Ultra Clean Holdings Inc (UCTT) 2017 Q2 法說會逐字稿

Good afternoon, and welcome to the Ultra Clean Second Quarter 2017 Earnings Conference Call. (Operator Instructions) Please note, that today's event is being recorded.

I would now like to turn the conference over to Ms. Annie Leschin with Investor Relations. Please go ahead.

Good afternoon, everyone. Thank you, operator. Thank you for joining us today for our call this afternoon.

With me are Jim Scholhamer, Chief Executive Officer; and Sheri Brumm, Senior Vice President and CFO.

Jim will begin with some prepared remarks about the business, and Sheri will follow with the financial review, after which we'll open up the call for questions.

Earlier this afternoon, we issued a press release reporting financial results for the second quarter of 2017. The press release 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 uct.com.

Before we begin, let me remind you that today's call may contain forward-looking statements, including the company's views regarding future financial performance, new products or orders, 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 listed here. Information concerning these risks and uncertainties is contained in our periodic filings with the SEC including our most recent Form 10-K and Form 10-Q, 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.

Today's call also includes non-GAAP adjusted financial measures. Reconciliations to GAAP measures are also contained in today's press release.

And with that, I'd like turn the call over to Jim. Jim?

Thank you, Annie, and good afternoon, everyone. Thank you for joining us today for our second quarter conference call and webcast.

Our impressive second quarter financial results underscore UCT's ability to consistently and reliably perform for our customers during this unprecedented ramp in semiconductor equipment.

Clearly, our growth strategy focusing on the fastest growing segments of the WFE market, expanding on our capabilities to manufacture major modules, is resonating with our customers.

For these reasons, we were again able to grow significantly faster than the markets we serve.

Total revenue grew 75.8% year-over-year to $228.3 million. Semiconductor revenue increased 79.6% and revenue from outside the U.S. rose 102.5% year-over-year.

Our sharp focus on operational excellence and the flexibility of our model, resulted in a meaningful expansion of our bottom line.

Non-GAAP EPS grew to $0.62 from $0.10 a year ago, a fivefold increase.

As the industry transforms to meet demand for more advanced semiconductor and display technologies, we are confident in UCT's position of delivering superior value to our customers, as we increase UCT's content on our customers platforms. Currently, there are multiple technologies driving the semiconductor equipment industry at an incredible rate. Ever higher DFE spend is required to enable emerging and expanding applications in such areas as cloud computing, robotics, autonomous cars, artificial intelligence and virtual reality devices, amongst many others.

Each of these technological shifts depend on sophisticated advances in semiconductor technology, and all are centered around capturing, transmitting, analyzing and storing data. The insatiable appetite for newer and faster devices with enhanced memory, logic and sensor capacity is driving the expansion of the semiconductor and semiconductor equipment markets and thus, we are in a more broad-based and continued high-demand market.

The complexity of these technologies and the speed at which they are developing is putting pressure on OEMs to quickly ramp capacity to meet demand. OEMs are depending more and more on outsourcing partners like UCT, resulting in a tremendous opportunity for growth.

As a vertically- integrated supplier, we are focused not just on our core business in gas panels, but also on critical fabrication, integration and assembly. When you combine improving industry fundamentals with our broad capabilities and strong supply chain partnerships, UCT is poised to continue to outperform WFE growth.

The decision we made a couple of years ago to acquire and invest in broadening our capabilities has enabled us to play a more vital role on our customers platforms. With our business firing on all cylinders, we are also exploring inorganic ways to add capabilities and to spur future revenue growth.

Turning to our non-semi display business, adoption of OLED technology continues at historic levels. Recent forecasts indicate that 2/3 of new smartphones are projected to have OLED displays by 2021, and manufacturers are accelerating their investment plans accordingly.

In parallel, as demand for large screen TVs gain traction, we are seeing investment in new GEN 10.5 capacity, resulting in the construction of multiple new fabs. For these reasons, revenue from our display business should continue at around 2x to 4x our historical rate, depending on the quarter.

We continue to believe that the fundamentals of the semiconductor cap equipment market remain intact, and we are well poised to take advantage of these exciting times in our industry.

Before I turn the call over to Sheri, as noted in our release today, I will be taking some time off to address a treatable medical condition. I expect to be back in the saddle in roughly 8 weeks’ time.

In the meantime, I have every confidence that Sheri and our strong executive team will keep things running on an even keel. As you saw by the guidance in our press release, the third quarter is looking very strong. The vast experience of our leadership team, coupled with the full support of the board, gives me the utmost confidence that the team is more than capable of running our day-to-day operations.

I look forward to speaking with all of you on our third quarter call.

