Ultra Clean Holdings, Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter ended June 29, 2018; six-month comparison is to the period ended June 30, 2017. Unaudited figures are presented in millions of dollars, except per-share data.
Business context and reporting period
Ultra Clean designs and manufactures production tools, modules and subsystems, primarily for semiconductor capital-equipment manufacturers. It reports one operating segment. Results reflect strong first-half semiconductor demand, but management said some OEM customers began reducing orders midway through 2018 as they deferred capital spending.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Sales | $290.2 | $228.3 | $605.1 | $432.9 |
| Gross profit | $46.1 | $43.4 | $94.9 | $80.9 |
| Gross margin | 15.9% | 19.0% | 15.7% | 18.7% |
| Operating income | $22.7 | $24.4 | $49.6 | $44.2 |
| Net income | $19.0 | $20.2 | $43.7 | $34.5 |
| Diluted EPS | $0.48 | $0.59 | $1.14 | $1.01 |
| Operating cash flow | Not separately presented | Not separately presented | $(12.0) | $20.2 |
Q2 sales rose 27.1% year over year; first-half sales rose 39.8%. Higher shipment volumes lifted gross-profit dollars, while margins declined mainly because of product mix, higher costs to meet demand and a faster ramp of new products. Q2 operating income fell despite revenue growth as operating expenses increased, particularly general and administrative expense. First-half net income increased, while diluted EPS also reflected growth in weighted-average shares following the February equity offering.
At June 29, 2018, cash and cash equivalents were $141.1, versus $68.3 at December 29, 2017. Total assets were $643.7 and stockholders’ equity was $439.3. Total bank debt was approximately $54.9, implying approximate net cash of $86.2. Available borrowing was limited: $0.1 under U.S. facilities and approximately $2.0 under the Czech facility. The company was compliant with its debt covenants.
First-half operating cash use of $12.0 compared with cash generation of $20.2 in the prior-year period. The filing attributes cash movements to working capital and timing; notably, accounts payable fell by $59.5. Investing cash use was $9.7, primarily for ERP development and facility expansion. Financing cash inflow of $94.6 primarily reflected approximately $94.3 of net proceeds from the February common-stock offering. Inventory was $228.6, and outstanding inventory purchase commitments were $134.2.
Material changes versus prior period
- Q2 net income declined 6.0% and diluted EPS declined from $0.59 to $0.48, despite 27.1% sales growth.
- Gross margin fell 3.1 percentage points in Q2 and 3.0 points for the first half.
- First-half operating cash flow swung from positive $20.2 to negative $12.0, largely amid working-capital movements, including a substantial reduction in accounts payable.
- Cash increased following the public equity offering; shares issued and outstanding increased to 38.9 million at quarter-end from 33.7 million at year-end 2017.
- General and administrative expense rose 31.3% in Q2, driven by outside services including non-capitalizable ERP implementation costs, incentive compensation, headcount and officer severance.
Outlook, risks and unusual items
- Management expected Q3 2018 sales to be lower than Q2 because of weaker semiconductor demand and customer capital-spending deferrals; it also expected lower gross profit. No numerical full-year guidance is provided in the filing.
- Customer concentration is significant: Lam Research and Applied Materials together accounted for 83.5% of Q2 sales and 85.7% of first-half sales. The company says customer orders are generally non-binding and lack minimum purchase commitments.
- On July 24, 2018, the company agreed to acquire Quantum Global Technologies for approximately $342 million in cash, subject to adjustments, plus potential earn-outs of up to $15 million. Closing was expected in Q3, subject to approvals and other conditions.
- Barclays committed, subject to customary conditions, to $400 million of senior secured facilities: a $350 million seven-year term loan and a $50 million five-year revolver. The term loan, together with cash on hand, was intended to fund the acquisition, refinance existing debt and pay related costs. The filing warns that the merger agreement has no financing contingency.
- Major risks include semiconductor-industry cyclicality, customer and supplier concentration, pricing pressure, inventory obsolescence, supply constraints, foreign-exchange and trade-policy exposure, and execution risks for the ERP implementation and acquisitions. The filing reports $85.2 million of goodwill and notes potential impairment risk.
- The company reported ordinary-course legal claims but did not expect them to have a material adverse effect. It maintained full valuation allowances on specified federal, state and Singapore deferred tax assets. The adoption of ASC 606 did not materially affect results or financial position.
- Management concluded disclosure controls were effective as of June 29, 2018 and reported no material change in internal control over financial reporting during the quarter.
Key facts for investors to verify
- Whether order reductions and deferred OEM capital spending caused the anticipated Q3 sales and gross-profit decline, and how demand evolved thereafter.
- Whether gross-margin pressure from mix, ramp costs and customer requirements persisted or improved.
- How operating cash flow and accounts payable developed, and whether inventory levels and $134.2 million of purchase commitments remained appropriate as demand softened.
- Whether the Quantum acquisition closed on expected terms, its financing and integration costs, and the resulting debt and covenant position.
- Whether customer concentration, particularly reliance on Lam Research and Applied Materials, changed materially.