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Edited Transcript of UCTT earnings conference call or presentation 2-May-19 8:45pm GMT

Q1 2019 Ultra Clean Holdings Inc Earnings Call

Hayward May 21, 2019 (Thomson StreetEvents) -- Edited Transcript of Ultra Clean Holdings Inc earnings conference call or presentation Thursday, May 2, 2019 at 8:45:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* James P. Scholhamer

Ultra Clean Holdings, Inc. - President, CEO & Director

* Rhonda M. Bennetto

Ultra Clean Holdings, Inc. - VP of IR

* Sheri Savage

Ultra Clean Holdings, Inc. - CFO, Senior VP of Finance & Secretary

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Conference Call Participants

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* Christian David Schwab

Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst

* David Duley

Steelhead Securities LLC - Managing Principal

* Karl Fredrick Ackerman

Cowen and Company, LLC, Research Division - Director & Senior Research Analyst

* Quinn Bolton

Needham & Company, LLC, Research Division - Senior Analyst

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Presentation

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Operator [1]

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Good day, everyone, and welcome to the Ultra Clean Technology First Quarter 2019 Earnings Conference Call. (Operator Instructions) Please also note, today's event is being recorded.

At this time, I'd like to turn the conference call over to Rhonda Bennetto, Investor Relations. Please go ahead.

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Rhonda M. Bennetto, Ultra Clean Holdings, Inc. - VP of IR [2]

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Thank you, operator. Good afternoon, everyone, and thank you for joining us. With me are Jim Scholhamer, Chief Executive Officer; and Sheri Savage, Chief Financial Officer. Jim will begin with some prepared remarks about the business, and Sheri will follow up with the financial review. Then we'll open up the call for questions.

The press release we issued earlier this afternoon, along with the information about the webcast, can be found on the Investor Relations section of our website at www.uct.com.

Today's call contains forward-looking statements that are subject to risks and uncertainties. For more information, please refer to the risk factors disclosure of our SEC public filings. All forward-looking statements are based on management's estimates, projections and assumptions as of today, and we assume no obligation to update them after today's call. Today's discussion of our financial results will be presented on a non-GAAP basis. The reconciliation between GAAP and non-GAAP results can be found in today's press release.

And finally, we will be participating in the Craig-Hallum Institutional Investor Conference in Minneapolis on May 29 and the Cowen Annual Technology Conference on May 30 in New York. In addition, we will be presenting and webcasting at the Stifel Cross Sector Insight Conference on June 11 in Boston. And you can find additional information on these conferences on our website, www.uct.com/investorevents (sic) [www.uct.com/investors/events].

And with that, I'll turn the call over to Jim. Jim?

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James P. Scholhamer, Ultra Clean Holdings, Inc. - President, CEO & Director [3]

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Thank you, Rhonda, and good afternoon, everyone. Thank you for joining us for our first quarter 2019 conference call and webcast. First, I'm going to highlight a few financial results that Sheri will expand on in her commentary. I'll continue with review of our Semiconductor Products and Solutions business, including an update on our cost improvement initiatives and our recent acquisition. I'll conclude with a recap of our Semiconductor Services Business, and then we will open up the call for questions.

As our first quarter results indicate, our approach is working both in terms of our diversification strategy and our ability to deliver for our customers. Total revenue for the first quarter was $260 million, above our guided range. Our Products and Solutions business contributed $200 million, and our Service business added $60 million. Non-GAAP EPS also exceeded our guided range at $0.21 for the quarter. We were able to outperform our guidance as our Product group executed on drop-in and pull-in orders. And our Service business saw an increase in sales from our largest IDM customer.

Let me start with our Products business. Our direct visibility, based on customers' orders, is limited and can change significantly even within a quarter. Our performance as a key supplier enabled us to deliver last-minute orders to meet our customer demand. The increase was due to adjustments in customer schedules and should not be viewed as a sign that the market has begun a recovery.

We see current industry conditions as relatively the same from a quarter ago. Industry CapEx plans for 2019 remain unchanged, and measures are being taken to manage supply, output and inventory levels, which bodes well for the industry heading into 2020. We are taking advantage of the digestion period by optimizing our product manufacturing footprint while broadening our capabilities. Both of these initiatives should increase profitability, creating long-term value for our shareholders.

