Ultra Clean Holdings, Inc.
Q3 2007 Earnings Call Transcript

Published: 23 Oct 2007

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome tothe Ultra Clean Technology Third Quarter Results Conference Call. During thepresentation, all participants will be in a listen-only mode. Afterwards, we willconduct a question-and-answer session. (Operator Instructions). As a reminder,this conference is being recorded on Monday, October 22nd, 2007. I would now like to turn the conference over to Mr. JackSexton, Chief Financial Officer. Please go ahead, sir.

[Jack Sexton:]

Thank you operator and good afternoon. And welcome to ourthird quarter financial results conference call. My name is Jack Sexton, ChiefFinancial Officer, of Ultra Clean Holdings. and with me today is our Chairmanand Chief Executive Officer, Clarence Granger. A few moments ago, we issued apress release reporting financial results for the third quarter 2007. The pressrelease can be accessed from the Investor Relations section of Ultra Clean'swebsite at www.UCT.com. In addition, we have arranged for a tape replay of thiscall, which may be accessed by phone. This replay will be availableapproximately one-hour after the call's conclusion and will be accessible fortwo weeks. The dial-in access number for this replay is 800-952-6697 fordomestic callers, and 212-231-2901 for international callers. The pass code is21352079 for both domestic and international dialers. This call is also beingwebcast live with a web replay also available for 14 days from the InvestorRelations section of our website at www.UCT.com. Together with our recently issued press release, thisconference call enables the Company to comply with the SEC Regulations for FairDisclosure. Therefore, investors should accept the contents of this call as theCompany's official guidance for the fourth quarter of fiscal 2007. Investors should note that only the CEO and CFO areauthorized to provide company guidance. If at any time after this call wecommunicate any material changes in guidance, it is our intent that such updateswill be done officially via public forum, such as a press release or publiclyannounced conference call. The matters that we discuss today include forward-lookingstatements, as defined in the U.S.Private Securities Litigation Reform Act of 1995, and relates to matters,including our future financial performance, new product orders and shipments,and expanded production at our Chinafacilities. Investors are cautioned that forward-looking statements are neitherpromises nor guarantees, but involve risks and uncertainties that may causeactual results to differ materially from those projected in the forward-lookingstatements. Some of those risks and uncertainties are detailed in our filingswith the Securities and Exchange Commission, including our most recent Form10-Q filed for the quarter-ended June 29, 2007, and Form 10-K filed for theyear-ended December 29, 2006. The Company disclaims any obligation to publiclyupdate or revise any such forward-looking statements or to reflect events orcircumstances that occur after this call. Now here are the third quarter results. Revenue for thethird quarter of 2007 was $95.5 million, a sequential decrease of 9% comparedto revenue of $104.7 million for the quarter-ended June 29, 2007 and a decreaseof 8% compared to revenue of $104.1 million in the same period a year ago. Thesequential decrease was due to reduced demand from nearly all semiconductorcapital equipment customers, with industry demand becoming progressively weakertowards the end of the quarter. As a result, our third quarter revenue was at alow end of our guided range of $95 million to $103 million. Gross margin for the third quarter was 14%, down from the15.1% recorded in the second quarter and a decrease from 14.8% in the sameperiod a year ago. The sequential reduction in gross margin is due to reducedfactory utilization, as a result of lower industry demand. Operating expenses in the third quarter were $7.8 millioncompared to $8.3 million for the prior quarter, a decrease of 6%. The sequentialdecrease of approximately $500,000 is due to reduced legal costs associatedwith our patent infringement lawsuits, partially offset by increased sales andmarketing expenses. Interest and other net expense of $460,000 was effectivelyflat with prior period. These charges relate primarily to interest expense ondebt, that were put in place in support of the Sieger acquisition. Our effective tax rate through the third quarter and therate projected for the full fiscal year 2007 is flat, with the prior period atapproximately 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 sharecharge for amortization of intangible assets related to the Sieger acquisitionand a $0.03 per share charge related to FAS 123R. Turning to the balance sheet; during the third quarter, cashof $28 million increased $8.1 million sequentially, while third-party debtdecreased $900,000 to $28 million. Taken together, net liquidity, now at zerowith cash equal to third-party debt, improved $9 million during the period. Accounts receivable of $42.9 million decreased $7 million or14%, due to improved collections and lower revenue during the period. Days sales outstanding decreased two days to 41 days at theend 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 thethird quarter in support of a new system implementation which I will discusslater in the call. Days inventory on hand calculated on a forward-looking basisand after adjusting out the exceptional increase in inventory was flat at 52days 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 four days to 43 days. Finally, I am pleased to report that UCT has successfullyimplemented a new fully-distributed enterprise resource planning or ERP systemat all of our U.S.based locations. At the beginning of the current month, we successfullytransitioned three U.S.sites to the same version of standardized ERP software. We plan to complete theChinaportion of this implementation in the first quarter of 2008. We expect to realize significant efficiencies over the nextseveral quarters by moving to an updated centralized ERP platform. This alsocompletes one of the final stages of Sieger's integration into UCT, by bringingall U.S.operations on to a common ERP system. Now, Clarence will discuss our operating highlights for thethird quarter and provide guidance for the fourth quarter of 2007. Clarence?

