Q1 2024 Ultra Clean Holdings Inc Earnings Call

Participants

Rhonda Bennetto; Investor Relations; Ultra Clean Holdings Inc

James Scholhamer; Chief Executive Officer, Director; Ultra Clean Holdings Inc

Sheri Savage; Chief Financial Officer; Ultra Clean Holdings Inc

Charles Shi; Analyst; Needham & Company

Krish Sankar; Analyst; Cowen Inc

Christian Schwab; Analyst; Craig-Hallum Capital Group LLC

Presentation

Operator

Good afternoon, ladies and gentlemen, and welcome to the Ultra Clean Technology UCT. First Quarter 2024 earnings call and webcast conference call. At this time, all lines are in listen only mode. Following the presentation, we will conduct a question and answer session. If at any time during this call you require immediate assistance, please press star zero for the operator, this call is being recorded on Monday, May sixth, 2024.
I would now like to turn the conference over to Rhonda Bonanno, Senior Vice President of Investor Relations. Please go ahead.

Rhonda Bennetto

Thank you, operator. Good afternoon, everyone, and thanks. Thank you, operator. Good afternoon, everyone, and thank you for joining us. With me today are Jim Shaw, hammer 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.

James Scholhamer

Hello, everyone, and thank you for joining our call this afternoon. I will start with a high-level summary of our financial and operating results for the first quarter, then share some thoughts on the broader industry and trends we are seeing. I'll close by highlighting a couple of important awards before turning the call over to Sheri for a more inclusive financial review before opening the call up for questions. We reported a solid first quarter at the top and bottom line. The increase in orders above midpoint was driven by ongoing strength in the domestic China market and high-bandwidth memory and advanced packaging demand. Supporting AI. earnings came in above our guided range due to higher volume, favorable mix and our ongoing focus on site efficiencies, elevated domestic China demand underscores the importance that the Chinese government and chip industry has placed on becoming self-sufficient. Chinese chip companies are rapidly investing in new semiconductor factories to advance the nation's capabilities and address export controls imposed by the U.S. and its allies.
We recently celebrated the 20th anniversary of our Shanghai facility and are ideally located to support our local customers' growth plans based on external analysis and our customer roadmaps confirmed by our internal marketing intelligence. We anticipate demand levels in the region to remain consistent or even increased slightly through the end of this year. The second reason, revenue increased beyond our expectations was related to areas of deposition and etch demand and high bandwidth memory and advanced packaging supporting AI. Artificial intelligent models are advancing rapidly so that they can run on edge devices like PCs and smartphones, creating new and compelling capabilities in both the consumer and enterprise sectors.
Additional industry investment is required to meet the forthcoming demand for advanced computing, memory and storage. So growth is likely to be uneven within the value chain for a while yet in this landscape successful favor, those who are capable of quickly driving technological progress while also introducing innovation that disrupt the complexity associated with semiconductor fabrication. UTT. supports the world technology leaders in this sector and our deep relationships with them are helping to advance their roadmaps with positive results. The drive for localized chip manufacturing capabilities happening now in several countries is another tailwind that will support future demand and elevate UCT's significance with our customers in the US alone that shifts in size active committed 30 billion to date, supporting 275 billion. Investment by 2030 has just become increasingly critical to multiple industries and use cases around the world.
The long-term outlook for the semiconductor market is very robust. The expansion and diversification of our vertical capabilities over the past several years gives us a distinct competitive advantage to participate at all levels of industry growth from pad construction support through equipment build out to production services like part recycling and refurbishment, cleanliness and analytics. Furthermore, our dedication to manufacturing excellence remains unparalleled, distinguishing us from competitors and solidifying our leading position. For example, we are honored to have received two very prestigious awards recently. First, we were recognized by Texas Instruments with a 2023 Supplier Excellence Award. This award is reserved for an elite group of suppliers with exemplary performance in the areas of cost, environmental and social responsibility, technology, responsiveness, assurance of supply and quality.
And for the 2nd year in a row, we earned a child's 2024 Epic distinguished Supplier Award for consistently exceeding expectations as one of only 27 award recipients, UCT stood out among thousands of other suppliers because of our relentless drive to improve and serve as a benchmark for other suppliers across the ecosystem. And we believe that supply and demand will incrementally rebalance throughout the rest of this year. However, our opinion has not changed, and we expect a broader base recovery in 2025. We're performing effectively and have achieved notable advances in streamlining and expanding our capacity to meet the evolving demands of technology shifts. We see coming mindful of these trends, we have strategically mapped out our global footprint to ensure a diversified and efficient manufacturing presence supporting all our global customers. We are pleased with UCT's execution and are prepared to outperform again to the next phase of industry growth.
With that, I'll turn the call over to Sheri for our financial review. Cheri?

