Ultra Clean Holdings, Inc. (NASDAQ:UCTT) Q4 2020 Earnings Conference Call February 17, 2021 4:45 PM ET

Company Participants

Rhonda Bennetto – Investor Relations
Jim Scholhamer – Chief Executive Officer
Sheri Savage – Chief Financial Officer

Conference Call Participants

Tom Diffely – D.A. Davidson
Krish Sankar – Cowen and Company
Quinn Bolton – Needham & Company
Patrick Ho – Stifel
Christian Schwab – Craig-Hallum Capital Group

Operator

Good afternoon, and welcome to the Ultra Clean Fourth Quarter and Full Year 2020 Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [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, and 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?

Jim Scholhamer

Thank you, Rhonda, and good afternoon, everyone. We appreciate your time today. I’m going to start with a short review of our full year results and briefly touch on our fourth quarter performance, then I’ll share my thoughts on the industry and how technology advancements are benefiting UCT as we execute on our growth strategy before turning the call over to Sheri for a financial review, then we will open up the call for questions.

For many reasons, 2020 was unlike any year we’ve ever seen, but by every measure it was an extraordinary one for UCT. I must start by thanking our global employees for their commitment, resiliency, determination and drive, to be the best. The team rose to the challenge and continued to exemplify our culture of integrity and teamwork, producing some of the best financial results we have seen in our 30-year history. UCT ended 2020 with a record total revenue of $1.4 billion, record operating margin of 11.3% and record EPS of $2.80. While significantly outgrowing the overall WFE market by 11% to reach these extraordinary milestones in a year fraught with challenges, we continuously adjusted to the changing work environment while staying focused on meeting customer demand and delivering strong returns to shareholders.

The fourth quarter benefited from ongoing strength in foundry and logic, as well as increased demand in memory as customers plan for expansion and equipment investment in 2021 and beyond. Both our product and service division saw increased engagement across all segments of the market, resulting in another quarter of growth and improved operating leverage. UCT remains solidly on track to outpace the accelerated growth of our served markets, again in 2021.

Technology advancements within our data-driven economy continue to fundamentally change how we live and work. This digital transformation is accelerating the adoption of semiconductor growth drivers, such as artificial intelligence, high performance computing, IoT and 5G. Capital intensity at the leading edge is increasing to support a more diverse set of end-use markets, which provides confidence for strong multi-year WFE demand. Our business is well balanced, and both our products and service businesses have broad exposure across all device types. This bodes well for UCT as we continue to engage in the early stages of customers’ technology roadmaps.

A key component to UCT delivering on its long-term growth strategy is the acquisition of Hamlet. The pre-close and integration planning process is going very smoothly and we are excited to begin operating as one company after closing, likely early in the second quarter. Adding Hamlet to our growing suite of vertical capabilities will support our customer partnerships with a significantly broader, higher value, higher margin portfolio of market-leading product solutions. You’ll recall that Hamlet’s components are used primarily within our current gas panel product line, as well as for gas distribution throughout semiconductor tools. In addition, gas delivery is a significant element of the sub-fab infrastructure within ship making facilities, providing an additional platform for growth. By leveraging UCT’s solid customer relationships and global operational footprint, we see a sizable opportunity to grow Hamlet’s 5% share of a $2 billion market.

UCT’s new facility in Malaysia remains on track to begin initial production in the third quarter of this year. This state-of-the-art facility will enable us to better serve and bring value to our local and global customer base. The facility enables us to provide additional capacity, ensuring business continuity to meet ongoing demand. There has never been a better, more opportune time to be a manufacturing leader in the semiconductor industry. Our customers and their customers are well positioned at the forefront of this technology renaissance, and we see our existing partnerships expanding with them as they hasted to advance their technology roadmaps. Our comprehensive portfolio of product and service offerings together with our strong fiscal discipline and resilient business model will drive continuous long-term performance and profitability with the goal of returning even more value to our shareholders.

Our guidance for the first quarter reflects an increase in business across our entire customer base. Industry sentiment backed by our internal market analysis project momentum continuing through 2021. Before handing the call over to Sheri, I want to again, thank our employees and our suppliers for their incredibly hard work this past year. And we look forward to again outperforming the markets we serve in 2021. And with that, I’ll turn the call over to Sheri to review our financial performance.

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 $359.6 million up 1.7% from the prior quarter. Our Product division grew 1.7% to $299.5 million and our Services business was up 1.8% to $70.1 million, both on increased demand across the customer base. Total revenue for the year was a record $1.4 billion up 31.2% from the prior year. Products generated revenue of $1.1 billion and Services contributed $267.4 million up 34.5% and 18.7% over 2019 respectively.

