Ultra Clean Holdings, Inc. (NASDAQ:UCTT) Q1 2021 Earnings Conference Call April 28, 2021 4:45 PM ET

Company Participants

Rhonda Bennetto - VP, IR
James Scholhamer - CEO & Director
Sheri Savage - SVP, Finance & CFO

Conference Call Participants

Nathaniel Bolton - Needham & Company
J. Ho - Stifel, Nicolaus & Company
Thomas Diffely - D.A. Davidson & Co.
Christian Schwab - Craig-Hallum Capital Group
Richard Ryan - Colliers Securities

Operator

Good day, and welcome to the Ultra Clean First Quarter 2021 Conference Call. [Operator Instructions]. Please note, this event is being recorded. I would now like to turn the conference over to Rhonda Bennetto, Investor Relations. Please go ahead.

Rhonda Bennetto

Thank you, Operator. Good afternoon, everyone, and thank you for joining us. With me today are Jim Scholhamer, Chief Executive Officer; and Sheri Savage, Chief Financial Officer. Jim will begin with some prepared remarks about the business, and Sheri will follow with the financial review, then we'll open up the call for questions.

Today's call contains forward-looking statements that are subject to risks and uncertainties. For more information, please refer to the Risk Factors section in our SEC filings. All forward-looking statements are based on estimates, projections and assumptions as of today, and we assume no obligation to update them after this call.

Discussion of our financial results will be presented on a non-GAAP basis. A reconciliation of GAAP to non-GAAP can be found in today's press release posted on our website.

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

James Scholhamer

Thank you, Rhonda, and good afternoon, everyone. We appreciate your time today. I'm going to start with a brief review of our fourth quarter performance, while sharing my thoughts on the industry and how accelerated technology advancements are benefiting UCT. After that, I'll turn the call over to Sheri for a review of our financial results and activities, then we will open up the call for questions.

UCT again delivered record revenue growth above expectations for the first quarter, driven by solid execution on higher-than-expected demand across both our products and services markets. I sincerely thank the thousands of employees around the world who collectively pulled together to anticipate, commit and deliver the best possible results for our customers, our company and our shareholders.

By making important continuous investments in our people, our facilities, our products and our services, we have grown our revenue by 30% and our earnings by 70% year-over-year. Because our strategic investments in our businesses are closely aligned with the needs of our customers, I am more confident than ever that we are well-positioned to capitalize on the long-term increase in industry demand.

UCT remains solidly on track to outpace the accelerated growth of our served markets again this year. The buildup of digital infrastructure that accelerated last year because of the pandemic, along with an expedited recovery and the need for semiconductors, is fueling overall growth. This has resulted in a considerable increase in productivity for our customers across all market segments compared to just 3 months ago.

Our customers and their customers are making significant investments in response to projected strong multiyear growth due to secular trends such as 5G, cloud computing and artificial intelligence. These investments have effectively reset equipment spending expectations to a much higher level for the foreseeable future. Our products business is strategically positioned to benefit from this increase due to our very broad exposure across all device types, and our services business will profit from the increase in fab utilization rates.

One of our most important accomplishments this past quarter was the closing of the Ham-Let acquisition. The addition of Ham-Let's high-purity flow control system means we can now offer our customers a more diversified set of product offerings. This enables us to play an increasingly important and pivotal role in meeting our customers' needs, from the design processes all the way to the support and service maintenance requirements found in any high-volume manufacturing fab.

And the timing of this acquisition couldn't have been better. Ham-Let's gas delivery capabilities not only play an important role within the equipment space, but also within the sub-fab infrastructure build-out phase, and CapEx for these projects is on the rise. With Intel recently announcing to spend an additional $20 billion, TSMC and SK hynix stating they at lease spend $100 billion, and Samsung reaffirming their $100 billion investment over the coming years, we plan to leverage existing relationships with our customers and see a clear opportunity to participate in the multiyear build-out of these foundry, logic and memory fabs.

UCT's new facility in Malaysia remains on track to begin production in the third quarter. This state-of-the-art facility is being built to support revenue run rates of $600 million to $800 million annually when fully ramped, enabling us to better serve and bring value to our local and global customer base. Hiring began earlier this year, and many employees are already being trained. We are uniquely positioned to support our customers and grow our share as outsourcing opportunities gain momentum.