[Clarence Granger:]

Thanks Jack. The third quarter of 2007 was a challengingperiod for the industry, in which we saw a progressive softening of demand fromnearly all of our customers. Despite this challenging environment, we managedto deliver relatively strong operating performance, while continuing to makesignificant progress on our key strategic initiatives. During the quarter we secured orders from three newcustomers

[Operator:]

Absolutely sir. (Operator Instructions) And our firstquestion comes from the line of Jay Deahna from JPMorgan. Please proceed with your question.

[Jay Deahna:]

Thanks very much. Good afternoon, Clarence and Jack.

[Jack Sexton:]

Hi, Jay.

[Clarence Granger:]

Hi, Jay.

[Jay Deahna:]

Two questions to get the ball rolling. Firstly, I am a littlebit surprised that you are not seeing a little bit more new process modulemomentum from your core customer base. The big semiconductor equipment OEMs,you've been working with for a long time. So I'm wondering, where does that allstand? And you indicated the 20% or 30% of modules being outsourced already;are you not getting your fair shot of share, relative to the big contractmanufacturers? If you could just kind of give me an update on that, and then Igot one follow-on?

[Clarence Granger:]

Sure. With regard to the new process module momentum, again,a lot of these happen at our customers' speed, so our customers are continuingto be anxious to move outsource more of this module. But we have not seenactual transition to this point in time, so we absolutely believe that we arecontinuing to get our share. Actually we believe we've been led to believe byour customers that we are actually gaining market share in terms of overallrevenue with our prospective customers. So, we absolutely don't believe we are losing any momentumor any market share. We just believe it's a matter of how quickly our customerstransition outsourcing of these modules.

[Jay Deahna:]

If you look at the big guys, at least two out of three,you've done some level of process chamber work with them. Are they just essentiallylooking to see little more data and how well will you execute on that, or doyou have to deal with different divisions' work at the different times? So whendo we see some sort of [daybreak] on getting more mandates from some of the bigguys? That's the follow-up. And then the other question as Lam Research indicated intheir call two weeks ago that they expect shipments of etch systems to increasein the first half of '08 versus the second half of '07? And they indicated that their orders bottom in the Q3 shouldbe up in 4Q, which means their shipment should be up in Q1. Based on whatyou're looking at with your business, this Q4 feels like the bottom forshipments from a cyclical perspective, and then you got some new businessscaling in the early part of the next year from mandates to share. Does thatimply that Q4 should be the bottom for you guys cyclically, and that's it?

