Portions of the registrant’s definitive proxy statement to be delivered to stockholders in connection with the 20072008 annual meeting of stockholders are incorporated by reference in Part III of thisForm 10-K.

 

 

We are a leading developer and supplier of critical subsystems, primarily for the semiconductor capital equipment industry. We also leverage the specialized skill sets required to support semiconductor capital equipment to serve the technologically similar markets in the flat panel, solar and medical device industries, collectively referred to as “Other Addressed Industries”. We develop, design, prototype, engineer, manufacture and test subsystems which are highly specialized and tailored to specific steps in the semiconductor manufacturing process. Currently, ourprocess as well as in Other Addressed Industries. Our revenue is derived primarily from the sale of Gas Delivery Systems. We have recently increased our revenue from the sale ofgas delivery systems and other non-gas deliverycritical subsystems (Other Critical Subsystems) including chemical mechanical planarization (CMP)sub-systems, subsystems, chemical delivery modules, top-plate assemblies, frame assemblies, process modules and process modules. Revenue from Other Critical Subsystems was 31.9% of annual revenue in 2006 compared with 7.8% of annual revenue in 2005. Due to the recent acquisition of Sieger Engineering, Inc., a California corporation (“Sieger”), in June 2006, we believe the results of our most recently completed quarter are the most indicative period for understanding the realignment and evolution of our revenue base. In the fourth quarter of 2006, revenue from Sieger and revenue from Other Critical Subsystems other than Sieger represented 24.8% and 19.3%, respectively or 44.1% on a combined basis. In the fourth quarter of 2005, revenue from Sieger and revenue from Other Critical Subsystems other than Sieger represented 0.0% and 11.4%, respectively.high level assemblies.

Our primary customers are semiconductorprimarily original equipment manufacturers.manufacturers (OEMs) in the industries we support. We provide our customers complete subsystem solutions that combine our expertise in design, test, component characterization and highly flexible manufacturing operations with quality control and financial stability. This combination helps us to drive down total manufacturing costs, reducedesign-to-delivery cycle times and maintain high quality standards for our customers. We believe these characteristics, as well as our standing as a leading supplier of Gas Delivery Systemsgas delivery systems and Other Critical Subsystems,other critical subsystems, place us in a strong position to benefit from the growing demand for subsystem outsourcing.

We had sales of $403.8 million, $337.2 million, $147.5 million and $184.2$147.5 million for the years ended December 31,2007, 2006 and 2005 and 2004,fiscal years, respectively. Our three largest customers in 20062007 were Applied Materials, Inc., Lam Research Corporation and Novellus Systems, Inc. To date, we have shipped substantially all of our products to customers in the United States. Our international sales represented 2.2%, 4.9%, 5.5% and 3.2%5.5% of sales for the years ended December 31,28, 2007, December 29, 2006 2005 and 2004,December 30, 2005, respectively. We conduct our operating activities primarily through our threefour wholly owned subsidiaries, Ultra Clean Technology Systems and Service, Inc., UCT-Sieger Engineering LLC, and Ultra Clean Technology (Shanghai) Co., LTD.Ltd and Ultra Clean Micro-Electronics Equipment (Shanghai) Co., Ltd.

Ultra Clean Holdings, Inc. was founded in November 2002 for the purpose of acquiring Ultra Clean Technology Systems and Services,Service Inc. Ultra Clean Technology Systems and Service, Inc. was founded in 1991 by Mitsubishi Corporation and was operated as a subsidiary of Mitsubishi until November 2002, when it was acquired by Ultra Clean Holdings, Inc. Ultra Clean Holdings, Inc. became a publicly traded company in March 2004. In June 2006, we completed the acquisition of Sieger through our wholly owned subsidiary UCT-Sieger

We are a leading developer and supplier of critical subsystems primarily for the semiconductor capital equipment industry.industry and Other Addressed Markets. Our products enable our original equipment manufacturer (OEM)OEM customers to realize lower manufacturing costs and reduceddesign-to-delivery cycle times while maintaining quality.quality standards. We offer our customers:

An integrated outsourced solution for Gas Delivery Systemsgas delivery systems and Other Critical Subsystems.other critical subsystems.  We provide our OEM customers a complete outsourced solution for the development, design, prototyping, engineering, manufacturing and testing of advanced Gas Delivery Systems. We also provide outsourced solutions for Other Critical Subsystems including CMP modules, chemicalgas delivery modules, top-plate assemblies, frame assembliessystems and process modules.other critical subsystems. We combine highly specialized engineering and manufacturing capabilities to produce high performance products that are customized to meet the needs of our customers, as well as their respective end users. We manage supply chain logistics in an effort to reduce the overall number of suppliers and inventory levels that our customers would otherwise be required to manage. We also believe we are often in a position to negotiate reduced component prices due to our large volume orders.

