Ultra Clean Holdings, Inc. 10-Q

ITEM 2. Management’s Discussion And Analysis of Financial Condition And Results Of Operations You should read the following discussion of our financial condition and results of operations in conjunction with the Condensed Consolidated Financial Statements and the notes thereto included elsewhere in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K filed with the SEC on March 6, 2024. This Quarterly Report on Form 10-Q contains “forward-looking statements” that involve substantial risks and uncertainties. The statements contained in this Quarterly Report on Form 10-Q that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, including, but not limited to, statements regarding our expectations, beliefs, intentions, strategies, future operations, future financial position, future revenue, projected expenses, gross margins and plans and objectives of management. In some cases, you can identify forward-looking statements by terms such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “might,” “plan,” “project,” “will,” “would,” “should,” “could,” “can,” “predict,” “potential,” “continue,” “objective,” or the negative of these terms, and similar expressions intended to identify forward-looking statements. However, not all forward-looking statements contain these identifying words. These forward-looking statements reflect our current views about future events and involve known risks, uncertainties and other factors that may cause our actual results, performance or achievement to be materially different from those expressed or implied by the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled “Risk Factors” included in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K filed with the SEC on March 6, 2024. Furthermore, such forward-looking statements speak only as of the date of this report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements. Overview Ultra Clean Holdings, Inc., (“UCT”, the “Company” or “We”) is a leading developer and supplier of critical subsystems, components, parts, and ultra-high purity cleaning and analytical services primarily for the semiconductor industry. UCT offers its customers an integrated outsourced solution for major subassemblies, improved design-to-delivery cycle times, design for manufacturability, prototyping and part and component manufacturing, as well as tool chamber parts cleaning and coating, and micro-contamination analytical services. We report results for two operating segments: Products and Services. Our Products segment primarily designs, engineers and manufactures production tools, components and parts, and modules and subsystems for the semiconductor and display capital equipment markets. Products include chemical delivery modules, frame assemblies, gas delivery systems, fluid delivery systems, precision robotics, process modules as well as other high-level assemblies. Our Services segment provides ultra-high purity parts cleaning, process tool part recoating, surface encapsulation and high sensitivity micro contamination analysis primarily for the semiconductor device makers and wafer fabrication equipment (“WFE”) markets. We ship a majority of our products and provide most of our services to U.S. registered customers with locations both in and outside the U.S. In addition to U.S. manufacturing and service operations, we manufacture products and provide parts cleaning and other related services in our Asia Pacific, Europe and Middle East (“EMEA”) facilities to support local and U.S. based customers. We conduct our operating activities primarily through our subsidiaries. Over the long term, we believe the semiconductor market we serve will continue to grow due to multi-year industry demand from a broad range of drivers, such as new processor architectures that enable higher performance servers necessary for cloud, artificial intelligence (“AI”) and machine learning applications. We also believe that semiconductor original equipment manufacturers (“OEM”) are increasingly relying on partners like UCT to fulfill their expanding capacity requirements. Additionally, our Services business is benefiting as device manufacturers rely on precision cleaning and coating to achieve ever more advanced devices. Critical Accounting Estimates Our Condensed Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States, which require us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses and related disclosure at the date of our Condensed Consolidated Financial Statements. On an ongoing basis, we evaluate our estimates and judgments, including those related to inventories, income taxes, business combinations, contingent earn-out liabilities and goodwill, intangible assets and long-lived assets. We base our estimates and judgments on historical experience and on various other factors that we believe to be reasonable under the circumstances, the results of which form the basis of our judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates. We consider certain accounting policies related to revenue recognition, inventory valuation, accounting for income taxes, business combinations, valuation of goodwill, intangible assets and long-lived assets to be critical policies due to the estimates and judgments involved in each. - 22 - Table of Contents There have been no significant changes to our critical accounting policies, significant judgments and estimates disclosed in our Annual Report on Form 10-K subsequent to December 29, 2023. For further information on our critical and other significant accounting policies and estimates, see Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the fiscal year ended December 29, 2023, as filed with the SEC. Results of Operations