Another major achievement this quarter was that UCT was awarded Intel's 2020 supplier Achievement award for COVID-19 response. We were one of only 38 suppliers in the Intel supply chain to receive such an award, and I would like to thank Intel for the prestigious recognition and all our employees for their hard work. This award is a testament to our dedication and deep commitment to our customers, and underscores why UCT is a partner of choice.

I mentioned this last quarter. It's even more meaningful today. There has never been a better, more opportune time to be the manufacturing leader in the semiconductor industry. Our growing portfolio of product and service offerings, together with our strong operational performance and resilient business model, will drive continuous long-term growth and profitability with the goal of returning even more value to our shareholders.

The addition of Ham-Let, share gains and unprecedented levels of demand all contributed to our substantial increase in revenue guidance for the second quarter. Industry sentiment, backed by our internal market analysis, project strong, sustainable momentum, and UCT is poised to continue to outperform through 2021 and beyond.

Before handing the call over to Sheri, I want to again thank our employees and our suppliers and partners for their incredibly hard work, and we look forward to speaking with you again in a few months.

And with that, I'll turn the call over to Sheri to review our financial activities and performance. Sheri?

Sheri Savage

Thanks, Jim, and good afternoon, everyone. Thanks for joining us. In today's discussion, I will be referring to non-GAAP numbers only.

Total revenue for the quarter was $417.6 million, up 13% from the prior quarter. Our products division was up 15.4% to $345.6 million, and our services business grew 2.7% to $72 million, both on increased demand across the board.

Total gross margin for the first quarter remains at the high end of our model, at 21.3% compared to 21.5% last quarter. Products gross margin was 18.2% compared to 17.8%, and services was 36% compared to 37.5% last quarter. Margins can be influenced by customer concentration, geography, product mix and volume, so you can expect to see variances quarter-to-quarter.

Operating expense for the quarter was $38.1 million compared to $35.7 million in Q4 due to typical costs related to year-end and increased headcount in support of the ramp. As a percentage of revenue, operating expenses decreased to 9.1% compared to 9.7% in the prior quarter. Total operating margin for the quarter increased to 12.2% compared to 11.9% in the fourth quarter. Margin from our products division grew to 11.7% from 10.8% in the prior quarter, and margin from our services division was 14.3% compared to 16.3% in the prior quarter.

Based on 41.6 million shares outstanding, earnings per share for the quarter were $0.92 on net income of $38.2 million compared to $0.81 on net income of $33.5 million in the prior quarter. Our tax rate for the quarter remained unchanged from last quarter at 18%. We expect our tax rate for 2021 to stay in the high teens.

Turning to the balance sheet, our cash and cash equivalents were $264.3 million at the end of the first quarter compared to $200.3 million last quarter. Cash from operations was very strong at $55.6 million, an increase of $21.2 million from the prior quarter.

In the first quarter, we refinanced our term loan to fund the Ham-Let acquisition. The offering was comprised of $355 million incremental debt and included the repricing of our existing $273 million loan. The offering was approximately 4x oversubscribed and resulted in a new term B loan totaling $628 million at an interest rate of 375 plus LIBOR compared to 450 plus LIBOR for the original loan. We are very pleased with the strong investor interest and resulting term of the new loan.

In addition, on April 8, we completed a public offering of 3.2 million shares at $55 per share, resulting in gross proceeds of approximately $175 million. Use of the proceeds will be used to fund our growth strategy, which may include capital expenditures and future M&A. These financing activities will be reflected in our Q2 financials. With the completion of our refinancing and our equity offering, we are well-positioned to capitalize on expansion opportunities while maintaining an ideal level of operating leverage.

To continue to meet accelerated demand and including a full quarter of revenue from Ham-Let, we anticipate revenue for the second quarter to be between $490 million and $520 million, an increase of 21% using the midpoint. Excluding Ham-Let, UCT's core business would have been guided up approximately 8%. We expect EPS in the range of $0.90 to $1.03.

And with that, I'd like to turn the call over to the operator for questions.

Question-and-Answer Session

Operator

[Operator Instructions]. The first question comes from Quinn Bolton with Needham and Company.

Nathaniel Bolton

Congratulations guys on the nice results and guidance. Sheri, wanted to start with the financial guidance for the June quarter. If I've got my numbers right, is the core UCT business up 8%, would be guided to roughly $450 million, and then the difference would be the Ham-Let contribution?

