Item 1A. Risk Factors
The following risk factors could materially and adversely affect the Company’s business, financial condition or results of operations and cause reputational harm and should be carefully considered in evaluating the Company and its business, in addition to other information presented elsewhere in this report.
COVID-19 outbreak continues to adversely affect semiconductor industry
The COVID-19 outbreak and global governmental responses to contain its spread, have impacted all levels of the semiconductor industry and global supply chain. Governmental measures, including stay-at-home orders, travel bans, China’s “zero COVID” policy and business closures, as well as our own efforts to minimize the impact of COVID-19 on our employees, suppliers and customers, affected, our business operations in 2021 and continue to have an impact, but to a lesser degree on our business continuity plans. Our pandemic guidelines remain in place which include social distancing guidelines, travel restrictions, work-from-home arrangements, and testing and quarantine guidelines.
The scale and duration of this ongoing pandemic and the effectiveness of response measures in curbing its impact, including distribution of COVID-19 vaccines and government stimulus programs, which makes it difficult to estimate their ongoing impact on our business and global economy.
Because the ongoing impact of the pandemic on our business is largely dependent upon current and future response measures outside of our control, we cannot with any degree of confidence provide assurance that we will be able to maintain the current level of production, as we may see a decrease in customer spending, demand for our products, delays and capacity limitations at our (and our customers’ and suppliers’) manufacturing facilities, and other adverse impacts on global economy, any one of which can have material adverse impact on our business.
The cyclical and highly volatile nature of the industries we serve could harm our operating results.
Our business depends in large part upon capital expenditures by manufacturers in the semiconductor and display industries, which in turn depend upon the current and anticipated market demand for such products. These industries (especially the semiconductor industry) have historically seen recurring periods of over-supply of products that have materially reduced the demand for both the capital equipment and the services required to manufacture such products. We likely will continue to experience fluctuations in customer orders through such cycles. Although some of our business, including the cleaning, coating and analytical services that support the semiconductor chip market, are less susceptible to such fluctuations, recurring slowdowns in the industries we serve have historically had adverse effects on our overall operating results. Demand shifts in these industries are rapid and difficult to predict, and we may not be able to anticipate or respond quickly enough to changes in demand.
Our revenues in periods of increasing demand depends, in part, upon our ability to: (i) timely mobilize our supply chain to maintain component and raw material supply; (ii) optimize our design, as well as mobilize our engineering and manufacturing capacity in a timely manner; (iii) expand, as necessary, our manufacturing, cleaning, coating and analytical services capacity; and (iv) maintain our product and service quality as we increase production. If we fail to timely respond to rapid increases in demand for our products and services, or to effectively manage the corresponding expansion of our manufacturing and service capacity, our customers may divert their purchases of products and services from us to our competitors.
Our ability to remain profitable and mitigate the impact on our business in periods of decreasing demand depends, in part, upon our ability to: (i) maintain the prices, quality and delivery cycles of our products and services while managing costs by optimizing our inventory levels, (ii) reduce or cancel orders from our suppliers, all without compromising our relationships with such suppliers; and (iii) continue to motivate our employees while reducing our fixed and variable costs through various initiatives, which may include reducing our workforce.
The limited visibility we have on the future needs of our customers, combined with the cyclical and volatile nature of the industries we serve, makes future revenues, results of operations and net cash flows difficult to estimate.
We rely on a small number of OEMs and IDMs for a large portion of our revenues, who could stop outsourcing critical subsystems or part cleaning, coating or analytical services, or give market share to our competitors.
A small number of OEM customers have historically accounted for a significant portion of our revenues, and we expect this trend to continue. Our top two customers accounted for 64.0%, 67.1% and 66.9% of our revenues for fiscal years 2021, 2020 and 2019, respectively. Because most of these customers are not contractually obligated to
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place any orders with us, the success of our products business largely depends on these OEMs’ own discretion, which discretion is buttressed by the fact that the OEMs generally own and are therefore free to license as they see fit, the designs and other intellectual property to the products we manufacture for them. And since most of these OEMs are already our customers, any lost revenue resulting from the loss, reduction, cancellation or delay in purchase orders by, any one of these customers would be difficult to replace. In the past, we have seen decreases in our business volume for those customers who have taken the manufacturing of our products in-house, given market share to our competitors, or declared bankruptcy.
Our Services business provides part cleaning, coating and analytical expertise to both IDM and OEM customers. Our IDM business is similarly concentrated in a small number of customers, and we compete with in-house capabilities, the OEMs who perform cleaning as part of service contracts, and other providers of cleaning, coating and analytical services. The OEM customer profile of our Services business has significant overlap with our Products business, and we similarly compete against other providers of cleaning, coating and analytical services. Because our cleaning and analytical processes are proprietary to us, our customers may need to go through a new qualification process if they decide to transition to a new service provider.
Consolidation among our customers, or a decision by any one or more of our customers to outsource all or most manufacturing, assembly, cleaning, coating and analytical services work to a single equipment manufacturer, may further concentrate our business in a limited number of customers and expose us to increased risks relating to dependence on an even smaller number of customers.
Our customers also exert a significant amount of negotiating leverage over us, which may force us to accept lower operating margins, increased liability risks or changes in our operations in order to retain their business.
Due to their size and level of contribution to our revenue, our largest customers are able to exert significant pressure to seek various concessions in our commercial agreements and individual purchase orders. Our customers often require reduced prices or other quality, manufacturing or delivery commitments as a condition to placing purchase orders. This could, among other things, result in reduced operating margins or require capital or other expenditures in order to maintain or expand our market share. Further, these customers may require us to agree on certain terms and conditions that shift certain risks onto us. For example, our customers generally require indemnity against certain liabilities, which may include claims of losses by their own customers arising out of property damages, bodily injuries or deaths, or infringement of intellectual property rights by our products. Our potential liability for infringing upon a third party’s intellectual property is generally uncapped, and in some cases, we have self-insured against these liability risks, such that we do not have a third-party insurer to reimburse us against these losses. Our customers may also pressure us to make other concessions in order to preserve or expand our market share with them. For example, customers may prevent us from moving our manufacturing sites from higher-cost regions to lower-cost regions, while simultaneously seeking price reductions. If we are unable to retain and expand our business on favorable commercial terms, our business will be adversely affected and we may be susceptible to increased liability risk.
Our dependence on our suppliers may prevent us from delivering an acceptable product on a timely basis.
We rely on both single-source and sole-source suppliers, many of whom have been specifically designated by our customers, for many of the components and raw materials we use in our products and services. If a supplier, who may not be under any long-term supply obligations, fails to provide the necessary volume of components or raw materials on a timely basis and at acceptable prices and quality, we would be forced to identify and qualify replacements from alternative sources. The process of qualifying new suppliers for complex components and raw materials is lengthy and could delay our production or delivery of services.
For example, our recently acquired subsidiary, Ham-Let may face sharp price fluctuations in raw materials, which can significantly affect its cost of revenue and could erode profitability and competitiveness.
We may also experience difficulty in obtaining sufficient quantities of components and raw materials in times of growth in our business. In the past, we have experienced shortages in supplies of various components, such as mass flow controllers, valves and regulators, and certain prefabricated parts, such as sheet metal enclosures, used in the manufacture of our products. Some of the suppliers designated by our customers are also our competitors, which presents a special challenge for us to procure the components in sufficient quantity to meet the customer demands. If we, or our suppliers, are unable to procure sufficient quantities of supplies, components or raw materials, our customers could delay or cancel orders or service contracts.
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The manufacturing of our products and the services we provide are highly complex, and if we are not able to manage our manufacturing and procurement process effectively, our business and operating results will suffer.
The manufacturing of our products is a highly complex process. The services we provide are also highly complex, and dependent upon procuring specialty materials necessary to correctly perform such complex services with precision. Both the manufacturing of our products and the services we provide involve the integration of multiple components and require effective management of our supply chain to meet our customers’ design-to-delivery cycle time requirements. Through the course of the manufacturing process, our customers may modify design and system configurations in response to changes in their own customers’ requirements. In order to respond to these modifications and deliver our products in a timely manner, we must effectively manage our manufacturing and procurement processes, the failure of which can lead to a loss of business and reputational damage. We may also be liable for certain damages under our agreements with our customers, if we or our suppliers fail to effectively or timely re-configure manufacturing processes or components in response to these modifications.
Our inability to successfully manage the implementation of a company-wide enterprise resource planning (“ERP”) system could adversely affect our operating results.
We are continuing the implementation of a new company-wide ERP system. This process has been and continues to be complex and time-consuming and we expect to incur additional capital outlays and expenses. This ERP system will replace many of our existing operating and financial systems, which is a major undertaking from a financial management and personnel perspective. Should the new ERP system not be implemented successfully throughout all our business units on time and within budget, or if the system does not perform in a satisfactory manner, it could be disruptive and adversely affect our operations, including our ability to: (i) report accurate, timely and consistent financial results; (ii) purchase supplies, components and raw materials from our suppliers; and (iii) deliver products and services to customers on a timely basis and to collect our receivables from them. We have teams leading the implementation of the ERP system at most of our locations. To the extent these teams or key individuals are not retained through the implementation process, the success of our implementation could be compromised and the expected benefits of the ERP system may not be realized.
We are subject to order and shipment uncertainties and any significant reductions, cancellations or delays in customer orders could cause our revenue to decline and our operating results to suffer.
Forecasting our revenue can be challenging because we generally do not have a material backlog of unfilled orders and because of the short time frame within which we are often required to design, produce or deliver products to our customers. Much of our revenue depends on customer orders for our products that we receive and fulfill in the same quarter. We generally do not have long-term purchase orders or contracts that contain minimum purchase commitments from our customers. Instead, we typically plan around non-binding volume forecasts we receive from our customers, and we sometimes order and build component inventory in advance of the receipt of actual customer orders. Customers may cancel order forecasts, change production quantities from forecasted volumes, or delay production for reasons beyond our control, and for which we usually are not entitled to compensation. Reductions, cancellations or delays in forecasted orders could cause us to hold inventory longer than anticipated, which could reduce our gross profit, restrict our ability to fund our operations and cause us to incur unanticipated reductions or delays in revenue. Moreover, many of the products we manufacture are custom built for our customers and are therefore not fungible with products we sell to other customers. If we do not obtain orders as we anticipate, we could have excess component inventory for a customized product that we would not be able to sell to another customer, likely resulting in inventory write-offs. In addition, because many of our costs are fixed in the short term, we could experience deterioration in our gross profit and operating margins when our sales volumes decline.
We hold our customers’ parts on our premises and any significant damage or loss to these parts could cause our operating results to suffer.
In connection with our Services business, we face a number of risks associated with customer parts being held on our premises, including the risk of mishandling or damaging, customer parts, any of which could be materially harmful for our business.
Our results of operations, financial position and cash flows may suffer if we do not effectively manage our inventory.
Inventory is one of the largest assets on our balance sheet, representing 18.7% of our total assets as of December 31, 2021. Effective management of raw materials, work-in-process and finished goods is imperative to keep inventory costs down and maintain or improve gross margins, all the while meeting changing customer requirements.
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Historically, the industries we serve (in particular the semiconductor capital equipment industry) have been highly cyclical, which makes accurately forecasting customers’ product needs difficult. Although we seek to maintain sufficient inventory of materials to guard against interruptions in supply and meet our customers’ needs, we may experience shortages of certain key materials, particularly in times of high industry demand. We also often face long lead times from our suppliers, which may be longer than the lead times provided to us by our customers. If we underestimate customer demand or if such demand exceeds our manufacturing capacity or available raw materials, we may lose sales opportunities and market share and potentially damage our relationships with customers.
An overestimation of customer demand may result in allocation of resources for products that we may not be able to sell, and we may be forced to hold excess or obsolete inventory. Some of our products can become obsolete while in storage due to changing customer specifications or become excess inventory due to a decrease in demand. Furthermore, if market prices drop below the prices at which we value our inventory, we would need to take a charge for a reduction in inventory values in accordance with the applicable accounting rules. Any unexpected changes in demand or increases in manufacturing costs that cause us to take additional charges for un-saleable, obsolete or excess inventory, or to reduce inventory values, would adversely affect our results of operations.
We hold our inventory at various manufacturing sites globally and many of these sites have more than one warehouse. We rely upon our IT systems and internal controls to accurately and timely manage, store and replenish inventory, complete and track customer orders, coordinate sales activities across all of our products and maintain and report vital data and information. A disruption in our IT systems or a failure of our internal controls could result in delays in receiving inventory and supplies, delays in filling customer orders, incorrect inventory counts, over or under stocking, and loss of inventory.