[Clarence Granger:]

Yeah, Jay. I guess the first part of your question wasagain, how quickly our customers are migrating to outsourcing major modules andwhen do we see the dam breaking. It is still very difficult for us to projectthat. Again, we announced a total of five major modules in thefirst half of this year. We are adding another one, although albeit it's notfrom one of our major customers. Again, we see this as a continual and consistent move on thepart of our customers. It's part of their major strategy. Our major customershave publicly announced outsourcing and outsourcing of larger subassemblies isa major part of their strategy. So in terms of the timing, that's really up to them. We keeptrying to accelerate that. And they do try to accelerate it as well, but ofcourse, there is always some challenges in actually making these things happen.So again, we remain very confident. We are moving, and I'd like to be movingfaster, but we are moving at a reasonable pace. The second question related to Lam Researcher's comments,and again, I don't want overlay our comments with their comments. Butcertainly, what we've heard is consistent from all of our customers. Again, my visibility beyond one quarter is pretty limited.I've demonstrated this, based on some of my comments in a previous call. If ourcustomers start to see increased shipments in Q1, we would certainly expect tobe a significant participant [in that].

[Jay Deahna:]

And I am just unclear that you indicate that your sense fromtalking to several customers. Is it thattheir outlook is similar to what Lam articulated, is that what you're insinuating?

[Clarence Granger:]

Well those are our internal discussions and our customers dotend to remain optimistic, more than one.

[Jay Deahna:]

Okay, thank you.

[Clarence Granger:]

You are welcome.

[Operator:]

And the next question comes from the line of Jesse Pichelfrom Piper Jaffray. Please proceed with your question.

[Jesse Pichel:]

Hi, good afternoon.

[Clarence Granger:]

Hi, Jesse.

[Jesse Pichel:]

How are you? What's the dollar value of the new programsfrom Axcelis and Photon Dynamics?

[Clarence Granger:]

We've try to anticipate that. Again, we think it could leadus to some significantly larger opportunities. But the two opportunities thatwe have specifically described, based on the orders that we have and theprojections that we have from them in the near future for just these particularproducts, is somewhere in the $5 million to $10 million range for 2008.

[Jesse Pichel:]

So does that bring up your total new programs for '08 to bein the range of about $45 million to $65 million?

[Clarence Granger:]

Yeah, actually I did the math myself. I think it came up to $45million to $70 million.

[Jesse Pichel:]

45 to 70 alright. And then are there, I would like to ask,is this the value of any end-of-life programs that you are aware of?

[Clarence Granger:]

I'm not aware of any major end-of-life programs here. Do youmean expenses or costs that we'd have associated with end-of-life programs or…?

[Jesse Pichel:]

No, no just I am trying to base '08 revenue numbers based onthe new wins, and I want to offset that with anything that's comingend-of-life.

[Clarence Granger:]

Oh, I see. These are incremental wins; these are not tied toany other projects that would have end-of-life. There are other ongoingprojects that will have end-of-life, and at the same they'll have a newgeneration of products associated with them. So I would say that would berelatively neutral, and our expectation is that this is incremental.

[Jack Sexton:]

We always speak just in terms of incremental wins. So as yougo back and check your notes, it's always in that mode. It's never this muchcoming in without discussing what's falling off, we always discussincrementally.

[Jesse Pichel:]

Right. Well how should we think of gross margin nextquarter, especially in-light of two new facilities that are going up? Will thathave a further drag on gross margins?

[Jack Sexton:]

Well, the volume impacts, we basically lost 110 basis pointsgoing from Q2 to Q3 and about 70 basis points of that was volume related. We'vegot a little bit less of a decline expected in Q4, but we will see maybe 50basis point drop as a result of that. The cost of the new facility in China is already baked into our number, so wehave pretty much starting cost level of expenditures in Q3 for the new Shanghai facility, thesecond machining facility. So I don’t see any further drag from that.

[Jesse Pichel:]

And what's the revenue generating capacity of the second Shanghai facility?