Now, I would like to turn the call over to Sheri to review our financial results in more detail, after which time, we will open the call for questions. Sheri?

Thanks, Jim.

In today's discussion, I will be referring to non-GAAP numbers only. A reconciliation can be found in the press release issued earlier today.

Ongoing industry momentum and strong execution by the UCT team resulted in another exceptional quarter. Once again, we met our customer's increasing demands and by leveraging the flexibility of our operations, we exceeded our expectations on the top and bottom line.

Total revenue for the second quarter was $228.3 million, an increase of 11.6% from the prior quarter. Semiconductor revenue reached a new high of $210.3 million, a sequential increase of 10.1%, as customer demand continued to climb.

As a percentage of total revenue, semiconductor held steady at 92.1% of total.

Leveraging our manufacturing facilities close to our customers in Asia, revenue from outside the U.S. rose to a record high of $118.6 million, compared to $105.8 million in the first quarter.

Our non-semiconductor business rose to $18 million from the previous quarter, accounting for 7.9% of total revenue.

The value that we bring to our customers, especially during this high-growth period, can be seen in our strong gross margins.

Second quarter gross margins increased 70 basis points to 19% from the prior quarter.

By keeping a close eye on our controllable costs, while investing incrementally to grow the business, we reduced our operating expenses as a percentage of revenue, driving more to the bottom line.

Operating expenses for the second quarter were $17.7 million or 7.8% of revenue, compared to $16.5 million or 8.1% in the first quarter.

Operating margins improved from 10.3% last quarter to 11.2%, as operating income increased by $4.6 million to $25.6 million.

Second quarter net income rose 33.8% to $21.3 million from $15.9 million in the first quarter. Likewise, EPS grew 31.9% to $0.52 from $0.47 last quarter.

In the second quarter, we generated $11 million in cash from operating activities, compared to $9.1 million in the prior quarter. We had noncash charges of $1.4 million related to stock compensation, $1.4 million in depreciation and $1.2 million for amortization of intangibles.

Turning to the balance sheet. Net liquidity increased $7.9 million and cash grew $4.5 million to $59.5 million. Outstanding debt decreased sequentially by $3.4 million to $60.8 million.

DSOs decreased to 40 days from 42 days last quarter due to timing of collections. Days payable outstanding remained flat at 51 days, while net inventory increased by $16.7 million over the prior quarter to support anticipated demand in the third quarter.

That concludes our prepared remarks. Operator, I'd like to open the call for questions.

(Operator Instructions) Our first question comes from Patrick Ho of Stifel.

Jim, best wishes to you in your recovery and Sheri, good luck. In terms of the outsourcing opportunities you're seeing today where the demand environment is obviously very high and you talked about additional opportunities that your customers are giving you, how sustainable do you believe these are once the demand trends kind of abate? So what I'm getting at is when things kind of return to more normalized levels, are these type of opportunities something that can stay with the company? Or do they go back to where they have been done previously whether it's in-house or at other places?

Yes. Patrick. Thank you and thank you, again. Yes, I've got incredible trust that I've got a great team here. So I'm really looking forward to a great Q3. As far as the demand that's coming from our customers, moving stuff from in-house to us, we believe that this is very, very sticky. Traditionally, it has always been sticky. It requires quite an investment to transition product manufacturing from one place to another. And I think the fundamentals of the overall WFE market aren't going to go away. And so more and more capacity is, I think, is something that we will be seeing over the long term that our customers need the higher capacity. So we believe what's been moved from insource to outsource is very, very sticky. We expect that to stay with us even through the normal undulations.

Great, that's helpful. And Sheri, you guys have done a great job in terms of the supply chain. Given your revenue results to date, you've obviously been able to meet the demand that's out there. Has anything changed for you with the supply chain and your suppliers, where either you're pushing them harder or you're taking some extra inventory to ensure that you meet your customers’ demands?

Yes. I mean, this is always -- this is something that we -- obviously is part of our DNA, in terms of managing supply chain. So we're constantly managing the different suppliers. There are opportunities where we can take on additional inventories needed, if we see that we need it for future use. But it's kind of a whack-a-mole type situation, where certain suppliers need extra focus and that's just something that we continue to do as we meet the demand of the customers.

Great. And final question for me. You talked about the OLED opportunity that's emerging for you guys, yet at the same time, the LCD market appears to be picking up steam as well in terms of needing new fabs for GEN 10.5. Is there a way for you to differentiate between what you're getting from OLED versus traditional LCD? Because that market also looks like it's pretty healthy today.