Our customers require our products to undergo a lengthy and expensive qualification process. Any delay or failure in this process could result in a material financial harm.
We have had to qualify as a supplier, and maintain that status, for each of our customers. This is often a lengthy process that normally involves customer inspection and approval of our engineering, documentation, manufacturing and quality control procedures before the customer will place volume orders. Such qualification requirements limit our ability to quickly add new customers to offset any loss of, or reduction in sales to, existing customers. Moreover, if we fail to maintain our status as a qualified supplier to any of our customers, such customer could cancel its orders or otherwise terminate its relationship with us.
Defects in our products or services could damage our reputation, decrease market acceptance of our products, release hazardous materials, and result in litigation, indemnification liability or unexpected warranty claims.
A number of factors, including design flaws, material and component failures, workmanship issues, contamination in the manufacturing, cleaning, coating or analytical environment, impurities in the materials or chemicals used, equipment failures, and unknown sensitivities to process conditions, such as temperature and humidity, may cause our products to contain undetected errors or defects. Problems with our products may:
• cause delays in product introductions and shipments for us or our customers;
• cause us to incur increased charges due to unusable inventory;
• result in lower yields for semiconductor manufacturers.
Acquisitions could result in operating and integration difficulties, dilution, margin deterioration, diversion of management’s attention, and other consequences that may materially impact our business.
We have made, and may in the future make, acquisitions of, or significant investments in, businesses that offer complementary products, services, technologies or market access. We expect that management will regularly evaluate potential strategic transactions with its advisors and our board of directors in the ordinary course of business. We may not be successful in negotiating the terms or financing for potential acquisitions and our due diligence may fail to identify all of the problems, liabilities or other challenges associated with an acquired business,
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product or technology, including issues related to intellectual property, product quality or product architecture, regulatory compliance practices, revenue recognition or other accounting practices or employee or customer retention issues. In addition, we may not be successful in effectively integrating the acquired business, product or technology into our existing business and operations. The areas where we face risks include:
• failure to realize expected returns from acquired businesses;
If we fail to address these risks, we may not be able to realize the anticipated benefits of such acquisitions or investments and incur unanticipated liabilities and substantial costs, materially harming our business in the process.
Our acquisitions could also result in one or more of the following: dilutive issuances of our equity securities, additional debt, contingent liabilities, amortization expenses, impairment charges and restructuring charges, any of which could harm our financial condition. Also, due to prevailing conditions in the credit market and our existing leverage, the financing of any such acquisition may be difficult to obtain, and the terms of any such financing may not be favorable.
On March 31, 2021, we completed the acquisition of Ham-Let. The integration of Ham-Let into our larger business operations will likely face similar challenges as occurred with our QGT and DMS acquisitions, and may pose additional challenges.
The challenges involved with this integration include: continuing to maintain customers and other important relationships; continuing to compete effectively in the served markets; completing the consolidation of IT, finance, general and administrative infrastructures; continuing to improve the coordination of our sales and marketing efforts to effectively position our capabilities; and fully integrating employees and related HR systems and benefits. The integration process continues to require significant management attention and may divert the attention of management from our other business and operational issues.
Our business may be adversely affected by IT disruptions, including by impairing our ability to effectively deliver our products or services, which could cause us to lose customers.
The manufacture and delivery of our products, the provision of our services and our financial reporting depend on the continuing operation of our technology infrastructure and systems, particularly our data center located in California. Any damage to or failure of our systems could result in interruptions in our ability to manufacture or
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deliver products or services, or adversely impact our ability to accurately and timely report our financial results. Interruptions could reduce our sales and profits, and our systems could be perceived as unreliable. Our systems and operations are vulnerable to damage or interruption from earthquakes, terrorist attacks, floods, fires, power loss, hardware or software failures, telecommunications failures, cybersecurity attacks, and similar events.Some of the critical components of our system are not redundant and we currently do not have a backup data center.
Cybersecurity attacks, in particular, are evolving and include, but are not limited to, malicious software, attempts to gain unauthorized access to data, and other electronic security breaches that could lead to disruptions in systems, unauthorized release of confidential or otherwise protected information and corruption of data (our own or that of third parties). Although we have adopted certain measures to mitigate potential impacts to our systems from IT-related disruptions, including adding a Chief Information Officer and a Chief Security Officer, and given the unpredictability of the timing, nature and scope of such disruptions, we could experience detrimental impacts on our operations or ability to provide products and services to our customers (such as production downtimes and operational delays), misappropriation, destruction or corruption of confidential information or other data, security breaches, other manipulation or improper use of our systems or networks, financial losses from remedial actions, and/or reputational harm, any of which could have a material adverse effect on our business.
If we experience frequent or persistent system failures, the attractiveness of our products or services to customers could be permanently harmed. Any steps we take to increase the reliability and redundancy of our systems may be expensive, reduce our operating margin and may not be successful in reducing the frequency or duration of unscheduled interruptions.
We are exposed to risks associated with volatility in the global economy.
We rely heavily on OEM customers for the success of our business. The success of OEMs’ business is, in turn, directly related to the success of the IDMs and other chipmakers, whose customers are engaged in consumer-facing businesses. Much of our success, therefore, depends on consumer spending and capital expenditures by retail businesses. Uncertainty regarding the global economy may exacerbate negative trends in business and consumer spending, which may cause our customers to scale back operations, reduce capital expenditures, exit businesses, move capacity to other manufacturers, in-source capacity or file for bankruptcy protection and potentially cease operations. Our customers may then be forced to push out, cancel or refrain from placing orders for our products or services. These conditions may also similarly affect key suppliers, impairing their ability to timely deliver components or raw materials. We may then be forced to procure components or raw materials from higher-cost suppliers or reconfigure the design and manufacture of our products or services, which may eventually lead to our failure to fill customer orders. Recent inflationary trends, have had, and could continue to have, a negative impact on many aspects of our cost structure.
Escalating trade tensions and the adoption of tariffs and trade restrictions could negatively impact us.
International trade tensions or trade wars, as well as other changes in social, political, regulatory and economic conditions or laws and policies, could have a material adverse impact on our business. We and our customers have significant operations in China. The impact of the ongoing conversation between the United States and China regarding each country’s commitments under the“Phase One” trade deal on current tariffs and other trade restrictions between the two countries are difficult to predict. Any newly imposed or threatened U.S. tariffs and retaliatory tariffs could have the negative effect of increasing the cost of materials for our products, which could result in our products becoming less competitive or generating lower margins. Also, the United Kingdom’s (“UK”) withdrawal from the European Union (“EU”) (“Brexit”) continues to create significant uncertainty concerning the future relationship between the UK and the EU and the impact on global markets. It remains unclear what financial, trade, regulatory and legal implications the trade arrangements between UK and EU, as well as between the UK and US, will have and how it will affect us. The economic uncertainty created by Brexit may cause our customers to closely monitor their costs and reduce their spending budgets, which could have a material adverse impact on our business, financial condition and results of operations.
Other changes in U.S. or international social, political, regulatory and economic conditions or laws and policies governing tax laws, foreign trade, manufacturing, and development and investment in the countries where we or our customers operate could also adversely affect our operating results and our business. International trade disputes could result in increases in tariffs and other trade restrictions and protectionist measures that could adversely impact our operations and reduce the competitiveness of our products relative to local and global competitors.
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We have significant existing indebtedness; the restrictive covenants under our credit agreement or other limitations on financing may limit our ability to expand or pursue our business strategy; if we are forced to pay our indebtedness prior to its maturity, our financial position could be materially and adversely affected.
As of December 31, 2021, we have gross debt of $565.4 million. Such debt is composed of a $555.1 million term loan outstanding under our credit agreement with Barclays Bank, $8.9 million under credit facilities at Ham-Let and $1.4 million under the credit facilities at Cinos China less unamortized debt costs of $13.4 million.
Our indebtedness could have adverse consequences, including: allotment of a portion of our cash to interest and principal payments and will therefore not be available for operations, working capital, capital expenditures, expansion, acquisitions or general corporate or other purposes; and inability to obtain additional financing in the future, if needed. If we are unable to meet our debt obligations as they come due, we could be forced to restructure or refinance such obligations, seek additional equity financing, incur additional debt or sell assets, which we may not be able to do on satisfactory terms, if at all.
Our credit agreement contains certain covenants that restrict our ability to take certain actions, including incurring additional debt, providing guarantees, creating liens, making certain investments, engaging in transactions with affiliates and engaging in certain mergers and acquisitions. We are also required to comply with certain financial covenants, including the maintenance of a maximum consolidated total gross leverage ratio and a minimum fixed charge coverage ratio. Failure to comply with these covenants could result in the acceleration of all of our indebtedness, which could materially and adversely affect our financial health. As long as our indebtedness remains outstanding, the restrictive covenants and mandatory prepayment provisions could impair our ability to expand or pursue our business strategies or obtain additional funding.
We may not be able to fund our future capital requirements or strategic acquisitions from our operations, and financing from other sources may not be available on favorable terms or at all.
We made capital expenditures of approximately $69.5 million and $37.2 million for fiscal years 2021 and 2020, respectively, which are primarily related to investments in our manufacturing facilities in the United States, Malaysia, China, Singapore and South Korea and to our ERP system implementation. The amount of our future capital requirements will depend on many factors, including: the cost associated with the expansion of our manufacturing capacity into Malaysia as part of our strategic growth plan; the cost to maintain appropriate IT systems; the cost to maintain adequate manufacturing capacity; the timing and extent of spending to support product development efforts; the timing of new product introductions and enhancements to existing products; the timing, size and availability of strategic transactions; the cost to integrate our acquisitions into our business environment; changing manufacturing capabilities to meet new or increased customer requirements; market acceptance of our products; and our ability to generate sufficient cash flow from our operating activities.
In order to finance our capital expenditures or any future strategic acquisitions, we may need to raise additional funds through public or private equity or debt financing, but such financing may not be available on terms satisfactory to us, or at all. In addition, equity financings could be dilutive to holders of our common stock, and debt financings would likely involve additional covenants that restrict our business operations. Any potential strategic acquisition or significant capital expenditure may also require the consent of our existing lenders. If we cannot raise funds on acceptable terms when needed, we may not be able to develop or enhance our products, take advantage of future opportunities, grow our business or respond to competitive pressures or unanticipated requirements.
Our quarterly revenue and operating results could fluctuate significantly from period to period, and this may cause volatility in our common stock price.
Our quarterly revenue and operating results, including our gross margin, have fluctuated significantly in the past, and we expect them to continue to fluctuate in the future for a variety of reasons, which may include:
• strategic consolidation by our customers;
• pricing pressure from either our competitors or our customers;
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• introduction of new products or services;
• changes in design-to-delivery cycle times;
• changes in our product and/or service mix;
• write-offs of excess or obsolete inventory;
• inability to control our operating costs consistent with target levels;
• geographic mix of customer orders or worldwide earnings.
As a result of the foregoing, we believe that quarter-to-quarter comparisons of our revenue and operating results may not be meaningful and that these comparisons may not be an accurate indicator of our future performance. Changes in the timing or terms of a small number of transactions could disproportionately affect our operating results in any particular quarter. Moreover, our operating results in one or more future quarters may fail to meet our guidance or the expectations of securities analysts or investors. If this occurs, we would expect to experience an immediate and significant decline in the trading price of our common stock.
We have established and, as circumstances may require, intend to expand our operations globally, which exposes us to risks associated with operating in foreign countries.
We generated approximately 65.1% and 58.4% of our revenues in international markets for fiscal years 2021 and 2020, respectively. Depending on market conditions, we intend to further expand our operations in Asia Pacific and EMEA. The carrying amount of our fixed assets in Asia Pacific and EMEA were $129.0 million and $53.4 million, respectively as of December 31, 2021 and $90.4 million and $9.4 million, respectively as of December 25, 2020.
We are exposed to political, economic, legal and other risks associated with operating in Asia and EMEA, including:
• foreign currency exchange fluctuations;
• political, civil, public health and economic instability;
• timing and availability of export licenses;
• the burden of complying with foreign and international laws and treaties;
• legal systems potentially subject to undue influence or corruption; and
Negative or uncertain global conditions could prevent us from accurately forecasting demand for our products and services. In addition, a shift in the mix of orders from our customers away from low-cost markets to higher cost markets could adversely affect our operating margins.
Our operations in Asia Pacific and EMEA are subject to U.S. regulations governing equipment export. These laws are complex and require us to obtain export licenses, a failure of which could expose us to fines, penalties and
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export ban. The U.S. Department of Commerce continually updates and often expands the list of entities, particularly in China, to whom U.S. companies cannot sell certain products without a license from the Department of Commerce. These rules and regulatory changes could have material adverse impact on the result of our operations.