[Jack Sexton:]

Yeah, our first Shanghaifacility has a capacity of about $150 million annually. And the second facilityis actually a little bit larger and there is larger modules than the first. Soit's actually incrementally above that. I would say somewhere between $150million and $200 million annually.

[Jesse Pichel:]

Okay. Just have to ask this question at the end. Are youseeing any coding activity for your services in the solar tool market or photovoltaictool market with any of your customers or potentially new customers?

[Clarence Granger:]

Yeah. We're already shipping to that market in very lowvolumes Jesse. But, as you know one of our major customers is a majorparticipant in this business and obviously it is still at an early stage, butwe will be a beneficiary from that as one of their major suppliers. And sowe're going to try and start looking at ways that we can quantify that a littlebetter, but we are already starting to see some growth in that area and we arealso going to target that as one of our future growth areas as well.

[Jesse Pichel:]

Okay, great. Thank you very much.

[Clarence Granger:]

You're welcome Jesse.

[Jack Sexton:]

Thanks Jesse.

[Operator:]

The next question comes from the line of Tim Summers fromStanford Financial Group. Please proceed with your question.

[Tim Summers -Stanford Financial Group:]

Yeah. Thanks for taking my question and good afternoon.

[Clarence Granger:]

Good afternoon.

[Jack Sexton:]

Good afternoon, Tim.

[Tim Summers:]

As you guys look at the third and the fourth quarter, thirdquarter revenue actuals in the fourth quarter outlook, are there a productlines or customers that are doing materially better or worse that either youexpected or sort of relative to each other?

[Clarence Granger:]

Yeah. Certainly, we want to get into that by customer, byproduct line, that would be very disruptive for us from our customerrelationship standpoint, but I guess what I would say was it did get worsethroughout the quarter. We did start to see more cancellations and push outthroughout, as we progress towards the end of the quarter and it did seems tobe by and large the majority of our customers, virtually all of our customers.There were one or two of the smaller customers where we get starting to gainpenetration, where we are still able to offset what happens with the industryby doing, picking up some new business. But of our big three customers it'svery similar.

[Tim Summers:]

So, as we sort of model the fourth quarter, is it reasonableto assume that we should be taking down our revenue expectations for theprocess module business figure and GDS business kind of equally or are therecertain pockets of weakness that might be, might see greater declines in 4Q?

[Jack Sexton:]

Well, Tim I would assume basically everything down in a verysimilar way. We would not really seeing pockets of strengths, just a consistentslide in the wrong direction.

[Clarence Granger:]

I guess, what I would say, the only thing I would say isthat we are starting to see an upturn in the flat panel. That business was veryslow for a long time and we are finally starting to see that comeback.

[Tim Summers:]

And is that a material percent of your business right now?

[Jack Sexton:]

It is, well it's in the low single, middle single-digits, Iwould say, 3%, 4%.

[Tim Summers:]

Okay, great, Jack. Thank you.

[Operator:]

(Operator Instructions). And we have a follow up questionfrom the line of Jay Deahna with JP Morgan. Please proceed.

[Jay Deahna:]

Thank you. Clarence, usually when the semiconductorequipment OEMs are busy in the active part of an up cycle, it's hard to gettheir attention for new programs, a new outsourcing module, things of thisnature. Now that we are in the slow period, when we think that their bandwidth,you have this types of discussion would be a little bit bigger and ultimatelythat plan for page four new mandates that come at faster rate. I am little bitsurprised that the magnitude of new mandates right now is actually as of 3Q,little bit slower than it was in 1Q and 2Q when things were busier. How do wethink about that?

[Clarence Granger:]

Well, I guess Jay we are seeing continual activity in thisarea, we just don’t have any wins to announce and another thing that we arealso seeing, its also very significant is we are seeing that our customers arespending a fair amount of their energy also focusing on how they can migratemore their products to low cost region. So I think again we haven't gotanything official to announce at this point in time, but we are prettyoptimistic that our customers are going to be spending quite a bit more timelooking at ways to transition things to low cost region, which we believe willbe a significant benefit to us, as a result of now having two facilitiesoperational in Shanghai.