Last quarter, we introduced a series of rigorous cost improvement initiatives to increase profitability by eliminating redundant operational footprint and consolidating capabilities. The majority of the initiatives will take several quarters to finalize, with the benefit being realized in the latter half of the year. We expect our annualized cost savings from the restructuring plan to be in the $15 million to $20 million range once completed later this year, with incremental margin expansion along the way.

In addition, we are growing our product portfolio and available market and increasing our share in key semiconductor equipment commodities. Recently, we announced the acquisition of Dynamic Manufacturing Solution. DMS provides a complete range of weldment solutions primarily to the semi industry and is adjacent to our existing Austin, Texas, facility. This acquisition is consistent with our strategy to pursue sustained profitable growth in our core semiconductor business. Our complementary technologies, together with our increased scale, position us as the leader in the semiconductor equipment weldment space.

This was a highly synergistic acquisition and immediately accretive to earnings. We expect DMS to generate over $5 million in adjusted EBITDA this year and add $0.05 to $0.07 to UCT's non-GAAP EPS. By optimizing our operations to improve profitability and expanding our suite of offering, we will capitalize on the increases in demand for our products during the next ramp.

Now I'd like to provide an update on our Services business. Services had a strong quarter due to an increase in demand from one of our largest customers. You'll recall, we derive revenue in 2 ways: first, from servicing the installed base; and secondly, from processing new equipment related to semi cap investment. Recently, Industry Intelligence and IDM's earnings report, confirmed by our marketing research, indicate that chip inventory levels are declining, and fab utilization rates have begun to pick up. In addition, leading-edge nodes require more stringent cleaning specifications and analytical validation. This transition bodes well for us as Quantum specializes in providing highly technical solutions.

In summary, we remain very upbeat about the demand drivers that will provide growth opportunities for our Products and Services business over the long term. We are taking the step necessary now to improve our profitability, increase our capabilities, strengthen our competitive position and deepen our customer engagement to emerge a much stronger company. I would like to thank our employees and our shareholders for their continued support, and I look forward to updating you on our next call.

With that, I'll turn the call over to Sheri.

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Sheri Savage, Ultra Clean Holdings, Inc. - CFO, Senior VP of Finance & Secretary [4]

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Thanks, Jim, and good afternoon, everyone. Thanks for joining us. In today's discussion, I'll be referring to non-GAAP numbers only. During this quarter, we have elected to change our organizational and reporting structure to capture efficiencies and operating leverage due to the Quantum acquisition. We are now reporting results for 2 operating segments: Semiconductor Products and Solutions, or SPS, and Semiconductor Services Business, or SSB. We have provided a reconciliation of GAAP to non-GAAP segmented financial measures in the tables in our press release.

Both our Products and Services divisions performed well this quarter, generating total revenue of $260.1 million, up just over 1% from last quarter and above our guided range. SPS contributed $200.2 million in revenue, and SSB added $59.8 million. Non-Semiconductor revenue, which includes display, generated $15.2 million or 5.8% of revenue.

Total gross margin stayed at the higher end of our range at 17.8% compared to 18.7% last quarter. SSB gross margin was 33.6%, and SPS was 13.1%. Higher overhead and labor costs required to meet unanticipated late quarter demand impacted gross margin. As we've shared before, margins can be influenced by customer concentration, geography, product mix and volumes and the timing of our restructuring initiatives. So you should expect to see variances quarter-to-quarter.

Operating expenses decreased 3.4% to $30.3 million compared to $31.4 million in the prior quarter. As a percentage of revenue, OpEx decreased to 11.7% from 12.2% last quarter. Operating margin for the first quarter was 6.1% compared to 6.5% last quarter. Margin contributed from SSB was 12.8% and SPS was 4.2%.

Our year-end audit and accounting fees over time to meet late quarter demand and seasonally higher employer payroll tax expenses impacted margins. We expect our restructuring plan, together with the synergies realized from our recent acquisition of DMS, will have a positive impact on margins in the second half of this year.

Based on 39.4 million shares outstanding, earnings per share for the first quarter were $0.21, derived from net income of $8.1 million. This compares to $8.7 million and $0.23 last quarter.

Our tax rate for the quarter was 19.2% compared to 17.2% last quarter. The increase was primarily due to the Quantum acquisition, impact of U.S. tax reform and the changes in the forecasted geographic mix of pretax income. Going forward, we expect our tax rate to be in the mid- to high teens, but as always, you can expect to see variances quarter-to-quarter.