Over the past several years, some foreign government authorities, including those in China and South Korea, have pursued economic reform policies by promoting local businesses and local economic activity. Without notice, these government authorities may continue or alter these policies to our detriment, including imposition of confiscatory taxation policies, new restrictions on currency conversion, and limitations on sources of supply.
We are subject to various laws and regulations of the countries where we conduct business, including laws and regulations relative to anti-corruption and anti-bribery, antitrust and competition, data privacy, and export regulations. These foreign laws and regulations are constantly evolving and may, in some cases, conflict with each other. Although our compliance policies against unethical business practices apply to all our employees and agents, any violation of these policies by a rogue employee or agent may expose us to enforcement actions against these laws and regulations.
Business practices in Asia may entail greater risk and dependence upon the personal relationships, and therefore some of our agreements with customers or suppliers in Asia could be difficult or impossible to enforce.
Our business activities in Asia are continuing to expand, where personal relationships generally play a larger part in the business culture than is common in the U.S. In some cases, oral agreements based on personal relationships play just as important a role as written contracts, resulting in certain material terms not being reduced to writing. Similarly, there is a tendency in some Asian businesses to treat written agreements as a starting point of an ongoing business relationship, which is expected to continually change over time. The difficulty associated with enforcing oral agreements may expose us to adverse business consequences.
We could be adversely affected by risks associated with joint ventures, including those in the Asian markets.
From time to time, we may seek to expand our business through investments in joint ventures with complementary businesses, technologies, services or products, in both new and existing market categories and geographic regions. Our investments in joint ventures are subject to a number of risks, including many of the same risks described above for our acquisition activities. In particular, at the closing of the QGT acquisition, we indirectly became a party to QGT’s joint venture with Cinos Co., Ltd. (“Cinos Korea”) in South Korea and Cinos Xi’an in China, which was our first experience with a joint venture. The success of these joint ventures will continue to demand significant management and capital resources, and effective management of those risks inherent in overseas joint venture operations, including: protection of our intellectual property; economic, political and labor instability; language and cultural differences; contractual enforcement issues; and managing product development, operations and sales activities that are physically far removed from our headquarters and have historically been centralized with local management. In addition, from time to time in the future, our joint venture partners may have economic or business interests that are different from ours. Furthermore, our joint venture with Cinos Korea will require us to make purchases of equity from time to time up to specified amounts. If each joint venture business does not progress according to our plans and anticipated timing, our investment in the joint ventures may not be successful.
The industries in which we participate are highly competitive and rapidly evolving.
We face intense competition from subsystem and component manufacturers in the industries we serve. Increased competition has in the past resulted, and could in the future result, in price reductions, reduced gross margins or loss of market share. Competitors may introduce new products in the markets currently being served by our products. These new products may have better performance, lower prices and achieve broader market acceptance than our products. Further, since our customers generally own the designs and other intellectual property to the products we manufacture on their behalf, we cannot prevent them from licensing such designs and other intellectual property to our competitors for the manufacture of such products. Similarly, while the cleaning and analytical processes we utilize are proprietary to us, OEMs are looking to increase their maintenance services and could create proprietary cleaning processes with competitors, limiting our ability to compete for future business.
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Our competitors may have greater financial, technical, manufacturing and marketing resources than we do. As a result, they may be able to respond more quickly to new or emerging technologies and changes in customer requirements, devote greater resources to the development, promotion, sale and support of their products and services, and reduce prices to increase market share. Moreover, there may be merger and acquisition activities among our competitors and potential competitors that may provide our competitors and potential competitors an advantage over us by enabling them to expand their product offerings and service capabilities to meet a broader range of customer needs. Further, if one of our customers develops or acquires the internal capability to develop and produce critical subsystems that we produce, or cleaning, coating and analytical services we provide, the loss of that customer could have a material adverse effect on our business, financial condition and operating results.
If our new products are not accepted by OEMs or other customers or if we are unable to obtain historical margins on our new products, our operating results would be adversely impacted.
We design, develop and market critical subsystems and proprietary cleaning, coating and analytical services to OEMs, IDMs and other customers. The introduction of new products and processes is inherently risky because it is difficult to foresee the adoption of new standards, coordinate our technical personnel and strategic relationships and win acceptance of new products by our customers, and ultimately not be able to recoup design and development expenditures. Newly introduced products typically carry lower gross margins than existing products for several quarters following their introduction. If any of our new systems or subsystems are not successful in the market, or if we are unable to obtain gross margins on new products that are similar to the gross margins we have historically achieved, our business, operating results and financial condition could be adversely affected.
If we were required to impair all or part of our goodwill and/or our acquired intangible assets, our net income and net worth could be materially adversely affected.
We had $270.0 million of goodwill recorded on our Consolidated Balance Sheet as of December 31, 2021. Goodwill represents the excess of cost over the fair market value of net tangible and finite lived, identifiable intangible assets acquired in business combinations. If our market capitalization drops significantly below the amount of net equity recorded on our balance sheet, it could indicate a decline in our value and would require us to further evaluate whether our goodwill has been impaired. During the fourth quarter of each year, we perform an annual review of our goodwill and acquired intangible assets to determine if they have become impaired. We also conduct the same evaluation whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. If we were required to impair all or a significant part of our goodwill and/or our acquired intangible assets, our financial results and net worth could be materially adversely affected.
Our business is largely dependent on the know-how of our employees, and we generally do not have an intellectual property position that is protected by patents.
Our business is largely dependent upon our design, engineering, manufacturing, chemical processing, analytical and testing know-how. We rely on a combination of trade secrets and contractual confidentiality provisions and, to a much lesser extent, patents, copyrights and trademarks to protect our proprietary rights. Confidentiality agreements with our employees and others may not adequately prevent disclosure of trade secrets and other proprietary information. Accordingly, our intellectual property position is more vulnerable than it would be if it were protected primarily by patents. If we fail to protect our proprietary rights successfully, our competitive position could suffer. We may be required to spend significant resources to monitor and protect our proprietary rights, and, in the event infringement or breach of our proprietary rights occurs, our competitive position in the market may be harmed. In addition, competitors may design around our technology or develop competing technologies and know-how.
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Third parties may claim we are infringing their intellectual property, which could subject us to litigation or licensing expenses, and we may be prevented from selling our products if any such claims prove successful.
We have in the past and may in the future receive claims that our products, processes or technologies infringe the patents or other proprietary rights of third parties. Any litigation regarding third party patents or other intellectual property rights could be costly and time-consuming and divert our key resources from our business operations. The complexity of the technology involved in our products and the uncertainty of intellectual property litigation increase these risks. Claims of intellectual property infringement may also require us to enter into costly license agreements, possibly on terms unacceptable to us. We also may be subject to significant damages or injunctions against the development, manufacture and sale of certain of our products if any such claims prove successful. We also rely on design specifications and other proprietary information provided by our customers to manufacture products for such customers. While many of our customers are contractually obligated to indemnify us for the costs to defend third party claims arising out of our use of the information provided by the customers, the indemnified amount may not be enough to make us whole, or if our customers refuse to honor its obligations, we could end up in costly litigations both to defend against such third-party claims and to enforce our contractual indemnification rights.
We may become involved in litigations and regulatory proceedings, which could require significant attention from our management and result in significant expense to us and disruptions to our business.
In addition to any litigation related to our intellectual property rights, we may in the future be named as a defendant in other lawsuits and regulatory actions relating to our business, such as commercial contract claims, environmental compliance claims, employment claims, and tax examinations, any one of which may expose us to significant damages and reputational harm. The outcome of such litigations and regulatory proceedings is difficult to predict. An unfavorable outcome could have a material adverse effect on our business, including limiting our ability to engage in certain business activities. In addition, such proceedings are often expensive, time-consuming and disruptive to normal business operations and require significant attention from our management.
If we do not keep pace with developments in the industries we serve and with technological innovation generally, our products may not be competitive.
Rapid technological innovation in the markets we serve requires us to anticipate and respond quickly to evolving customer requirements and could render our current product or service offerings and technology obsolete. Technological innovations are inherently complex. We believe that our future success will depend upon our ability to timely design, engineer and manufacture products and services that meet the changing needs of our customers. If we are unable to integrate new technical specifications into competitive product and service designs, develop the technical capabilities necessary to manufacture new products or provide new services or make necessary modifications or enhancements to existing products or services, our business prospects could be harmed.
The timely development of new or enhanced products and services requires us to:
• accurately identify and design new products and services to meet market needs;
• successfully manage development production cycles; and
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We must achieve design wins to retain our existing customers and to obtain new customers.
New capital equipment typically has a lifespan of several years, and OEMs frequently specify which systems, subsystems, components and instruments are to be incorporated in their equipment. Once incorporated, the OEM will likely maintain that same composition of products for at least several months. IDMs typically establish cleaning, coating, and analytical services as they develop and qualify new chip designs for production. Once a cleaned or coated part has been qualified, the refurbishment processes used to clean or coat the qualified part will likely continue to be used. Accordingly, it is important that our products and services are designed into the new capital equipment and new chip designs (known as a “design win”), to retain our existing customers and to obtain new customers.
We incur technology development and sales expenses with no assurance that our products will ultimately be designed into an OEM’s capital equipment or into an IDM’s manufacturing process. Further, developing new customer relationships, as well as maintaining and increasing our market share with existing customers, requires a substantial investment of our sales, engineering and management resources without any assurance from prospective customers that they will place orders. We believe that OEMs and IDMs often consider long-term relationships in selecting and placing orders, which could mean we may have difficulty achieving design wins from OEMs and IDMs that are not our current customers.
Fluctuations in foreign currency exchange rates may adversely affect our financial condition and results of operations.
The majority of our international revenues are denominated in U.S. Dollars. Many of the costs and expenses associated with our international operations are paid in foreign currencies, including Chinese Renminbi, Singapore Dollars, Japanese Yen, South Korean Won, Israeli New Shekel, Taiwanese Dollars, Malaysian Ringgits and Euro, and we expect our exposure to these foreign currencies to increase as we increase production in those regions. Changes in exchange rates among these foreign currencies may affect our revenue, cost of revenues, operating margins and tax.
We use derivative instruments, such as foreign currency forward contracts, to hedge certain exposures to fluctuations in foreign currency exchange rates. The use of such hedging activities may not fully offset the adverse financial effects of unfavorable movements in foreign currency exchange rates over the time the hedges are in place.
The market for our stock is subject to significant fluctuation.
The size of our public market capitalization is relatively small, and the average volume of our shares that are traded is relatively low. The market price of our common stock could be subject to significant fluctuations. Among the factors that could affect our stock price are:
• quarterly variations in our operating results;
• speculation in the press or investment community;
• the effects of war and terrorist attacks;
The stock markets in general, and the markets for technology stocks in particular, have experienced extreme volatility that has often been unrelated to the operating performance of particular companies. These broad market fluctuations may adversely affect the trading price of our common stock.
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The technology labor market is very competitive, and we must hire, promote and retain key personnel.
Our future success depends in part on the continued service of our key executive officers, as well as our research, engineering, sales, manufacturing and administrative personnel, most of whom are not subject to employment or non-competition agreements. In addition, the competition for qualified personnel in the technology industry is intense, and we operate in geographic locations in which labor markets are particularly competitive.
Our business is particularly dependent on expertise which only a limited number of engineers possess. The loss of any of our key employees and officers, including our Chief Executive Officer, Chief Financial Officer, Chief Operating Officer, any of our Executive or Senior Vice Presidents or any of our other senior managers, or the failure to attract, promote and retain qualified employees, could adversely affect our business. Also, uncertainty and disruption to our organization as a result of executive management transition could divert the executive management’s attention away from key areas of our business and have a material adverse effect on our business.
As pandemic related disruptions began to ease, the competition for qualified work force further intensified in 2021 to include jobs that do not require technological expertise. We have not been immune to this heightened competition for available labor force.
Any environmental contamination at any of our production facilities could result in substantial liabilities.
Our facilities use substances regulated under various foreign, federal, state and local environmental laws and regulations. We may not always be aware of, or in compliance with, all environmental laws or regulations, and our failure or inability to comply with existing or future environmental requirements could result in significant remediation and other liabilities, imposition of fines, and suspension of our services and products.
Our business is subject to the risks of earthquakes, fire, power outages, floods, and other catastrophic events, and to interruption by man-made disruptions, such as terrorism.
