The difficult wait at Ultratech (UTEK) goes on, as investors are growing restless with the lack of much-needed laser spike annealing orders. While I still believe that Ultratech has very competitive technology in this market and that LSA is going to be vital to sub-20nm chip production, that belief is being tested in the face of poor ordering results. In the meantime, growth in the advanced packaging, metrology, and ALD is nice to see, but not enough to drive the stock.
Recreating the company's past market share in LSA in this next generation of chips would still make this a stock very much worth owning. I would also point out that the company has nearly $10 a share in cash on the balance sheet on a fully-diluted basis. It must be said, though, that Ultratech is getting very close to that "put up or shut up" point where talking about technology and revenue potential feels pointless in the face of relative performance data from Applied Materials (AMAT), Dainippon Screen (OTC:DINRY), and perhaps Mattson (MTSN).
Another Unimpressive Quarter
Ultratech didn't have a great fourth quarter, though there really was no expectation that it would. Revenue fell a whopping 63% from the year-ago period and 19% from the third quarter, missing average expectations by close to 15%. Management doesn't give particularly detailed information about sales by product line, but systems revenue did fall about 74% while service revenue was down 20%. System revenue was driven in large part by a decline in LSA sales.
Gross margin plunged as the company saw serious operating deleverage, dropping almost 50 points. With that, operating income fell to a loss from last year, with the loss more than doubling on a sequential basis.
Revenue Guidance Looked Good, But The Order Book Is A Big Question Mark
Ultratech reported 15% sequential order growth for the fourth quarter, which was actually pretty solid relative to expectations. That level of orders translated into a book-to-bill above 1.5x overall and 1.9x in new systems. With that, management's expectations for 25% to 30% revenue growth in fiscal 2014 was actually positive compared to expectations going into the quarter.
Now for the "buts".
Management said that about 85% of the bookings were for advanced packaging systems. These systems, used to make "flip chips", are a legitimate growth opportunity as flip chip penetration grows from the low-to-mid teens into the high teens. The problem is that Ultratech's main rival, Canon (CAJ), has gotten very aggressive on pricing and Ultratech has chosen to cut prices in response. Because of those lower prices and margins, Ultratech is now looking for 2014 margins more in the mid-40%'s than the 50%-plus range (as the price cut has hurt GM by about 5%).
The second "but" is that there were no meaningful LSA orders in the book. With companies like Samsung and Taiwan Semiconductor (TSM) pushing back their capital spending, this isn't a huge surprise, but it does underline the risk of further delays. It looks as though Dainippon has made some gains in the sub-20nm anneal space and winning Samsung is becoming increasingly important to Ultratech fulfilling the expectations of those remaining bulls on this stock. Management did not have a lot of incremental information to offer, other than to mention the systems are still being evaluated at multiple steps at multiple customers. Without an acceleration in LSA orders as the year moves on, this stock is going to have a hard time getting ahead.
Can Ultratech Still Win In LSA?
Ultratech established leading share with LSA on the strength of its technology, but it has seen that share decline in the face of competition. I believe the company still leads in terms of market share, but it definitely does not dominate as it used to just a couple of years ago.
I think Ultratech can still compete. LSA is already established as the process of record for the bulk of 14nm/16nm production. Applied Materials does license UTEK's underlying LSA technology, but Ultratech's finished systems have historically been superior in terms of yield, throughput, and long-term cost of ownership. Still, the question bears asking as to why Ultratech has not been getting strong initial LSA orders and what that says about the company's competitiveness in this next generation of chips.
Good Potential, But Potential Is A Dangerous Word
If Ultratech can regain its mojo in LSA, I still believe that low teens revenue growth and significant free cash flow growth is attainable in the coming years. Take the case of the company's horrible gross margin this quarter. The GM got crushed in part because of a jump in treated glass inventory; if orders materialize, that will improve significantly in later quarters.
The problem with potential is that there is still the need to deliver. If Ultratech cannot win LSA orders at Samsung, this story gets very challenging - Samsung isn't the end-all/be-all for Ultratech, but it's a big pool of orders that the company should be in good place to win. If it cannot, if Samsung chooses Applied Material, Dainippon, or someone else for the annealing steps, it's going to be harder and harder to argue that Ultratech has a real position of value in that part of the semiconductor equipment world.
The Bottom Line
I trimmed by DCF-based fair value slightly after the earnings announcement (to $31), but that still suggests significant upside if Ultratech can win those LSA orders. Time after time, Ultratech has shown that it can develop good technology - in LSA, in advanced packaging, in metrology - but good technology, good products, and good revenue are unfortunately not synonymous or inextricably linked. The next couple of quarters will tell the tale on this stock, but I'm remaining long for now.