Good day, and welcome to the Ultra Clean Third Quarter 2019 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. At this time, I would 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. 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 that with 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?.

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 improve 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 suggests 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 in-sourcing to outsourcing during the cycle, adding to our overall competence level for our product 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 advance notes 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 customers technology roadmap, 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 starts 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 will 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..

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 product 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 with 15.1%.

As we've shared before, margins can be influenced by customer concentration, geography, product mix, and volume 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.

As 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 increase profits in a higher tax region along with exchange rate movement.

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 a 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..

Great. Thanks for taking my question. Great start this quarter in guidance. As you're looking to I know, we'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'd expect over the next few quarters there?.

Yeah, Christian. Yeah, as expected, we had the 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 in the end to begin to recover as wafer started to increase.

So we're still expecting that in the fourth quarter, it's going to return back to the level -- SSB will return back to the levels that we had in the first quarter of the year. And then I think next year, 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 start's taken so I expect 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..

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?.

Yeah, I think we're seeing signs of life in 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..

Great. No other questions. Thank you..

Thanks, Christian..

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

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 or real time or is there still a lag that you may see from one or both customers that you deal with?.

Yeah, difficult question to answer. I mean, there is always a delta between us and the OEM. A couple of factors. One, I think you pointed out sometimes there's 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 OEM rate of acceleration is kind of the shipping time. Sometimes we ship directly to our customers' customer, in which case our revenues line up pretty well. In other cases, we ship to their factory which then has a lag.

So often there's a quarter to quarter shift in the revenue, the revenue growth between us and the OEM due to that effect as well. But I think the inventory pieces, there's still a piece of that, but I don't think it's nearly the size it has been, obviously, but I think it's relatively small..

Great, that's helpful.

And maybe as my follow up question in terms of some of the market, you're getting an opportunity in some of your other businesses that you've talked about whether it's on the Wellman sides or in the machining side of things, how do you look at 2020 as a recovery starts to emerge? How those potential market share gains may contribute? Maybe not quantitative 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're looking at?.

Yeah, good question. There's a lot of elements in the market share, the Wellman side, we made a step functioning 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 shares is definitely kind of a reasonable assumption.

So I think that will grow -- the Wellman side should grow along with the overall market. Another customer projects and penetrations we've seen a kind of a mixed bag, some of the OEMs are more aggressive and more steadily out -- continuing outsourcing through the downturn and others were kind of more flat or even have 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 towards 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..

Great, thank you very much..

Thanks, Patrick..

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

Hi, Jim. Hi Sheri. This Sam Rifle [ph] 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 model makers?.

Yeah, hi Sam. That's a good thing. Yeah, we are seeing -- we're starting to see some of the recovery hit the 3D NAND first. I think you're seeing several moments 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 it's kind of a double effect, not only the volume of the equipment going out but also the fact that adding 35% roughly third more a process chambers to achieve the 128 nanometer. So we expect that the NAND recovery is definitely a good thing for us.

I think there have been a lot of announcements and I'm sure you've been following them. But you know, especially from the larger players in NAND. So I think outside of some of the smaller players who are Chinese players who are still lagging a little bit, I think it's obviously being led by the big three in that area. .

Definitely helpful and then for Chinese investment.

Do you see that being anything other than linear in 2020, more CapEx front loaded or back loaded, or do you have an opinion on that yet?.

` If you’re speaking about NAND in general, obviously….

Yes, sure, NAND. .

Yeah YMCC [ph] they're still ramping their 32 layers in their transition to 64 in '19. They're looking to make the jump in 2020. But I think we expect that not really have much of an impact for us in the year 2020. We think that would be a later impact. .

Understood, great. And then one more from -- about QGT. So one of the main benefits that we see in the Quantum acquisition is that it diversifies your customer base in the IDNs.

Moving into 2020, how are you and your team looking to expand your customer base further? And how would you clarify your visibility in this market today versus your enrollment in gas delivery systems businesses sold to front end suppliers?.

Yeah, I'll handle 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, there's not a lot there.

It's pretty well consolidated but there are accounts that have lower penetration in Taiwan, we have a fab that has been put in not so long ago, and so in southern Taiwan, in Tainan and so we see a lot of opportunity as we're penetrating into the TSMC account out there to improve our share, which we have a decent revenue from TSMC, but it's not near the level 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. .

Actually, looking at my notes. I think you touched upon it. So that's it for me. Thank you very much. .

Thank you..

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

Thank you.

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

Yeah, for Q4, I would assume it 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..

Okay. 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?.

Yes, we were 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's a lot of lot of factors in play. .

Okay.

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

Yes, I would say it was less of a churn situation and more of a market building, market demand building up -- less of I mean, there's always a pull in but what we saw were a lot of we call them in the industry bloopers or drop ins that are not a pull in.

And so I think what we started to see as we went to the high end of our of our forecasted revenue we started to see the strength of the order stream, and not just shifting from one quarter to the other. .

Okay, and your comments on investing for growth opportunities, can you provide any specifics what you're doing there?.

Yes, 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 it the right spots and as we've seen the ramp doesn't never hits evenly. So we see as some of our sites taking off earlier than others.

So we've added back some capability as we see the revenues are going to continue to climb. So we're continue to add more capacity in the form of people mostly. .

Okay. All right, thank you..

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..

Yes, thank you for attending our third quarter conference call and we look forward to speaking with you next quarter..

The conference has now concluded. Thank you for attending today's presentation and you may now disconnect your lines..