Fiscal Year Our fiscal year is the 52- or 53-week period ending on the Friday nearest December 31. Fiscal year 2024 is a 52-week period ending December 27, 2024 and fiscal year 2023 was a 52-week ended December 29, 2023. The fiscal quarters ended March 29, 2024 and March 31, 2023 were both 13-week periods. Discussion of Results of Operations for the Three months ended March 29, 2024 compared to the Three months ended March 31, 2023 Revenues Three Months Ended Revenues by Segment (Dollars in millions) March 29, 2024 March 31, 2023 Percent Change Products $ 418.5 $ 368.6 13.5 % Services 59.2 64.7 (8.5) % Total revenues $ 477.7 $ 433.3 10.2 % Products as a percentage of total revenues 87.6 % 85.1 % Services as a percentage of total revenues 12.4 % 14.9 % Products revenues increased $49.9 million from the three months ended March 31, 2023 to the three months ended March 29, 2024. The increase in Products revenues was primarily due to an increase in customer demand, along with an overall market improvement in the semiconductor industry and in part due to the acquisition of HIS in October 2023. Services revenues decreased $5.5 million from the three months ended March 31, 2023 to the three months ended March 29, 2024 , primarily due to decrease in demand across its customer base. Three Months Ended Revenues by Geography (Dollars in millions) March 29, 2024 March 31, 2023 Percent Change United States $ 141.0 $ 133.8 5.4 % International 336.7 299.5 12.4 % Total revenues $ 477.7 $ 433.3 10.2 % United States as a percentage of total revenues 29.5 % 30.9 % International as a percentage of total revenues 70.5 % 69.1 % Revenues by geographic area are categorized based on the customer’s location to which the products were shipped or services were performed. For the three months period ended March 29, 2024, U.S. revenues increased $7.2 million, compared to the same period in the prior year, primarily as a result of the acquisition of HIS in October 2023, whose customers are primarily U.S. based. International revenues increased $37.2 million in the three months period ended March 29, 2024, compared to the same period in the prior year, primarily as a result of market improvement driving higher customer demand. - 23 - Table of Contents Cost of Revenues Three Months Ended Cost of revenues by Segment (Dollars in millions) March 29, 2024 March 31, 2023 Percent Change Products $ 354.0 $ 315.1 12.3 % Services 41.1 45.2 (9.1) % Total Cost of revenues $ 395.1 $ 360.3 9.7 % Products cost as a percentage of total Products revenues 84.6 % 85.5 % Services cost as a percentage of total Services revenues 69.4 % 69.9 % Cost of Products revenues consists of purchased materials, direct labor and manufacturing overhead. Cost of Products revenues increased $38.9 million for the three months ended March 29, 2024 compared to the same period in the prior year. The increase was due to higher sales volumes driving increased material costs of $38.3 million. Cost of Services revenues consists of direct labor, overhead and materials (such as chemicals, gases and consumables). Cost of Services revenues decreased $4.1 million for the three months ended March 29, 2024, respectively, compared to the same periods in the prior year, driven by lower volumes of service orders, resulting in decreased labor related costs (the largest component of Cost of Services) of $3.1 million. Gross Margin Three Months Ended Gross Profit by Segment (Dollars in millions) March 29, 2024 March 31, 2023 Percent Change Products $ 64.5 $ 53.5 20.6 % Services 18.1 19.5 (7.2) % Gross profit $ 82.6 $ 73.0 13.2 % Gross Margin by Segment Products 15.4 % 14.5 % Services 30.6 % 30.1 % Total Company 17.3 % 16.8 % Gross profit and gross margins fluctuate with revenue levels, product mix, material costs, and labor costs. Products gross profit and gross margin increased for the three months ended March 29, 2024, compared to the same period in the prior year, primarily due to higher revenue levels, product shift and volume shift from high to low cost regions. Services gross profit decreased for the three months ended March 29, 2024, compared to the same period in the prior year, primarily due to lower revenue levels. Services gross margin increased for the three months ended March 29, 2024, compared to the same period in the prior year, due to site efficiencies. Operating Margin Three Months Ended Operating Profit by Segment (Dollars in millions) March 29, 2024 March 31, 2023 Percent Change Products $ 14.7 $ 8.7 69.0 % Services 2.6 3.7 (29.7) % Operating profit $ 17.3 $ 12.4 39.5 % Operating Margin by Segment Products 3.5 % 2.4 % Services 4.4 % 5.7 % Total Company 3.6 % 2.9 % Operating profit and operating margin of Products increased for the three months period ended March 29, 2024, compared to the same period in the prior year, primarily due to increases in business volumes and customer demands offset partially - 24 - Table of Contents by an increase in restructuring costs and by an increase in the amortization of intangibles in conjunction with the acquisition of HIS. Operating profit and operating margin of Services decreased for the three months period ended March 29, 2024, compared to the same period in the prior year, primarily due to the lower gross profit resulting from reduced customer demand. Research and Development Three Months Ended (Dollars in millions) March 29, 2024 March 31, 2023 Percent Change Research and development $ 7.0 $ 7.1 (1.4) % Research and development as a percentage of total revenues 1.5 % 1.6 % Research and development expenses were consistent in the three months ended March 29, 2024, compared to the same period in the prior year. Sales and Marketing Three Months Ended (Dollars in millions) March 