Improveddesign-to-delivery cycle times.  Our strong relationships with our customers and intimate familiarity with their products and requirements help us reducedesign-to-delivery cycle times for Gas Delivery Systemsgas delivery systems or Other Critical Subsystems.other critical subsystems. We have optimized our supply chain management, design and manufacturing coordination and controls to respond rapidly to order requests, enabling us to decreasedesign-to-delivery cycle times for our customers.

Component neutral design and manufacturing.  We do not manufacture any of the components within our Gas Delivery Systemsgas delivery systems and Other Critical Subsystemsother critical subsystems ourselves. Our component neutral position enables us to recommend components on the basis of technology, performance and cost and to optimize our customers’ overall designs based on these criteria. Furthermore, our neutral approach allows us to maintain close relationships with a wide range of component suppliers.

Component testing capabilities.  We utilize our engineering expertise to test and characterize key components and subsystems. We have made significant investments in advanced analytical and automated test equipment to test and qualify key components. We can perform diagnostic tests, design verification and failure analysis for customers and suppliers. Our analytical and testing capabilities enable us to evaluate multiple supplier component technologies and provide customers with a wide range of appropriate component and design choices for their subsystems.

Increased integration with OEMs through local presence.  Our local presence in close proximity to the facilities of most of our OEM customers enables us to remain closely integrated with their design, development and implementation teams. This level of integration enables us to respond quickly and efficiently to customer changes and requests.

Precision machining capabilities.  We manufacture high quality, precision machined parts using state of the art equipment capable of efficiently providing complex parts with exacting tolerance. Our diverse precision fabrication equipment enables us to manufacture a broad range of machined parts using a broad range of materials, from exotic metals to basic plastics. Our manufacturing capabilities include horizontal and vertical milling, turning and welding.

 

Our objective is to maintain our position as a leading developer and supplier of Gas Delivery Systemsgas delivery systems and become a leading developer and supplier of Other Critical Subsystems,other critical subsystems, primarily for the semiconductor capital equipment, flat panel, and solar industries. As additional opportunities present themselves, we intend to increase our

Leverage our expanding geographic presence in lower cost manufacturing regions.  In March 2005, we completed construction of a manufacturing facility in Shanghai, China, allowing us to expand production in a low cost region. In FebruaryNovember 2007, we began expanding our presence in China by leasingcompleted construction of a second manufacturing facility in Shanghai, China to house our precision machined parts and subsystem assembly operations. These facilities put us in close proximity to the manufacturing facilities of potential customers and their end users.

Drive profitable growth with our flexible cost structure.  We implement cost containment and capacity enhancement initiatives throughout the semiconductor capital equipment demand cycle and benefit greatly from our supply chain efficiencies. In addition, we believe our Shanghai facilities position us to respond effectively to future business demands.

Continue to selectively pursue strategic acquisitions.On June 29, 2006, with the Sieger acquisition, we:

We may choose to further accelerate the growth of our business by selectively pursuing additional new strategic acquisitions. We will continue to consider acquisitions that will enable us to expand our geographic presence, secure new customers and diversify into complementary products and markets as well as broaden our technological capabilities in semiconductor capital equipment manufacturing.

 

We develop, design, prototype, engineer, manufacture and test subsystems, primarily for the semiconductor capital equipment industry.industry, flat panel, solar and medical device industries. A majority of our products consist of Gas Delivery Systemsgas delivery systems that enable the precise delivery of numerous specialty gases used in a majority of the key steps in the semiconductor manufacturing process, including deposition, etch, cleaning and annealing. Our Gas Delivery Systemsgas delivery systems control the flow, pressure, sequencing and mixing of specialty gases into and out of the reaction chambers of semiconductor manufacturing tools. Our products also include Other Critical Subsystems,other critical subsystems, including chemical mechanical planarization modules, chemical delivery modules, top-plate assemblies, frame assemblies and process modules.