Yes. It definitely is. And it's -- I think Applied estimated that the market -- equipment market, the new norm is now, I think $17 billion. And as you know, Patrick, it used to bounce around between $6 billion and $9 billion for many years. So it's nearly doubled. And it's a mixture of -- you're right, it's a mixture of OLED and the GEN 10.5, which is starting up. The OLED is -- can be a little bit -- it can bounce around from one quarter to other. Display tends to do that. So it's nice where maybe an OLED might be down one quarter a little bit on the amount of equipment shipping, I think we'll see GEN 10.5 coming in. It's basically how fast the big 5 -- big 7 now can really digest that equipment. So you're right. There's definitely an impact of GEN 10.5 coming in and smoothing it out. But we predict, for us, it's roughly -- that's why we see it flattening out at roughly 2x to 4x of our historical rate.

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

Again, also wish you good luck, Jim, and we look forward to [working] with you, Sheri, for the next 2 months. So first question I have on the margin side. You guys delivered a very nice gross margin this quarter in terms of your guidance implied maybe even better margin leverage in the coming quarter. How do you guys think about the margin profile of your business? The -- is this kind of a newer level in the high teens or even approaching 20%?

Well, I think, Edwin, based on the volumes that we're seeing, this is kind of a new norm for us, in terms of seeing the higher end of our margin model. Again, it depends on volume, as well as where we're actually shipping our revenue out of as well as product mix. And those 3 really aligned very well, I mean this last quarter, to beat our margin model. So we're seeing that as something that could continue depending upon the mix of products that we're building.

Okay, that's helpful. I've got a question around kind of the growth and share gain around the outsourcing. I'm just curious, is there a way to think about are you guys winning share on now larger modules, and therefore, driving better dollar to sell for you guys? Or is it more block and tackle, just on the business that you have, as customer ramp, they give you more orders? Is there a way to kind of think about kind of either the size of the module or the capabilities that you guys are adding to the newer share gains that you guys talked about?

Yes, Edwin. I think I can give you a little color. It's not a haphazard process. Basically, it's usually pretty well planned out together with the customer. And it's done over a period of several quarters, where there is a decision to move. And these are some of the larger modules that -- this is in the [non-GAAP] panel area, the semiconductor tool. And so typically, there is kind of a train of moving a certain module over a period of a few quarters from their internal manufacturing over to one of our sites. There is a program, as we ramp up and they ramp down, followed by or in parallel with the second module and the third module. So it's typically pretty well planned out. And that's why I mentioned, it's a quite a process to do. It will take some time. I think even a few years ago, I talked about these share gains take a while to start to show up because the transition times are pretty significant. And that's -- it's another reason why answering that first call from Patrick, why they're so sticky. It's quite a process to do it. So that's to give you a little color, a little feel. It's basically module-by-module, kind of a planned work that's done together with our customers and ourselves.

And is it fair to describe that you are winning more business on these larger modules? Like you said, you also have a gas panel that allows you to have this really spectacular growth?

Yes. As you're seeing us outpace the industry -- even outpace the dep and etch area of the industry, roughly in the mid-teens. Almost all of that is coming from modules outside the gas panel that we've been winning, mostly from the -- customers that are in-sourced moving it to companies -- moving it to us. But we've also won some from some of our competitors in the -- outside the gas panel area.

Our next question comes from Timothy Arcuri of Cowen.

This is Karl Ackerman on for Timothy. First, Jim, I would like to extend my thoughts and prayers to you and hope that you recover speedily. If I could just circle back to the gross margin question a bit earlier. Clearly, even your last comment would indicate that you potentially grow above your TAM outlook for the next several quarters, as you continue to gain some incremental share from modules outside of your core competency. So when I think about the margin outlook for the second half of the year, to me, it would suggest that margins should inflect higher from here, even in the September quarter. So for the first question is, am I correct in that regard? And then secondarily, even if in fact you can grow above your TAM, I guess could you put more pen on paper with regard to how long are sort of these higher gross margin rates sustainable? And if they are sustainable for a longer period of time, how should I think about more of the longer-term opportunities, both regarding to gross margin and operating margins, relative to your current model? Should we assume more of a much higher model from what is indicated today for the next several quarters? And then I have a follow-up please.

Yes. And I can start and Jim can follow on. I mean, obviously, we're seeing higher volumes than we'd seen in the past. So our previous -- our model had been 15% to 18%, which we've been very, very comfortable in. So, with a certain volume, you may be able to see higher margins than you're currently seeing in our current release. So it really depends on the mix of products. It can fluctuate from quarter-to-quarter. And again, because we have so much going out of Asia, that's really quite helping us a lot with the structure of cost that we have there. So that's something that we see as somewhat sustainable as we stay at these volumes. I think that's kind of what you're looking at, whether it's continued on going forward. So we see that as a sustainable area for us at the higher end of our range. And I'll let Jim talk about the TAM a little bit.

