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Ultra Clean Holdings Inc (NASDAQ:UCTT)
Q3 2019 Earnings Call
Oct 30, 2019, 1:45 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, and welcome to the Ultra Clean Third Quarter 2019 Earnings Conference Call. [Operator Instructions]

At this time, I'd like to turn the conference over to Rhonda Bennetto of Investor Relations. Please go ahead.

Rhonda Bennetto -- Vice President, Investor Relations

Thank you, operator. Good afternoon, everyone, and thank you for joining us. With me today are Jim Scholhamer, 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, and 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 disclosure in our SEC public 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.

And with that, I would like to turn the call over to Jim. Jim?

Jim Scholhamer -- Chief Executive Officer

Thank you, Rhonda, and good afternoon everyone. Thank you for joining us for our third quarter 2019 conference call and webcast. First, I'm going to highlight a few financial results that Sheri will expand on in her commentary. I'll follow that with our current view of the semiconductor industry and how it relates to our products and services businesses. After that, we will open up the call for questions.

Our third quarter showed improvement in both business divisions, enabling us to reach the top end of our guidance on revenue and earnings per share. Internal inventory reduction and strong cash flow from operations enabled us to further reduce our debt resulting in improved leverage and a very healthy cash balance. We continue to optimize our operations, implement new processes and systems, and strategically invest for growth.

Recently, industry sentiment has shifted to the upside. Current peer and customer commentary verified by our internal marketing analysis suggest that some elements consistent with the recovery are starting to take shape. Memory inventory dynamics are stabilizing and there are signs of recovery in the wafer fab equipment spending to support next generation leading edge devices, where UCT has a distinct competitive advantage in products and services. These factors supported by ongoing strength in foundry and logic, which makes up around 55% of UCT's business, shows improvement in the WFE market. When memory spending resumes, we expect to see the recovery accelerate.

We continue to see project wins with several accounts as customers shift from insourcing to outsourcing during the cycle, adding to our overall confidence level for our products division. As devices become more complex and more functionality needs to be added in a limited space, technology advancements supporting 5G wireless, high performance cloud computing, Internet of Things and Artificial Intelligence are leading the way. The race to advanced nodes in our core markets enables us to play an even more influential role in the value chain.

Capitalizing on the modest momentum we are seeing in the industry, we are supporting our customer's technology roadmaps further solidifying UCT as a partner of choice. With overall sentiment more upbeat and constructive heading into 2020, we are well positioned in attractive end-markets with multiple levers for value creation to capitalize on the opportunities ahead.

Our Services business saw a slight recovery after memory producers increased utilization coming off the reductions implemented in the second quarter. We anticipate this trend continuing through the fourth quarter as inventory supply and demand align. As wafer start to accelerate and WFE capital equipment investment rises, cleaning and analytical services will become even more critical to our IDM and OEM customers. Our highly technical and unique service offerings provide a great platform for growth and we'll continue to transform our financial profile.

Our integration and cost reduction initiatives remain on track and we have been successful in adapting manufacturing capacities and capital expenditures to match demand during the slowdown. With a strong balance sheet and a healthy cash position, we are focused on strengthening our market position by making opportunistic investments in people and capabilities in preparation for growth. This will ensure we are positioned as a stronger company better able to address the longer-term needs of our global customer base as the industry rebounds.

In summary, we are more optimistic than we were just a few months ago that the cycle has bottomed and the industry is on the road to recovery. Our goal is to maintain sustainable growth and outpace the markets we serve. I want to thank our employees and our shareholders for their continued support and I look forward to updating you on our next call.

With that, I'll turn the call over to Sheri.

Sheri Savage -- Chief Financial Officer

Thanks, Jim, and good afternoon everyone. Thanks for joining us. In today's discussion, I will be referring to non-GAAP numbers only. We executed well in the third quarter, generating total revenue of $254.3 million, down slightly over the prior quarter but at the top end of our guidance. Our Products division accounted for $200 million and our Services division contributed $54.3 million. Non-semiconductor revenue, which includes display, generated $13.6 million or 5.4% of revenue, down slightly from the prior quarter.

Favorable mix together with ongoing reductions in labor material costs brought total gross margin to 19.2%, up from 18.8% in the previous quarter. Our Services gross margin was 34.3% and Products was 15.1%. As we've shared before, margins can be influenced by customer concentration, geography, product mix, and volumes and the timing of our restructuring initiatives, so you should expect to see variances quarter-to-quarter.

