Motley Fool  Jun 12  Comment 
Will these high-flying stocks climb further? Find out.
Motley Fool  Apr 27  Comment 
The critical systems and subsystems supplier delivered a great quarter. Here's what investors need to know.
Motley Fool  Feb 23  Comment 
Revenue and profit exploded, beating analyst estimates, and the company called for continued growth in 2017.


Founded as a subsidiary of Mitsubishi Corporation in 1991, Ultra Clean Holdings, Inc. (UCTT) completed its initial public offering (IPO) in 2004. The Menlo Park, California-based company operates through its subsidiary, Ultra Clean Technology, which specializes in the production of gas delivery systems used in the front-end semiconductor manufacturing process tools.

The front-end process begins with device formation. This process begins with a wafer (usually made of silicon) having a layer of photoresist (a chemical that hardens when exposed to an ultraviolet light source) spin-coated onto the surface in liquid form to drive off the excess solvent, and then "soft-baked" or cured. A photomask is then loaded into the lithography system. Photomasks, also called masks or reticles (if the mask is "stepped" across the wafer), are high-purity quartz or glass plates containing precise microscopic images that are used by a photolithography tool, also known as a stepper. An excimer laser is then passed over the photomask and through a reduction lens system that exposes the desired areas of photoresist, which is then subsequently removed, permitting deposition to the surface of the wafer. A strip system is utilized to remove the photoresist or other chemical residues following diffusion processing or film deposition. Thin layers of dopants are then grown or deposited in a precise pattern within the wafer using various chemical, vapor or ion implant techniques. The deposition process alters the atomic structure of the material, and therefore necessarily the electronic properties of the material. Further into the wafer fabrication process, a series of metallization steps are executed, in which conducting materials, that interconnect the semiconductor devices, are deposited. Multiple layers of conducting, semiconducting and insulating materials are constructed on and within the wafer via successive steps of lithography, etching and deposition, utilizing unique masks for each layer. Depending on the geometry and the device, anywhere from 35 to 45 unique masks are used in the device formation process with 10 to 100 layers (or more for microprocessors) being constructed. Typically, the outcome is a wafer with multi-layered semiconducting devices, known as transistors. The transistors are interconnected with conducting materials, and insulating materials are used to electronically isolate the active components. The net result is a silicon wafer that contains multiple copies of integrated circuit devices.

Gases (including steam) are used in a number of processing steps. These include deposition, etch, chemical mechanical planarization (CMP, which is a process used to polish off high spots on wafers or films deposited on wafers), cleaning (stripping/ashing) and rapid thermal processing (RTP, or annealing). Deposition involves the conversion of certain materials into a gaseous form called plasma, which then deposits the conducting, semiconducting or insulating material evenly over the surface of the wafer. As a result of the photolithography process, the IC pattern is imprinted on to the wafer and the surface oxidized to protect the pattern. The oxidized material that remains unexposed and does not bear the IC pattern is etched away using another plasma treatment. A stripping or ashing system (wet or dry) removes photoresist or other residues after each diffusion or film deposition step, as well as the metallization steps, without damaging the wafer. A dry strip system utilizes gaseous or plasma treatment. Rapid thermal processing uniformly heats a semiconductor wafer to temperatures of up to 1,200 centigrade, and then rapidly cools the wafer in the presence of different gases. This locks in the atomic structure at the wafer surface (since the doped material properties determine the operational electronic properties).

A gas delivery system typically consists of components that would enable the precise dispersal of specialty gases in any of the processes outlined above. It consists of filters (that prevent particles from entering the process chambers), mass flow controllers (MFCs), regulators (that control pressure), pressure sensors (that indicate the pressure by means of an analog signal), valves and associated interconnect tubing. MFCs, which may be analog or digital, manage the flow rate of gases entering and exiting a process chamber. Ultra Clean's gas delivery systems are developed in collaboration with customers. They can be upgraded when necessary due to process changes within the lifecycle of a process tool. The company offers components from varied sources, depending on customer specifications or requirements.

Ultra Clean has also developed a catalytic steam generating system. Conventional steam generating systems are in the form of pyrogenic torches that enable controlled ignition of oxygen and hydrogen, thus producing steam. However, increasing complexities in the manufacturing process have exposed certain disadvantages inherent in these torches. For example, the torches have limited steam concentration ranges, high temperatures of operation, reduced repeatability at low flows and frequent maintenance issues. Further, the use of quartz nozzle tips increases periodic particle contamination concerns. Therefore, the pyrogenic torch is increasingly being replaced by catalytic steam generating systems. UCTT has made an entry into this area with its internally developed catalytic steam generation system. The catalyst, which does not itself require pre-heating, reduces the activation energy required for the chemical reaction, enabling the reaction to occur at close to room temperature. The catalyst is available in modules and one or more of such modules can be integrated into a gas flow tool. The catalytic material is non-toxic and stable, with a response time of less than one second. The efficiency factor for the conversion of hydrogen and oxygen into steam is estimated to be 99%.

