clean Holdings Inc (UCTT) 2010 Q2 法說會逐字稿

Good afternoon. My name is Kristen, and I will be your conference operator today. At this time I would like to welcome everyone to the Ultra Clean Technology second quarter financial results conference call. (Operator Instructions).

Joining us today is Mr. Casey Eichler, Chief Financial Officer; and Mr. Clarence Granger, Chairman and Chief Executive Officer. I will now turn the call over to Mr. Eichler. Sir, you may begin your conference.

Thank you Kristen. Welcome to our second quarter financial results conference call. With me is Clarence Granger, Ultra Clean's Chairman and Chief Executive Officer.

I will begin by presenting the financial results for our second quarter, and Clarence will follow with some remarks about the business.

A few moments ago we issued a press release reporting financial results for the second quarter, ended July 2, 2010. The press release can be accessed from the investor relations section of Ultra Clean's website, along with the information in today's tape delay and replay of the live webcast, 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 third quarter of fiscal 2010.

Investors should note that only the CEO and CFO are authorized to provide company guidance. If at any time this call -- after this call we can communicate any material information and guidance, it is our intent that such update will be done unofficially 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 by the US Private Securities Litigation Reform Act of 1995 related to matters including our 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.

Some of those risks and uncertainties are detailed in our filings with the Securities and Exchange Commission.

The company disclaims any obligation to publicly update or revise any such forward-looking statements or to reflect the events or circumstances that occur after this call.

Now here are the second-quarter results.

Revenue from the second quarter was $105.9 million, or an increase of 7.5% from the prior quarter, and an increase of 355% when compared to the same period a year ago.

Semiconductor revenue for the second quarter was $83.7 million, an increase of 493%, and non-semiconductor revenue was $22.2 million, an increase of 143% when compared to the same people a year ago.

Gross margin for the second quarter increased to 14.0%, compared to 12.6% in the first quarter and a negative 3.7% in the same period a year ago.

Although revenue margins were at or near record levels, we will continue to focus on operational (technical difficulty) [efficiency] in our gross margins.

Operating expenses were $8.2 million, an increase of approximately $474,000 from the prior quarter. As revenue continues to increase, operating expenses as a percentage of revenue continued to decline and will be in the range of 7% to 8%, as previously discussed.

Our operating income was $6.6 million or $0.29 per share before interest expense and income taxes, compared to an operating income of $4.4 million or $0.20 per share for the first quarter.

An income tax expense of $770,000 or $0.03 per share was recorded in the second quarter.

Second-quarter net income was $5.7 million or $0.25 per share. This compares to a net income of $3.9 million or $0.17 per share for the first quarter.

The fully diluted share count was 23 million shares, an increase of 100,000 shares from the prior quarter.

Non-cash charges for the second quarter were $910,000 related to FAS 123(R), and $589,000 related to depreciation and amortization.

Turning to the balance sheet, cash decreased by $4.6 million from the prior quarter. Cash net of third-party debt decreased $4.1 million during the period.

Accounts receivable was $45.7 million, flat with Q1, and days sales outstanding decreased to 39 days from 42 days.

Accounts payable were $43.3 million, decreasing by $11 million.

Accounts receivable and accounts payable have traditionally been more balanced at the end of each quarter. While we have done an excellent job of cash management over the past few quarters, we felt it was important to bring these back into line. Our suppliers continue to be important partners as we build the business in the future.

Days payable outstanding at the end of the second quarter decreased to 43 days from 57 days at the end of the first quarter.

Net inventory was $55.1 million, a decrease of $1.6 million over the prior quarter. Inventory levels are projected to be flat during the third quarter.

Now Clarence will discuss our operating highlights for the second quarter. Clarence?

Thanks Casey. I'd like to start off by saying that we are very excited about the continuing strength of the recovery in our served markets. Q2 was an excellent quarter for UCT, and Q3 promises to be an all-time high in both revenue and profit.

