Ultra Clean Holdings, Inc. annual report, FY2013

Ultra Clean Holdings, Inc. — FY2013 Form 10-K

Business and period. Ultra Clean supplies engineered subsystems, primarily to semiconductor equipment OEMs, and also serves medical, flat panel, energy and research markets. This annual report covers the fiscal year ended December 27, 2013; fiscal 2013 had 52 weeks. The company reports one operating segment. The figures below are in millions of dollars unless stated otherwise.

Financial results and liquidity

Metric	FY2013	FY2012
Sales	$444.0	$403.4
Gross profit / margin	$67.3 / 15.2%	$55.8 / 13.8%
Operating income / margin	$15.9 / 3.6%	$8.3 / 2.1%
Net income	$10.4	$5.2
Diluted earnings per share	$0.36	$0.20
Cash from operating activities	$29.9	$27.3
Cash used in investing activities	$2.9	$75.6
Cash from (used in) financing activities	$(21.0)	$50.4

Fourth-quarter FY2013 sales were $126.3 million, gross profit $21.6 million and net income $6.4 million; diluted EPS was $0.22.
Year-end cash and cash equivalents were $60.4 million, working capital $100.4 million and total assets $292.5 million. Accounts receivable was $67.5 million and inventory $63.9 million.
Debt totaled $55.1 million net of issuance costs: $27.5 million under the term loan and $28.8 million under the revolving facility before the netting reflected in the reported total. The company classified revolver borrowings as short-term because of acceleration provisions. It reported $11 million of additional revolver availability.
Approximately $42.9 million of cash was held by foreign subsidiaries. Repatriating foreign funds could trigger U.S. taxes; the company reported $43.7 million of foreign earnings intended to remain invested abroad.

Changes from the prior period

Sales increased 10.1%, but the increase primarily reflected a full year of AIT sales in FY2013 ($122.4 million) versus six months in FY2012 ($63.8 million). Excluding AIT, Ultra Clean’s sales declined, affected by the FEI transition, a customer’s decision to in-source part of its gas-panel business and semiconductor market softness.
Gross margin improved to 15.2% from 13.8%, which management attributed chiefly to product mix and operating efficiencies, partly offset by higher inventory reserves.
Operating income and net income rose from FY2012, which included $2.4 million of AIT acquisition costs. Higher FY2013 operating results were partly offset by interest and other expense rising to $3.3 million from $1.6 million, primarily due to acquisition-related borrowing.
Operating cash flow increased to $29.9 million from $27.3 million. Inventory declined as a use of cash by $9.1 million, while accounts payable and other current liabilities increased substantially; operating cash flow therefore also reflected working-capital timing.
FY2012 results included the AIT acquisition only from July 2012, so reported year-over-year comparisons are not like-for-like.

Outlook, management commentary and risks

Management expected sales to increase modestly in the first quarter of FY2014 versus the fourth quarter of FY2013 and gross profit to be slightly higher, primarily with the expected sales increase. No full-year numerical guidance is provided in the filing.
Management said existing cash and expected operating cash flow should be sufficient to service debt and fund working capital and technology development for at least the next 12 months, subject to business conditions and covenant compliance. The company was in compliance with its debt covenants during FY2013, following a 2013 amendment and waiver related to FY2012 noncompliance.
Customer concentration is significant: management reported the top three customers accounted for 81% of FY2013 sales. Applied Materials represented 35%, Lam Research 33% and ASM International 13%. The filing gives differing prior-period top-three concentration figures in different sections; investors should verify the comparison and definitions.
Key risks include semiconductor cyclicality, customer concentration and customers’ ability to cancel or delay orders, in-source production or pressure pricing; supplier and component availability; execution and integration of AIT; debt, covenant and refinancing constraints; foreign operations and repatriation taxes; and potential inventory obsolescence or goodwill impairment. Inventory write-downs were $1.5 million in FY2013.
The AIT acquisition had a total purchase price of $104.9 million, funded partly with debt and 4.5 million newly issued shares. Goodwill was $55.9 million at year-end; management reported no goodwill impairment in its FY2013 test.
President and COO Gino Addiego notified the company in February 2014 of his intent to resign, effective on or about March 10, 2014. This was subsequent to the fiscal year-end.
The company reported an unqualified independent audit opinion on the financial statements and internal control over financial reporting. Ordinary-course legal proceedings were not believed by management to be materially adverse.

Important facts for investors to verify

How much of sales growth and margin improvement is sustainable absent the AIT acquisition effect, and how customer in-sourcing and the semiconductor cycle affect FY2014 demand.
The customer-concentration disclosures: the filing’s narrative gives top-three shares of 81%, 80% and 68% for FY2013, FY2012 and FY2011, while its customer table reports different prior-year totals for customers individually above 10%.
Debt classification, available borrowing capacity, upcoming covenant thresholds and the ability to maintain required domestic cash balances; the revolver is presented as short-term due to acceleration clauses.
The amount, tax cost and accessibility of overseas cash, and the effect of the Singapore tax holiday expiring for tax years beginning in January 2015.
AIT integration progress, customer retention, realized synergies, and the impact of the COO’s planned departure.
Potential inventory valuation exposure, purchase commitments of $53.6 million, and the assumptions supporting the $55.9 million goodwill balance.