Ultra Clean Holdings, Inc. — Q2 2019 Form 10-Q
Business context and period. The quarter ended June 28, 2019. Ultra Clean supplies semiconductor equipment subsystems and provides semiconductor parts-cleaning and related services. Results include the Quantum Global Technologies (QGT) services business, acquired in August 2018, and Dynamic Manufacturing Solutions (DMS), acquired April 15, 2019; therefore, year-over-year comparisons reflect a changed business mix. The company reports Semiconductor Products and Solutions (SPS) and Semiconductor Services Business (SSB).
Key financial results
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Revenue | $265.4m | $290.2m | $525.5m | $605.1m |
| Gross profit; gross margin | $48.2m; 18.2% | $46.1m; 15.9% | $93.0m; 17.7% | $94.9m; 15.7% |
| Operating income; margin | $9.0m; 3.4% | $22.7m; 7.8% | $17.2m; 3.3% | $49.6m; 8.2% |
| Net income (loss) attributable to UCT | $(0.2)m | $19.0m | $0.4m | $43.7m |
| Diluted EPS | $(0.01) | $0.48 | $0.01 | $1.14 |
| Cash from operating activities | — | $68.0m | $(12.0)m |
- Drivers and changes: Q2 revenue fell 8.6%; SPS revenue declined to $210.4m from $290.2m, partly offset by $55.0m of SSB revenue, with no comparable SSB segment in Q2 2018. Management attributed weaker SPS demand to reduced semiconductor-equipment customer demand, including excess memory levels and slower China investment. First-half revenue fell 13.1%. SPS gross profit and operating income declined; SSB contributed $18.9m gross profit and $2.6m operating income in Q2.
- Margins and expenses: Consolidated gross margin improved, reflecting the higher-margin SSB business, partly offset by SPS mix and QGT-related intangible amortization. Operating income fell as operating expenses rose, notably G&A, which included acquired-business costs, acquisition expenses, amortization, audit work and ERP implementation costs. Net interest and other expense was $6.4m in Q2 and $11.7m for the first half, primarily due to higher debt and interest following QGT financing. Q2 income-tax provision was $2.8m, with a 109.8% effective rate; the filing attributes rate changes principally to geographic earnings mix and losses in jurisdictions with full valuation allowances.
- Cash and liquidity: Cash was $168.1m at June 28, up from $144.1m at year-end. First-half operating cash flow was $68.0m, supported in part by working-capital movements, including lower inventory and receivables. Investing cash use was $36.2m, including $29.9m paid for DMS; financing cash use was $5.5m. Capital expenditures were approximately $6.0m. Management expected cash, operating cash flow and available facilities to cover debt service and working-capital needs for at least 12 months.
- Debt and obligations: Total bank debt was $338.1m net of $10.6m of unamortized issuance costs; this included a $333.4m term loan and $15.0m drawn on the U.S. revolver, plus a small foreign facility. The term loan matures in 2025 and bears LIBOR-based interest plus 4.5%, subject to adjustments. The company was compliant with its financial covenants at quarter-end. It reported $48.5m available on the U.S. revolving facility and $9.1m available on the Czech facility. Inventory purchase commitments were $82.6m.
Outlook, risks and unusual items
- Management expected revenue to decrease in Q3 2019 because of continued decline in overall customer demand; no numerical revenue or earnings guidance is provided in the filing.
- Key risks include semiconductor-industry cyclicality, limited order visibility, customer and revenue concentration, pricing pressure, supply-chain and inventory exposure, acquisition integration, significant debt and covenant constraints, foreign operations and tariffs, and execution of the company-wide ERP implementation.
- Lam Research and Applied Materials represented 60.3% of Q2 revenue and 60.5% of first-half revenue. Three customers together represented approximately 62.3% of accounts receivable at quarter-end.
- QGT and DMS acquisitions added goodwill, acquired intangibles and contingent earn-outs. Potential earn-outs are up to $15.0m for QGT and $12.5m for DMS; purchase price allocations remained preliminary. Q2 included $2.3m of QGT acquisition-related costs and $1.2m of DMS acquisition-related costs for the first half, as disclosed in the notes.
- Adoption of lease accounting standard ASC 842 added operating lease right-of-use assets and liabilities; reported operating lease liabilities totaled $37.0m at quarter-end. The company maintained a full valuation allowance on federal and state deferred tax assets. Management said ordinary-course legal proceedings were not expected to have a material adverse effect.
Important facts for investors to verify
- Whether customer demand and SPS revenue stabilize, and whether management’s stated Q3 revenue decline develops as expected.
- SSB’s standalone growth, margins and contribution to consolidated results as acquisition comparisons become more representative.
- Debt repayment capacity, interest expense, covenant headroom and remaining availability under credit facilities.
- Acquisition integration and final purchase-price allocations, including goodwill, intangible amortization and earn-out outcomes.
- Customer concentration, $82.6m of inventory purchase commitments, and progress and costs of the ERP implementation.