Our facilities may experience catastrophic losses caused by natural disasters or other causalities, such as earthquakes, storms, floods, fires, public health epidemic, labor disruptions, power outages, terrorist attacks or political unrest, the occurrence of any one of which could disrupt our operations, delay production and shipments, and result in large repair expenses. We have facilities in areas with above average seismic activity, such as our facilities in South San Francisco and Hayward, California, and our Taiwan facilities in Hsinchu and Tainan. We also have experienced fires and extended power outages at our facilities, such as the fire that occurred at a Korean plant operated by our joint venture, Cinos Korea, on September 19, 2018. This risk is further exacerbated by the fact that our insurance policies do not cover the losses caused by earthquakes or other natural disasters or power loss. Our operations in Israel have significantly expanded with our acquisition of Ham-Let whose management, offices and some of its production facilities are located in the north of Israel. The political, economic and security situation in Israel has a direct impact on our operations there, and a state of war in Israel may harm our ability to supply our products to customers.
In addition, our suppliers experiencing natural disasters may not be able to provide sufficient components or raw materials in a timely manner, which can cause disruptions in our operations. For example, in 2011, some of our Japanese suppliers had to temporarily shut down their operations as a result of a severe earthquake followed by a tsunami in northern Japan. Similar events may occur again to our material detriment.
Changes in tax rates or tax assets and liabilities could affect results of operations.
As a global company, we are subject to taxation in the United States and various other countries. Significant judgment is required to determine and estimate worldwide tax liabilities. Our annual and quarterly tax rates could be affected by numerous factors, including changes in the applicable tax laws, amount and composition of pre-tax income in countries with different tax rates, and valuation of our deferred tax assets and liabilities.
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We are subject to examinations of our income tax returns by domestic and foreign tax authorities. We regularly assess the likelihood of favorable or unfavorable outcomes resulting from these examinations to determine the adequacy of our provision for income taxes and have reserved for potential adjustments that may result from these examinations. There can be no assurance that any final determination will not be materially different from the treatment reflected in our historical income tax provisions and accruals, which could materially and adversely affect our financial condition and results of operations.
Certain regulations related to conflict minerals could adversely impact our business.
We use conflict minerals in manufacturing our products. As a result, we are required to perform ongoing due diligence on our supply chain and publicly disclose the nature and results of such efforts. Our most recent disclosure was filed on Form SD on January 25, 2022, noting that we could not yet determine whether the conflict minerals we source were, directly or indirectly, used to finance or benefit armed groups in the Democratic Republic of Congo and its adjoining countries. There have been and there will be costs associated with complying with these disclosure requirements to determine the sources of conflict minerals used in our products, and potential changes to products, processes or sources of supply as a consequence of such verification activities. Complying with these rules could adversely affect the sourcing, supply and pricing of materials used in our products and result in substantial additional costs. As there may be only a limited number of suppliers offering “conflict free” conflict minerals, we are not certain that we will be able to obtain the conflict minerals from such suppliers in sufficient quantities or at competitive prices. We may also face reputational challenges if we determine that certain of our products contain minerals not determined to be conflict free or if we are unable to sufficiently verify the origins for all conflict minerals used in our products. If we are unable to comply with these disclosure rules (which themselves may be subject to potential re-formulation by the new administration), we could be subject to enforcement actions by the SEC and liability under the Securities Exchange Act of 1934, which could result in material adverse consequences to our business, as well as significant fines and penalties.
If securities or industry analysts do not publish research or reports about our business, or if they issue an adverse opinion regarding our stock, our stock price and trading volume could decline.
The trading market for our common stock is influenced by the research and reports that industry analysts publish about us or our business. If any of the analysts issue an adverse opinion regarding our stock, our stock price would likely decline. Similarly, if these analysts cease publishing regular reports on us, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline.
We do not currently intend to pay dividends on our common stock and, consequently, our shareholders’ ability to achieve a return on their investment will depend on appreciation in the price of our common stock.
Given our current business plan to invest our earnings to fund our growth, we do not intend on declaring any dividends on UCT’s common stock (which ability to do so is also restricted by the terms of our credit agreement). For the foreseeable future, therefore, any return on our shareholders’ investment will depend exclusively on the capital appreciation of our common stock.
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Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
UCT’s headquarters is located in Hayward, California. This facility provides administrative, sales and support, engineering and technology development and manufacturing operations. This lease expires in 2027.
The Company has manufacturing and engineering facilities in California, Texas, Arizona, Israel, China, Malaysia, Singapore, South Korea, United Kingdom, Philippines and Czech Republic. The Company has parts cleaning, analytics and engineering facilities in Colorado, Arizona, California, Oregon, Maine, Texas, Israel, Taiwan, South Korea, Singapore and China. These facilities have leases that expire on various dates through 2031 and are subject to periodic changes. We also own buildings and land that are located in South Korea, China and the United Kingdom. We believe that our existing facilities are well-maintained and in good operating condition.
Item 3. Legal Proceedings
From time to time, we are subject to various legal proceedings and claims, either asserted or unasserted, that arise in the ordinary course of business. Although the outcome of the various legal proceedings and claims cannot be predicted with certainty, we have not had a history of outcomes to date that have been material to our statement of operations and do not believe that any of these proceedings or other claims will have a material adverse effect on our consolidated financial condition or results of operations.
Item 4. Mine Safety Disclosures
Not applicable.
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PART II
Stock Exchange Listing
Our common stock has been traded on the NASDAQ Global Market under the symbol “UCTT” since March 25, 2004. As of February 22, 2022, there were five holders of record of UCTT common stock.
Dividends on Common Stock
To date, we have not declared or paid cash dividends to our UCT stockholders and we do not intend to do so for the foreseeable future in order to retain earnings for use in our business. Our credit facility also limits our ability to pay dividends.
Stock Performance Graph
The following stock performance graph and related information shall not be deemed “soliciting material” or “filed” with the Securities and Exchange Commission, nor shall such information be incorporated by reference into any future filings under the Securities Act of 1933 or the Exchange Act, each as amended, except to the extent that we specifically incorporate it by reference into such filing.
The following stock performance graph compares the cumulative total stockholder returns during the period from December 30, 2016 to December 31, 2021, of our common stock to the NASDAQ Composite Index and the RDG Semiconductor Composite Index. The comparison assumes $100 was invested on December 30, 2016, in our common stock and in each of the foregoing indices. The stock performance shown on the following graph represents historical stock performance and is not necessarily indicative of future stock price performance.
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The following table sets forth for the periods indicated the high and low sales prices per share of our common stock as reported by the NASDAQ Global Market:
High Low
Recent Sales of Unregistered Sales of Equity Securities
None.
Purchase of Equity Securities by the Issuer and Affiliated Purchasers
None.
Item 6. Reserved
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This section and other parts of this Annual Report on Form 10-K contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve risks and uncertainties. Forward-looking statements can also be identified by words such as “expects,” “anticipates,” “targets,” “goals,” “projects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “continues,” “may,” “will be,” “will continue,” “will likely results, and similar terms. Forward-looking statements are not guarantees of future performance and our actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such differences include, but are not limited to, those discussed in “Item 1A — Risk Factors” above. The following discussion should be read in conjunction with the Consolidated Financial Statement and notes thereto included in Item 8 of this report. We assume no obligation to revise or update any forward-looking statements for any reason, except as required by law.
Overview
Ultra Clean Holdings, Inc., (“UCT”, the “Company” or “We”) is a leading developer and supplier of critical subsystems, components and 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 (formerly known as “SPS” and “SSB”, respectively). 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 Asian, 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 including mobile demand driven by 5G, new CPU 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 complex devices.
On March 31, 2021, we completed the acquisition of Ham-Let (Israel-Canada) Ltd. (“Ham-Let”), a public company organized under the laws of the State of Israel (not a U.S. registrant), pursuant to an Agreement and Plan of Merger, for approximately $362.9 million. Ham-Let engages in the development, manufacturing and marketing of innovative control valves, fittings, and hoses for the control and monitoring of industrial systems in a variety of markets, including the Semiconductor market. These products are primarily used in ultra clean gas transportation systems as well as other systems for the transmission of liquids and gases. The Company’s primary reason for this acquisition was to broaden UCT’s relevance to the semiconductor equipment market and to provide access to a new set of customers in the semiconductor fab infrastructure market. Ham-Let operations are conducted and reported under our products segment.
During April 2021, we completed an underwritten public offering of 3.7 million shares of our common stock, in which we received net proceeds of $192.8 million, after deducting the underwriting discounts and offering expenses. We intend to use the net proceeds from this offering for general corporate purposes, which may include working capital, sales and marketing activities, product development, general and administrative matters, and capital expenditures. We may use a portion of the net proceeds to acquire complementary businesses, products, services, or technologies, although we have no agreements, commitments, or plans for any specific acquisitions at this time.
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Critical Accounting Estimates
Our 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 Consolidated Financial Statements. On an on-going basis, we evaluate our estimates and judgments, including those related to inventories, income taxes, business combinations 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.
Revenue Recognition
Our revenues for fiscal years 2021, 2020 and 2019, were highly concentrated with a small number of OEM customers in the semiconductor capital equipment industry. We recognize revenue when promised goods or services (performance obligations) are transferred to a customer in an amount that reflects the consideration to which we expect to be entitled in exchange for those goods or services. We perform the following five steps to determine when to recognize revenue:
Inventory Valuation
We write down the carrying value of our inventory to net realizable value for estimated obsolescence or unmarketable inventory in an amount equal to the difference between the cost of inventory and its estimated realizable value based upon inventory age and assumptions about future demand and market conditions. We assess the valuation of all inventories, including raw materials, work-in-process, finished goods and spare parts on a periodic basis.
Obsolete inventory or inventory in excess of our estimated usage is written down to its estimated market value less costs to sell, if less than its cost. The inventory write-downs are recorded as an inventory valuation allowance established on the basis of obsolete inventory or specifically identified inventory in excess of established usage. Inherent in our estimates of demand and market value in determining inventory valuation are estimates related to economic trends, future demand for our products. If actual demand and market conditions are less favorable than our projections, additional inventory write-downs may be required. If the inventory value is written down to its net
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realizable value, and subsequently there is an increased demand for the inventory at a higher value, the increased value of the inventory is not realized until the inventory is sold either as a component of a subsystem or as separate inventory. For fiscal years 2021, 2020 and 2019, we wrote down inventories of$6.1 million, $3.4 million, and $2.5 million, respectively.
Accounting for Income Taxes
The determination of our tax provision is highly dependent upon the geographic composition of worldwide earnings and tax regulations governing each region and is subject to judgments and estimates. Management carefully monitors the changes in many factors and adjusts the effective tax rate as required.
We must assess the likelihood that we will be able to recover our deferred tax assets. If recovery is not likely, we must increase our provision for taxes by recording a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be recoverable. In determining whether the realization of these deferred tax assets may be impaired, we make judgments with respect to whether we are likely to generate sufficient future taxable income to realize these assets. In order to reverse a valuation allowance, accounting principles generally accepted in the United States of America suggest that we review our recent cumulative income/loss as well as determine our ability to generate sufficient future taxable income to realize our net deferred tax assets. As of December 31, 2021, we maintained full valuation allowances on our U.S. federal and state deferred tax assets in the amount of $30.9 million as we believe it is more likely than not that these deferred tax assets will not be realized.
In addition, the calculation of tax liabilities involves significant judgment in estimating the impact of uncertainties in the application of complex tax laws. We recognize liabilities for uncertain tax positions based on a two-step process. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely to be realized upon ultimate settlement. Resolution of these uncertainties in a manner inconsistent with our expectations could have a material impact on the results of our operations and financial position. We believe we have adequately reserved for our uncertain tax positions; however, no assurance can be given that the final tax outcome of these matters will not be different than what we expect. We adjust these reserves in light of changing facts and circumstances, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will impact the provision for income taxes in the period in which such determination is made. The provision for income taxes includes the impact of reserve provisions and changes to reserves that are considered appropriate, as well as the related net interest.
Business Combinations
In accordance with accounting for business combinations, we allocate the purchase price of acquired companies to the identified tangible and intangible assets acquired and liabilities assumed based on their estimated fair values. We may engage third-party valuation firms to assist management in reviewing management’s identification and determination of the fair values of acquired intangible assets such as customer relationships and tradenames. Such valuations require management to make significant estimates and assumptions. Management makes estimates of fair value based upon assumptions believed to be reasonable. These estimates are based on historical experience and information obtained from the management of the acquired companies and are inherently uncertain.
Goodwill, Intangibles Assets, and Long-lived Assets
Goodwill is measured as the excess of the cost of an acquisition over the sum of the amounts assigned to identifiable assets acquired less liabilities assumed.