Sheri Savage

Yes, that's correct.

Nathaniel Bolton

Second question, perhaps for Jim. Just as you look at how the company's positioned in 2021, you've talked about being able to grow faster than WFE in the industry. And I guess I'm wondering, do you think the core SSP and SPS businesses are growing in line to faster than WFE, if you were to exclude the Ham-Let acquisition?

James Scholhamer

Definitely on the SPS side, obviously, we're seeing very strong growth quarter-on-quarter, and I think we expect to see that. And we're really looking forward to our increased capacity coming out of Malaysia in the last half of the year to really help with that.

As you know, on the services side, the cleaning side, that grows more along with wafer starts. So we expect to see that grow more in line with the wafer start growth, or hopefully slightly above that as we work through our programs.

Nathaniel Bolton

And then just last one for me. The strength of results, just from the broader semi-cap companies that have reported to date, seem to be raising fears again about a near-term peak. Can you make any comments about how you see the second half of the year? Do you think it's sort of flat with the higher first half? Do you think the business can continue to grow half-over-half in the second half?

James Scholhamer

Yes. I'd say it's safe to say we see no reason why it couldn't continue to grow throughout the year.

Operator

The next question comes from Patrick Ho with Stifel.

J. Ho

Congrats on the really nice quarter and outlook. Jim, maybe first off, you guys did a great job last year in terms of procuring supplies and meeting customer demand during a very challenging period with the pandemic. This year, we're starting off where demand is obviously exceeding everyone's expectations. What lessons did you learn from last year that you're applying this year? And how are you keeping pace with a lot of your customers' demand needs? Because, again, the demand expectations have significantly risen in the short-term, and your results obviously indicate you're keeping pace with what your customers need. Anything that you've learned from last year that you're applying this year? Or are you just able to meet a lot of that excess demand?

James Scholhamer

Yes, you're absolutely right. It's very constrained environment right now. I think one of the big things, and I think our customers also learned that, it's really to take the projection and the commitment back as far as you can through the supply chain, through your suppliers and through your suppliers' suppliers, and really operate beyond a PO-to-PO kind of basis and work more on a forecast and a partnership kind of basis with the suppliers.

So I think we've done a good job with that. There's always more to do. But I think the industry has moved away from being transactional to being more of a partnership all the way back through the supply chain.

J. Ho

And maybe as my follow-up question, in terms of the new facility in Malaysia; traditionally, new facilities tend to weigh a little bit on costs as you're working through some duplicate costs and things of that nature with the new facility ramp. But given the current environment and the expectations as we go into the second half of the year, Sheri, maybe you can give a little color on the potential impacts to gross margins; or, if there are any, given that the demand environment could absorb a lot of it in a much quicker fashion.

Sheri Savage

Yes, Patrick, you're right. With the volumes that we're seeing, we're not seeing as much impact on the margins as we move through the year. So we're seeing, obviously, the volumes be very, very high in other locations, which offsets those additional costs coming in, and we are utilizing that labor within Asia to help us with that output within those other facilities.

So I would kind of think about Malaysia and Singapore almost being a combined entity when we look at those costs, and those are actually assisting us with meeting the demand that we need. So it's not putting as much pressure on had we not been in this situation from a volume perspective.

Operator

The next question comes from Tom Diffely with D.A. Davidson.

Thomas Diffely

First, a couple of housekeeping for Sheri. What is the new share count? And what are you projecting the interest expense to be, going forward?

Sheri Savage

Yes. We expect the interest expense to be closer to $5 million. The new share count adds 3.2 million shares to our current count. So closer to $45 million from a share count perspective. I can give you the exact numbers a little bit later, but that's where we anticipate being.

Thomas Diffely

Just wanted to make sure. And then, Jim, when you look at the Ham-Let business, do those products grow with WFE? And then, what has been the customer response so far? Have you -- controlling it? And what is the timing for getting more of their products into your gas pedals?

James Scholhamer

Yes, as I think we elaborated earlier, about 60% of the revenue is semiconductor related. And yes, we do expect that to grow with WFE in the short-term; and actually, as we're seeing actually in the short-, medium-term, potentially outgrowing that as well. In the long-term, I think we see the 2 to 3-year period, we see a lot of opportunity to make huge gains in the market share of the Ham-Let components in this space. And so that's a percentage that's actually relatively high. But I think, to think of it in the next year, we expect Ham-Let as an entity to at least grow along with WFE, and our goal is to continue to make that outgrow WFE, just like we do in our base business.