The second quarter of 2010 saw an overall revenue increase of 7.5% and a significant improvement in our gross margin. Revenue from our Asian operations increased from 21% of total revenue in Q1 to 26% in Q2. And our non-semiconductor equipment revenue increased by 10%, while our semiconductor equipment revenue increased by 7% quarter over quarter.

UCT once again exceeded the revenue and EPS guidance we provided at the beginning of the second quarter. We were at near record revenue levels while matching our highest EPS since Q3 of 2006.

In the third quarter we anticipate a continued increase in revenue with a greater percentage coming from our Asian facilities and with the mix between semiconductor and other target markets remaining relatively flat.

In our first-quarter earnings call, I mentioned that due to delays from some of our key suppliers, we were experiencing operational inefficiencies. I'm pleased to say that these supplier delays have been almost completely eliminated, which was a significant factor in our improved gross margins for the quarter.

I will now provide highlights of our activities and accomplishments for the second quarter.

Our total non-semiconductor revenue for the quarter increased from $20.2 million in Q1 to $22.2 million in Q2, a 10% increase. Overall, a slight decline in medical equipment demand was more than offset by growth in the research segment. We also made our first shipment into the solar market in over a year, as one of our existing semiconductor customers launched a new product into the solar market.

However, our biggest near-term growth opportunity by far is in the high brightness LED market. During the second quarter we shipped several prototype orders to multiple customers for a total of $1.8 million in revenue, and we expect to receive production orders in Q4 for shipments beginning in late Q4 and into 2011.

In general, our relationship with all of our non-semiconductor customers remains very strong.

Our Asian manufacturing operations are continuing to grow. As stated earlier, during Q2 revenue from our Asian facilities was at a record high of 26% of our total revenue, up from 21% in Q1. Almost all of this increase came from our China operations.

In May we held the official grand opening of our new Singapore facility. We anticipate ramping production in this facility during Q3 and to achieve profitability in Singapore by Q4.

As stated during our first-quarter call, we project continued significant increases in the percentage of revenue from our Asian facilities during 2010, with the transfer of US production to China and Singapore in support of the activities of our key customers. The focus on transferring additional products from the US to Asia is a critical activity for achieving our long-term financial goals.

I would now like to shift to our guidance for the third quarter of 2010.

In the third quarter we are projecting record levels of revenue and income from operations. Our revenue guidance for the third quarter is $118 million to $123 million, with earnings per share in the range of $0.29 to $0.33. The tax rate for the third quarter is currently projected at 20%.

In summary, during the second quarter of 2010, UCT continued to experience significant growth, generating near record revenues and matching our record earnings per share. We continued to meet our customers' demand while improving our operating efficiency. We continued to expand revenue from our Asian operations, and we grew revenues from our adjacent served markets.

Looking forward, we anticipate record revenues and earnings per share in Q3, with significant new business opportunities, particularly in the high brightness LED market in Q4 and beyond.

In closing, we are very pleased with our financial and operating performance, and we are extremely optimistic about the strength of our business model.

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

(Operator Instructions). Edwin Mok, Needham & Company.

Congratulations for a good quarter and great guidance. I'll start with some financial question, just to give Clarence some time.

Thank you.

To have a sip of water. But on the model side, you guys really have this margin expansion in the last quarter, and you mentioned on the prepared remarks that it was mainly driven by Asian -- increased Asian mix. Can I ask you, is there any kind of difference in terms of mix on non-semi versus semi? Is there any way you can kind of generalize that? Or should we think of it differently? Or is it just mostly Asian?

I think it's a combination of not only the increased business moving to Asia or low-cost regions in general and also slightly the increase in volume and the straightening out of some of the supplier issues that Clarence referenced and talked about. I think that there wasn't one in particular element that was more than the other. They all helped contribute to that, and as Clarence referenced and I think I mentioned, we are very, very pleased with what we've got accomplished, but we think there's still some opportunities to pick up some increase going forward as well. But for the vast majority of it at this point, I think that a lot of the supplier issues have been resolved.