Turning to the balance sheet. We ended the quarter with $154.8 million in cash and cash equivalents, an increase of $10.6 million over the prior quarter. Cash from operations was $18.1 million compared to $30.1 million last quarter. Inventory decreased $5.8 million during the quarter, and we will continue to manage inventory levels to closely match customer demand.

Our second quarter outlook assumes total revenue between $245 million and $265 million and a non-GAAP EPS in the range of $0.12 to $0.22.

And with that, I'd like to turn the call over to the operator for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question today comes from Quinn Bolton from Needham & Company.

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Quinn Bolton, Needham & Company, LLC, Research Division - Senior Analyst [2]

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Jim, Sheri and Rhonda, congratulations on a nice result. It's relative to guidance for the first quarter. I wanted to start with the pull-ins that you talked about. While I understand it's kind of just rescheduling of orders, I can't help but notice that revs were better both for Q1, but also, the guidance for the second quarter is better than The Street. So it feels like the business overall is performing a little bit better.

I'm just wondering if you could talk about where you think some of that strength maybe is coming from and particularly kind of love to get your opinion on what you're seeing on the logic, foundry side of business because I think some of your peers that have reported this earnings season have noted that the foundry, logic outlook may have upticked over the last 90 days.

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James P. Scholhamer, Ultra Clean Holdings, Inc. - President, CEO & Director [3]

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Yes. Thanks, Quinn. Yes, it was a combination of pull-ins and, as you've noted also, a drop in orders as well. The majority of the strength, yes, logic definitely played a key role. But in all chip types of the leading-edge technology, there is still some investments that are happening that are a little bit more difficult to predict. So definitely a leading edge on all chip types as well as logic being stronger than expected.

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Quinn Bolton, Needham & Company, LLC, Research Division - Senior Analyst [4]

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Okay. Great. And then one of the questions I had: Lam, on their call, talked about the ability to go out and generate sales through the upgrade and process chambers in the field. I'm wondering, is there any part of your business, whether it's components to gas panels, that might benefit from field upgrade of your large OEM customers rather than new tool sales? Or does most of your revenue track new tool shipment?

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James P. Scholhamer, Ultra Clean Holdings, Inc. - President, CEO & Director [5]

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Good question. No, a lot of the action, if you would, is happening on upgrade business as well. And many of the upgrades require either new gas panels or a gas panel reconfigurations. And new chamber adds require all the same material roughly as you would in a tool. So that's definitely an important part of our business, yes. And it's also less visible with a shorter lead time.

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Quinn Bolton, Needham & Company, LLC, Research Division - Senior Analyst [6]

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I assume that you're seeing that sort of -- that same trend that did in 2019, upgrade becoming a bigger part of the business.

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James P. Scholhamer, Ultra Clean Holdings, Inc. - President, CEO & Director [7]

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Yes.

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Quinn Bolton, Needham & Company, LLC, Research Division - Senior Analyst [8]

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Okay. Great. And then just the last question. Wondering if you had mentioned Quantum saw strength at one of your leading customers. I assume that's probably on the logic side. Some of the memory manufacturers have talked about reducing wafer starts as a way to try to digest some of the overcapacity situation in the industry. Wondering if you've seen any impact on the memory side of Quantum's business from reduced wafer starts.

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James P. Scholhamer, Ultra Clean Holdings, Inc. - President, CEO & Director [9]

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No. Obviously, we don't break it out in detail, but we haven't seen anything material on that side.

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Quinn Bolton, Needham & Company, LLC, Research Division - Senior Analyst [10]

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Okay. Great. And then just lastly, can you give us what you think the DMS contribution will be for the June quarter? I think in the press release, when you announced the transaction, it was about a $50 million revenue run rate last year. Obviously, overall demand was better last year. Should we be thinking maybe something in the $10-ish million range?

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Sheri Savage, Ultra Clean Holdings, Inc. - CFO, Senior VP of Finance & Secretary [11]

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Yes. That's about right. We assume that they'll give us $0.05 to $0.07 for the year, so approximately maybe $0.01 contribution for this next quarter.

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Operator [12]

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Our next question comes from Karl Ackerman from Cowen and Company.

