Sheryl Crow may have been right that the first cut is the deepest, but by the time you get to the third or fourth cut, they all get pretty annoying. Ultratech (NASDAQ:UTEK) continues to do the best it can, given that it's tethered to a team of horses (its customers) that don't seem to know where they're going or when they'll get there. FinFET development has proved frustratingly slow, but there are still credibly reasons to believe that this represents a $600 million-plus market for Ultratech's leading LSA tools.
What to do with the stock? Honestly, if you've made it this far, I'd suggest holding on. The development of FinFET timelines (and tool orders) has been slower and more opaque than I'd expected, but I haven't really seen much to suggest that flash anneal from Dainippon Screen (OTC:OTC:DINRY) or Mattson (NASDAQ:MTSN) is the best way forward. When (and if) the orders materialize, Ultratech could double its revenue over two years. Of course, there is the risk that Dainippon/Mattson win over fabs and that Ultratech's LSA tools aren't adopted, so this is really only suitable for those with above-average risk tolerance.
Another Quarter, Another Miss
Ultratech once again reported a weaker quarter than expected, even though analysts had been revising and whispering down their numbers.
Revenue fell 14% from last year, but did rise 17% from the first quarter, missing the average guess by about 7% (which can mean just one or two tools, depending on the specifics). System revenue declined 11% from last year, but did improve more than 20% from the first quarter. Ultratech gives line-item detail by percentages, but extrapolating from that, I came up with advanced packaging tool revenue declining 8% yoy/12% qoq, LSA tool revenue declining 28% yoy but more than doubling sequentially, and HBLED revenue going from nil to $4 million. There was no (or at least no significant) nano-related revenue.
Gross margins were weaker on the lower-than-expected volume, falling 250bp from last year and rising 370bp sequentially. Operating income fell from a year-ago profit of $1 million to a loss of $4 million, but the loss did shrink from last quarter's $7 million. Ultratech ended the quarter with just under $300 million in net cash.
Timelines Slipping, But Ultratech Is Shipping
Ultratech did sport a 1.4 book-to-bill in new systems this quarter, with close to two-thirds of that going to its advanced packaging steppers. The company did see LSA orders, though, including systems targeted at 14nm FinFET production.
Unfortunately for Ultratech, it's tethered to an industry still working out the kinks in these new chip architectures. Almost everyone has seen delays, with Intel (NASDAQ:INTC) recently confirming a modest delay and Taiwan Semiconductor (NYSE:TSM) pushing production expectations well back into 2015. I don't want to presume to speak for Ultratech management, but I feel as though there was a level of frustration just barely below the surface in talking about the situation with these fabs; the FinFET opportunity remains large for tool companies like Ultratech, DNS, Applied Material (NASDAQ:AMAT), and Mattson, but yields are proving problematic, and that's holding everything up.
Based on management's guidance given on the call, it's not unreasonable to think that a fab could end up ordering $300 million worth of LSA tools over a full cycle. There's no way that Ultratech is going to get every order at every fab; DNS has gained share with TSMC, and Mattson is trying to gain share with Samsung; but just among the major fabs (TSMC, Samsung, Intel, GloFo), that still suggests a significant opportunity, provided that LSA is adopted for thermal processing.
On that front, there's really not much new to add. Ultratech continues to state its position that it offers the best LSA tools (though Applied Materials has a license to its technology) and that LSA is a better approach due to less stress to the wafer (less breakage and pattern effect). For their part, the flash annealing tool companies claim that their newest technology is much better, and there is a risk that Ultratech sees major players like TSMC and Intel go that route.
I'm still bullish on Ultratech's technology and capabilities. Management gave the following snippet on the call - in terms of cost of ownership, an LSA system will consume about $16,000 year in gases, while a flash system will consume $300,000 to $3 million in replacement lamps. On the subject of advanced packaging steppers, management also noted that it takes three old steppers to equal the throughput of a modern new Ultratech stepper tool.
Holding Steady For Now On Valuation
Wall Street price targets have come down a bit, though the initiation of another firm at "neutral" helped to bring down the average. All things considered, for a day on which the Nasdaq is down 1.5%, the response to this quarter has been fairly restrained, though the shares weakened considerably in mid-June as worries picked up about delayed FinFET orders and the possibility that Ultratech was losing share to DNS and others. Even so, numbers are heading down again, as the third-quarter guidance was lower than analysts expected.
For my part, I continue to look for revenue to ramp up to close to $400 million in 2018, with strong free cash flow growth (a FCF margin of 20%). That's not going to be sustainable across the cycle, and trying to model a full equipment cycle all but guarantees some errors. Even so, a discounted cash flow model does support a fair value around $30 to $31, with metrics like EV/sales and price/book (using multiples based on projected 2015/2016 margins and ROEs) likewise supporting fair value above $30.
The Bottom Line
Ultratech has been a frustrating stock to own, but I continue to believe that the potential over the next two to three years will more than make up for carrying a paper loss today. The company with the best technology doesn't always win, but I believe Ultratech's leverage to advanced packaging and LSA will serve it well in the coming years. As I said in the beginning, though, this is not a stock for nervous investors or those who cannot take the possibility of a large loss.
Disclosure: The author is long UTEK. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.