Gas Delivery Systems:delivery systems:  A typical Gas Delivery Systemgas delivery system consists of one or more gas lines, comprised of several filters, mass flow controllers, regulators, pressure transducers and valves, associated interconnect tubing and an integrated electronicand/or pneumatic control system. These systems are mounted on a pallet and are typically enclosed in a sheet metal encasing. Our Gas Delivery Systemgas delivery system designs are developed in collaboration with our customers and are customized to meet the needs of specific OEMs. We do not sell standard systems. Our customers either specify the particular brands of components they want incorporated into a particular system or rely on our design expertise and component characterization capabilities to help them select the appropriate components for their particular system.

Chemical mechanical planarization (CMP) electro-mechanical subsystems:  CMP is a process used to polish off high spots on wafers or films deposited on wafers. CMP equipment represents the front end “polishing” step in

In addition, we frequently evaluate acquisitions of, or significant investments in, complementary companies, assets, businesses and technologies. Even if an acquisition or other investment is not completed, we may incur significant management time and effort and financial cost in evaluating such acquisition or investment, which has in the past had, and could in the future have, an adverse effect on our results of operations.

 

We are exposed to political, economic, legal and other risks associated with operating in China, including:

 

Our quarterly revenue and operating results 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:

 

Our revenue is difficult to forecast 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 and deliver products to our customers. Most of our revenue in any quarter depends on customer orders for our products that we receive and fulfill in the same quarter. We do not have long-term purchase orders or contracts that contain minimum purchase commitments from our customers. Instead, we receive non-binding forecasts of the future volume of orders from our customers. Occasionally, we 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. Furthermore, reductions, cancellations or delays in customer order forecasts occur without penalty to, or compensation from, the customer. 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. If we do not obtain orders as we anticipate, we could have excess component inventory for a specific product that we would not be able to sell to another customer, likely resulting in inventory write-offs, which could have a material adverse affect on our business, financial condition and operating results. In addition, because many of our costs are fixed in the short term, we could experience deterioration in our gross profit when our production volumes decline.

 

The manufacturing of our products is a highly complex process that involves the integration of multiple components and requires effective management of our supply chain while meeting our customers’design-to-delivery cycle time requirements. Through the course of the manufacturing process, our customers may modify design

 

Demand shifts in the semiconductor industry are rapid and difficult to predict, and we may not be able to respond quickly enough to an increase in demand. Our ability to increase sales of our products depends, in part, upon our ability to:

If we are unable to respond to rapid increases in demand for our products on a timely basis or to manage any corresponding expansion of our manufacturing capacity effectively, our customers could increase their purchases from our competitors, which would adversely affect our business.

 

We rely on both single-source and sole-source suppliers some of whom are relatively small, for many of the components we use in our products. In addition, our customers often specify components of particular suppliers that we must incorporate into our products. Our suppliers are under no obligation to provide us with components. As a result, the loss of or failure to perform by any of these providers could adversely affect our business and operating results. In addition, the manufacturing of certain components and subsystems is an extremely complex process. Therefore, if a supplier were unable to provide the volume of components we require on a timely basis and at acceptable prices, we would have to identify and qualify replacements from alternative sources of supply. The process of qualifying new suppliers for these complex components is lengthy and could delay our production, which would adversely affect our business, operating results and financial condition. We may also experience difficulty in obtaining sufficient supplies of components and raw materials in times of significant growth in our business. For example, we have in the past 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

If any of our products contain defects or have reliability, quality or compatibility problems, our reputation might be damaged and customers might be reluctant to buy our products. We may also face a higher rate of product defects as we increase our production levels. Product defects could result in the loss of existing customers, or impair our ability to attract new customers. In addition, we may not find defects or failures in our products until after they are installed in a semiconductor manufacturer’s fabrication facility. We may have to invest significant capital and other resources to correct these problems. Our current or potential customers also might seek to recover from us any losses resulting from defects or failures in our products. Hazardous materials flow through and are controlled by our products and an unintended release of these materials could result in serious injury or death. Liability claims could require us to spend significant time and money in litigation or pay significant damages.

 

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, 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 very limited number of engineers possess. The loss of

 

We have made capital expenditures of $8.0 million in 2007, of which $4.3 million related to the implementation of our new ERP system, and $1.7 million related to the development of our manufacturing facilities in China. This compares to capital expenditures of $4.0 million in 2006, most of which was for facility cleanroom expansion and improvementsimprovement and the implementation of our new ERP system, and $1.1 million in 2005, most of which was for facility leasehold improvements and equipment in connection with the establishment of a manufacturing facility in Shanghai, China. We made capital expenditures of $3.3 million in 2004.system. We have recently leased a second manufacturing facility in Shanghai, China in close proximity to our existing facility.facility for which we have invested $1.5 million to date, and we have leased a new manufacturing facility in Hayward, California. We expect to invest