Investing in people and manufacturing optimization via the SAP implementation and preparation for the industry upturn resulted in operating expenses increasing to $34.2 million compared to $33.6 million last quarter. As a percentage of revenue, OpEx was 13.4% versus 12.7% last quarter.

Total operating margin for the third quarter was 5.8% compared to 6.2% in the previous quarter. Margin contributed from Services was 9.8% and Products contributed 4.6%. Based on 40 million shares outstanding, earnings per share for the quarter was $0.21, derived from net income of $8.5 million. This compares to $8.2 million and $0.21 last quarter. Had we excluded share-based compensation and our non-GAAP reconciliation, which we plan to do in the first quarter of 2020, our earnings per share would have been $0.28 for the quarter. Our tax rate for the quarter was 23% compared to 18.9% last quarter, due to increased profit in a higher tax region along with exchange rate movements.

Turning to the balance sheet. We ended the quarter with $158.7 million in cash and cash equivalents. Cash from operations was $23.2 million. Along with our scheduled loan payments, we made additional loan payments of $15 million on our long-term debt and $10 million on our revolving loan.

Based on increased demand, we are projecting total revenue for the fourth quarter between $260 million and $280 million, and EPS in the range of $0.20 to $0.30. If we exclude stock-based compensation, EPS would be between $0.26 and $0.36.

And with that, I'd like to turn the call over to the operator for questions.

Questions and Answers:

Operator

Thank you. We will now begin the question-and-answer session. [Operator Instructions] And our first question today will come from Christian Schwab of Craig-Hallum Capital Group. Please go ahead.

Christian Schwab -- Craig-Hallum Capital Group -- Analsyt

Great. Thanks for taking my question. Great start this quarter in guidance. As you're looking to -- I know, you're only looking one quarter at a time, but can you talk to about what you're seeing in the quantum business and what you would expect over the next few quarters there?

Jim Scholhamer -- Chief Executive Officer

Yeah, hi, Christian. Yeah, as expected, we had a drop in business, mostly driven by DRAM, especially Korea. And we saw that continue into the third quarter and then we started to see that bottom out and to begin to recover as wafer started to increase. So we're still expecting in the fourth quarter. It's going to return back to the -- SSP will return back to the levels that we had in the first quarter of the year. And then I think next year, we can't really project, obviously, it's going to depend on continued growth of wafer starts.

And there's always a lag between when equipment goes in and when the wafer starts, you know take-ins are expected to be a little bit more lag in that business growth behind the -- what we would see on the SPS or the equipment side, but obviously as wafer starts continue to improve just through the installed base, we would hope to see improvement next year as well.

Christian Schwab -- Craig-Hallum Capital Group -- Analsyt

And as you're talking to your leading customers, one of them seeing initial signs of potential recovery at least on the NAND side. In your conversations with them, it sounds like you're probably more optimistic about a memory recovery sometime in 2020. Is that fair?

Jim Scholhamer -- Chief Executive Officer

Yeah, I think we're seeing signs of life in the NAND part and feeling very confident on that side. Yeah, memory -- DRAM memory is still the timing question. Obviously, we expect there will be an improvement in the DRAM spending, but it's still a question of when that will hit.

Christian Schwab -- Craig-Hallum Capital Group -- Analsyt

Great. No other questions. Thank you.

Jim Scholhamer -- Chief Executive Officer

Thanks, Christian.

Operator

And our next question today will come from Patrick Ho of Stifel. Please go ahead.

Patrick Ho -- Stifel, Nicolaus and Company -- Analyst

Thank you very much, and congrats on a nice quarter. Jim, maybe first off on the product side of things. Given your leading customers, I guess, change in their sentiment and their outlooks on a going forward basis, can you just discuss from a broader perspective, how they manage their inventories and how much you believe some of the emerging size of a recovery are real-time or is there still a lag that you may see from one or both customers that you deal with?