29, 2024 March 31, 2023 Percent Change Sales and marketing $ 13.7 $ 13.1 4.6 % Sales and marketing as a percentage of total revenues 2.9 % 3.0 % Sales and marketing expenses were consistent in the three months ended March 29, 2024, compared to the same period in the prior year. General and Administrative Three Months Ended (Dollars in millions) March 29, 2024 March 31, 2023 Percent Change General and administrative $ 44.6 $ 40.4 10.4 % General and administrative as a percentage of total revenues 9.3 % 9.3 % General and administrative expenses increased $4.2 million in th e three months ended March 29, 2024, compared to the same period in the prior year, primarily driven by increases in amortization of intangible assets acquired through business combinations and in restructuring costs in addition to a combination of other factors, none of which were individually significant. The restructuring costs primarily reflect employee severance costs and facilities consolidation costs to improve efficiencies in our operational activities and to reduce redundancies. Interest and Other Expense, net Three Months Ended (Dollars in millions) March 29, 2024 March 31, 2023 Percent Change Interest income $ 1.4 $ 0.5 180.0 % Interest expense $ (12.2) $ (11.8) 3.4 % Other expense, net $ (3.8) $ 2.8 (235.7) % Interest income increased $0.9 million in the three months ended March 29, 2024 compared to the same period in the prior year, primarily due to higher interest income earned on cash and cash equivalent balances attributed to higher interest rates in the current period. Interest expense increased $0.4 million in the three months ended March 29, 2024 compared to the same period in the prior year, due primarily to higher interest rates. Other expense, net, decreased $6.6 million in the three months ended March 29, 2024, compared to the same period in the prior year, due to the unfavorable foreign exchange transactions and remeasurements and due to the loss from the change of the fair value of contingent earn-out of $1.3 million. - 25 - Table of Contents Provision for Income Taxes Three Months Ended (Dollars in millions) March 29, 2024 March 31, 2023 Percent Change Provision for income taxes $ 9.9 $ 3.5 182.9 % Effective tax rate 366.7 % 89.7 % The increase in the effective tax rate for the three months ended March 29, 2024 compared to the same period in the prior year is primarily attributable to changes in the geographic mix of worldwide earnings and financial results in jurisdictions which are taxed at different rates and the impact of losses in jurisdictions with full federal and state valuation allowances. The increase also reflects the impact of the expiration of a reduced tax rate incentive on a portion of our earnings in certain international subsidiaries and thus we are applying the local corporate statutory tax rate on those earnings. We are in the process of renewing the international tax incentive; when renewed will make an adjustment to its effective tax rate in that period. Company management continuously evaluates the need for a valuation allowance on its deferred tax assets and, as of March 29, 2024, concluded that a full valuation allowance on its federal, state and certain of its foreign deferred tax assets remained appropriate. Liquidity and Capital Resources Cash and cash Equivalents The following table summarizes our cash and cash equivalents: (In millions) March 29, 2024 December 29, 2023 Decrease Total cash and cash equivalents $ 293.0 $ 307.0 $ (14.0) The following table summarizes the Condensed Consolidated Statements of Cash Flow information: Three Months Ended (In millions) March 29, 2024 March 31, 2023 Operating activities $ 9.8 $ 28.0 Investing activities (17.9) (27.3) Financing activities (4.5) (36.2) Effects of exchange rate changes on cash and cash equivalents (1.4) (1.2) Net decrease in cash and cash equivalents $ (14.0) $ (36.7) Our primary cash inflows and outflows were as follows: • For the three months ended March 29, 2024, we generated cash from operating activities of $9.8 million compared to $28.0 million for the three months ended March 31, 2023. The $18.2 million decrease in net cash from operating activities was driven by a $16.4 million unfavorable change in net working capital and by a $7.6 million decrease in net income offset in part by a $5.8 million increase from non-cash items included in net income. • The major contributors in net changes in operating assets and liabilities for the three months ended March 29, 2024 were as follows: ◦ Accounts receivable increased $13.7 million primarily due to the timing of shipments and collections and $13.6 million increase in inventories due to increased production levels. ◦ Accounts payable increased $25.1 million, income taxes payable increased $2.1 million, and accrued compensation and related benefits decreased $10.6 million, primarily due to the timing of payments. • Net cash used in investing activities during the three months ended March 29, 2024 and March 31, 2023 consisted primarily of $18.0 million and $27.3 million purchases of property, plant and equipment, respectively. • During the three months ended March 29, 2024, cash used in financing activities was $4.5 million, compared to cash used in financing activities of $36.2 million in the three months ended March 31, 2023. When compared to - 26 - Table of Contents the same period in the prior year, the change in cash used in financing activities is due to $17.5 million higher principal payments on bank borrowings and to $14.2 million cash used in our share repurchase program. We believe we have sufficient capital to fund our working capital needs, satisfy our debt obligations, maintain our existing capital