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Karl Fredrick Ackerman, Cowen and Company, LLC, Research Division - Director & Senior Research Analyst [13]

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Jim and Sheri, congrats on closing on DMS. My question is really kind of around outsourcing opportunities. You know we know the overall -- that a few markets should be down for a mid- to high teens this year, but have you seen a slowdown in outsourcing opportunities for your non-Service business as demand trends have softened? And if not, do you continue to see the greatest opportunity in the mechanical areas of each tool set, which is wafer transfer and process chamber? Or are you seeing a pickup at all for gas panels?

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James P. Scholhamer, Ultra Clean Holdings, Inc. - President, CEO & Director [14]

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So several questions. I think the first one being on outsourcing opportunities. Yes, we saw -- obviously, we saw -- during the upturn in '16 and '17, we saw great acceleration of outsourcing during that period. And several quarters ago, that obviously abated as the output continued to -- it actually went down a bit. So the outsourcing still occurs on a project-by-project basis of things being outsourced, but definitely the accelerated rate of outsourcing that we saw in '16 and '17 is already kind of reflected in our business.

The second part, I think, of your question is around where in the system side of our business we're seeing activities. Obviously, it hit all areas, but it's when -- as upgrades increase, you see a lot more action around the process chamber part of the tool. And a lot of the process chambers require gas panels. So we see obviously increased activity in that space.

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Karl Fredrick Ackerman, Cowen and Company, LLC, Research Division - Director & Senior Research Analyst [15]

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That's very helpful. We mentioned briefly about pull-ins and whatnot. I guess, what is your level of visibility in order rate today? And do you think that's kind of improved at all over the last perhaps couple of months?

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James P. Scholhamer, Ultra Clean Holdings, Inc. - President, CEO & Director [16]

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The visibility is low, and actually, in the last few months, it's gotten even more difficult. But I think one of the reasons that our customers view us as the go-to supplier is our ability to take a drop-in or a pull-in and react to that. And that's -- we call that churn. And the churn in the industry, especially during a slower period like now, tends to be higher than -- and then when the market is moving up, the forecast is more stable, and further out, we have more visibility. So our visibility is lower right now, but we're benefiting from the fact that with our global presence and our big -- our broad capabilities, that we're able -- we're the go-to supplier to turn around a lot of those sudden orders.

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Karl Fredrick Ackerman, Cowen and Company, LLC, Research Division - Director & Senior Research Analyst [17]

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Understood. And last question, if I may. One of your -- one of the traditional EMS providers ended up buying more of an OLED -- more of a display-type business. And I know your display business is not the upside lever it used to be, at least several quarters ago. But with new form factors utilizing both small panel and large panel displays in the second half, what is your view of the display business going forward?

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James P. Scholhamer, Ultra Clean Holdings, Inc. - President, CEO & Director [18]

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Yes. Display is obviously not running at the levels it was before, but it's -- there's still some activity in OLED. And there's obviously continued investment in Gen 10.5 tools and that -- as the TV sizes expand. So we're seeing the activity, we're seeing it kind of spread between the -- as you mentioned, the smaller panel size than the OLED and the very large tools that are making the large TVs.

And so going forward, I think we used to -- we saw levels pre-displays expansion. We used to see 3 million of 5 million a quarter from display. During the last few years, we were kind of bouncing around 8 million to 15 million in our -- or bouncing around the lower end of that range right now. And that's kind of where we see it going forward.

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Operator [19]

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Our next question comes from Christian Schwab from Craig-Hallum Capital Group.

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Christian David Schwab, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [20]

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Great start to the year. I know with the caveat of limited visibility, but would you expect the second half of the calendar year to be better than the first half?

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James P. Scholhamer, Ultra Clean Holdings, Inc. - President, CEO & Director [21]

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Yes. Our -- for planning purposes, we're assuming that the whole year is roughly bouncing around these levels. I think we have more optimism than pessimism for the second half, but our base assumptions are that we continue to see this level of business through '19.

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Christian David Schwab, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [22]

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Perfect. And then just what type of margin improvement should we expect first half versus the second half that you guys highlighted?

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Sheri Savage, Ultra Clean Holdings, Inc. - CFO, Senior VP of Finance & Secretary [23]

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I think the key thing, Christian, that we talked about in our previous calls is some of the cost reductions. I think we had mentioned that we would be at a run rate by the end of the year at $15 million to $20 million of costs coming out. So that will definitely help with some of the margins that we're seeing and seeing the improvement in the second half. Obviously, this depends on timing of everything as well as execution of some of the cost initiatives we're doing. But we do see that they are going to ramp up a little bit in the second half than -- as compared to the first half.

