The past year wasn't a great one for the semiconductor equipment industry, and in fact Ultratech's (NASDAQ:UTEK) 2% rise over the last twelve months puts it on pretty high ground compared to rivals like Mattson (NASDAQ:MTSN) (down 30%), Rudolph (NYSE:RTEC) (down 7%), and Screen Holdings (OTC:DINRY) (down 2%), as well as other industry bellwethers like Applied Materials (NASDAQ:AMAT) and ASML (NASDAQ:ASML). That comes despite a disappointing run of performance that saw a 1% drop in full year-over-year revenue and two straight top line misses to end the year.
This remains what it has been for some time - an increasingly speculative story predicated on improving orders for the company's advanced packaging, laser processing, and wafer inspection tools. While Ultratech clearly dropped the ball with respect to laser processing at sub-20nm nodes (or perhaps it is more fair to say that Mattson stripped it away), there may be some early signs of improvement, as well as the opportunity to leverage follow-on orders at 28nm and above.
If Ultratech can build on its three core businesses in 2016 and start outperforming, the shares could certainly move into the mid-to-high $20s, but investors have to at least consider the risk that companies like Rudolph and SUSS MicroTec (SMHN.XE) will do to Ultratech in advanced packaging what Mattson did in thermal processing and that the company fails to regain momentum with its laser processing business.
Another Miss, But This One May Be Excused
Ultratech once again missed expectations, with fourth quarter revenue falling 41% from last year's level and missing expectations by 16% (or around $5 million). Management noted that two tool shipments slipped into the next quarter, constituting about $7.5 million in lost revenue. If the first quarter results are strong, nobody will really mind that this quarter came up light.
System revenue fell 46% from last year and 18% from the prior quarter, as the company's laser processing business all but vanished (down to 1% of sales). Advanced packaging sales were down 3%, and nano sales were down about 60%, while inspection contributed almost one-quarter to sales. Parts revenue declined 28% from last year, while service was down about 16%. As these two items often contribute around 20% to 25% of sales, their contributions are not trivial to the company's results, but also don't really drive expectations or sentiment.
Gross margin fell about three points from last year and four points sequentially, which I'll argue isn't a bad result in the context of the poor system sales. Even so, the operating loss grew substantially from last year on the weaker operating leverage.
Orders Show Some Life
Ultratech regrettably does not report product sales or orders in a clean, easy-to-follow fashion and instead uses percentages. Consequently, there's always some ambiguity in the real numbers. Nevertheless, it looks like orders improved more than 40% from last year's level, as the company reported a 2.1x book-to-bill versus last year's 0.8x.
Advanced packaging orders rose about 240% from last year, while LSA orders were down about 17% but have shown some life after no orders in the third quarter. Management talked about "increased quoting activity" and "regaining traction," with the new LSA Turbo 101 tool seeing use at the 28nm and 10nm nodes and getting qualified at the 7nm node. Orders were no doubt boosted by a large multi-system LSA order that Ultratech announced back in December, and the company announced a multi-system order for its advanced packaging tools after the announcement of this quarter as well.
All told, Ultratech's Singapore manufacturing facility is booked through the first half of 2016 and into the third quarter. At a minimum, that should be good for gross margins and operating leverage in the first half of the year.
Can They Build And Maintain?
I've written at some length in the past about how Mattson stole the march from Ultratech in this latest generation of thermal processing tools. While Ultratech continued to talk about the patterning effects and thermal stress caused by flash annealing, Mattson's latest tools helped work around that problem by heating from above and below, while cutting thermal activation times in millisecond annealing from around 1 second to 1-2.5 milliseconds.
It does seem as though Ultratech has moved to correct some of the issues with laser spike annealing that led to the big shift in market share (LSA had 50+ share at 28nm, but less than 25% so far at < 20nm). What happens now will be interesting to watch. Screen Holdings frankly doesn't seem to care all that much about thermal processing - the business generated around $17 million in fiscal 2016 first half revenue (which is still more than Ultratech generated for all of 2015), but the company rarely talks about the business and talks more about new initiatives in inspection equipment, life science applications of its technology, and share growth in semiconductor coater/developers.
Given the issues with the market transition from 28nm to < 20nm, it's worth noting that Ultratech doesn't have the advanced packaging market to itself either. Several companies, including Rudolph Technologies and SUSS MicroTec (as well as more established players like Canon and Nikon) have developed or repurposed lithography tools to address the rapidly-growing market created by copper-pillar, fan-in, fan-out, and other advanced chip packaging options.
Rudolph recently talked about some wins for its JetStep AP Lithography tools and the company posted good growth in the last year. Then again, compare Rudolph's 30% growth to $16.5 million in advanced packaging sales in 2015 to Ultratech's approximately 56% full-year growth and roughly $74 million in sales. Ultratech can't afford to take it for granted that they maintain leadership, but they are at least still competing from a position of strength.
Recalculating The Value
There is enough growth potential in Ultratech's addressed markets (advanced packaging, thermal processing, and inspection) to support a much higher level of orders, revenue, and market capitalization. Execution is the key unknown, though, and management will have to maintain a strong level of orders into and through 2016 to regain Wall Street interest. After all, 2015 was supposed to be a big year of order development and that fell flat. Even if some of that underperformance was due to companies like TSMC (NYSE:TSM) and Intel (NASDAQ:INTC) ordering less equipment than expected, I think it is nevertheless fair to say that laser processing was a big disappointment that advanced packaging couldn't offset.
I think $16.50 to $20 is still a reasonable range of fair values for Ultratech until/unless the company shows a consistent level of meaningful order growth - at least enough to drive the business back into profitability (and not just "above zero"; I mean double-digit operating margins). The stock could ultimately go quite a bit higher on renewed share growth in thermal processing, growth in inspection, and growth in advanced packaging, but I believe that's more of a "believe it if/when you see it" proposition.
The Bottom Line
My Ultratech holdings have always been a small "let's see what happens" position, so I'm not inclined to do anything with it right now. If the year goes on and Ultratech can't regain any momentum in thermal processing and/or seems to be slipping in advanced packaging, I'll take the loss and move on. For now, though, I'm still willing to see how 2016 order patterns play out and whether management can reestablish this story as a strong niche player in the larger semiconductor equipment space.
Disclosure: I am/we are long UTEK.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.