Rhonda Bennetto - Investor Relations Jim Scholhamer - Chief Executive Officer Sheri Savage - Chief Financial Officer.

Brian Chin - Stifel Nicolaus Tyler Burmeister - Craig-Hallum Capital Group Karl Ackerman - Cowen and Company, LLC.

Good day, everyone, and welcome to the Ultra Clean Technologies’ Q2 2018 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] And please note that, today’s event is being recorded.

I would now like to turn the conference over to Rhonda Bennetto of Investor Relations. Please go ahead..

Thank you, operator. Good afternoon, everyone, and thank you for joining us for our second quarter 2018 earnings conference call. With me 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, after which we will open up the call for questions.

The press release we issued earlier this afternoon, along with the information about the webcast and how to access a replay of this call can be found on the Investor Relations section of our website at www.uct.com.

Today’s call may contain forward-looking statements, including the company’s views regarding future financial performance, mergers or acquisitions, new capabilities or orders, shipments and industry growth.

Investors are cautioned that forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from those results listed here.

Information concerning these risks and uncertainties is contained in our periodic filings with the SEC, including our most recent Form 10-Q and 10-K and in the press release relating to today’s call.

All forward-looking statements are based on management’s estimates, projections and assumptions as of today, and we assumes no obligation to update them after today’s call. Also on today’s call, we will be referring to non-GAAP adjusted financial measures and reconciliations to GAAP measures can be found in today’s press release.

With that, I’d like to turn the call over to Jim.

Jim?.

Thank you, Rhonda, and good afternoon, everyone. Before I dive into the details around the exciting acquisition we announced a couple of days ago, I will update you on our second quarter. The heightened demand we saw near the end of the first quarter extended into the early part of the second quarter.

Midway through the quarter, we began to see a reduction in orders from some of our OEM customers, as certain manufacturers announced they were deferring capital investment. We remain very optimistic about the longer-term trends for the semiconductor industry.

Total revenue for the second quarter was $290 million, above the midpoint of our guidance and non-GAAP EPS was $0.55 within our guided range. Due to the push outs from our customers, profitability did not keep pace with revenues this quarter.

Leveraging our flexible financial model, we are taking action to reduce both variable and fixed cost, positioning UCT to achieve more balanced profitability going forward. Our display business had another strong quarter. We continue to expect our display revenue to remain at healthy levels for the next several years.

The market continues to be driven by a balance of OLED and Gen 10.5 LCD TV fabs. On Tuesday, we announced an agreement to acquire Quantum Global Technologies, expanding our addressable market by over $1 billion.

Quantum is a global leader in ultrahigh purity, sub 10-nanometer outsourced tool chamber parts cleaning and coding services, tool part life extension, micro contamination analytical services and other optimization solutions to OEM and IDM customers. This acquisition is consistent with our strategy to expand within the semiconductor market.

There are several reasons why this transaction increases our value and extend our competitive position. First, both Ultra Clean and Quantum Clean are leading players in the semiconductor market. Cleaning and contamination control is becoming even more critical with the advancement of cutting-edge chip technology.

Expanding into the service market, it is a natural fit and very complimentary. As a combined company, we will be able to provide a total suite of capabilities in a global capacity. From an OEM perspective, we will have two core competencies within the semi space.

Second, we are broadening and diversifying our customer base, which is driven by both WFE investment and ongoing fab operational spend, providing a more consistent and stable revenue stream. Third, this transaction is financially very attractive, and upon closing, this combination will be accretive in the fourth quarter of this year.

In addition to increasing our revenue, it will improve our financial model meaningfully, both from a margin and EPS perspective. In conjunction with the release, we have spoken to our OEM customers and Quantum’s IDM customers. They’re very supportive of this transaction and recognize the value of a large global partner.

In summary, with our broadened suite of offerings, we will continue to play an increasingly vital role in our customer success. While we firmly believe in the long-term drivers of the WFE market, we are actively focusing on driving operational efficiencies to adjust to market conditions.

We believe all of the building blocks are in place for us to achieve future growth and profitability. Now I would like to turn the call over to Sheri to review our financial results in more detail, and then open the call for questions.

Sheri?.

Thanks, Jim. In today’s discussion, I’ll be referring to non-GAAP numbers only. Momentum from the first quarter carried into the early part of the second quarter. Total revenue for the second quarter was $290.2 million, above the midpoint of our guidance range.

This is a decrease of 7.8% from our record first quarter and an increase of 27.1% from the same period last year. Semiconductor revenue decreased 9.3% sequentially to $272 million, accounting for 93.7% of total revenue, compared to 95.3% last quarter. Revenue from outside the U.S. was $169.7 million, compared to $180.9 million in the first quarter.

Non-semiconductor sales for the quarter were $18.2 million, an increase of $3.3 million over the prior quarter. Gross margin for the quarter was 15.9%, up from 15.8% last quarter and within our targeted ranges. A reduction in material cost and product mix accounted for the increase.

With the acquisition of Quantum Global Technologies, we’re in the process of updating our longer-term model. Operating expenses as a percentage of revenue for the quarter was 7.2%, compared to 6.6% last quarter, as our SAP program went live and on schedule.