[Jay Deahna:]

Okay, then a follow up on that notion with Jack. You've saidin the past that when you guys come out of this thing, you are going to have aleverage effect. Just kind of curious if that leverage effect is being mutedbased on the new facilities, particularly the new one in Silicon Valley that we haven't heard of before? That's part one and parttwo. You've said in the past that every $10 million of newrevenue in China,number one primarily, I guess, would be 14.0% of gross margin for the overallcompany, is that still the case?

[Jack Sexton:]

Yeah, Jay. Both of those pretty much stand firm. I mean justto clarify, there is a new facility. We don't expect a step function increasein our expenditures as a result of this Silicon Valleyfacility. This will be basically a consolidation of efforts and resources intoa single facility here in Silicon Valley. So,we don't see that as being a drag on our margins, depending it should be movingthe other direction. And the new Shanghai facility, the machining operation wehave out there, the same math, in fact the math on that facility is a littlebit greater in terms of the differential we've realized, producing a machine,part of a machine assembly and then these larger assemblies in Shanghais versusthe cost of those in the U.S. So, no, we are not moving in anyway away fromthose two fundamental changes.

[Clarence Granger:]

So, Jay, this is Clarence again. I'd just like to reiterateJack's comments on 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've beenlooking at logical ways to improve our overall efficiency and we determine thatthe most significant way we can benefit efficiency is by combining those twooperations and ultimately eliminating some redundancy. So our lease -- we will be on a month-to-month lease in our Menlo Park facility atthat point in time. So as soon as we move out of Menlo Park, we'll be able to eliminate thatcost.

[Jack Sexton:]

And similarly Jay, we've got a multi-site facility in SouthSan Francisco, with leases expiring, which allow us to move out of those andshrink significantly the footprint in South San Francisco and move thingsnicely into this new facility.

[Clarence Granger:]

We may have a very brief time where there is someoverlapping of costs, but obviously you can anticipate that with combining twooperations in the one, we should have some significant efficiencies andpotential economy. So that's our strategy behind this. This is not perceived asan incremental addition. This is a perceived on our part as an incrementalconsolidation and reduction of our expenses in the U.S.

[Jay Deahna:]

That was a detailed and very clear explanation. The onlyfollow-up I have is, well the majority of the brief time of cost overlap be 1Q?

[Jack Sexton:]

Yeah. We looked at the -- the expensive transitioning isminimal, we did spent a lot of time negotiating this lease and we think we gota very solid deal. So there might be one quarter of minimal transition cost butthen lower expenses from there.

[Jay Deahna:]

So assuming 2Q is a better quarter for revenue and you'repretty much fully consolidated into the new facility in Silicon Valley, shouldwe be modeling a little bit more upside gross margin leverage effect in 2Q than1Q?

[Jack Sexton:]

Yeah. We've basically indicated drive up to 18% gross marginin the fourth quarter of '08 and that number stands. I mean that incorporatesome level of efficiencies. It's a number I wouldn't alter from your model, Imean because we have known for some time we're going to go through this levelof consolidation.

[Jay Deahna:]

Okay. Then lastly here, what is your utilization in Chinaas of the end of 3Q?

[Jack Sexton:]

It's right, just south of 50%.

[Jay Deahna:]

South of what?

[Jack Sexton:]

50% of the existing the first facility.

[Jay Deahna:]

Is that up sequentially?

[Jack Sexton:]

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

[Clarence Granger:]

But we will see some good growth in that in Q4.

[Jay Deahna:]

Okay. Thank you.

[Operator:]

And there are no further questions at this time. Pleaseproceed.

[Jack Sexton:]

So I would like to thank everybody for joining the call. Welook forward to speaking to you at an upcoming investor conference or event.Please check our website at www.UCT.com for the schedules of those upcomingconferences. And with that operator, I'll return it to you.

[Operator:]

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