Total gross margin for the fourth quarter remains at the high end of our model at 21.5% compared to 21% last quarter. Products gross margin was 17.8% compared to 17.5% and Services gross margin was 37.5% compared to 36% last quarter. Margins can be influenced by customer concentration, geography, product mix and volume, so you can expect a variances quarter-to-quarter. Total gross margin for the year was 21.4% up from 19.3% in the prior year. Once the Hamlet acquisition is closed, we will take the opportunity to review and adjust our model.

Operating expenses for the quarter were $35.7 million compared to $34.3 million in Q3 due to typical costs related to year-end. As a percentage of revenue operating expenses increased to 9.7% compared to 9.4% in the prior quarter. As a result of our revenue increasing by 31.2% year-over-year, operating expenses as a percentage of revenue declined to 10.1% compared to 11.5% in the prior period.

Total operating margin for the quarter increased to 11.9% compared to 11.6% in the third quarter. Margin from our Products division remained flat at 10.8% and margin from our Services division was 16.3% compared to 14.9% in the prior quarter. Total operating margin for the year was 11.3% a significant improvement from 7.8% in the prior year due to higher volumes and ongoing management of expenses.

Based on $41.4 million shares outstanding, earnings per share for the quarter were $0.81 on net income of $33.5 million compared to $0.73 on net income of $29.9 million in the prior quarter. For the full year earnings per share were $2.80 on net income of $115 million compared to a $1.16 on net income of $46.5 million in 2019. Our tax rate for the year was 18% compared to 18.1% last quarter. For the full year, our tax rate was 18.4%. We expect our tax rate for 2021 to remain in the high-teens.

Turning to the balance sheet, our cash and cash equivalents were $200.3 million at the end of the fourth quarter compared to $176.1 million last quarter. Cash from operations was $44.4 million, an increase of $24.7 million from the prior quarter. For the full year, our cash from operations totaled $97.3 million. We have made significant progress paying down our Term B loan over the last couple of years. During 2020, we made additional voluntary Term B loan payments totaling $18.4 million, bringing our total debt repayment for the year to $25 million.

A key component of our overall growth strategy is to ensure we are ready to capitalize on expansion opportunities, while maintaining an ideal level of operating leverage. As mentioned in our last call, we are currently reviewing our capital structure to support this strategy so that we may conserve a healthy balance sheet and maintain flexibility. We anticipate revenue for the first quarter to be between $375 million and $405 million and EPS in a range of $0.80 to $0.93.

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

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from Tom Diffely with D.A. Davidson. Please go ahead.

Tom Diffely

Yes. Good afternoon. First I wanted to check on the Hamlet acquisition, sounds like the close was moved from the first quarter into the second quarter. And I was wondering if there is any big hiccups at this point.

Jim Scholhamer

Yes. Hi, Tom. We don’t – really don’t consider the close moving. We talked about it being end of the first quarter, early second quarter and we’re still projecting in that timeframe again, most likely early the second quarter.

Tom Diffely

Okay.

Jim Scholhamer

And we’re still waiting for our one clearance from one government, but we don’t see that there’ll be any issues with that.

Tom Diffely

Okay. That sounds good. And then when you look at the ramp in Malaysia, sounds like its on track for the third quarter. What do you do between then and now to ramp up capacity if you need it? Obviously, things are getting stronger in the first quarter. But then if they grow again in the second quarter, will you have enough capacity on hand before the facility’s done to handle?

Jim Scholhamer

Yes, absolutely. I mean, we always have a significant amount of burst capacity and different things that we can do with overtime and extended shifts and things like that. So we definitely – it’s not a concern in the short-term. Obviously, as we see 2021 and 2022 continuing to strengthen in the long-term, that additional capacity in Malaysia is going to really pay off for us. But, yes, there’ll be no constraints in the near-term.

Tom Diffely

Okay. And then final question, when you look at the kind of consensus view up there for 15% growth in the industry, everything you’ve seen correlate with that?

Jim Scholhamer

Yes. Yes. We see – obviously the 15% number that a lot of people are talking about definitely seems like a reasonable estimate. There’ve been a lot of announcements, especially, in the foundry side of things to support that, and as well as memory moving into more capacity adds in this year versus the node expansions that they were mostly focused on last year. So we still think everything planning up really well for strong growth in that range for 2021.

Tom Diffely

Great. I appreciate your time today.

Jim Scholhamer

Yes. Thank you, Tom.

Operator

The next question is from Krish Sankar with Cowen and Company. Please go ahead.

Krish Sankar

Hi. Thanks for the question. I had a couple of them, Jim. Just to follow up on Tom’s last question, you said that you expect the outperformance to continue. So if you think WFE is going to be up 15% this year, is it fair to assume your revenues could be higher than that?

