Q1 2023 Ultra Clean Holdings Inc Earnings Call

Participants

James P. Scholhamer; CEO & Director; Ultra Clean Holdings, Inc.

Rhonda M. Bennetto; SVP of IR; Ultra Clean Holdings, Inc.

Sheri L. Savage; CFO & Senior VP of Finance; Ultra Clean Holdings, Inc.

Christian David Schwab; Senior Research Analyst & Partner; Craig-Hallum Capital Group LLC, Research Division

Robert Bruce Mertens; Research Associate; TD Cowen, Research Division

Unidentified Analyst

Presentation

Operator

Good day, and welcome to the Ultra Clean First Quarter 2023 Earnings Call and Webcast. 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 M. 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 P. Scholhamer

Thank you, Rhonda, and good afternoon, everyone. Thank you for joining us for our first quarter 2023 conference call and webcast. I'll start with a high-level overview of the first quarter that Sheri will expand on in our comments and follow that with the steps we are taking to manage through this downturn and conclude with our view on the longer-term prospects of our industry.

As expected, industry demand remained under pressure in the first quarter as OEM customers continue to cancel or push out orders against the backdrop of inventory surplus and ongoing geopolitical and macroeconomic uncertainty. End market demand remains weak, therefore, UCT's revenue is likely to remain constrained in this environment.

Holding from our playbook from the last downturn, we are focused on aligning our operational efficiencies and cost structure with the prevailing business environment. Our objective is twofold: to mitigate the impact of the downturn as much as possible and prepared to outperform the market again during the next expansion phase. While we are slowing down some of our global capacity expansions in both products and services to align with our customers' road maps, we are moving some projects forward to be ready for the inevitable ramp in volume that follows every semiconductor downturn.

We saw growth in our Fluid Solutions business in the first quarter and continued to expand production in our Malaysia plant, which will improve our profitability and deliver performance down the road. In the services business, we are developing higher-value solutions such as special yield-enhancing part coatings and cleaning methods to support ongoing node transitions. We are one of the few large purely semiconductor-focused manufacturers with the proven ability to support the dynamic product demand and stringent quality levels required for advanced chip manufacturing.

We are extremely confident about the industry's upward trajectory over the long term, driven by emerging key sectors such as automotive and industrial automation, high-performance computing and especially for artificial intelligence and machine learning. To add some perspective, today's average electric car has doubled the chips of a nonelectric vehicle. Even more impressive is the phenomenal growth of Microsoft's AI ChatGPT, which requires massive amounts of memory and data processing chip technology. When launched last November, it attracted 1 million registered users in just five days and only two months later, it had registered more than 100 million users. It is by far the fastest-growing chip dependent consumer application and history.

Leading-edge technologies like this are in the very early stages of widespread deployment and have only touched on the exponential growth in commercial use cases, which should drive the semi industry towards the trillion dollar mark this decade. While it feels like we are in the doldrums at the moment, we believe it is temporary, and we couldn't be more excited about the future. UCT has been enabling technology and supporting the life cycle of chip manufacturing for over 30 years. We indirectly touch nearly every chip on the planet and are ideally positioned with the expertise and capacity to fully capitalize on opportunities during the next upturn. I would like to thank our employees and our shareholders for their continued support through all our phases, and I look forward to updating you on our next call. With that, I'll turn the call over to Sheri.

Sheri L. Savage

Thanks, Jim, and good afternoon, everyone. Thanks for joining us. In today's discussion, I will be referring to non-GAAP numbers only. As Jim noted, the abrupt industry downturn that started late in Q4 carried over to Q1 as customers continue to push out and cancel orders. We have implemented cost-saving initiatives and our top priorities are to protect profitability and generate cash on reduced revenue while keeping in mind the industry will recover. Total revenue for the first quarter came in at $433.3 million compared to $566.4 million in the prior quarter. Products division revenue was $368.6 million compared to $499.5 million last quarter. And revenue from our Services division was $64.7 million compared to $66.9 million in Q4.

Total gross margin for the quarter was 17.3% compared to 19.5% last quarter. Products gross margin was 14.7% compared to 17.7% in the prior quarter, and services was 31.7% compared to 33.5% in Q4. The decline in Q1 can be attributed to lower volumes and product mix. We are continuing to focus on cost improvements to strengthen profitability. Operating expense for the quarter was $52.7 million compared with $53.8 million in Q4. As a percentage of revenue, operating expense was 12.2% compared to 9.5% in the prior quarter. Total operating margin for the quarter was 5.1% compared to 10% in the fourth quarter. Margin from our Products division was 4.1% compared to 9.9% in the prior quarter, and services margin was 10.8% compared to 11.3% in the prior quarter.

The reduction in margins was due mainly to decreased efficiencies on lower volumes and product mix and some higher year-end related expenses. Many of the cost reduction initiatives we have implemented, some of which were initiated late in the quarter, can take time to be reflected in our financial results. Based on 44.8 million shares outstanding, earnings per share for the quarter were $0.17 on net income of $7.6 million compared to $0.93 on net income of $42.6 million in the prior quarter. Our tax rate for the quarter was 16% compared to 13.7% last quarter. We expect our tax rate for 2023 to stay in the mid- to high teens.

Turning to the balance sheet. Our cash and cash equivalents were $322.1 million at the end of the first quarter compared to $358.8 million last quarter. Cash from operations was $28 million compared to an outflow of $38.8 million in the prior quarter, driven primarily by improvements in working capital. The effective management of our working capital continues to be an important focus, especially in the current phase of the cycle. During the quarter, we made an additional debt payment of $20 million and repurchased 433,000 shares at a cost of $14.2 million. Given the current dynamic state of the industry, we are keeping our guidance range wide. We project total revenue for the second quarter of 2023 between $410 million and $460 million. We expect EPS in the range of $0.15 to $0.35.