We continue to leverage our variable cost model and are actively looking at ways to reduce our annual run rate across both COGS overhead and operating expenses starting in the third quarter. Operating margins for the second quarter was 8.7%, down from 9.2% in the prior quarter and within our targeted range.

Second quarter net income was $21.5 million, or $0.55 per share, based on $39.3 million diluted shares outstanding. This compared to $25.7 million, or $0.69 per share, based on $37.5 million diluted shares outstanding in the first quarter. Tax rate for the quarter was 11.9% compared to 12.4% last quarter.

We expect our tax rate to be within the ranges of 12% to 15% for 2018. Turning to the balance sheet. Inventory decreased by $33.2 million, as we met customer demand and cycle through the build up from prior quarters.

We used $17.2 million cash this quarter, compared with cash generation of $5.1 million in the first quarter due to the timing of shipments and payments. We ended the second quarter with a cash balance of $141.1 million. Two days ago, we announced the acquisition of Quantum Global Technologies.

We are very excited about the addition of this acquisition to UCT. Quantum generated revenue of $217.9 million, net income of $22 million, and adjusted EBITDA of $50.5 million in 2017. Upon close, the transaction is expected to be immediately accretive to UCT’s bottom line on a non-GAAP basis.

We anticipate that Quantum’s operating margins will be in the ranges of 14% to 18% and the EPS accretion will be in the range of 20% to 25% on a full-year basis. That concludes our prepared remarks. Operator, I’d like to open the call for questions..

Thank you. And we will now begin the question-and-answer session. [Operator Instructions] And the first questioner today will be Patrick Ho with Stifel. Please go ahead..

Hi there, good afternoon. This is actually Brian calling in for Patrick. Thanks for letting us ask a few questions. Maybe first, just to kick off of that last – Sheri’s last comment. First is to clarify.

Did you say, Sheri, $0.20 to $0.25 accretion on an annual basis, number one? Number two, is that accretion – I guess a thought to that is, what sort of cost synergies are you embedding in the accretion? Also, when you talk about the accretion, are you netting that against the debt cost, as well as the prior share issuance earlier in the year? And kind of last part to that multi-part question, what is the cost of that financing? And what’s the structure of that debt financing?.

Well, that’s a long question. So the first portion of it, it was 20% to 25% accretion from an EPS perspective. So if you look at our total, they would add an additional 20% to 25% of our total for the year, so if you look at a pro forma for the entire year. In terms of what was your second portion? It was about the debt financing surrounding.

We have not priced that completely yet. We have a committed financing with Barclays and we will go out to rating agencies and basically go through the process of the debt issuance at that point. So we will have that done within the next month. The other question you had was surrounding synergies. There’s small synergies, not a lot.

Basically, the key factor is really more from a revenue synergistic standpoint, and Jim can add on to that if necessary, but not a lot of cost synergies..

Okay. I got it.

So that the 20% to 25% of accretion is sort of a gross number, not factoring in sort of the cost of debt and probably the shares you guys issued early in the year?.

No, that takes into account our shares as well as that’s the bottom line accretion that we plan on seeing for the year..

Okay..

Full year’s worth of EPS..

Okay. Yes, I’ll just double back on that. Maybe also just to go through maybe some of the merits of the actual acquisition just getting and solely better understanding of QGT. Can you define that landscape? I think, Jim, yesterday, a couple of days ago, you said that the TAM for chamber of park cleaning is roughly $1 billion.

Is that just a merchant market opportunity, or is that inclusive of what’s in-house done by IDMs today? And then can you also a bit sort of segment the market out by whatever the TAM all in is? How much is done by IDMs, the chip companies? And so how much is done by merchant third-parties like QGT? How much is done by equipment companies like your direct customers?.

Yes. Well, Brian you bring up a point, which I think that really clarifies. This type of work that Quantum does and its competitors are not done typically in-house by either the OEMs or the IDMs. So this TAM of greater than $1 billion is serviced almost entirely by companies like Quantum.

As you just heard, it’s a very accretive to our deal and very attractive. And it’s becoming a much more important space, especially as we’re going to the leading edge chip.

I think, if you listen to the LAM call, you could hear a lot of the emphasis on the requirements in this space and the opportunities of increasing importance of the service space here..

All right. Thanks, Jim. Thanks for the clarification. What that doing is basically a merchant TAM today. Can you also maybe just to understand sort of the growth rate? And moving sub 10-nanometer, maybe there’s an acceleration here.

But 1 billion TAM in 2017, roughly how large was that TAM, say, three years ago? And also QGT said, it was $217 million, $218 million revenues in 2017.

How much of that revenue in 2016?.

Yes, I think, for prior – if you look at the company, Quantum actually grew very quickly up until two or three years ago through a – lot through acquisitions. The market and Quantum has been growing in the double-digit range and a CAGR year-upon-year. And look, going forward, we will, as we close and we integrate, I think, we’ll learn more.

But just from a qualitative aspect of what’s going on in this area, we expect that this is an increasingly important area. This is where the pocket is going to be going. So this is a – we expect to see this area continue to heat up..