We evaluate our goodwill and indefinite life tradename for impairment, at the reporting unit level, on an annual basis, and whenever events or changes in circumstances indicate that the carrying value may not be fully recoverable. In addition, we evaluate our identifiable intangible assets and other long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Factors we consider important which could trigger an impairment review include the following:
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• Significant negative changes in revenue of specific products or services;
• Significant negative industry or economic trends; and
• Significant decline in our stock price for a sustained period.
We continually apply judgment when performing these evaluations and continuously monitor for events and circumstances that could negatively impact the key assumptions in determining fair value, including long-term revenue growth projections, undiscounted cash flows, discount rates, recent market valuations from transactions by comparable companies, volatility in our market capitalization and general industry, market and macroeconomic conditions. It is possible that changes in such circumstances, or in the variables associated with the judgments, assumptions and estimates used in assessing fair value, would require us to record a non-cash impairment charge.
Results of Operations
Fiscal Year
Our fiscal year is the 52- or 53-week period ending on the Friday nearest December 31. Fiscal year 2021, contained 53 weeks. Fiscal years 2020, and 2019, each contained 52 weeks.
A discussion regarding our financial condition and results of operations for fiscal 2021, compared to fiscal 2020, is presented below. The results of operations for 2021, and the discussion below reflect nine months of activity resulting from the acquisition of Ham-Let.
A discussion regarding our financial condition and results of operations for fiscal 2020, compared to fiscal 2019, can be found under Item 7 in our Annual Report on Form 10-K for the fiscal year ended December 25, 2020, filed with the SEC on February 23, 2021, which is available on the SEC’s website at www.sec.gov and our Investor Relations website at ww.uct.com/investors.
Discussion of Results of Operations
Revenues
Years Ended
Revenues by Segment December 31, Percent December 25, Percent December 27,
Products as a percentage of total revenues 85.8 % 80.9 % 78.9 %
Services as a percentage of total revenues 14.2 % 19.1 % 21.1 %
Total Products revenue increased $672.7 million in fiscal year 2021 over fiscal year 2020, primarily due to an increase in customer demand in the semiconductor industry, in particular, the wafer fabrication equipment industry and in part to the inclusion of Ham-Let which contributed $187.5 million of revenues for fiscal year 2021.
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Total Services revenue increased $30.3 million in fiscal year 2021 over fiscal year 2020, primarily due to increases in demand across our entire customer base.
Years Ended
Revenues by Geography December 31, Percent December 25, Percent December 27,
Unites States as a percentage of total revenues 34.9 % 41.6 % 47.9 %
International as a percentage of total revenues 65.1 % 58.4 % 52.1 %
On a geographic basis, revenue represents products shipped from or services performed in our U.S. and international locations. Both U.S. and foreign revenues increased in absolute terms and as a percentage of total revenue in fiscal 2021 over fiscal 2020, due to an overall global increase in semiconductor and general industry demand.
Cost of Revenues
Years Ended
Products as a percentage of total Products revenues 82.0 % 82.6 % 85.5 %
Services as a percentage of total Services revenues 64.8 % 64.4 % 66.7 %
Total cost of revenues increased $564.8 million in fiscal year 2021 over fiscal year 2020, due to higher demand for both Products and Services.
Cost of products revenues consists of purchased materials, direct labor and manufacturing overhead. Cost of products revenues increased $544.0 million for fiscal 2021 compared to fiscal 2020, due to the inclusion of Ham-Let and higher volume of sales driving increased material costs of $427.0 million including $10.1 million of materials costs resulting from the step-up in value of Ham-Let’s inventories. Also contributing to the increase in cost of products revenues, were higher direct labor spending of $272.2 million and higher overhead costs of $44.8 million including $2.0 million of intangible amortization resulting from the acquisition of Ham-Let.
Cost of services revenues consists of direct labor, manufacturing overhead and materials (such as chemicals, gases and consumables). Cost of services revenues increased $20.8 million in fiscal 2021 compared to the prior year driven by higher volumes of service orders, resulting in an increase in labor costs of $7.1 million the largest component of total cost of services revenues, higher material costs of $4.7 million and higher overhead costs of $9.0 million driven by higher service orders.
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Gross Margin
Years Ended
(Dollars in millions) December 31, Percent December 25, Percent December 27,
Percentage by Segment
Products gross margin increased in fiscal year 2021 over fiscal year 2020, due primarily to higher volume, and the favorable mix of higher margin products. Services gross margin increased in fiscal year 2021, over fiscal year 2020, due to direct labor efficiencies along with lower facility-related costs.
Research and Development
Years Ended
December 31, Percent December 25, Percent December 27,
Research and development as a percentage of total revenues 1.2 % 1.1 % 1.4 %
Research and development expenses consist primarily of activities related to new component testing and evaluation, test equipment and fixture development, product design, the advancement of cleaning and coating and analytical processes, and other product-development activities. Research and development expenses increased $9.7 million in fiscal year 2021 compared to fiscal year 2020, primarily due to the inclusion of Ham-Let’s research and development activities and an increase in personnel-related expenses associated with an overall increase in headcount.
Sales and Marketing
Years Ended
December 31, Percent December 25, Percent December 27,
Sales and marketing as a percentage of total revenues 2.3 % 1.8 % 2.1 %
Sales and marketing expenses consist primarily of salaries and commissions paid to our sales employees, salaries paid to our engineers who work with sales and service employees to help determine the components and configuration requirements for new products and other costs related to the sales of our products. Sales and marketing expenses increased $23.1 million in fiscal year 2021 over fiscal year 2020, primarily due to the inclusion of Ham-Let’s sales and marketing activities and an increase in personnel-related costs driven by higher headcount and bonuses.
General and Administrative
Years Ended
December 31, Percent December 25, Percent December 27,
General and administrative as a percentage of total revenues 8.2 % 9.3 % 12.2 %
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General and administrative expenses increased $41.1 million in fiscal year 2021 over fiscal year 2020, due to the inclusion of Ham-Let’s general and administrative activities and higher personnel-related expenses driven by higher headcount.
Interest and Other Income (Expense), net
Years Ended
December 31, Percent December 25, Percent December 27,
Other income (expense), net $ (7.6 ) 33.3 % $ (5.7 ) 137.5 % $ (2.4 )
Interest expense increased $7.3 million in fiscal year 2021 over fiscal year 2020 due to a higher debt balance resulting from the acquisition of Ham-Let, partially offset by lower interest rates resulting from lower LIBOR rates.
Other income (expense), net, increased $1.9 million in fiscal year 2021 over fiscal year 2020 primarily due to an increase of $12.1 million in the fair value of forward hedge contracts related to the non-U.S. Dollar-denominated acquisition price of Ham-Let and a $3.6 million increase in foreign exchange losses. These increases were offset by insurance proceeds of $7.3 million received for the reimbursement of our losses in the Cinos Korea fire and by the absence of $6.5 million loss from the change in fair value of the Cinos Korea common stock purchase obligation in fiscal 2021.
Provision for Income Taxes
Years Ended
December 31, Percent December 25, Percent December 27,
The change in respective tax rates reflects, primarily, changes in the geographic distribution of our worldwide earnings. For fiscal year 2021, our effective tax rate was lower than the federal statutory rate of 21% primarily due to favorable effects of the geographic distribution of our worldwide earnings in foreign jurisdictions with lower effective tax rates.
For the year ended December 31, 2021, the Company concluded that a full valuation allowance against its U.S. federal and state deferred tax assets continues to be necessary. The Company also concluded that some of its foreign deferred tax assets acquired as part of the QGT and Ham-Let acquisitions required a valuation allowance. As of December 31, 2021, the total U.S. and foreign valuation allowances for deferred tax assets were $27.5 million and $3.4 million, respectively.
Our ability to realize deferred tax assets depends on our ability to generate sufficient future taxable income. In assessing our future taxable income, we have considered all sources of future taxable income available to realize our deferred tax assets, including the taxable income from future reversal of existing temporary differences, carry forwards, and tax-planning strategies. If changes occur in the assumptions underlying our tax planning strategies or in the scheduling of the reversal of our deferred tax liabilities, the valuation allowance may need to be adjusted in the future.
The Company remitted foreign earnings from one of its subsidiaries in Singapore in 2021. The Company has no plans to remit foreign earnings other than possibly from a particular Singapore subsidiary. We may change our intent to reinvest certain of our undistributed foreign earnings indefinitely, which could require us to accrue or pay taxes on some or all of these undistributed earnings.
Liquidity and Capital Resources
Cash and cash Equivalents
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The following table summarizes our cash and cash equivalents:
Years Ended
December 31, December 25,
The increase in cash and cash equivalents in fiscal year 2021, compared to fiscal year 2020, was primarily due to the cash provided by operating activities of $211.6 million and financing activities of $460.8 million primarily offset by the $404.8 million used in investing activities related to the Ham-Let acquisition.
Cash Flows
Years Ended
December 31, December 25, December 27,
Effects of exchange rate changes on cash and cash equivalents (1.4 ) 1.4 -
Net increase in cash and cash equivalents $ 266.2 $ 37.8 $ 18.4
Our primary cash inflows and outflows were as follows:
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 December 31, 2021, we had cash and cash equivalents of $466.5 million compared to $200.3 million as of December 25, 2020. Our cash and cash equivalents, cash generated from operations and borrowings under our term loan described below, were our principal sources of liquidity as of December 31, 2021.
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Our subsidiary Ham-Let, has an existing factoring arrangement with a financial institution in which a portion of its accounts receivable are sold on a none recourse basis. For the nine months ended December 31, 2021, Ham-Let factored $30.6 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 financings. 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 financings. 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.
In 2017, we determined that a portion of the current year and future year earnings of one of our China subsidiaries may be remitted in the future to one of our foreign subsidiaries outside of mainland China and, accordingly, we provided for the related withholding taxes in our Consolidated Financial Statements. As of December 31, 2021, we had undistributed earnings of approximately $449.3 million from our foreign subsidiaries that are indefinitely invested outside of the U.S. As of December 31, 2021, we have cash of approximately $351.1 million in our foreign subsidiaries.
Borrowing Arrangements
December 31, December 25,
Cinos China Credit Facilities 1.4 4.1 % 1.9 3.1 %
Ham-Let 8.9 1.0 % — —
Debt issuance costs (13.4 ) — (7.9 ) —
In August 2018, the Company entered into a Credit Agreement with Barclays Bank that provided a Term Loan, a Revolving Credit Facility and a Letter of Credit Facility (the “Credit Facility”). UCT and certain of its subsidiaries have agreed to secure all of their obligations under the Credit Facility by granting a first priority lien in substantially all of their respective personal property assets (subject to certain exceptions and limitations). In August 2018, the Company borrowed $350.0 million under the Term Loan and used the proceeds, together with cash on hand, to finance the acquisition of QGT.
On March 31, 2021, the Company entered into a Second Amendment (the “Second Amendment”) to the Credit Agreement to, among other things, (i) refinance and reprice $272.8 million of existing Term Loan borrowings that will remain outstanding and (ii) obtain a $355.0 million senior secured incremental term loan B facility ((i) and (ii) collectively the “Term Loan”) with Barclays Bank, which increased the amount of term loan indebtedness outstanding under the Company’s Credit Facility.
The Term Loan has a maturity date of August 27, 2025, with monthly interest payments in arrears, quarterly principal payments of 0.625% of the outstanding principal balance thereof as of March 31, 2021, with the remaining principal paid upon maturity. Under the Credit Facility, the Company may elect that the Term Loan bear interest at a rate per annum equal to either (a) “ABR” (as defined in the Credit Agreement), plus the applicable margin or (b) the “Eurodollar Rate” (as defined in the Credit Agreement), based on LIBOR, plus the applicable margin. The applicable margin for the Term Loan is equal to a rate per annum to either (i) at any time that the Company’s
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corporate family rating is Ba3 (with a stable outlook) or higher from Moody’s and BB- (with a stable outlook) or higher from S&P, (x) 3.50% for such Eurodollar term loans and (y) 2.50% for such ABR term loans or (ii) at all other times, (x) 3.75% for such Eurodollar term loans and (y) 2.75% for such ABR term loans. Interest on the Term Loan is payable on (1) in the case of such ABR term loans, the last day of each calendar quarter and (2) in the case of such Eurodollar term loans, the last day of each relevant interest period and, in the case of any interest period longer than three months, on each successive date three months after the first day of such interest period. On March 29, 2021, the Company elected that the Term Loan outstanding as of March 31, 2021, accrue interest based on the “Eurodollar Rate” for an initial interest period of one month. As of March 31, 2021, the applicable margin with respect to the Term Loan facility was 3.75%. Pursuant to the Second Amendment to the Credit Agreement, the Credit Facility contains customary LIBOR replacement provisions in the event LIBOR is discontinued. AtDecember 31, 2021, the Company had an outstanding amount under the Term Loan of$555.1 million, gross of unamortized debt issuance costs of $13.4 million. As of December 31, 2021, the interest rate on the outstanding Term Loan was 3.9%.