 

Our facilities could be subject to a catastrophic loss caused by natural disasters, including fires and earthquakes. We have facilities in areas with above average seismic activity, such as our manufacturing facility in South San Francisco, California, and our manufacturing and headquarters facilities in Menlo Park, California and our new facilities in Hayward, California. If any of our facilities were to experience a catastrophic loss, it could disrupt our operations, delay production and shipments, reduce revenue and result in large expenses to repair or replace the facility. In addition, we have in the past experienced, and may in the future experience, extended power outages at our facilities in South San Francisco, and Menlo Park California facilities.and our new facility in Hayward, California. We do not carry insurance policies that cover potential losses caused by earthquakes or other natural disasters or power loss.

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.

 

 

 

A relatively small number of OEM customers have historically accounted for a significant portion of our revenue, and we expect this trend to continue. Applied Materials, Inc., Lam Research Corporation and Novellus Systems, Inc. as a groupcollectively accounted for 83% of our sales in 2007, 86% of our sales in 2006 and 89% of our sales in 2005 and 93% of our sales in 2004.2005. Because of the small number of OEMs in our industry, most of whom are already our customers, it would be difficult to replace lost revenue resulting from the loss of, reduction in, cancellation of or delay in purchase orders by, any one of these customers. Consolidation among our customers may further concentrate our business in a limited number of customers and expose us to increased risks relating to dependence on a small number of customers. In addition, any significant pricing pressure exerted by a key customer could adversely affect our operating results.

We have had to qualify, and are required to maintain our status, as a supplier for each of our customers. This is a lengthy process that involves the inspection and approval by a customer of our engineering, documentation, manufacturing and quality control procedures before that customer will place volume orders. Our ability to lessen the adverse effect of any loss of or reduction in sales to an existing customer through the rapid addition of one or more new customers is minimal because of these qualification requirements. Consequently, our business, operating results and financial condition would be adversely affected by the loss of, or any reduction in orders by, any of our significant customers.

In 2007, 2006 and 2005, 2.2%, 4.9% and 2004, 4.9%, 5.5% and 3.2%, respectively, of our total sales were derived from sales outside the United States, based upon the location to which our products were shipped.

Gross profit for the year ended December 29, 2006 increased to $50.7 million, or 15.0% of sales, from $20.1 million, or 13.6% of sales, for the year ended December 31, 2005. The increase in gross profit was due primarily to an increase in the percentage of revenue generated from our Shanghai facility, as well as improved margins from our U.S. operations. This increase was partially offset by SFAS 123(R) stock-based compensation expense of $0.4 million.

 

Research and development expense consists primarily of activities related to new component testing and evaluation, test equipment, design and implementation, new product design and testing and other product development activities. Research and development expense increased to $3.1 million or 0.9% of sales for the year ended December 31,29, 2006 from $2.4 million, or 1.6% of sales for the year ended 2005. The increase in absolute dollars was due primarily to an increase in engineering activity related to new product design and other product development activity and $0.1 million of SFAS 123(R)stock-based compensation expenses. The decrease as a percentage of sales was due primarily to a higher revenue base in 2006 as compared to 2005.

 

Sales and marketing expense consists primarily of salaries and commissions paid to our sales and service employees, salaries paid to our engineers who work with our 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 expense was $4.6 million and $3.4 million for the years ended December 31,29, 2006 and December 30, 2005, respectively. The increased spending was due primarily to approximately $1.1 million in additional compensation expense as a result ofresulting from increases in commissions and sales and service headcount to support higher revenue and the balance of the increase was primarily attributed to increased travel expense and $0.1 million of SFAS 123(R) stock compensation expenses. As a percentage of sales, sales and marketing expense

 

General and administrative expense consists primarily of salaries and overhead of our administrative staff, and professional fees. The Sarbanes-Oxley Act of 2002, as well as new rules subsequently implemented by the Securities and Exchange Commission, or SEC, the Public Company Accounting Oversight Board, or PCAOB, and the NASDAQ Global Market, have required changes in the corporate governance practices of public companies. These new rules and regulations have substantially increased our legal and financial compliance costs and made our legal, accounting and administrative activities more time-consuming and costly. In particular, beginning with this Annual Report onForm 10-K for the year ended December 31, 2006, we were required to report on the effectiveness of our internal controls over financial reporting. In order to maintain and improve the effectiveness of our disclosure

GeneralWe assess collectability based on the creditworthiness of the customer and administrative expensepast transaction history. We perform on-going credit evaluations of, and do not require collateral from, our customers. We have not experienced significant collection losses in the past. A significant change in the liquidity or financial position of any one customer could make it more difficult for us to assess collectability.

