Ultra Clean Holdings, Inc. — Q3 2018 Form 10-Q
Reporting period: Fiscal quarter ended September 28, 2018; comparisons are with the quarter ended September 29, 2017. Amounts are in U.S. dollars; financial figures below are in millions unless stated otherwise.
Business context
Ultra Clean designs and manufactures production tools, modules and subsystems, primarily for semiconductor equipment makers. On August 27, 2018, it acquired Quantum Global Technologies (QGT), adding semiconductor parts-cleaning, recoating and related services. QGT contributed approximately $22.5 million of sales after acquisition during the quarter.
Key financial metrics
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Sales | $234.1 | $242.6 | $839.1 | $675.5 |
| Gross profit / margin | $35.0 / 14.9% | $42.7 / 17.6% | $129.9 / 15.5% | $123.6 / 18.3% |
| Operating income | $0.9 | $23.3 | $50.5 | $67.4 |
| Net income (loss) attributable to UCT | $(6.0) | $19.7 | $37.7 | $54.2 |
| Diluted earnings (loss) per share | $(0.15) | $0.57 | $0.97 | $1.59 |
| Operating cash flow | Not separately provided | Not separately provided | $15.3 | $37.6 |
At September 28, cash was $160.3 million, current assets $484.8 million and current liabilities $175.6 million. Total assets were $986.6 million. Total bank debt was reported at $373.8 million, net of $12.0 million of unamortized issuance costs; the $350.0 million term loan was outstanding, and the U.S. revolver had no borrowings and $65.0 million available. The company also reported a €6.0 million FDS revolver borrowing and $28.8 million of acquired Korean subsidiary debt, which was repaid in October.
Nine-month investing cash outflow was $306.0 million, primarily reflecting the QGT acquisition; financing cash inflow was $383.0 million, including bank borrowing proceeds and the February stock offering. Cash increased by $92.0 million over the period. Inventory was $198.6 million, down from $236.8 million at year-end 2017; purchase-order commitments for inventory were approximately $94.3 million.
Material changes versus the prior comparable periods
- Q3 sales declined 3.5% year over year, which management attributed primarily to lower semiconductor customer demand. Nine-month sales increased 24.2%, reflecting higher shipment and service volumes, major-customer demand and the acquired QGT business.
- Q3 gross margin fell 2.7 percentage points. Management cited product mix, higher costs to meet demand and accelerated new-product ramps. Nine-month gross margin declined 2.8 percentage points for similar reasons.
- Q3 general and administrative expense more than doubled to $27.0 million. The increase included QGT acquisition costs, QGT operating expenses and amortization, and non-capitalizable costs of the new ERP implementation. The company reported $9.4 million of QGT deal costs for the three and nine months.
- The company issued 4.76 million shares in a February follow-on offering, raising approximately $94.5 million in cash proceeds. Outstanding common shares increased to approximately 39.0 million from 33.7 million at December 2017.
- QGT added $176.2 million of acquired identifiable intangible assets and $66.6 million of goodwill in the preliminary purchase-price allocation. The allocation remained subject to finalization.
Outlook, commentary and risks
- Management expected Q4 2018 sales to increase, primarily because QGT would contribute a full quarter. It also said reduced orders from some OEM customers, following deferred capital investment announcements, were expected to continue at least through Q4. No quantified sales or earnings guidance was provided.
- Management expected cash and operating cash flow to be sufficient for debt service, working capital and technology development for at least the next 12 months; longer-term liquidity depends on demand, acquisitions, capital needs and covenant compliance.
- The new $350.0 million term loan matures in August 2025; scheduled quarterly principal payments begin in January 2019. The credit agreement includes leverage and fixed-charge coverage covenants, which the company said it met at quarter-end. On October 1, loan pricing was amended to higher stated spreads, and the prepayment-fee period was extended from six to twelve months.
- Customer concentration remains significant: Lam Research and Applied Materials together represented 71.7% of Q3 sales and 81.8% of nine-month sales. Management highlighted semiconductor cyclicality, order reductions, customer pricing pressure, supply constraints and inventory management as key business risks.
- A fire at a QGT-related Korean facility destroyed a building and other assets. The company recorded a $5.2 million impairment and a corresponding $5.2 million insurance receivable and gain; the cost of customer-owned inventory destroyed in the fire was still being determined. Management said other facilities helped limit disruption to revenue and that it was evaluating additional losses and claims.
- The company recorded a $1.1 million loss on the sale of UAMC, its additive-manufacturing business. It maintained a full valuation allowance on federal and state deferred tax assets and continued evaluating the effects of U.S. tax reform.
- Management said disclosure controls were effective at quarter-end and reported no material change in internal control over financial reporting during the quarter. Ordinary-course legal proceedings were not expected by the company to have a material adverse effect.
Important facts for investors to verify
- Reconcile the filing’s different presentations of “interest and other” expense: the statements of operations report $(2.8) million for Q3 and $(3.2) million for nine months, while the MD&A discussion gives different figures. The filing text does not provide a clear reconciliation.
- Track customer orders and Q4 performance against management’s expectation of higher sales from a full quarter of QGT, while considering the stated continuation of OEM order reductions.
- Review QGT integration, final purchase-price allocation, earn-out conditions and the Korean share-purchase obligation; assess the impact of the acquired business on margins, cash generation and leverage.
- Confirm the status and amount of insurance recoveries and any additional costs or claims arising from the facility fire and destroyed customer inventory.
- Monitor debt pricing, amortization and covenant headroom, including the October amendment, and the company’s ability to fund operations and planned spending from cash flow.
- Assess the durability of gross margins, inventory levels and customer concentration, as well as execution and cost risks from the ERP implementation.