Thomas Diffely

And then what are your assumptions for the non-semi part of that business? Is it fairly flat?

James Scholhamer

Yes. We're seeing the semi part so strong that I would actually say the whole company is growing along with WFE, or maybe ahead of that. But the non-semi part, it's kind of the case of like hits and other misses. I think the liquid nitrogen gas is starting to show some signs of life. We're starting to see some activity there. We're really starting to just learn about those other parts and try to get a feel for how those industries might grow or change over the course of time.

But I think a simple way to think about it is we expect Ham-Let as a whole to at least grow along with WFE, the combination of the 2 sides of the business, and hopefully beat that by the normal 10 points that we do.

Thomas Diffely

And then, finally, congratulations on the Intel supplier award. Was that for the clean business? Yes, it was. That was for our response to Covid, which actually both sides of our business did a great job. But yes, that was, in particular, to our ability to really use our global footprint to really keep the intel fabs moving and flowing when one factory would be hit by Covid. We were able to use our footprint to really move things around and be adaptive and flexible, and we are really very delighted to be recognized by Intel for that.

Operator

The next question comes from Christian Schwab with Craig-Hallum Capital Group.

Christian Schwab

Going back to Malaysia, if we kind of look at Singapore and Malaysia as a combined basis, is there any way, when the capacity is fully online in Malaysia, the incremental revenue opportunity of the company? In other words, today, we have X amount of opportunity a year or a quarter; and then, after Malaysia has fully ramped, it's this much bigger?

James Scholhamer

Yes. So Christian, yes, I think we're looking at Malaysia as adding $600 million to $800 million annually of more capacity. Right now, it is a very symbiotic nature with Singapore as we move things back and forth as we're still finishing off the building right now. But yes, I think, at the end of the day, Malaysia should all in had $600 million to $800 million in additional revenue annually to us.

Christian Schwab

And how utilized is that currently?

James Scholhamer

It's not finished being built yet. So we're ramping it in the third quarter. So we're utilizing some of the employees that we've hired for it with the Singapore operations to help deal with high demand out there. But at this point, we're still just starting up and finishing off the building.

Christian Schwab

So as we look to the huge, or strong or meaningful, whatever adjective you want to use, multiyear CapEx spending environment by the world's largest vendors and your largest customers; as that kicks in in Q3, you should be very well-positioned for that strength in potential market share gains. Is that fair?

James Scholhamer

Absolutely. And actually, we're seeing different projects that we're winning are actually going straight into Malaysia production as the initial production site, which is highly unusual with a new production site. So I think the environment is so that new capacity coming on board right now is a very valuable commodity. So we're seeing a great reception from our customers to move product either from their own factories or from other sources to our new Malaysia site. So we have pretty high expectations of our ability to use that new capacity coming online, I would say, right in the nick of time.

Christian Schwab

So if you look at Malaysia coming online, and then you look at all the new fab builds and your opportunity with Ham-Let there, as well as more equipment for Quantum to clean, I don't want to put words in your mouth, but it seems to me that your ability to outgrow the market over the next 2 to 3 years could even be more meaningful than it has been in the last few years.

James Scholhamer

Yes, I think that's a fair statement. 10% has been our average outgrowth of the market, but we certainly strive to do much more on that, especially with acquisitions. So we are definitely looking at outpacing the market by at least 10%, and obviously more if we can. And the addition of Malaysia sets us up really nicely for that.

Operator

The next question comes again from Quinn Bolton with Needham & Company.

Nathaniel Bolton

Just two follow-ups, the first sort of a follow-up to Christian's question. As you look at your share gains, how much is that being driven by the COVID supply chain tightness and OEMs being willing to sort of open up new second sources or additional sources of supply, whether that's in your core business or opportunities for Ham-Let?

James Scholhamer

I think the COVID impact, I think we've seen a lot of that already flow through. I think the majority of what we're seeing is just simply an overall need for capacity and the overall ability to build the equipment. I think we've all seen this before. Obviously, the capacity coming online right now is certainly an opportune time for us.