Sheri Savage

Thanks, Jim, and good afternoon, everyone. Thanks for joining us in today's discussion. I'll be referring to non-GAAP numbers only. As Jim noted, in the first quarter, we saw an increase in our products business within the China domestic market and some new demand for products to bring AI, which we expect to stay around these levels.
Our service business, we also saw elevated demand from China along with some additional business from a fab relocation. Total revenue for the first quarter came in at $477.7 million compared to $444.8 million in the prior quarter. Revenue from products increased to $418.5 million compared to $389.7 million last quarter, services revenue was $59.2 million compared to $55.1 million in Q4. Total gross margin for the first quarter increased to 17.9% from 16.7% last quarter. Product gross margin was 15.8% compared to 14.6% in the prior quarter, and services was 32.3% compared to 31.7%. And Q4 margins can be influenced by fluctuations in volume, mix and manufacturing region as well as material and transportation costs. So there will be variances quarter to quarter.
Operating expense for the quarter was $54.5 million compared with $51.3 million in Q4. As a percentage of revenue operating expense remained flat compared to Q4 at 11.4%. Total operating margin for the quarter increased to 6.5% compared to 5.2% in the fourth quarter margin from our products division was 6% compared to 4.6% in Q4, and services margin was 10.1% compared to 9.5% in the prior quarter. Margin improvements were largely due to higher revenue and operating efficiencies based on 45.1 million shares outstanding. Earnings per share for the quarter were $0.27 on net income of $12.1 million compared to $0.19 on net income of $8.5 million in the prior quarter due to favorable product mix and factory utilization. Our tax rate for the quarter was 19.7% compared to 16.4% last quarter. We expect to we expect it to stay in the high 10s for 2024 free as the balance sheet, our cash and cash equivalents were $293 million compared to $307 million in Q4 cash flow from operations was $9.8 million compared to $35.3 million last quarter. The change in cash flow from operations was due to year-end compensation payments and increased inventory to meet elevated demand. In early April, we amended our term B debt facility to extended to February 2028, strong demand from existing and new high-quality lenders enabled us to incrementally upsize the offering by $20 million and reduce our interest rate by a quarter point in conjunction, we extended the maturity of our revolving credit facility to August 2027. For the second quarter, we project total revenue between $465 million to $515 million. And we expect EPS in the range of $0.16 to $0.36.
And with that, I'd like to turn the call over to the operator for questions.

Question and Answer Session

Operator

Ladies and gentlemen, we will now begin the question and answer session. Should you have a question, please press star followed by the number one on your telephone and you will be you will hear a prompt that your hand has been raised should you wish to decline from the polling process, please press star followed by the number two. If you are in a speakerphone, please lift the handset before pressing any keys. Your question comes from the line of Charlie Chen from Needham. Please go ahead.

Charles Shi

Hey, good afternoon, Jim and Sheri. Congrats on the solid results and very strong guidance. I think I Jim in your prepared remarks, I got the sense that your your strength in Q1 seems to be primarily due to some of the upside you see with your Chinese OEM customers and I did notice that your PowerPoint that that the category called other OEM, meaning outside of Lam and Applied, seems to have seen the most amount of growth, but it gets a little bit hard for me to reconcile because China revenue has been like a single digit percent of your total revenue. So how do I think about your actual exposure to the Chinese OEMs at this point?

James Scholhamer

Yes, Charles, hi, Tom. Yes, you're right over the Chinese revenue is directly to the OEMs is relatively small, but it actually and it doubled. I think over the last two or three quarters and then nearly doubled again. So if you think about our our overdrive on revenue, I mean that was about half of it. The other half was on deposition tools that are used in the AI applications.

Charles Shi

Got it. So it sounds like the hemoai. side, it's probably largely dominated by a deposition type of tools, probably electroplating, if I have to take a guess?

James Scholhamer

That's a good guess.

Charles Shi

Thanks, Jim. So maybe another question about service share. You mentioned about fab relocation of part of the reason for the service revenue strength, what do you mean by that fab relocation?

Sheri Savage

Yes, we had a customer that moved some of their parts that needed to be cleaned on to a different location. And as a result, we had some additional revenue flow through the services P&L.

Charles Shi

Got it. That's not a China customer.

Sheri Savage

No, no, no, it is not, I mean, with every incremental dollar that we put into service. And basically, it really helps them bring that margin up with with the volume flowing through their garden.

Charles Shi

So so maybe the two largest stuff, I mean, SAP customers, I would guess it's an Intel and Samsung, but that and how how are the business there are trending so far as are still looking quite positively so far?

James Scholhamer

Yes. I mean, again, child so you have a positive would be would be optimistic, is that it's definitely inching up. It has inched up a little bit, as you saw, it's not a it's not a extremely strong recovery, but we are seeing signs of utilization starting to increase and some of the idled systems starting to be, but back in getting ready for her for a scaling up. So yes, it is getting a little bit better, but it's not it's not extremely Steve Perbio.