Jim Scholhamer -- Chief Executive Officer

Yeah, difficult question to answer. I mean, there is always a delta between us and our -- and the OEMs. A couple of factors: one, I think you pointed out sometimes is inventory. I believe in special cases there still is some inventory left, but that's eroding quickly in the upturn. The bigger factor between bridging between us and the OEMs rate of acceleration is kind of the shipping time. Sometimes we ship directly to our customers' customers, and in which case, our revenues line up pretty well. In other cases, we ship to their factory with [Indecipherable] have the lag. So often, there's a quarter-to-quarter shift in the revenue -- you know, the revenue growth between us and the OEMs due to that effect as well. But I think the inventory pieces, there is still a piece of that, but I don't think it's nearly the size it has been through the year, obviously, but I think it's relatively small.

Patrick Ho -- Stifel, Nicolaus and Company -- Analyst

Great, that's helpful. And maybe as my follow-up question, in terms of, some of the market share gain opportunities in some of your other businesses that you've talked about, whether it's on the weldments side or in the machining side of things, how do you look at 2020 as the recovery starts to emerge? How those potential market share gains may contribute, maybe not a quantitative basis but on a qualitative basis, how do you expect that to kind of give you an extra tailwind, and I guess, the above average growth you are looking?

Jim Scholhamer -- Chief Executive Officer

Yeah, good question. There's a lot of elements in the market share. The weldment side, we made a step function improvement in market share with the acquisition of DMS. And at this point, I think we're pretty well penetrated in those accounts. So I think holding those share is definitely kind of a reasonable assumption. So I think that will grow, the weldment side should grow along with the overall market.

On other customer projects and penetrations, we've seen a kind of a mixed bag, some of the OEMs are more aggressive -- have been more steadily out -- continuing outsourcing through the downturn and others were kind of more flat or even had pulled back a little bit. So we're kind of seeing a mixed bag, but we definitely will see -- I think, all the OEM customers shift toward either outsourcing again or more outsourcing than they currently are doing when we see the DRAM business start to come in and push the capacities of the OEMs.

Patrick Ho -- Stifel, Nicolaus and Company -- Analyst

Great. Thank you very much.

Jim Scholhamer -- Chief Executive Officer

Thanks, Patrick.

Operator

[Operator Instructions] Our next question today will come from Karl Ackerman of Cowen & Company. Please go ahead.

Sam Reiff -- Cowen & Company -- Analyst

Hi, Jim. Hi Sheri. This is Sam Reiff on for Karl. I was wondering if you could stick to memory and discuss your thoughts about 128-layer 3D NAND ramping in 2020, as well as indigenous Chinese memory production and what that means for you and other module makers?

Jim Scholhamer -- Chief Executive Officer

Yeah, hi, Sam. Yeah, that's a good thing. Yeah, we are seeing -- yeah, we're starting to see some of the recovery hit the 3D NAND first. I think you're seeing several movements as you're aware of several of the larger players moving to 128. If you're referring to obviously that -- the effect that has on us is kind of a double effect in not only the volume of equipment going out, but also the fact that you're adding 35% roughly, you know a third more process chambers to achieve that -- to achieve the 128 nanometer. So we expect -- the NAND recovery is definitely a good thing for us. I think there have been a lot of announcements. I'm sure you've been following them, but especially from the larger players in NAND. So I think outside of some of the smaller players who -- the Chinese players, who are still lagging a little bit, I think it's obviously being led by the big three in that area.

Sam Reiff -- Cowen & Company -- Analyst

Definitely helpful. And then for the four Chinese investment, do you see that being anything other than linear in 2020, more and more capex front loaded or back-loaded or do you have an opinion on that yet?

Jim Scholhamer -- Chief Executive Officer

If you're speaking about NAND in general, I mean, obviously...

Sam Reiff -- Cowen & Company -- Analyst

Yeah, sure, NAND.

Jim Scholhamer -- Chief Executive Officer

Yeah, YMTC, you know there is still ramping their 32 layers and their transition to 64 in '19. They're looking to make the jump in 2020, but I think we expect that to really have much of an impact for us in the year of 2020. I think -- we think that would be a later impact.

Sam Reiff -- Cowen & Company -- Analyst

Understood, great. And then one more if I may, about QGT . So one of the main benefits that we see in the Quantum acquisition that it diversifies our customer base in the IDMs. Moving into 2020, how are you and your team working to expand your customer base further and how would you clarify your visibility in this market today versus your [Indecipherable] gas delivery systems businesses sold to front-end suppliers.