The Credit Agreement requires the Company to maintain certain financial covenants including a consolidated fixed charge coverage ratio (as defined in the Credit Agreement) as of the last day of any fiscal quarter of at least 1.25 to 1.00, and a consolidated leverage ratio (as defined in the Credit Agreement) as of the last day of any fiscal quarter of no greater than 3.75 to 1.00. The Company was in compliance with all financial covenants during the year ended December 31, 2021.
In 2020, Cinos China amended its existing Credit Agreement and entered into two additional Credit Agreements with a local bank that provide a term loan of $1.9 million with maturity date through September 23, 2022 and interest rates of 4.1%. As of December 31, 2021, Cinos China had $1.4 million outstanding amount of under this credit facility.
Ham-Let has credit facilities and loan agreements with various financial institutions. As of December 31, 2021, Ham-Let had $8.9 million of outstanding debt with interest rate of 1.0%
The Revolving Credit Facility has an initial available commitment of $65.0 million and a maturity date of August 27, 2023. The Company pays a quarterly commitment fee in arrears equal to 0.25% of the average daily available commitment outstanding. As of December 31, 2021, the Company had no outstanding amount under this revolving credit facility.
The Letter of Credit Facility has an initial available commitment of $50.0 million and a maturity date of August 27, 2023. The Company pays quarterly in arrears a fee equal to 2.5% (subject to certain adjustments to the Term Loan) of the dollar equivalent of all outstanding letters of credit, and a fronting fee equal to 0.125% of the undrawn and unexpired amount of each letter of credit. As of December 31, 2021, the Company had $2.4 million of outstanding letters of credit with beneficiaries such as landlords of certain facility leases, insurance providers and government agencies making up the majority of the outstanding balance. The remaining available commitments are $47.6 million on the Letter of Credit Facility.
In 2020, Cinos China amended its existing Credit Agreement and entered into two additional Credit Agreements with a local bank that provide Revolving Credit Facilities for a total available commitment of $1.0 million with various maturity dates through September 23, 2022 and interest rates of 2.0%. As of December 31, 2021, Cinos China had no outstanding amount of under this credit facility.
Cinos Korea has Credit Agreements with various banks that provide Revolving Credit Facilities for a total available commitment of 600.0 million Korean Won (approximately $0.5 million) with annual renewals beginning from June 2022 and interest rate of 2.9%. During the fiscal year ended December 31, 2021, borrowings under these Revolving Facilities were insignificant and no amounts were outstanding as of December 31, 2021.
Fluid delivery systems (“FDS”) 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 6.0 million euros (approximately $6.8 million). As of December 31, 2021, the Company had no outstanding amount under this revolving credit facility.
As of December 31, 2021, the Company’s total bank debt was $552.0 million, net of unamortized debt issuance costs of $13.4 million. As of December 31, 2021, we had $112.6 million, $6.8 million, $0.5 million and $1.0 million available to draw from our revolving credit facilities in the U.S., Czech Republic, South Korea and China, respectively.
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The fair value of our long-term debt was based on Level 2 inputs, and fair value was determined using quoted prices for similar liabilities in inactive markets. The carrying value of our long-term debt approximates fair value.
Capital Expenditures
Capital expenditures were $69.5 million for the year ended December 31, 2021, primarily attributable to the expansion of our South Korea, Singapore, Czech Republic and certain U.S. facilities and our ERP system.
Contractual Obligations
The Company had commitments to various third parties to purchase inventories totaling approximately $562.5 million on December 31, 2021.
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 December 31, 2021, 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.
During the periods presented, we do not have unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
Recently Issued and Adopted Accounting Pronouncement
For a description of recent accounting pronouncements, including the expected dates of adoption and estimated effects, if any, on UCT’s Consolidated Financial Statements, see Note 1, “Organization and Significant Accounting Policies,” of the Notes to Consolidated Financial Statements.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to financial market risks, including credit risk, foreign currency exchange rate risk and interest rate risk.
Credit Risk
A substantial majority of our trade receivables are derived from sales to OEMs. We believe the net accounts receivable balances from our three largest customers (44.9% as of December 31, 2021) does not represent a significant credit risk, based on cash flow forecasts, balance sheet analysis, and past collection experience. For more information about the customers that represent our accounts receivable balance, see Note 1, Organization and Significant Accounting Policies.
We have adopted credit policies and standards intended to accommodate industry growth and inherent risk. We believe credit risks are moderated by the financial stability of our major customers. We assess credit risk through quantitative and qualitative analysis. From these analyses, we establish shipping and credit limits and determine whether we will seek to use one or more credit support protection devices, such as obtaining a parent guarantee, prepayment or standby letter of credit.
Foreign Currency Exchange Rate Risk
We operate in international markets, which expose us to market risk associated with foreign currency exchange rate fluctuations between the U.S. Dollar and various foreign currencies. Historically, the majority of our revenue contracts and arrangements with third party suppliers are denominated in U.S. Dollars. Additionally, a portion of our expenses, primarily the cost to manufacture, cost of personnel to deliver technical support on our products and professional services, sales and sales support and research and development, are denominated in foreign currencies.
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Revenue resulting from selling in currencies and costs incurred in local currencies are exposed to foreign currency exchange rate fluctuations which can affect our operating income. As foreign currency exchange rates vary, operating income may differ from expectations. Increases in the value of the U.S. Dollar relative to other currencies would make our products more expensive relative to competing products priced in such other currencies, which could negatively impact our ability to compete. Conversely, decreases in the value of the U.S. Dollar relative to other currencies could result in our foreign suppliers raising their prices in order to continue doing business with us. However, we do not expect foreign currency exchange rate fluctuations to have a material effect on our results of operations.
We use derivative instruments, such as foreign currency exchange contracts, to hedge certain exposures to fluctuations in foreign currency exchange rates. These contracts reduce, but do not entirely eliminate the impact of currency exchange rates movement on our assets and liabilities.
Interest Rate Risk
We are exposed to market risk due to changing interest rates under our credit facilities. Our Credit Facility is comprised of a Term B loan and a revolving credit agreement with interest rates as described under Note 6 of Notes to the Consolidated Financial Statements.
At the end of fiscal 2021, the Term B loan had a balance of $555.1 million. A hypothetical 10% increase in our borrowing rates at the end of fiscal 2021, would result in approximately $2.2 million annual increase in interest expense on this existing principal balance.
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Item 8. Financial Statements and Supplementary Data
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm 43
Consolidated Balance Sheets as of December 31, 2021 and December 25, 2020 46
Notes to Consolidated Financial Statements 51
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and the Board of Directors of
Ultra Clean Holdings, Inc.
Opinions on the Financial Statements and Internal Control Over Financial Reporting
We have audited the accompanying consolidated balance sheets of Ultra Clean Holdings, Inc. (the “Company”) as of December 31, 2021 and December 25, 2020, the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity and cash flows for each of the years ended December 31, 2021, December 25, 2020 and December 27, 2019, and the related notes (collectively referred to as the “consolidated financial statements”). We also have audited the Company’s internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). As discussed in Management’s Report on Internal Control over Financial Reporting, on March 31, 2021, the Company acquired Ham-Let (Israel-Canada) Ltd (Ham-Let). For the purposes of assessing internal control over financial reporting, management excluded Ham-Let, whose financial statements constitute 13.5% and 8.9% of the Company’s consolidated total assets (excluding $203.6 million of goodwill and intangible assets, net, which were integrated into the Company’s control environment), and revenues, respectively. Accordingly, our audit did not include the internal control over financial reporting of Ham-Let.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2021 and December 25, 2020, and the consolidated results of its operations and its cash flows for each of the years ended December 31, 2021, December 25, 2020, and December 27, 2019, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control - Integrated Framework (2013) issued by COSO.
Basis for Opinions
The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management Report on Internal Control over Financial Reporting included in Item 9A. Our responsibility is to express an opinion on the Company’s consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures to respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
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Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing a separate opinion on the critical audit matters or on the accounts or disclosures to which they relate.
Valuation of Inventories
As described in Notes 1 and 3 to the consolidated financial statements, the Company’s consolidated inventories balance was $379.2 million as of December 31, 2021. The Company values its inventories at the lower of cost (first-in, first-out) or net realizable value. Obsolete inventory or inventory in excess of management’s estimated usage is written-down to its estimated market value less costs to sell, if less than its cost. Inherent in the estimates of market value are management’s estimates related to economic trends and future demand for the Company’s products. As disclosed by management, if these factors are less favorable than those projected, additional inventory write-downs may be required.
The valuation of inventories, specific to write downs, requires management to make significant assumptions and especially complex judgments about the future salability of the inventory and its net realizable value. These assumptions include the assessment of net realizable value by inventory category considering retention periods, future usage and market demand for their products. Additionally, management makes qualitative judgments related to slow moving and obsolete inventories. These factors were the principal considerations that led us to determine that the valuation of inventories is a critical audit matter.
Considering the fact that Ham-Let was excluded by management in assessing internal control over financial reporting, and taking into account our risk assessment for each of the various locations and components, the most relevant procedures we performed to address this critical audit matter included:
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Valuation of Intangible Assets Associated with Business Acquisition
As described in Note 2 to the consolidated financial statements, the Company completed the acquisition of Ham-Let (Israel-Canada) Ltd. As a result of the acquisition, the Company recorded goodwill of $98.9 million, and intangible assets of $118.6 million. The acquisition was accounted for as a business combination.
Auditing the Company’s accounting for the acquisition was especially challenging as the determination of the fair value of the intangible assets acquired required management to make subjective estimates and assumptions. The Company used an income approach to measure the acquired intangible assets. The valuation of the intangible assets is subject to higher estimation uncertainty due to management’s judgments in determining significant assumptions that included projected revenue growth, estimated expenses and royalty and discount rates. Changes in these significant assumptions could have a significant effect on the fair value of the intangible assets.
The primary procedures we performed to address this critical audit matter included:
/s/ Moss Adams LLP
San Francisco, California
March 1, 2022
We have served as the Company’s auditor since 2015.
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Ultra Clean Holdings, Inc.
Consolidated Balance Sheets
December 31, December 25,
(In millions, except par value)
ASSETS
Current assets:
Cash and cash equivalents $ 466.5 $ 200.3
Prepaid expenses and other current assets 41.3 18.9
Property, plant and equipment, net 242.3 159.2
Deferred tax assets, net 37.6 23.5
Operating lease right-of-use assets 83.4 37.8
Other non-current assets 9.3 5.3
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Bank borrowings $ 22.1 $ 7.4
Accrued compensation and related benefits 46.8 34.5
Operating lease liabilities 17.3 11.7
Other current liabilities 50.0 26.3
Bank borrowings, net of current portion 529.9 261.6
Deferred tax liabilities 54.9 33.6
Operating lease liabilities 65.9 31.1
Commitments and contingencies (See Note 9)
Equity:
UCT stockholders’ equity:
Preferred stock — $0.001 par value, 10.0 authorized; none outstanding — —
Accumulated other comprehensive income (loss) (0.2 ) 5.1
Total UCT stockholders' equity 848.9 532.6
Noncontrolling interests 43.8 18.6
(See accompanying Notes to Consolidated Financial Statements)
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Ultra Clean Holdings, Inc.
Consolidated Statements of Operations
Fiscal Year Ended
December 31, December 25, December 27,
(In millions, except per share amounts)
Revenues:
Cost of revenues:
Operating expenses:
Other income (expense), net (7.6 ) (5.7 ) (2.4 )
Income before provision for income taxes 154.3 99.7 2.3
Less: Net income attributable to noncontrolling interests 6.9 2.8 1.7
Net income (loss) attributable to UCT $ 119.5 $ 77.6 $ (9.4 )
Net income (loss) per share attributable to UCT common stockholders:
Shares used in computing net income (loss) per share:
(See accompanying Notes to Consolidated Financial Statements)
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Ultra Clean Holdings, Inc.
Consolidated Statements of Comprehensive Income (Loss)
Fiscal Year Ended
December 31, December 25, December 27,
(In millions)
Other comprehensive income (loss):
Change in cumulative translation adjustment (5.0 ) 6.5 (0.4 )
Change in pension net actuarial gain / (loss) 0.4 (0.1 ) (0.3 )
Cash flow hedges:
Change in fair value of derivatives (0.7 ) — —
Total other comprehensive income (loss), net of tax (5.3 ) 6.4 (0.7 )
Comprehensive income (loss) attributable to UCT $ 114.2 $ 84.0 $ (10.1 )
(See accompanying Notes to Consolidated Financial Statements)
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Ultra Clean Holdings, Inc.