Okay, I’ll wait it there for now. Thanks for the questions..

And the next questioner today will be Christian Schwab with Craig-Hallum. Please go ahead..

Hi, this is actually Tyler on for Christian. Thanks for taking the question. First, another question stay on the same track of the acquisition, the question we’ve been getting, so I’ll put to you guys. Understand part of the rationale for the acquisition was diversify your business.

But I think the cleaning space and the service business a little far from Ultra Clean’s kind of core business?.

No, actually, it’s exactly within our space. What we do is, we make the hardware. We make the hardware to the cleanliness and to the specifications and contamination needed as it first goes into the fab. As a matter of fact, we use Quantum as one of the steps as we prepare the hardware for the fabs.

So after it goes into the fab, it’s a continuing process to keep the equipment that we’re providing into the fabs at the same high-level performance. And, as I mentioned, that’s becoming more and more important. So Quantum is servicing both the OEMs that just like we do, and us, as well as the IDM.

So it’s exactly on our core competence of the kind of stringent requirements needed to – that are getting more and more stringent in the chipmaking space. And so it’s actually a very good fit. And as you mentioned, it diversifies and it gives us a continuous revenue stream that grows through WFE cycle.

It’s much more heavily based on the installed base growth. It’s kind of an annuity of sort..

Perfect, perfect. Thank you..

We – by the way, we’ve spoken. I’m sorry, if I could finish one more thing. We’ve spoken to both our OEMs and our IDMs and Quantum’s IDM customers prior to in conjunction with the release. And they’re all very supportive of this transaction as they recognize the value – the tremendous value of having a large global partner entering into the space.

So it’s a big positive for them..

Great, thank you. And then second, you mentioned along with the release that this will diversify your customer base.

Can you maybe give a little more color what Quantum’s customer concentration looks like?.

Yes, I think a little bit of the inverse. Obviously, they’re very heavily – the customer base is very heavily in the IDM and the chipmakers. And I think where we’re seeing a more – even more momentum is in the global chipmakers. The ones who – they have factories around the world and they need the same exact performance.

And they’re really – and so Quantum came along, and now together with us, they haven’t had a global supplier for – to meet their needs. And so this is – that in particular is an increasingly important area. So it’s more heavily in the IDM space. But as I mentioned also, the OEMs and the sub-tiers of the OEMs like ourselves..

By inverse, would be something greater than 50% of the revenue be for the IDM space is something that [indiscernible].

Yes..

Perfect. Okay. All right. That’s all for me. Thanks, guys..

Thanks, Tyler..

Yes..

[Operator Instructions] And the next questioner today will be Karl Ackerman with Cowen and Company. Please go ahead..

Hi, Jim and Sheri. I guess, I have a question on gross margins. When your largest customers just gave an implicit that we see a guide that while shipments are – will decline in September, December, of course, will rebound from that and then first-half should be stronger than, I think, the second-half of 2018.

So could you talk about the variability of your cost model and capability to act swiftly if needed during this market oscillation?.

Yes. Thank you, Karl. The key thing, as we talked about in the past, is our flexible model and a couple of factors that play into that obviously are material and our direct labor. So those two factors can come down quite exponentially with revenue changes up or down for that matter. The key thing is more of the fixed cost piece.

And we already have started looking at our cost model at the end of Q2 seeing that Q3 was going to be down. So we’re already in the midst of looking at that.

Obviously, we have to be somewhat careful, because we want to make sure that we can support our customers’ future demand and make sure we don’t cut too deep, but also be able to obviously continue to show profitability. So that’s something that we are looking at. And with our variable model, we do bring certain factors up and down fairly quickly..

Understood. I guess, as my follow-up, we talked about making this acquisition and kind of expanding your overall footprint within key areas of focus. But I guess, maybe taking a step back, where are we in the process of customers outsourcing their manufacturing and systems integration, the merchant suppliers like yourself.

I mean, do you still think there’s still opportunities in gas and chemical, or how do we think about those opportunities there over time? Thank you..

Yes. So to split it out a little bit, gas and chemical was outsourced quite a long time ago and that’s pretty stable as far as how that is. The majority of that business has been outsourced and it’s done by, as you guys are calling, merchant suppliers.

The major modules and some of the other modules that are made outside of the gas panel, those are the ones that have been transitioning out. Obviously, accelerated very dramatically through 2017, as our customers’ revenues and output went up dramatically. And obviously, there’s not as big of a need for that in – within this quarter or so.

But I think going forward, seeing the market after the pause here and taking off again, we expect that will continue to be an important trend of outsourcing of the other major modules. This is a big part of the business that we picked up a lot in 2017, which is why we saw dramatically outgrew the WFE growth rate.

So we expect that to pick up again stronger through the next upturn here..

Thank you..

Thanks, Karl..

And this will conclude our question-and-answer session. I would now like to to turn the conference back over to Jim Scholhamer for any closing remarks..

Yes. Well, thank you for joining us, and we look forward to talking to you again soon..

And the conference is now concluded. Thank you for attending today’s presentation. You may now disconnect your lines..