Jim Scholhamer -- Chief Executive Officer

Yeah, I'll hand over -- I answer the first part, and then I'll ask you to repeat the second one, because I missed that. But the first question on expanding -- obviously, expanding into new IDM players, you know there's not a lot -- not a lot there. It's pretty well consolidated. But there are accounts that have lower penetration. In Taiwan, we have fab that has been put in not so long ago. And so in southern Taiwan and China, and so we see a lot of opportunity is we're penetrating into the TSMC account down there to improve our share, which -- we have a decent revenue from TSMC, but it's not near the levels that we have like Intel and Samsung. So I think the biggest opportunity we see is expanding our share with TSMC.

Hopefully that answered the first part. If you could repeat the second part again, Sam?

Sam Reiff -- Cowen & Company -- Analyst

Yeah, no. Actually looking over my notes, I think you touched upon it. So that's it for me. Thank you very much.

Jim Scholhamer -- Chief Executive Officer

Thank you.

Operator

Our next question will come from Dick Ryan of Dougherty. Please go ahead.

Richard Ryan -- Dougherty & Company -- Analyst

Thank you. Hey, Sheri, how should we view taxes going forward?

Sheri Savage -- Chief Financial Officer

Yeah. For Q4, I would assume it would be similar to Q3 at this point. We have lots of tax initiatives that will come into play for 2020, but for the rest of the year, I would assume it would be flat from the Q3 level.

Richard Ryan -- Dougherty & Company -- Analyst

Okay. And the cost savings, $15 million to $20 million, is that still a reasonable rate and how are you looking at that so far in Q2 and Q3?

Sheri Savage -- Chief Financial Officer

Yeah, we are starting to see the beginnings of that. Similar to last quarter, we're in the initial innings on that one as you saw our gross margin showed a little bit of an increase quarter-over-quarter and that's the result of both the product mix as well as our initiatives going on. Going forward, I think you'll see more of that, starting in Q4 and Q1. So that's kind of where we're at right now, but there is a lot of -- a lot of factors in play.

Richard Ryan -- Dougherty & Company -- Analyst

Okay. Hey Jim, on churn, last couple of calls you talked about kind of late quarter pull-ins. So what -- how did churn look for Q3?

Jim Scholhamer -- Chief Executive Officer

Yes, I would say it was less of a churn situation then more of a market building -- market demand building up -- less of -- I mean, there is always pull-ins, but what we saw were a lot of, we call them in the industry bluebirds or drop-ins that are not a pull-in. And so I think what we started to see as we -- as we went to the high end of our forecasted revenue is we started to see the strength of the order stream not just shifting from one quarter to the other.

Richard Ryan -- Dougherty & Company -- Analyst

Okay. And your comments on investing for growth opportunities. Can you provide any specifics, what you're doing now?

Jim Scholhamer -- Chief Executive Officer

Yeah, I mean, obviously some of the cost reductions that we've done are structural as we've reduced footprint and consolidated sites and so those continue. Other -- those cost reductions we've made in the right spots. We've seen -- you know the ramp doesn't -- never heads evenly. So we see some of our sites taking off earlier than others. So we've added -- we've added added back on capability as we see the revenues are going to continue to climb. So we'll continue to add more capacity in the form of people mostly.

Richard Ryan -- Dougherty & Company -- Analyst

Okay. All right. Thank you.

Sheri Savage -- Chief Financial Officer

Thank you.

Jim Scholhamer -- Chief Executive Officer

Thank you.

Operator

And this will conclude our question-and-answer session. At this time, I'd like to turn the conference back over to Jim Scholhamer for any closing remarks.

Jim Scholhamer -- Chief Executive Officer

Yeah. Thank you for attending our third quarter conference call and we look forward to speaking with you next quarter.

Operator

[Operator Closing Remarks].

Duration: 22 minutes

Call participants:

Rhonda Bennetto -- Vice President, Investor Relations

Jim Scholhamer -- Chief Executive Officer

Sheri Savage -- Chief Financial Officer

Christian Schwab -- Craig-Hallum Capital Group -- Analsyt

Patrick Ho -- Stifel, Nicolaus and Company -- Analyst

Sam Reiff -- Cowen & Company -- Analyst

Richard Ryan -- Dougherty & Company -- Analyst

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