Great. And then, Casey, if I look at the numbers that you guide for in terms of revenue and EPS and then just kind of bake it into my model, it seems that you imply an OpEx increase, obviously with higher revenue. How do we think about OpEx going forward? And should we expect further increase in -- especially in the sales and marketing side, assuming that you guys continue to grow your revenue?

Right. Obviously a lot of that increase is related to increased compensation, not only potential bonus and profit sharing but commissions. I think, as I indicated, it's going to stay between 7% and 8%. I think it will get better as revenue grows and as we get more of our business off into Asia. But I have been kind of consistently saying that we think we can get it down closer to 7%, but I don't think that there's a lot more pickup after that unless there is a very big increase in volume beyond what we talked about.

I see. Great, that's fair. And then baked into your revenue guidance, how do you kind of think about the semi versus non-semi in terms of which area do we think will grow more? And then on the prepared remarks you guys talk about your medical device market dropped a little bit, but your -- it was offset by growth on the instrumentation. It that the kind of ongoing trend you expect to extend into third quarter? Or [today] it just slip over? Or how do we think about that?

Yes, Edwin, this is Clarence. Let me give that a shot. So in terms of our semiconductor versus non-semiconductor market, we would expect over time our non-semiconductor market to grow at a higher rate than our semiconductor market. Near term it should be fairly even from a growth standpoint, so we are still seeing significant growth on the semiconductor side. So I would anticipate similar breakdowns in revenue between semiconductor and non-semiconductor into Q3. Again, longer term we think more growth is going to come outside of semiconductor.

In terms of the other markets that we're serving and the comment about the medical being down a little bit and the FEI or research portion being up a little bit, I think the medical one being down a little bit is just a temporary situation, a one-quarter situation, where the demand for -- from our customer primarily, Intuitive Surgical, was down a little bit to us. Now, that doesn't necessarily reflect their overall demand, but we are -- still are supplying 100% of the robots to them.

So -- but we expect that demand to recover, and Intuitive Surgical, in some of their prepared remarks, had said that their projected growth for the year is 30% to 33%, up from their previous projection of 27% to 30%. So I'm pretty confident that that's going to rebound this quarter.

Great. Thanks for the color there. Then, I think last order you guys announced a contract with your flat panel display customer there. How is that tracking? Are you still planning to hit that target? I think you talked about something around $13 million to $15 million, kind of a revenue target for this year. Are you still (multiple speakers)

No, I said $10 million. (multiple speakers) I said $10 million, revenue target this year, up from $3 million last year -- $3.3 million last year. So we are still tracking close to that. I would say it might be a little short of $10 million, but it's only a matter of timing. Does something occur in the fourth quarter, or does some of it occur in the first quarter? But our relationship with them is tracking very strongly.

Then one last question, and then I will go away. If I take a look at your guidance, and assuming semi grows just -- grows in line with what -- basically a sequential growth rate that you are guiding on your revenue, your revenue is approaching the prior peak, which was -- I believe was $99 million. I understand you guys won new contracts, and it help -- obviously help drive this high revenue base. But have you -- but this approaching the $100 million target that you talked about previously as a peak, how do you kind of think about that? Is there any kind of updated view on that end that you might be able to share with us?

No. I think at this point, Edwin, what we've said previously is that we do expect to get to 1.5 times our -- or, excuse me -- our previous peak revenue was $110 million in Q1 of '07. I've said our expectation is to get to $150 million sometime this cycle. I'm still very confident that we'll get to that $150 million. I know I said that $100 million of that would be semiconductor and the rest would be non-semiconductor. I'm not sure exactly what that split is going to be, but I'm very confident that sometime this cycle we will hit $150 million in revenue.

Sure. To speak of a split can be [cost] -- difficult with the change from quarter to quarter.

Sorry, one last question, and then I will go away. On [hybrids I know] you talked about it being an opportunity. I think you guys talked about that before. Any kind of update in terms of qualification and potential incremental revenue that we should expect to come in? Are we still talking about fourth quarter?

Yes. Again, Edwin -- this is Clarence again. So in terms of projections, we try and only give projections one quarter out, but obviously we're very optimistic. Last quarter I said we were making some prototype shipments. This quarter I said we made 1.8 million in prototype shipments this quarter.