Consolidated Statements of Cash Flows
Fiscal Year Ended
December 31, December 25, December 27,
(In millions)
Cash flows from operating activities:
Amortization of intangible assets 33.4 19.8 20.1
Amortization of debt issuance costs 3.4 1.9 1.8
Loss (gain) on the disposal of assets and business 0.2 (1.4 ) 2.0
Gain from insurance proceeds (7.3 ) (1.0 ) —
Deferred income taxes (3.2 ) 0.4 (3.6 )
Change in the fair value of financial instruments 12.4 7.7 2.8
Changes in assets and liabilities, net of effects of acquisitions:
Accounts receivable (53.0 ) (32.7 ) (4.5 )
Prepaid expenses and other current assets (4.2 ) 1.2 3.7
Other non-current assets (0.8 ) (0.1 ) —
Accrued compensation and related benefits 1.8 9.7 9.0
Income taxes payable 7.7 2.8 (2.9 )
Operating lease assets and liabilities (1.1 ) (1.1 ) 7.1
Other liabilities 0.5 (7.4 ) 6.3
Net cash provided by operating activities 211.6 97.3 121.0
Cash flows from investing activities:
Purchases of property, plant and equipment (59.3 ) (36.4 ) (26.3 )
Proceeds from sale of equipment, including insurance proceeds 7.7 6.6 7.0
Settlement of forward contracts in conjunction with acquisition (10.4 ) — —
Acquisition of businesses, net of cash acquired (342.8 ) — (29.9 )
Net cash used in investing activities (404.8 ) (29.8 ) (49.2 )
Cash flows from financing activities:
Proceeds from issuance of common stock 193.6 0.6 0.3
Payment of contingent earn-out — (1.4 ) —
Payments of debt issuance costs (8.9 ) — —
Payments of dividends to a joint venture shareholder — — (0.6 )
Net cash provided by (used in) financing activities 460.8 (31.1 ) (53.4 )
Effect of exchange rate changes on cash and cash equivalents (1.4 ) 1.4 —
Net increase in cash and cash equivalents 266.2 37.8 18.4
Cash and cash equivalents at beginning of period 200.3 162.5 144.1
Cash and cash equivalents at end of period 466.5 $ 200.3 $ 162.5
Supplemental cash flow information:
Income taxes paid, net of income tax refunds $ 23.1 $ 16.4 $ 14.5
Non-cash investing and financing activities:
Fair value of earn-out payment related to business acquisitions $ — $ — $ 1.4
(See accompanying Notes to Consolidated Financial Statements)
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Ultra Clean Holdings, Inc.
Consolidated Statements of Stockholders’ Equity
Common Stock Treasury shares
(In millions)
Issuance under employee stock plans 0.9 - 0.3 - - - - 0.3 - 0.3
Stock-based compensation expense - - 12.1 - - - - 12.1 - 12.1
Net income (loss) - - - - - (9.4 ) - (9.4 ) 1.7 (7.7 )
Dividend payments to a joint venture shareholder - - - - - - - - (0.6 ) (0.6 )
Other comprehensive loss - - - - - - (0.7 ) (0.7 ) - (0.7 )
Issuance under employee stock plans 0.8 - 0.6 - - - - 0.6 - 0.6
Stock-based compensation expense - - 12.8 - - - - 12.8 - 12.8
Other comprehensive income - - - - - - 6.4 6.4 - 6.4
Issuance under employee stock plans 0.7 — 0.8 - - - - 0.8 - 0.8
Stock-based compensation expense - - 15.8 - - - - 15.8 - 15.8
Dividend income - - - - - - - - (0.1 ) (0.1 )
Acquisition of Ham-Let - - - - - - - - 1.9 1.9
Reclassification related to Cinos Korea - - - - - - - - 16.5 16.5
Other comprehensive income - - - - - - (5.3 ) (5.3 ) - (5.3 )
(See accompanying Notes to Consolidated Financial Statements)
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Ultra Clean Holdings, Inc.
Notes to Consolidated Financial Statements
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Organization
Ultra Clean Holdings, Inc., (the “Company” or “UCT”) a Delaware corporation, was founded in November 2002 and became a publicly traded company on the NASDAQ Global Market in March 2004. The Company is a global leader in the design, engineering and manufacture of production tools, modules and subsystems for the semiconductor and display capital equipment markets. The Company’s products include chemical delivery modules, frame assemblies, gas delivery systems, fluid delivery systems, precision robotics, process modules as well as other high-level assemblies. The Company’s services provide part cleaning, surface encapsulation, and high sensitivity micro contamination analysis primarily for the semiconductor device makers and wafer fabrication equipment markets.
Fiscal Year
The Company uses a 52-53-week fiscal year ending on the Friday nearest December 31. All references to quarters refer to fiscal quarters and all references to years refer to fiscal years.
Principles of Consolidation
The Company’s Consolidated Financial Statements include the accounts of the Company and its wholly-owned subsidiaries and all intercompany accounts and transactions have been eliminated in consolidation.
Noncontrolling interests
Noncontrolling interests are recognized to reflect the portion of the equity of the majority-owned subsidiaries which is not attributable, directly or indirectly, to the controlling stockholder. The Company’s consolidated entities include partially-owned entities, which are (1) Cinos Co., Ltd (“Cinos Korea”), a South Korean company that provides outsourced cleaning and recycling of precision parts for the semiconductor industry through its operating facilities in South Korea and whose results the Company consolidates, (2) Cinos Xian Clean Technology, Ltd. (“Cinos China”), a Chinese entity that is majority owned by Cinos Korea and (3) Rovac Pte, Ltd (“Rovac”), a Singaporean Company that is majority owned by Ham-Let. The interest held by others in Cinos Korea, in Cinos China and in Rovac are presented as noncontrolling interests in the accompanying Consolidated Financial Statements. The noncontrolling interests will continue to be attributed their share of gains and losses even if that attribution results in a deficit noncontrolling interests’ balance.
Segments
The Financial Accounting Standards Board’s (“FASB”) guidance regarding disclosure about segments in an enterprise and related information establishes standards for the reporting by public business enterprises of information about reportable segments, products and services, geographic areas, and major customers. The method for determining what information to report is based on the manner in which management organizes the reportable segments within the Company for making operational decisions and assessments of financial performance. The Company’s chief operating decision-maker is the Chief Executive Officer. The Company has three operating segments and two reportable segments: Products and Services. See Note 15 to the Company’s Consolidated Financial Statements.
Foreign Currency Translation and Remeasurement
As of December 31, 2021, the functional currency of the Products business unit’s foreign subsidiaries, excluding the subsidiaries of Ham-Let, is the U.S. Dollar. The functional currency of the Ham-Let subsidiaries in Singapore, United Kingdom, Norway, Taiwan, South Korea and China, is their local currency, except for Israel, which is the
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U.S. Dollar. The functional currency of the Service business unit’s foreign subsidiaries is the local currency, except for that of its Singapore and Scotland entities, which is the U.S. Dollar.
Due to the changes in economic factors in fluid delivery systems (“FDS”) and in Services’ entity in Scotland in fiscal 2020, the Company determined that the functional currency designation of FDS and Services’ entity in Scotland is the U.S. Dollar, a change from the functional foreign currency utilized in the prior year. The impact of these changes was not significant.
For the Company’s foreign subsidiaries where the local currency is the functional currency, the Company translates the financial statements of these subsidiaries to U.S. Dollars using month-end exchange rates for assets and liabilities, and average exchange rates for revenue, costs and expenses. Translation gains and losses are recorded in accumulated other comprehensive income (“AOCI”) within UCT stockholders’ equity. For the Company’s foreign subsidiaries where the U.S. Dollar is the functional currency, any gains and losses resulting from the translation of the assets and liabilities of these subsidiaries are recorded in other income (expense), net.
Use of Estimates
The presentation of financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosures of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Such estimates and assumptions include inventory valuation, accounting for income taxes, business combinations, valuation of goodwill, intangible assets and long-lived assets. The Company bases its estimates and judgments on historical experience and on various other assumptions that it believes are reasonable under the circumstances. However, future events are subject to change and the best estimates and judgments routinely require adjustments. Actual amounts may differ from those estimates.
Cash and Cash Equivalents
The Company considers currency on hand, demand deposits, time deposits, and all highly liquid investments with an original maturity of three months or less at the date of purchase to be cash and cash equivalents. Cash and cash equivalents are held in various financial institutions in the United States and internationally.
Concentration of Credit Risk
Financial instruments which subject the Company to concentrations of credit risk consist principally of cash and cash equivalents and accounts receivable. The Company sells its products and provides services primarily to semiconductor capital equipment manufacturers in the United States. The Company performs credit evaluations of its customers’ financial condition and generally requires no collateral.
The Company’s most significant customers (having individually accounted for 10% or more of accounts receivable) and their related revenues as a percentage of total revenues were as follows:
Fiscal Year Ended
Two customers’ accounts receivable balances, Lam Research Corporation and Applied Materials, Inc. were individually greater than 10.0% of accounts receivable as of December 31, 2021, in the aggregate they represented 39.0%.
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Fair Value of Measurements
The Company measures its cash equivalents, derivative contracts, contingent earn-out liabilities, pension obligation and common stock purchase obligation (prior to the reclass discussed in Note 10) at fair value on a recurring basis. Fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that is determined based on assumptions that market participants would use in pricing an asset or a liability. Assets and liabilities recorded at fair value are measured and classified in accordance with a three-tier fair value hierarchy based on the observability of the inputs available in the market used to measure fair value:
Level 1 — Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2 — Inputs that are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant inputs are observable in the market or can be derived from observable market data. Where applicable, these models project future cash flows and discount the future amounts to a present value using market-based observable inputs including interest rate curves, foreign exchange rates, and credit ratings.
Level 3 — Unobservable inputs that are supported by little or no market activities.
Derivative Financial Instruments
The Company uses forward contracts to hedge a portion of, but not all, existing and anticipated foreign currency denominated transactions typically expected to occur within 24 months. The purpose of the hedge is to mitigate the effect of exchange rate fluctuations on certain foreign currency denominated costs and eventual cash flows. The Company recognizes derivative instruments as either assets or liabilities in the accompanying Consolidated Balance Sheets at fair value. The Company records changes in the fair value of the derivatives in the accompanying Consolidated Statements of Operations as other income (expense), net, or as a component of AOCI in the accompanying Consolidated Balance Sheets.
Inventories
Inventories are stated at the lower of cost (which approximates actual cost on a first-in, first-out basis) or net realizable value. The Company evaluates the valuation of all inventories, including raw materials, work-in-process, finished goods and spare parts on a periodic basis. Obsolete inventory or inventory in excess of management’s estimated usage is written down to its estimated market value less costs to sell, if less than its cost. Inherent in the estimates of market value are management’s estimates related to economic trends and future demand for the Company’s products.
Inventory write downs inherently involve judgments as to assumptions about expected future demand and the impact of market conditions on those assumptions. Although the Company believes that the assumptions it used in estimating inventory write downs are reasonable, significant changes in any one of the assumptions in the future could produce a significantly different result. There can be no assurances that future events and changing market conditions will not result in significant increases in inventory write downs. For further discussion of the Company’s inventory see Note 3 of Notes to the Consolidated Financial Statements. .
Property, Plant andEquipment
Property, plant and equipment are stated at cost, or, in the case of equipment under finance leases, the present value of future minimum lease payments at inception of the related lease. The Company also capitalizes interest on borrowings related to eligible capital expenditures. Capitalized interest is added to the cost of the qualified assets and is subject to depreciation. Depreciation and amortization are computed using the straight-line method over the lesser of the estimated useful lives of the assets or the terms of the leases. Useful lives range from three to fifty years. Direct costs incurred to develop software for internal use are capitalized and amortized over an estimated useful life of three or ten years. Costs related to the design or maintenance of internal use software are expensed as incurred. Capitalized internal use software is included in computer equipment and software. For further discussion of the Company’s property, plant and equipment see Note 3 of Notes to the Consolidated Financial Statements. .
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Long-lived Assets
The Company evaluates long-lived assets for impairment whenever events or changes in circumstances indicate the carrying value of an asset group may not be recoverable. The Company assesses the fair value of the assets based on the amount of the undiscounted future cash flows that the assets are expected to generate and recognizes an impairment loss when estimated undiscounted future cash flows expected to result from the use of the asset are less than the carrying value of the asset. If the Company identifies an impairment, the Company reduces the carrying value of the group of assets to comparable market values, when available and appropriate, or to its estimated fair value based on a discounted cash flow approach.