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

Question and Answer Session

Operator

We will now begin the question-and-answer session. (Operator Instructions.] Our first question comes from Quinn Bolton with Needham.

Unidentified Analyst

This is Trevor on for Quinn. So last quarter, you noted that without the $30 million impact, revenue guidance for the first quarter would have been around $450 million and then stabilize around that figure through 2023. And now with Lam and ASMI stating that memory is weaker than expected and that foundry logic outlook has slightly weakened as well. Do you see that $435 million guidance midpoint as the new baseline? And then also, how much of that $30 million impact falls into Q2?

James P. Scholhamer

Yes. Trevor, Short answer is yes. That's probably a new baseline. What we saw in the first quarter, we were able to make up a lot of that $30 million that we thought was going to move out of the quarter due to the supplier issue, but we did see further drops from two of our customers unexpectedly that did happen, some pushouts and cancellations within that quarter. So that's why we ended up roughly where we expected in Q1. But that kind of a little bit of a notch down that occurred in orders in Q1, we expect that will carry forward. So yes, this is roughly the new baseline is where we are right now.

Unidentified Analyst

Okay. I guess based off that, with most of the $30 million falling into 1Q, could we possibly see a half-over-half increase in the second half with most of the demand coming in towards the end of the year? I guess any positioning thinking about 2023 would be helpful.

James P. Scholhamer

No. As I said on the last call, we expect things to be relatively constant through the year. So that's our expectation, and we're not forecasting the second half. If there were any movements from that, I think it's more likely that it could be up versus down. But our outlook right now is relatively flat through the year.

Unidentified Analyst

Okay. And if I could sneak one more in. So, with mature spending continuing to be robust, particularly in China. I'm wondering if you can quantify your exposure to both the leading edge and mature markets? Any color there would be awesome as well.

James P. Scholhamer

Sure. Yes. A lot of the items that we make are for both leading edge and legacy. So, we don't have it broken down by -- when we make a module, it could go on a leading-edge tool for the very same module could go on a trailing-edge tool. So that's something we don't really have broken down. What we make and sell directly into China is around $20 million a quarter. But where the customer sends it, which application, that's difficult for us to really ascertain. But obviously, a little bit of that strength has helped stabilize where we are at this current level. Yes.

Operator

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

Christian David Schwab

So, as we look to the recovery, I assume you kind of think it will probably run like Lam highlighted where, first, we have utilization rates go up, you should see that, your Quantum business, and memory, and then we'll do some upgrades and then capital equipment will kick in. Is that kind of the way you guys are thinking about it?

James P. Scholhamer

Yes, exactly, Christian. And this go around, there's a bit of finished goods inventory on our customer side as well. So that will create an additional bit of lag even after wafer starts to go up. I think there needs to be a little bit more flush through of finished goods from our customers, the equipment makers.

Christian David Schwab

Okay. So, if we get towards the tail end of this year, beginning of next year and begin to see a capital equipment recovery cycle, you would still maybe have a quarter lag or so versus maybe, say, your two largest customers, AMAT and Lam if we saw a recovery. Is that the right way to think about it?

James P. Scholhamer

Yes. I think a quarter at the most. We're seeing -- obviously, there's efforts on their side to draw their inventory down through this year and that, so we're seeing some of that impact in our year this year. So hopefully, the delay is at most a quarter, but hopefully even less.

Operator

Our next question comes from Krish Sankar with Cowen.

Robert Bruce Mertens

This is Rob Mertens on behalf of Krish. I guess just in terms of last quarter, when you were talking about seeing the industry downturn sort of later in the quarter with customers either push out orders or canceling. Could you just provide a little bit more detail into the timing of these orders or cancelations that you've seen and how does it progress through the most recent quarter? Is that something that's sort of worsening or you're expecting more of a steady state from your guidance?

James P. Scholhamer

Sure. Yes. We saw a bit of a notch down which we overcame by overcoming some of the supplier issues on the other side. We saw a bit of a notch down in roughly halfway through the quarter. And that was most -- a lot of that was from one of the OEM manufacturers that hadn't really done a lot of pushouts yet. So, it felt more like a delay from the late November actions that took a little bit longer to work through into end of January. So having said that, we've seen things pretty stable since then. So, we don't expect a lot of movement on that side going forward.

Robert Bruce Mertens

Great. That's helpful. And then just in terms of inventory levels at your major customers, I know you mentioned a little bit, but just sort of if you had any sort of guidance into what you might expect to see more of a balance there. Would that be something that the back half of the year or potentially further out?

James P. Scholhamer

Yes. Typically, our customers do not inventory the majority of the things that we manufacture. That's just kind of an unusual situation given how sudden this downturn hit at the end of November. So that's not -- typically, we are not making things like power supplies or standard components that sit on the shelf. So, it's a bit of an unusual situation. So, they're drawing some of those things down now, which is impacting our revenue. We expect they'll draw that down through the year. And as I just said to Christian, hopefully, by the end of the year, we would expect it to be back to the more normal levels where there just isn't much finished goods between us and the OEM customers. But that's really hard to tell. You can -- there's a really good report on tech insights showing the inventory levels in the systems both at the OEM level and also the subsystem level, the suppliers like us. And so, you could see the inventory problem pretty clearly in those charts. But that's through the end of 2022. So, I'm looking forward to seeing the data as it comes out. But my anticipation would be that we start to see those start to drop through 2023 and hopefully clear out somewhere in the second half.

Operator

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

James P. Scholhamer

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

Operator

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