I'd just -- to give you an idea of how we are kind of quantifying this market, we will initially penetrate this market in terms of delivering gas and chemical delivery systems on to customers -- that go on to customers' MOCVD tools. And these are extremely complex subsystems. They are much more complex than we produce for the semiconductor industry.

The average selling price of one of these subsystems looks like it will be about $500,000. And the market -- one of the analysts that we've been following projected that the market this year for these MOCVD tools is about -- the worldwide market is about 800 tools in 2010, moving up to 800 to 1,000 in 2011. So our potential market opportunity at 400 of -- excuse me -- at 800 to 1,000 at $500,000 each could be $400 million to $500 million.

Now, our customers are not going to sole source that opportunity, but even if we get second source -- second supplier status, typically our customers divide market share 70% and 30%. So 30% of a potential $400 million to $500 million business -- obviously, you can figure it out -- $120 million to $150 million in revenue, and we think we have a very good chance of moving aggressively toward that.

Beginning at the end of Q4 this year we would expect to start seeing production orders, and certainly we wouldn't be able to ramp to that kind of quantity right -- or that volume right away, but we certainly think that in sometime in 2011 it wouldn't be unreasonable for us to target that market share.

Great. Thanks. Very helpful in terms of quantifying the market, and definitely a little bit of [vehicles] result today, it definitely looks like things are tracking quite with that -- quite with that market. So that's all I have. Thanks Clarence, and thanks Casey.

[Jay Deahna], private investor.

Casey, a couple of questions on the financials here. First of all, I didn't quite hear the whole response to Edwin's question on operating expenses. Do you expect operating expenses in 3Q to grow sequentially faster, slower, or at the same rate as revenues?

My answer to the question with Edwin was that I think it's going to stay between 7% to 8%, but I think we're going to improve where we were in this past quarter. So I think it will grow, but I think we will improve as a percentage of revenue.

So OpEx should grow at a slightly slower rate than revenue so that the operating margin should come up a little bit, ex the changes in gross margin?

Correct.

Okay. The other question I had is, it looks like your tax rate in the second quarter was about 12% or so. Is that right? And what do you expect that to be in 3Q?

Yes, it was about 12%, 13%. And what I was going to or what Clarence guided to is 20% for this quarter. Obviously, based on increased profitability and also what we are seeing as we continue to look at our tax structure, both domestically and internationally, I have been guiding that we were going to increase our tax rate a little bit as the year goes on. So right now in my visibility, what I can see into Q3, I'd suggest using a 20% tax rate, which I think is the right place to be.

Now, do you think that that's where it sort of tops out for the long haul now? Or is there a little upside to that still?

I think over the course of the year -- we haven't given full-year guidance -- but I don't know that we get much more than that as a full-year rate. Obviously we've been provisioning at a lower rate at the beginning of the year, but I think if we get the right tax structure in place moving forward, we will see -- back traditionally our business has had about a 30% -- 28% to 30% tax rate. What we're doing in some of our structuring in the way the business is moving around the globe, I think we can improve upon that over the long term.

If we look at the gross margin scenario, it's my understanding or my recollection that 2Q was the first quarter where you didn't have a labor cost recovery versus the prior quarter, and you had some -- probably a reduction in expedite fees and whatnot. So going forward from here, are the primary levers for gross margin expansion the transition of more sales to Asia? Is there anything else where you can find some efficiencies to get the gross margin up?

Well, we've been talking about supply chain or materials, and I think that we still have some opportunity in that area as well. But certainly one of the big drivers is not only volume but the move to low-cost regions, yes.

Okay. So most of the inefficiencies from the last couple of quarters, combined with the cost recovery from having people at lower than normal pay rates in the downturn, that's all pretty much cleaned up?

For the most part, yes.

Then you said something about payables in your prepared remarks. I didn't quite catch that. Can you repeat that, please?