Yes. I think we are increasing our [SAM] in the TAM space. And obviously, that helps -- is one of the main causes of us -- we have what we call -- there is really several vectors causing our growth. One is this, the overall WFE growth. On top of that, we are very well positioned in the fastest going area of WFE dep and etch, which is growing at least 5 points higher than the rest of WFE. And then the third vector in our growth why we are outpacing is obviously a lot of these insourcing and outsourcing and other share movements that we're making outside the gas panel area that I just talked about. And then also, we've had some smaller unpredicted wins, which happened because operationally we were able to execute so well in the beginning part of this ramp, and able to get business from some of the other smaller suppliers that had trouble -- didn't have really the resources and had some trouble keeping up at least in the ramping part. So we've had several different things. I think except for the last one, the first, which is unpredictable, the first 3 reasons why we're growing, we expect to continue.

Got it. And I guess as a follow-up, I was hoping you could opine on your view of the cadence of WFE spending for the next several quarters. I think clearly end of May would suggest that demand, at least for your largest customers, even more back half load is more even for the back half of the year. But do you see that extending further and maybe in the first half of 2018, particularly as there seems to be some additional DRAM capacity and OLED fabs are expected to ramp in earnest in 2018? Just curious to get your incremental thoughts there?

Yes, just talking about the WFE and not predicting out UCT's revenue in Q4 and Q1, but we continue to see strength in WFE being talked about by many other sources. So I think, and I think by all accounts, 2018, it looks like the WFE spending is going to continue to very strong with many predicting actually increases over '17.

Then I just have one last question if I may. Obviously, I think, one of the most interesting aspects of this semi-supply chain is the fact that you -- UCT -- happens to be in the middle of what is still a very fragmented market and that arguably is ripe for consolidation. I'm just curious, how much cash do you think you need to run the day-to-day operations of your business, and with another $38 million to $40 million of free cash flow likely this year, how should we think about your opportunity for shareholder value creation?

Yes. We've actually -- UCT historically has -- we've been very aggressive in M&A activity. And our last 2 we did in 2015. Obviously in 2016, we shifted our focus towards this unprecedented historical ramp in the business. The organic growth in front of us was rather tremendous. But as we move forward, I think that's definitely an area that we're kind of putting more emphasis on once again, is looking at different M&A activity. I think to talk about cash, I'll turn it over to Sheri.

Yes. I mean, we generated $11 million of cash this quarter. So clearly at these volumes we're seeing great cash generation, which is great, and we are a low-ROIC company, so we're not a heavy capital-intensive company. So I see that cash generation continuing depending upon how much we generate, we'll use some of that for M&A activities as well as continuing to pay down our debt. So I'm hoping that continues for us.

Our next question comes from the Dick Ryan of Dougherty.

Echo best wishes again from me too, Jim. Extending the M&A comment, what areas might you be considering? Is there any specific targets or holes that you would need to fill?

Thank you, Dick. Obviously, our strategy that we've pivoted to a couple of years ago, which is an intense focus on the semiconductor and semiconductor-like display market. So obviously, we're looking at opportunities in the semiconductor or the display area; that's our main focus. As far as the breath of our capabilities, I think over the last 10 years, UCT has done a tremendous job of filling out I think, areas from a capability standpoint and we have the ability to make almost all the different kinds of parts that are used in most semiconductor tools, the main parts like frames, and sheet metal and machine parts and plastic and gas panels and so on, weldments. So I think from a capability standpoint, from broad capability, we are already there. I think we're looking for more specific positions in some of the more sensitive areas of the tools, surrounding like the process chamber and other areas. So again, the main focus is going to be on semiconductor and display -- I'd say the only focus. And then more looking around different positions on the tools, penetrates -- further penetration in the different platforms of our customers rather than just a capability play.

Okay. And kind of looking at that $240 million midpoint guidance. Are you running into any capacity issues where your CapEx is -- CapEx increases are going to be required?

Nothing significant. I'll use -- I'll borrow Sheri's whack-a-mole. But there's always issues to tamp down, these are obviously -- every quarter has been a record upon a record upon a record and we've more than doubled our revenue in a year. So -- but most of the issues that we have to deal with, especially in the short to near term, are around just managing the supply chain.

Dick, this is Sheri. We have made that investment a little over a year ago. I think, we talked about in the past (inaudible) so that really kind of set us up for where we're at from a volume perspective right now and like Jim said, it's incremental adds if we need anything.

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

Well thank you everyone for joining us for today's call. And I look forward to speaking with you on next quarter's call. Thank you.

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