equipment, purchase new capital equipment and make strategic acquisitions from time to time. As of March 29, 2024, we had cash and cash equivalents of $293.0 million compared to $307.0 million as of December 29, 2023. Our cash and cash equivalents, cash generated from operations, and amounts available under our revolving line of credit described below were our principal sources of liquidity as of March 29, 2024. Fluid Solutions has an existing factoring arrangement with a financial institution in which a portion of its accounts receivable are sold on a non-recourse basis. As of March 29, 2024, Fluid Solutions factored $6.9 million under this arrangement. We anticipate that our existing cash and cash equivalents balance and operating cash flow will be sufficient to service our indebtedness and meet our working capital requirements and technology development projects for at least the next twelve months. The adequacy of these resources to meet our liquidity needs beyond that period will depend on our growth, the size and number of any acquisitions, the state of the worldwide economy, our ability to meet our financial covenants with our credit facility, the cyclical expansion or contraction of the semiconductor capital equipment industry and the other industries we serve and capital expenditures required to meet possible increased demand for our products. In order to expand our business or acquire additional complementary businesses or technologies, we may need to raise additional funds through equity or debt financing. If required, additional financing may not be available on terms that are favorable to us, if at all. If we raise additional funds through the issuance of equity or convertible debt securities, our stockholders’ equity interest will be diluted and these securities might have rights, preferences and privileges senior to those of our current stockholders. We may also require the consent of our new lenders to raise additional funds through equity or debt financing. No assurance can be given that additional financing will be available or that, if available, such financing can be obtained on terms favorable to our stockholders and us. As of March 29, 2024, we have cash of approximately $204.0 million in our foreign subsidiaries. It is not practicable to determine the tax liability that might be incurred if the undistributed earnings of these foreign subsidiaries were to be distributed. For undistributed earnings of foreign subsidiaries which are not considered indefinitely reinvested, deferred taxes have been accrued. Borrowing Arrangements The following table summarizes our borrowings: March 29, 2024 (Dollars in millions) Amount Weighted- Average Interest Rate U.S. Term Loan $ 475.4 9.2 % Fluid Solutions Debt Facilities 5.3 7.7 % Debt issuance costs (5.5) $ 475.2 At March 29, 2024, the Company had an outstanding amount under the Term Loan of $475.4 million, gross of unamortized debt issuance costs of $5.5 million. As of March 29, 2024, the interest rate on the outstanding Term Loan was 9.2%. As of March 29, 2024, the Company had $146.1 million, net of $3.9 million of outstanding letters of credit, available under this revolving credit facility. As of March 29, 2024, the Company was in compliance with the financial covenants contained within the Amended Credit Agreement. The Company has a credit agreement with a local bank in the Czech Republic that provides for a revolving credit facility in the aggregate of up to 7.0 million euros (approximately 7.6 million). As of March 29, 2024, no debt was outstanding under this revolving credit facility. Fluid Solutions has credit facilities with various financial institutions in Israel that provides borrowings of up to $11.0 million. As of March 29, 2024, Fluid Solutions had $5.3 million of outstanding debt with average interest rate ranges from 7.6% to 7.8%. As of March 29, 2024, the Company’s total bank debt was $475.2 million, net of unamortized debt issuance costs of $5.5 million. As of March 29, 2024, the Company had $146.1 million, $5.7 million and $7.6 million available to draw from our credit facilities in the U.S., Israel and Czech Republic, respectively. - 27 - Table of Contents See Note 6 - Borrowing Arrangements, of our Condensed Consolidated Financial Statements, included in Part 1 of this Form-10Q for additional information. Capital Expenditures Capital expenditures were $18.0 million during the three months ended March 29, 2024 and were primarily attributable to the capital invested in our manufacturing facilities worldwide as well as costs associated with the ongoing design and implementation of our new enterprise resource planning system. The Company’s anticipated capital expenditures for the remainder of 2024 are expected to be financed primarily from our cash flow generated from operations and cash on hand. Contractual Obligations The Company had commitments to various third parties to purchase inventories totaling approximately $364.8 million as of March 29, 2024. In conjunction with the sale of our products in the ordinary course of business, we provide standard indemnification against certain liabilities to our customers, which may include claims of losses by their own customers resulting out of property damages, bodily injuries or deaths, or infringement of intellectual property rights by our products. Our potential liability arising out of intellectual property infringement claims by any third party is generally uncapped. As of March 29, 2024, we have not incurred any significant costs to defend lawsuits or settle claims related to these indemnification arrangements. As a result, we believe the estimated fair value of these arrangements is minimal. - 28 - Table of Contents