Well, if you look at our AR and our AP, our AR has typically run a little bit higher than our AP. Our AR -- our AP was significantly higher than AR, and so that obviously provided us cash to build the business in very lean times and as the market turned, but over the long term it's not reasonable to run it at the level of discrepancy between AR and AP that we were running at, and so what I was recognizing is, though inventory stayed relatively flat, some of the use of cash was to bring that back into balance so that we could better partner with our suppliers going forward.

So now if that's normalized, are you expecting to be cash flow positive now here going forward? (multiple speakers) In 3Q?

I think that (multiple speakers) [could be] the case, yes.

Okay. Then last question, for Clarence -- Clarence, you articulated the possibility to work towards a $120 million to $150 million LED MOCVD gas delivery subsystem revenue opportunity next year. That's a long explanation there. But that would be an incremental 20% or 25% of your business, which is certainly very compelling. What gives you the confidence level that Ultra Clean is positioned to do that? Do you have design wins in 4 inch MOCVD tools that will ramp next year or something like that? Just kind of wondering where the confidence comes from.

Sure. Well, I guess there are several factors. First of all, the confidence comes from our current relationship with our potential customers, in that they've led us to believe that we are progressing very well on the qualification stages. We are not (technical difficulty) we have not received production orders yet from these customers, so we are still receiving evaluation unit orders. So we are not officially qualified, but we seem to be moving closer and closer to qualification every day. Obviously the fact that we are still shipping additional prototype units gives me a great deal of confidence.

The second reason I have a great deal of confidence is that we are talking about -- I'm not allowed to talk about specific customers, but we are talking about multiple customers at this point in time. And so we're very excited about that. And we are talking about tools that are potentially already on the market or very close to being on the market. So I think our exposure in terms of the customer risk is relatively low.

I think the reason why prospective customers find us very appealing in this space is that we are actually the world's largest supplier of gas and chemical delivery systems, so we bring a lot of expertise to this area. As customers are looking for design expertise or component evaluation expertise or test engineering expertise, we bring a lot of value, and obviously we've been building gas delivery systems since 1991.

We also -- by virtue of our size and our global positioning of our manufacturing operations, we can manufacture in locations that might provide competitive cost advantages.

So we think we bring a lot to the table, and we are very excited about the opportunity. And again, I'm not projecting that we would become a majority supplier right off the bat. I'm just targeting for a secondary position which could be a very large number.

Just one very quick follow-up, and then I will be done. So it sounds like what you are saying is that you have some opportunities to scale into existing MOCVD tools that are shipping into the market, predicated on the fact that you're -- the existing suppliers may be capacity constrained and/or in a high-cost region, being based in the US or Europe, whereas you could potentially offer the capacity and/or a lower cost coming out of Asia? Then secondarily, it's -- so that would be sort of like a retrofit opportunity I guess, and then secondarily you are looking at design wins for new models. Is that correct?

Yes. Again, all of this stuff does take time, and we will have been working on it roughly for nine months. But yes, I'm very optimistic that we will get an opportunity to start ramping production levels of new and existing products towards the end of this year.

(Operator Instructions). Satya Kumar, Credit Suisse.

[Viji Subramanian] calling in for such a Satya. I have a question on your semi revenues now. Over the last couple of weeks a number of semi companies have increased their wafer fab equipment guidance, and currently they are tracking 14 fabs, new and expansions included. So in context of this positive outlook, can you provide us some color on the shipments for you semi revenues? You gave us some guidance for Q3, but like when moving forward, what you think is the guidance for Q4, as well as Q1?

Yes, I saw that same data. Obviously that's one of our customers that made that projection, saying that they have been projecting in the March time frame nine new fabs in 2011 and 2012, and most recently they've projected 14 new fabs in 2011 in 2012.

That's revenue -- that -- obviously that bodes well for revenue opportunities in 2011. We probably wouldn't be seeing much of that at this point in time. But we are certainly not only optimistic about our near-term future in semiconductor but believe that there's good growth opportunities in 2011 as well.

I had a follow-up question. So as you are ramping, are you facing any component constraints? And what are your current lead times?