Charles Shi

Thanks, Jim. And Sheri, congrats on the results. I'll hop back in the queue.

James Scholhamer

Thanks, Jerome.

Sheri Savage

And Jim.

Operator

Your next question comes from the line of Krish Sankar from Cowen. Please go ahead.

Krish Sankar

Yes, thanks, for taking the question and congrats on the strong results out of a couple of questions. One is a follow-up on Charles' question on the China revenues. You mentioned the domestic China strength. Is that maybe is that comment related to what you're seeing from China semi-cap volumes or is that also tied to your US semi-cap customers?

James Scholhamer

Because my understanding was that you might not have the visibility with the U.S. semi-cap customers with the end customer is yes, you're right, Krish, we don't usually have the visibility or we have it, but it's in thousands of pieces on where we're shipping everything, but this is direct business from our Chinese factory directly to Chinese OEMs who've been servicing and several of these OEMs for over 15 years. We have long relationships with them, and we're pretty unique in the supply chain to have to have that where we're directly supplied into the OEM in China and have been doing that for a long time. We've seen a significant, like I mentioned earlier to Charles, we've seen that that business grow from mid-single digits to double and then double again. And we expect that to continue throughout the year. And as we as we look into what's going on with it and where it's going, we estimate about anticipate your next question, Chris, that we anticipate about half of it is going in directly at the line and going into production. And the other half is a little bit pre-ordered in anticipation of perhaps some more rules coming down, the trade trade restrictions. So that all of that we think is being is being driven directly as an immediate need, but it's been a very healthy growth and we think it's not just the stockpiling these cut. These customers are picking up new applications and are starting to grow much faster than we've seen over the last 15 years.

Krish Sankar

Data and data will follow up with you and then like a follow up, you know, obviously one of your US semi cap OEMs, we have pretty good exposure to some of the lagging edge product nodes versus the Southern term. Just kind of curious, I understand China demand is very strong, which is lagging edge. But how do you see the non-China lagging edge demand.

James Scholhamer

I'm sorry, non-China what demand?

Krish Sankar

Leading edge?

James Scholhamer

Yes, on the lagging edge demand has also been strong, and that's what you're asking about. But it is I think that strength was appeared maybe a quarter to show that it's going to be tough temper a little bit, but it has been elevated.

Krish Sankar

Got it. Got it. And then one final question. Obviously, I think you've spoken about ASML exposure in the past year. The demand side was probably for more of the high-pressure components was a little greater than 10%. Customers is still too small for you for.

James Scholhamer

It is not mid single digits and on its way, we believe in a within a few years. But yes, it is. And I think Charles mentioned the other. The other has a smasmlkla. has as well as the Chinese OEM. So that's where you see a lot of the a lot of the numbers pile up, Firebag.

Krish Sankar

Thank you very much.
Very helpful.

Operator

Your next question comes from the line of Christian Schwab from Craig-Hallum Capital Group. Please go ahead.

Christian Schwab

Congrats on the good quarter. And Jim, what would you anticipate from your memory customers utilization to improve enough to show up in the clean business.

James Scholhamer

And we're anticipating we've been pretty consistent and above the WFE side of it. The product side probably not improving until 2025. And I think we're sticking with that. And the service decided it's difficult to predict. It's definitely outside of our bottoms up would know by you would anticipate from the past that we'd see that start to tick up. You know, in the latter half of 2024, you start to see the equipment orders coming in in 2025.

Christian Schwab

Okay. Okay. And then what is your, you know, your kind of baseline thoughts of what you would anticipate on WFE growth to be in '25.
And the next question to that would be what type of growth rate would you anticipate you could position forward and outgrow WFE on a go-forward basis, similar to what you did the last upcycle?

James Scholhamer

Yes. Think we're our current view, which we're always updating is low double digit in 2025 growth in WFE. And of course, you know, it's always difficult to predict and things tend to be stronger than you expected weaker than you expect, depending on the where we are in the cycle.
As far as our growing, I think ITO, it's the same formula we've been following for for years that has led to our outgrowing WFE. We have a lot of I would say, whereas a lot of the runway or the green pastures are the opportunities. The HIS. acquisition has a lot of growth expected in that segment. As with all the fab buildouts and their strong position there that we're making stronger from our Fluid Solutions acquisition as well. I mean, we have a relative we have a great product line, but a relatively small our market share versus the two industry leaders. But we've been working on getting those qualified in our main main customer that that prior to our acquisition that was a slower slog for Hamlin, the company that we bought. So we're seeing that accelerate as well as I think with what I would say, we're pretty well penetrated at our largest customer. But I think in the segment and when you look at the second, third and fourth is a lot of opportunity there for are market share growth within those customers.

Christian Schwab

Okay. No other questions. Thanks, guys.

Operator

There are no further questions at this time. I would like to hand the call back to Jim Shaw Halmar for closing remarks.

James Scholhamer

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

Operator

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.