And I think the majority of the impact is simply the demand is very strong for equipment and the ability for whoever can deliver right now. You're right. I mean, there's a level of COVID, but there's also an openness to opening up avenues to reach the delivery needs of the end customers. So I think, at the end of the day, the biggest stress is simply the overall need for capacity in the industry.

Nathaniel Bolton

And the second question was a follow-up on Ham-Let in the in-sourcing opportunity to the extent you qualify Ham-Let components in your gas panels, I guess that doesn't show up as revenue since it's included in your gas panel, but it shows up as margin enhancement.

So I guess two questions. One, when you talk about Ham-Let growing in line or faster than WFE, I assume that that excludes the opportunity to in-source components to UCT gas panels, but I just wanted to confirm that. And then, the second question is can you kind of walk us through the math? What's the opportunity as you in-source those Ham-Let components in your gas panels? How much of a margin boost do you think you could see?

James Scholhamer

To the first question, yes, it does exclude in-sourcing or internal transactions as far as the growth that we're seeing on the Ham-Let side. On the overall potential to grow, I think there's several areas that are driving that. Certainly, there's OEMs and their requirements, as well as some of the chip makers, and there's a lot of new fab announcements as well, as I think you've all seen. And those fabs demand a lot of the same type of components that are used on the OEM equipment. So I think we're seeing pretty strong demand over the next several years across the board.

Operator

The next question comes from Dick Ryan with Colliers.

Richard Ryan

A couple for Sheri. Sheri, do you have any debt paydown goals, what you might be looking at for this year?

Sheri Savage

Yes, absolutely, Dick. We plan to substantially pay off some of the debt this year with our cash flow that we've generated. So I would say our goal is around $50 million for the year.

Richard Ryan

Obviously, with the addition of Ham-Let and the trends underlying the market, can we expect any kind of operating model updates from you guys in the next coming quarters?

Sheri Savage

Yes. So obviously, we just closed the acquisition, so we have identified synergies, and we do see that we will need to update our model as we move through the next quarter or two. We see an overall update potentially to gross margin. And then, ultimately, they will assist us with updating our operating margin as we go into next year. But we will make an update in the next quarter or 2 as we see how they perform and how the synergies flow through that we anticipate happening shorter-term.

Richard Ryan

And Jim, what kind of base or operating assumptions are you using for WFE and wafer starts?

James Scholhamer

I think WFE, we're looking at the same assumptions that the overall market is looking at, 20% to 22% increase in WFE. Wafer starts, I think the latest numbers, they're coming out pretty quickly and often. I think they're in the high single digits, maybe the low double digits. We could look that up for you what our latest market forecast for that is.

Richard Ryan

No, that's just a range. That's good.

Operator

[Operator Instructions]. The next question comes again from Patrick Ho with Stifel.

J. Ho

Jim, maybe a bigger picture question on the services side and the parts cleaning. Obviously, fab utilization is the biggest driver for demand in that business. But with some of your major customers at the most leading edge on both the foundry logic as well as the memory side of things, are the complexities of manufacturing these next-generation devices, enhancing the need for parts cleaning? And what I'm getting by that is, again, utilization is probably the biggest driver. But because yield is becoming so much more and more important at the most advanced nodes, that's driving, I guess, incremental needs for parts cleaning to ensure that the tools keep running at the highest throughputs and yields.

James Scholhamer

Yes. That's a good point, Patrick. I think what we're also seeing, you're right, at the advanced nodes, the parts cleaning, this cycle seems to be more vigorous in order to keep the yields up. But what we're also starting to see is advanced coatings are becoming a really important factor. So it used to be you cleaned a part and you return it. And there's always been certain coatings that are applied to the parts for certain reasons. As we move down to 7-, into 5-, into 3-nanometer, we're starting to see specialty coatings and surface texturing becoming a more important player. So not just cleaning the part, but also applying these special coatings and texturing.

And so it's growing. I mean, obviously, it's a very small revenue overall compared to overall cleaning at this point, but we're seeing the growth in that space is really kind of off the charts. And we think that's an area that's really going to take off the next few years, which is really a lot more around cleaning plus. And that's where we have a great position, and we're doing a lot of work with the leading IDMs in that space.

Operator

There are no further questions, so I would like to turn the call back over to Mr. Scholhamer for any closing remarks.

James Scholhamer

Thank you, everyone, for joining us today, and we look forward to speaking to you next quarter. Thank you very much.

Operator

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