At the end of fiscal years 2021, 2020 and 2019, the Company assessed the useful lives of its long-lived assets, including property, plant and equipment as well as its intangible assets and concluded that no impairment was required.
Leases
The Company determines if an arrangement is a lease, or contains a lease, at the inception of the arrangement and reassess that conclusion if the arrangement is modified. When the Company determines the arrangement is a lease, or contains a lease, at lease inception, it then determines whether the lease is an operating lease or a finance lease. Operating and finance leases with lease terms of one year or greater result in the Company recording a right-of-use (“ROU”) asset and lease liability on its balance sheet. ROU assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent its obligation to make lease payments arising from the lease. Operating and finance lease ROU assets and liabilities are initially recognized based on the present value of lease payments over the lease term. In determining the present value of lease payments, the Company uses the implicit interest rate if readily determinable or when the implicit interest rate is not readily determinable, the Company uses its incremental borrowing rate.
The incremental borrowing rate is not a commonly quoted rate and is derived through a combination of inputs including the Company’s credit rating and the impact of full collateralization. The incremental borrowing rate is based on the Company’s collateralized borrowing capabilities over a similar term of the lease payments. The Company utilizes the incremental borrowing rate based on bank loan rates at the respective locations for leases where appropriate and the consolidated group bank loan rate where the Company does not have local bank financings.
The operating lease ROU asset also includes any lease payments made prior to the adoption of ASC 842 and excludes any lease incentives. Specific lease terms used in computing the ROU assets and lease liabilities may include options to extend or terminate the lease when the Company believes it is reasonably certain that it will exercise that option. Lease expense for operating lease payments is recognized on a straight-line basis over the lease term. As allowed by the guidance, the Company has elected not to recognize ROU assets and lease liabilities that arise from short-term (12 months or less) leases for any class of underlying asset. Operating leases are included in operating lease ROU assets, other current liabilities, and long-term operating lease liabilities on the Company’s consolidated balance sheet. The Company’s finance leases at December 31, 2021 were not significant. For further discussion of the Company’s leases see Note 13 of Notes to the Consolidated Financial Statements..
Goodwill and Indefinite Lived Intangible Assets
Goodwill and indefinite-lived intangible assets are not amortized but are reviewed for impairment annually. Intangible assets are presented at cost, net of accumulated amortization, and are amortized on either a straight-line method or on an accelerated method over their estimated future discounted cash flows. The Company reviews goodwill and purchased intangible assets with indefinite lives for impairment annually and whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable, such as when reductions in demand or significant economic slowdowns in the semiconductor industry are present. There were no impairments of the Company’s goodwill and purchased intangible assets in fiscal year 2021. For further discussion of the Company’s goodwill and intangible assets see Note 5 of Notes to the Consolidated Financial Statements.
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Deferred Debt Issuance Costs
Debt issuance costs incurred in connection with obtaining debt financing are deferred and presented as a direct deduction from Bank Borrowings in the accompanying Consolidated Balance Sheets. Deferred costs are amortized on an effective interest method basis over the contractual term.
Defined Benefit Pension Plan
The Company has a noncontributory defined benefit pension plan covering substantially all of the employees of three of its foreign entities upon termination of their employee services. For further discussion of the Company’s defined benefit pension plan see Note 8 of Notes to the Consolidated Financial Statements.
Revenue Recognition
Revenue is recognized when control of the promised goods or services is transferred to the Company’s customers, in an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods or services. The Company performs the following five steps to determine when to recognize revenue: (1) identification of the contract(s) with customers, (2) identification of the performance obligations in the contract, (3) determination of the transaction price, (4) allocation of the transaction price to the performance obligations in the contract, and (5) recognition of revenue when, or as, a performance obligation is satisfied. For further discussion of the Company’s revenue recognition see Note 12 of Notes to the Consolidated Financial Statements.
Shipping and Handling Costs
Shipping and handling costs are included as a component of cost of revenues.
Research and Development Costs
Research and development costs are expensed as incurred.
Stock-Based Compensation Expense
The Company maintains stock-based compensation plans which allow for the issuance of equity-based awards to executives and certain employees. These equity-based awards include restricted stock awards (“RSAs”) and restricted stock units (“RSUs”). These awards are granted to employees with a unit purchase price of zero dollars and typically vest over three years, subject to the employee’s continued service with the Company. The RSAs and RSUs use grant date stock price as a proxy for fair value and compensation expense. For awards that contain market conditions, compensation expense is measured using a Monte Carlo simulation model and recognized over the derived service period based on the expected market performance as of the grant date. The Company also maintains an employee stock purchase plan (“ESPP”) that provides for the issuance of shares to all eligible employees of the Company at a discounted price. For further discussion of the Company’s employees stock plans see Note 11 of Notes to the Consolidated Financial Statements.
Government Subsidies
Government subsidies are recognized where there is reasonable assurance that the subsidy will be received and all attached conditions will be complied with. When the subsidy relates to an expense item, it is recognized as income on a systematic basis over the periods that the related costs, for which it is intended to compensate, are expensed. When the subsidy relates to an asset, it is recognized as income in equal amounts over the expected useful life of the related asset. When the subsidy does not relate to specific expenses or assets, the income is accounted for in the period where there is reasonable assurance that the subsidy will be received. For further discussion of the Company’s government subsidies see Note 16 of Notes to the Consolidated Financial Statements.
Income Taxes
The Company utilizes the asset and liability method of accounting for income taxes, under which deferred taxes are determined based on the temporary differences between the financial statement and tax basis of assets and liabilities
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using tax rates expected to be in effect during the years in which the basis differences reverse. Deferred income taxes arise from temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements, which will result in taxable or deductible amounts in the future. In evaluating our ability to realize our deferred tax assets within the jurisdiction from which they arise, we consider all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax-planning strategies, and results of recent operations. In projecting future taxable income, we begin with historical results and incorporate assumptions about the amount of future federal, state, and foreign pretax operating income adjusted for items that do not have tax consequences. The assumptions about future taxable income require significant judgment and are consistent with the plans and estimates we are using to manage the underlying businesses. In evaluating the objective evidence that historical results provide, we consider recent cumulative income (loss). A valuation allowance is recorded when it is more likely than not that some of the deferred tax assets will not be realized.
Income tax positions must meet a more likely than not recognition threshold to be recognized. The Company recognizes tax benefits from uncertain tax positions only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such positions are then measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. The Company recognizes potential accrued interest and penalties related to unrecognized tax benefits within the consolidated statements of income as income tax expense.
The Company accounts for Global Intangible Low-Taxed Income as period costs when incurred. For further discussion of the Company’s income taxes see Note 7 of Notes to the Consolidated Financial Statements
Net Income per Share
Basic net income per share is computed by dividing net income by the weighted average number of shares outstanding for the period. Diluted net income per share is calculated by dividing net income by the weighted average number of common shares outstanding and common equivalent shares from dilutive stock options and restricted stock using the treasury stock method, except when such shares are anti-dilutive. For further information of the Company’s income per share see Note 14 of Notes to Consolidated Financial Statements.
Business Combinations
The Company recognizes assets acquired (including goodwill and identifiable intangible assets), liabilities assumed and noncontrolling interest at fair value on the acquisition date. Subsequent changes to the fair value of such assets acquired and liabilities assumed are recognized in earnings, after the expiration of the measurement period, a period not to exceed 12 months from the acquisition date. Acquisition-related expenses and acquisition-related restructuring costs are recognized in earnings in the period in which they are incurred. For further discussion of the Company’s business combinations see Note 2 of Notes to the Consolidated Financial Statements
Accounting Standards Recently Adopted
In December 2019, the FASB issued Accounting Standards Update No. 2019-12, “Income Taxes (Topic 740) Simplifying the Accounting for Income Taxes”, as part of its initiative to reduce complexity in the accounting standards. The ASU eliminates certain exceptions from ASC 740 related to the approach for intra-period tax allocation, the methodology for calculating income taxes in an interim period and the recognition of deferred tax liabilities for outside basis differences. ASU 2019-12 also clarifies and simplifies other aspects of the accounting for income taxes. The guidance is effective for fiscal years beginning after December 15, 2020 and for interim periods within those fiscal years. The Company adopted ASU 2019-12 on December 26, 2020. The adoption of this standard did not have a material impact on the Company’s Consolidated Financial Statements.
Accounting Standards Not Yet Adopted
In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financing Reporting. This guidance provides temporary optional expedients and exceptions through December 31, 2022, to the U.S. GAAP guidance on contract modifications to ease the financial
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reporting burdens of the expected market transition from the London Interbank Offered Rate (“LIBOR”) and other interbank offered rates to alternative reference rates. The Company expects to adopt this guidance and apply it to reference rate reform effected arrangement modifications.The Company does not expect this new standard to have a material effect on its Consolidated Financial Statements.
Although there are several other new accounting pronouncements issued by the FASB, the Company does not believe any of these accounting pronouncements had or will have a material impact on its Consolidated Financial Statements.
2. BUSINESS COMBINATIONS
Ham-Let (Israel-Canada) Ltd.
On March 31, 2021, the Company acquired all of the outstanding common shares of Ham-Let (Israel-Canada) Ltd., (“Ham-Let”) for total purchase consideration of $362.9 million paid in cash. In addition, the Company incurred approximately $11.0 million of costs related to the acquisition ($1.0 million incurred in fiscal year 2020 and $10.0 million in fiscal 2021). Ham-Let engages in the development, manufacturing and marketing of process valves, fittings and hoses for the control and monitoring of industrial systems in a variety of markets, including the Semiconductor market. These products are primarily used in ultra clean gas delivery systems for the transmission of liquids and gases. The Company’s primary reason for this acquisition was to broaden UCT’s relevance to the semiconductor equipment market and provide access to a new set of customers in the semiconductor fab infrastructure market. The Company borrowed an additional $355.0 million from its existing Credit Facility to finance the acquisition. See further discussion in Note 6 to the Notes to Consolidated Financial Statements.
In December 2020, the Company announced the acquisition of Ham-Let. The expected cash consideration for the equity valuation at that time was approximately 934.7 million Israeli New Shekel (“ILS”) or $287.1 million in equity value. US GAAP requires the recording of the purchase price of the acquired entity at the spot rate on acquisition date, rather than the cash amount hedged and paid. A loss of $10.4 million on the forward hedge contract that was adjusted for measurement period adjustments, was recorded in the accompanying Consolidated Statements of Operations as other income (expense), net for the year ended December 31, 2021.
The Company has assigned the purchase price of Ham-Let to the tangible assets, liabilities, identifiable intangible assets acquired and noncontrolling interest, based on their estimated fair values. The excess of purchase price over the aggregate fair value was recorded as goodwill. Goodwill associated with the acquisition is primarily attributable to the future technology, market presence and knowledgeable and experienced workforce. The fair value assigned to identifiable intangible assets acquired was determined using the income approach taking into account the Company’s consideration of a number of inputs, including an third-party analysis that was based upon estimates and assumptions provided by the Company. These estimates and assumptions were determined through established and generally accepted valuation techniques and with the assistance of a valuation specialist.
The assigned purchase price is preliminary pending the completion of various analyses and the finalization of estimates. The primary areas of the purchase price that are not yet finalized relate to the fair values of certain tangible assets and liabilities primarily, income and other taxes, intangible assets and residual goodwill. During the measurement period, which can be no more than one year from the date of acquisition, we expect to continue to obtain information to assist us in determining the final fair value of the net assets acquired at the acquisition date during the measurement period. Assets acquired, liabilities assumed and noncontrolling interest are recorded based on valuations derived from estimated fair value assessments and assumptions used by the Company. Thus, the provisional measurements of fair value discussed above are subject to change. The Company expects to finalize the valuation as soon as practicable, but not later than one year from the acquisition date. While the Company believes that its estimates and assumptions underlying the valuations are reasonable, different estimates and assumptions could result in different valuations assigned to the individual assets acquired, liabilities assumed and noncontrolling interest, and the resulting amount of goodwill.
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The following table summarizes the preliminary fair values of assets acquired, liabilities assumed and noncontrolling interest as of December 31, 2021 (in millions):
Fair Market Values (In millions)
Cash and cash equivalents $ 20.1
Accounts receivable 51.6
Inventories 73.7
Prepaid expenses and other 17.3
Property, plant and equipment 52.1
Purchased intangible assets 118.6
Deferred tax assets 0.8
Operating lease right-of-use assets 27.7
Other non-current assets 2.2
Total assets acquired 463.0
Bank borrowings (5.0 )