Ultra Clean has been expanding into other areas as well. Although currently contributing just a small percentage of revenue, the company has started offering frame assemblies, top plate assemblies, process modules and chemical delivery modules. Frame assemblies provide the basic framework within which other assemblies are attached and top plate assemblies consist of the upper portion of the chambers in which wafers are processed. Process modules are larger subassemblies of wafer processing equipment such as the chamber and all related electronic, pneumatic and mechanical sub-assemblies for processing integrated circuits. Frame assemblies started shipping in the second quarter of 2004, top plate assemblies in the fourth quarter of 2004, while the chemical delivery system started shipping in the last quarter. The company shipped the first process module in the June 2005 quarter.

The company reports results in a single operating segment. Over 96% of the $184 million in 2004 revenue was generated in the U.S., while the balance came from Europe and Asia. Ultra Clean is actively expanding into Asia and has recently constructed a manufacturing facility in Shanghai, China. The company has a highly concentrated customer base, with substantially all of its 2004 revenue (93%) coming from Applied Materials, Novellus Systems and Lam Research. UCTT faces competition from other companies supplying gas delivery systems as well as from the internal manufacturing units of OEMs. Its closest direct competitors are Celerity Group, Integrated Flow Systems, Matheson Tri-Gas and Wolfe Engineering.

Ultra Clean has benefited from several trends in the market. Cost cutting initiatives of original equipment manufacturers led them to increasingly outsource their gas panel requirements to companies such as UCTT. This is part of the disaggregation model in which it is economically advantageous to outsource complex sub-function components to specialist firms. The company carved a niche out in this market, although it is characterized by slow growth and lower margins. The company's flexible operating model (with its variable workforce and generally low inventory levels) enables it to adjust the cost structure quickly to more closely align it with the level of revenue. This dampens operating losses even during a downturn in the industry. Usually, when demand is low, the company cuts back overtime, and then reduces the workdays by one a week, and then starts reducing the workforce. When demand returns, the company first starts working normal weeks and then brings in overtime, and then goes for workforce increases.

The low growth profile of the gas panel business prompted management to seek other growth avenues to supplement its core business. In keeping with this strategic decision, UCTT started supplying subassemblies, which currently generate around 16% of quarterly revenue. With the first chemical delivery and process module shipments underway, management expects this product line to be the primary growth driver for the company. The ASP of the new process module is 4-5x the ASP of a typical gas panel supplied by the company.

In the past year Ultra Clean announced two new wins with existing large OEM companies outside the gas panel market. This doubles UCTT's non gas business projects from two to four. These four projects should combine for $40-$50 million once fully ramped up.

Ultra Clean also recently inaugurated its Chinese facility. Management ultimately intends to transfer process module operations to this facility. The transfer is expected to yield savings in materials, labor, overhead and SG&A expenses. The reduction in costs, stable ASPs and improving utilization rates at the new facility are likely to boost operating margins. The facility will also enable UCTT to improve services to customers in the high-growth Asia/Pacific region. Total revenue from products produced at the Shanghai facility increased 38% from the second quarter. The company had a 51% sequential increase of their non-GAAP delivery system revenue, which was enabled by the major contract wins they announced in the fourth quarter of 2005.

Ultra Clean completed the acquisition of Seiger Engineering in the second quarter of 2006, which will allow UCTT to better leverage the existing China operations. The merger will also expand relationships with customers that seek suppliers with low cost manufacturing and precision machining capabilities. It will also increase their purchasing power which should lead to greater supply chain efficiencies for UCTT and its customer base. The Seiger acquisition will position UCTT increase its total addressable share by three to four times by expanding into process modules and other subsystems.

Although management is changing the strategic direction of the company, its current business focus will continue to impact near-term performance. The disappointing aspect of this quarter is the limited margin accretion on increased volume. As a result of the Seiger acquisition gross margin fell from 15.6% to 14.7% sequentially.

Management's investments to develop the subassembly business continue to raise operating expenses. While this is necessary for growth, near term operating margins could continue to suffer. Operating margins have been range bound in the past three quarters.

Ultra Clean had orders from three new clients Axcelis Technologies, Photon Dynamics, and IPS. (Korea)

The Photon Dynamics business is key. UCTT was awarded module business. Photon Dynamics provides test equipment to the flat panel industry. This is UCTT's first extension into the test equipment industry. The first Photon Dynamics process module is expected to ship in Q1 2008 from one of our U.S. facilities, and then transfer the manufacturing of this module to the new Shanghai facility in Q2 of 2008.


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