Jim Scholhamer

Yes, obviously, we’re not guiding for all of 2021, but our target is to always outgrow WFE and we’ve outgrown that on an average of about 10 points over the last five or six years. And obviously, some years are higher and some are lower than others depending on many factors. But, yes, our aim is to continue to outgrow WFE by roughly on average of 10 points.

Krish Sankar

Got it. Got it. And then Jim, I think in the last call, you kind of spoke about some potential approved design wins at ASML. I’m kind of curious, when do you think that translates into tangible revenues?

Jim Scholhamer

Yes. As I mentioned that’s kind of a long-term goal over a few years and there are several reasons. A lot of the wins and a lot of the work that we’re doing are on the next-generation tools in the litho space. And so those obviously have to go and get adopted and they have to ramp up on their own.

And also the wins, the wins come in – they come in chunks along the way. They don’t come in one big movement of operations from – into ours. So you see – on any given quarter, you’ll see several wins in certain sub modules and modules or components and those continue to kind of stack up on each other over time as well as the new tools really start to roll out as they introduce them to the market. That’s where we see kind of a slow general growth over the next several years and our target to get that space up to a reportable segment.

Krish Sankar

Got it. Jim, and then a final question for Sheri. It looks like the Malaysia facility is on track for a second half ramp. I’m just curious how should I think about gross margin at least in the second half of this year as that facility ramps up?

Sheri Savage

Yes. I think we’ll take a look at how that will affect our model over the course of the year. Right now we see ourselves still at the high-end of our model, especially now that we’re starting to get into the $1.5 billion to $2 billion bucket that we put out in our model. So we’ll see some increase in margin, but we will see how that flows through with the volume of revenue that flows in at the latter half of the year.

Krish Sankar

Got it. Thanks, Jim. Thanks, Sheri.

Sheri Savage

Thank you.

Operator

The next question is from Quinn Bolton with Needham & Company. Please go ahead.

Quinn Bolton

Hey, guys. Congratulations. Just wanted to follow up on the last question just about the gross margin effect from Malaysia, I assume that as that comes online, you are saying that you think that that’s margin accretive and could be a tailwind in the second half. I just want to make sure I got your comment correctly.

Sheri Savage

Yes. So it just really depends on the amount of volume going through. So obviously, it is a lower-cost region for us, and that will obviously help us from a labor perspective. The volume is really the key thing there in terms of how much goes through. But yes, it could be helpful to get us continue to have us be at the higher end of our gross margin model and possible expansion. We will be looking at our model, as mentioned before, once the Hamlet acquisition comes into play and we will be taking a look holistically across all of our product lines to provide a updated model based upon that.

Quinn Bolton

Great. Second question for me. The services business actually growing in the fourth quarter, surprised to say, I thought you were looking for potentially a step back in that business in the December quarter as one of your large customers went through a fab transition. It doesn’t look like that had an impact on the business. So just wondering if you could give us a little bit more color on the services business and do you expect that to grow in – sequentially in the March quarter?

Jim Scholhamer

Yes. We saw some – yes, you’re right. We definitely saw a temporary slowdown in the – from the Israel logic site as we had talked about before. We saw a little bit more strength in the memory side of things in Korea than what we had anticipated. And I think we do see that will continuing. And then with the fab conversion kind of coming back in logic in Israel there, we would expect to see service continue to grow sequentially over the next quarters.

Quinn Bolton

Great. And then the last question for me. I understand you’re not giving guidance for the full year, but it sounds like 15% WFE growth you guys target growing faster than that. Could you make any comments about linearity sort of first half versus second half? Has there been – there has been some debate in the industry as to whether it’s a front-half weighted year or more of a balanced or even a second-half weighted year. Just any thoughts you have on kind of first half versus second half would be helpful.

Jim Scholhamer

Yes. Yes, we’ve been following those comments as well. Obviously, the first half benefits from improved visibility and it looks pretty strong. As we look at the end market fundamentals though, I think a lot of the second half and 2022 and increasing the strength kind of compounding from that it’s kind of a little bit dependent on some more NAND capacity adds versus the technology moves and also memory, which is starting to add capacity continuing to accelerate. So it’s difficult – it’s really difficult to call.

I mean, obviously people call in the first half because that’s where we could see pretty clearly. But I don’t know if I would call – I would make a call at this point that the first half is going to be stronger than the second half. It’s really – I think it’s really too early. I had a look at it. The first half is pretty strong, very strong and then we see a lot of downstream indicators that there is no reason why the second half shouldn’t continue, but there’s always – with the caveat of, I mean unusual events that occur. So it’s really too early to say, I think the entire year being pretty strong as its kind of – it’s definitely there’s a consensus on that. And if there is any waiting, I don’t think it would be significant that’s kind of my view.