Sure. A typical lead time -- again, we produce a very wide variety of systems, and some of them are much more complex than others. But on a typical gas delivery system that we provide to our customers, our lead times are about 4 to 6 weeks, and so -- I forget what -- what was the other part of your question?

Checking whether you had any (multiple speakers)

Oh, supplier constraints -- excuse me. Yes. So in Q1 we had significant supplier constraints, and at that time at our Q1 earnings call I mentioned that, and that was some of the reason for some of our inefficiencies in gross margin. As I mentioned earlier in my prepared statements, we really have improved those efficiencies, and it's largely due to our suppliers catching up.

We still have some supply constraints, but it has not caused us to miss any critical customer shipments at this point in time. But literally every day that does seem to be improving. So it is still a bit of a limitation that does cause some inefficiencies. But it's far less of an issue than it was in Q1 of this year.

Michael Bertz, Kennedy Capital.

So just in terms of sort of trajectory and build plans -- and Clarence, I don't know if you can speak to -- or as granular as you can, just sort of how that's progressed over the last several months here, if you've seen sort of steady increasing, if there's been a surge at some point in time? Are you seeing on like a project basis where it's -- okay, we've got to have it now -- and then you've got to back off a little bit? What's that look like for you?

Well, I guess I would say with that, just given our recent guidance from -- going from Q1 to Q2, our guidance was relatively flat. We've now -- obviously we came in 7.5% up. Our guidance this quarter is significantly higher. We are saying $118 million to $123 million, up from $105 million. So we're obviously anticipating a bigger growth ramp than we saw last quarter or this quarter. So it is -- it does tend to be a little bit lumpy, but obviously conditions seem very strong to us right now. And in general the tone seems to be one of adding in orders as opposed to pushing out orders.

Good. That's what I was sort of aiming for at the end there, just on like a weekly basis how that is. So that's fine.

On the balance sheet it looks like fairly flattish to me. Is there a kind of a structural limit to where you can get in terms of your ability to turn the balance sheet and handle let's say revenue if you get to that $150 million peak? I mean, is there -- I expect to see that have to increase incrementally to get there?

Well, I think our balance sheet is pretty strong right now. We also -- what's not reflected in there is obviously our capacity to borrow. We do have a good relationship with Silicon Valley Bank, who has been a terrific partner for us, and have availability there as well. So we feel that we can finance ourselves into this ramp and continue to build our business.

We also do have capacity, so we have the ability to pick up additional or incremental business without having to spend a lot in CapEx, and so we feel that we've got a good balance sheet. Hopefully we will be strengthening that balance sheet. But we don't have any immediate needs today.

I understand, Casey. I guess I'm less worried about the cash or the ability to build with more than your ability to turn inventory and sort of keep that flattish if you keep moving up the volume level. Do you think that sort of range we're at now in terms of inventories in the mid-50s, is that something you could hold steady as we get to $150 million in quarterly revenue?

We guided that over this next quarter that we felt that we could keep relatively flat, and so obviously that should give some indication that we think that we can hold the inventory where it is. Whether or not it can stay at that rate up until $150 million would depend a little bit on mix and a few other factors. But I think in the short term we feel that we can keep that relatively flat.

But going to $150 million, it would have to go up a little bit. It's kind of hard to quantify right now.

Yes, and I wouldn't be surprised. I'm just curious as to just how well you can keep that flat for how long. So okay. And then within your largest customer you sell a lot of different things too, any change to mix there? Obviously a lot of things changing with them.

I'm sorry, say that --?

In terms of (multiple speakers) selling -- I'm sorry. In terms of selling into Applied Materials, you provide a lot of different stuff. Do you see any sort of changes to mix with them?

Every day. I don't want to talk too much about specific customers. I don't think that's appropriate. But overall our semiconductor business is obviously very strong, and I don't think any one specific area of the semiconductor segment is stronger than any other.

(Operator Instructions). It looks like we have no further questions at this time.

All right. Well, we appreciate the interest and everybody's attendance today and look forward to speaking with you over the quarter. Thank you very much.

Thank you. And this does conclude today's conference call. You may now disconnect.