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Operator [24]

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(Operator Instructions) Our next question comes from David Duley from Steelhead Securities.

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David Duley, Steelhead Securities LLC - Managing Principal [25]

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Just as far as the Q2 goes, how should the 2 pieces of your business act in Q2 versus Q1?

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Sheri Savage, Ultra Clean Holdings, Inc. - CFO, Senior VP of Finance & Secretary [26]

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From a breakdown of revenue, it's fairly similar as compared to this quarter, very similar percentages.

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David Duley, Steelhead Securities LLC - Managing Principal [27]

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Okay. And then you mentioned as you have node shrinks, the intensity to clean goes up. Is there -- do you have any examples of how much more intense node-to-node it might be? Or how much more of a revenue opportunity that might be as you see shrinks from your large customers?

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James P. Scholhamer, Ultra Clean Holdings, Inc. - President, CEO & Director [28]

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Obviously, there's a mix in those going on. We're seeing activity across all the nodes. As far as the cycle clean, there's so many different platforms and so many different applications for each platform. I don't think we could break out the frequency of clean. Obviously, the trend is up, and it's part of why -- I guess, it's factored in of why we believe that industry -- why our Services business will grow in the mid- to high single digits.

It's a combination of the wafer starts going up from the investments from the last year as well as being the factor of the increased frequency at the leading-edge node. It's difficult to break out what -- how much of that is due to the increased frequency, but I would guess it's roughly half of the impact of the Service business growth.

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David Duley, Steelhead Securities LLC - Managing Principal [29]

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Okay. Great. And did you have any 10% customers during the quarter?

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James P. Scholhamer, Ultra Clean Holdings, Inc. - President, CEO & Director [30]

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Oh, yes. At least 2, that's what I know.

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Sheri Savage, Ultra Clean Holdings, Inc. - CFO, Senior VP of Finance & Secretary [31]

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Yes. So the typical that we have in most quarters continue to be. So the 2 highest customers that we typically put into our 10-K are -- continue to be...

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James P. Scholhamer, Ultra Clean Holdings, Inc. - President, CEO & Director [32]

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Lam.

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Sheri Savage, Ultra Clean Holdings, Inc. - CFO, Senior VP of Finance & Secretary [33]

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Lam, Applied.

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David Duley, Steelhead Securities LLC - Managing Principal [34]

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Yes. And you don't break out the -- that on a quarterly basis, the percentages. I just don't recall. I'm sorry.

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Sheri Savage, Ultra Clean Holdings, Inc. - CFO, Senior VP of Finance & Secretary [35]

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Oh, okay. No worries. Generally, the Lam is around 40%, and Applied is close to 21%.

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David Duley, Steelhead Securities LLC - Managing Principal [36]

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Okay. And then just -- Jim, if you could just speculate on what you think the overall -- for planning purposes, let's say, what is the WFE number that you're planning for as far as the decline on an annual basis this year?

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James P. Scholhamer, Ultra Clean Holdings, Inc. - President, CEO & Director [37]

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So low 40s, so roughly about a 20% drop over 2018.

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David Duley, Steelhead Securities LLC - Managing Principal [38]

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And when you compare that to your core revenue, it's fair to assume that your core revenue would drop a little bit more just because WFEs -- overall WFEs is helped by EUV, lithography and the Services businesses of your large OEMs. So if they drop 20%, what will we think your core business might drop?

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James P. Scholhamer, Ultra Clean Holdings, Inc. - President, CEO & Director [39]

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Actually, tracking pretty closely. We do have -- although it's not in our top 10, we do have a footprint in the litho space as well. I think the bigger impact in the first few quarters would be inventory in the chain, all the way down through the chain between us and our customers and our customers and their customers and so on and so forth. So I -- but I think overall, if you do the math, we're relatively in line with the overall WFE.

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Operator [40]

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And ladies and gentlemen, that will conclude our question-and-answer session. I'd like to turn the conference call over to management for any closing remarks.

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James P. Scholhamer, Ultra Clean Holdings, Inc. - President, CEO & Director [41]

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Well, thank you for joining us, and we look forward to speaking to you on the next quarterly call.

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Operator [42]

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And ladies and gentlemen, with that, we'll conclude today's conference call. We do thank you for attending today's presentation. You may now disconnect your lines.