Quinn Bolton

Great. Thank you, Jim.

Operator

The next question is from Patrick Ho with Stifel. Please go ahead.

Patrick Ho

Thank you very much for taking the question. And congrats on a really nice end to the year. Jim, maybe first off staying on the Services side for a second, on the parts cleaning business, typically utilization rates are key driver for that business and obviously showing that on the memory front, but can you talk about any potential incremental increases in that business due to the complexities of devices, maybe more specifically on memory both for NAND and DRAM as they get more complex. Do you see, quote increasing, I guess content or increasing services use because of the complexities of those devices on top of high utilization rates?

Jim Scholhamer

Yes. I think that’s a fair assumption, that definitely you could see the cleaning cycles accelerate like they are towards the leading nodes and not logic which would obviously cause a higher cleaning intensity, if you would. And in addition to that, it also requires more the leading edge kind of cleaning applications and more complex approaches to it, which obviously fits well into our bailiwick.

And then third, then you still have logic pushing some pretty extreme dimensions with 7-nanometer and 5-nanometer and 3-nanometer, which is adding new requirements to cleaning, which is the coating and the texturing of the parts for yield and particle control is starting to become a more significant added process that you don’t tend to see at those at those older nodes. So I think there’s kind of three factors that really come into play that should help the cleaning and the analytics business to really maybe start to part ways with wafer starts and actually become grow a little faster. But, I think it’s kind of early days to see how that happens. But I think that’s definitely something kind of cooking in, those forces are building up.

We’re also seeing a lot of those devices start moving into more vacuum-based litho, even though some of the litho applications have started to become more vacuum-based, so you see another tailwind coming on there. So all those things added together bodes pretty well for that segment of the industry to really grow at an accelerated rate.

Patrick Ho

Great. That’s helpful Jim, and maybe as my follow-up question. You guys performed really well last year in 2020 despite the pandemic issues. Can you describe the supply chain – the supply chain situation that you have right now? And whether you feel you can meet the increasing demand that we’re seeing in the current environment?

Jim Scholhamer

Yes, I think in Asia the effect of COVID on the supply chain in the last few quarters has been minimal to almost nothing. Obviously in the U.S. and in Europe to some extent too around the holiday season, it was definitely something in the fourth quarter that we had to deal with the suppliers. UCT’s hasn’t been directly impacted in any way – any significant way by any COVID events.

And we saw that at the beginning of the quarter that we’re in, but I think we’re seeing less and less of COVID related supplier issues. Now it’s the – it’s the typical issues going or ramping, ramping the supplier issues that come up, but it’s not. So at this point – at this point in time, its knock on wood, it hasn’t been anything that has been really materially impacting our ability to get our output.

Patrick Ho

Great. Thank you very much.

Jim Scholhamer

Thank you, Patrick.

Operator

The next question is from Christian Schwab with Craig-Hallum Capital Group. Please go ahead.

Christian Schwab

Great. Hey Jim, I just have one quick question, follow-up on memory. Have you seen any change in the last 90 days in your outlook between DRAM and NAND?

Jim Scholhamer

Not much of a change. I mean, NAND is still kind of where we thought, the people starting to continuing to transition to 128-layers, I think in the last quarter or two, we start seeing the 176-layer pilot production has started up. That was anticipated though, but we’re starting to see some of that kind of pick up but no real major capacity add we had in NAND and then still a little bit, kind of like the last cylinder to kind of really, really go forward with capacity.

DRAM is kind of moving along as we expected, after the price has stabilized, after the utilization of the fab – the existing fabs went up, we started to see DRAM capacity especially in Korea and in Xian. Some areas we started to see DRAM capacity add, start to roll in which we also anticipated. So I mean, those things are happening, but I think that was kind of how we saw the year rolling out.

Christian Schwab

Okay. The only reason I ask is, some of our checks have suggested that NAND utilization rates have immediately improved since December. And so it appears that improvement has not yet led to any dialogue that you’re hearing regarding increased wafer starts you got. Is that fair?

Jim Scholhamer

That’s correct. Yes. The first indicator is those utilization rate is going up. Yes, the next step is typically the discussions around or plan is around the capacity adds and that’s still we haven’t seen that taking place yet.

Christian Schwab

Great. No other questions. Thanks guys.

Jim Scholhamer

Thank you, Christian.

Operator

Showing no further questions, this concludes our question-and-answer session. I would like to turn the conference back over to management for any closing remarks.

Jim Scholhamer

Yes. Thank you very much for joining us today. And we look forward to speaking to you again in next quarter.

Operator

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