We value the majority of our inventories at the lesser of standard cost, determined on afirst-in, first-out basis, or market. We value inventory of our subsidiary, UCT-Sieger, at the lesser of actual cost or market. 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 specific identified inventory in excess of established usage. Inherent in our estimates of market value in determining inventory valuation are estimates related to economic trends, future demand for our products and technological obsolescence of our products. If actual 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 realizable value, and subsequently there is an increased to $11.8 million, or 8.0% of sales,demand for the yearinventory 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 the years ended December 31, 2005 from $9.828, 2007 and December 29, 2006, we wrote off $0.9 million or 5.3% of sales,and $0.8 million, respectively, in inventory determined to be obsolete.

The increase was due to the addition of administrative personnel in China, accounting and consulting costs relating toSarbanes-Oxley 404 compliance, severance costs associated with the departuredetermination of our former Chief Financial Officer,tax provision is subject to judgments and expenses related to a potential acquisition, discussions with which were terminated during the fourth quarter of 2005.estimates. The increase was partially offset by a decrease in stock and deferred compensation charges attributable to the absence of stock charges related to the vestingcarrying value of our Series A Senior Notes followingnet deferred tax assets, which is made up primarily of tax deductions, assumes we will be able to generate sufficient future income to fully realize these deductions. 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. We have not recorded any valuation allowance to impair our initial public offering in 2004.

We are currently open to audit under the statute of limitations by the Internal Revenue Service for fiscal years 2004 through 2007, and our state income exclusion.tax returns are open to audit under the statute of limitations for fiscal years 2003 through 2007.

 

The following tables set forth statement of operations data, in thousands, for the periods indicated. The information for each of these periods is unaudited and has been prepared on the same basis as our audited consolidated financial statements included herein and includes all adjustments, consisting only of normal recurring adjustments that we consider necessary for a fair presentation of our unaudited operations data for the periods presented. Historical results are not necessarily indicative of the results to be expected in the future (in thousands):

Our operating results for fiscal 20062007 reflect a recovery ofdownturn in the semiconductor capital equipment industry beginning in the firstsecond quarter of 2006 as well as,2007 and to a lesser extent, incremental revenue derived fromworsening further in the additionthird and fourth quarters of UCT-Sieger operations in June 2006. As a result, revenues and gross margins for thefiscal year ended December 31, 2006 increased in comparison with year ended December 31, 2005. Sales for the year ended December 31, 2006 increased 128.6% to $337.2 million from $147.5 million for the year ended December 31, 2005.2007. Gross profit for the fourth quarter and full year ended December 31, 2006 also2007 reflects a correction in inventory resulting from incorrect material transfers in our newly implemented ERP system which increased to $50.6 million, or 15.0%our cost of sales,goods sold by $297,000 from $20.1 million, or 13.6%amounts previously reported in our earnings release dated February 19, 2008. On a comparative basis, the operations of sales, forSieger are included in the year ended December 31, 2005. As a result, net incomeoperating results above beginning in the third quarter of $16.3 million for the year ended December 31, 2006 increased 714.3% from $2.0 million for the year ended December 31, 2005.fiscal 2006.

Net cash provided byused in financing activities for the year ended December 31, 200628, 2007 increased $38.4$47.0 million to $5.7 million used in financing activities from $41.3 million from $2.9 millionprovided by financing activities in the year ended December 31, 2005. We29, 2006. In 2007 the use of cash in financing activities was primarily due to payments on long-term debt of $9.4 million offset primarily by proceeds from the issuance of common stock from our employee stock compensation plans. In 2006, we generated cash primarily through bank borrowings and stock issuance, including approximately $10.5 million in net proceeds from our secondary stock offering of 1.6 million shares of common stock conducted in March 2006. Cash provided by financing activities in 2006 was used primarily to fund the acquisition of Sieger.

We anticipate that our operating cash flow, together with available borrowings under our revolving credit facility, will be sufficient to meet our working capital requirements, capital lease obligations, expansion plans 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 cyclical expansion or contraction of the semiconductor capital equipment industry and capital expenditures required to meet possible increased demand for our products.

 

In connection with our acquisition of UCT-SiegerSieger in the second quarter of 2006, we entered into a borrowing arrangement and an equipment loan with two commercial banks.loan. The loan and security agreement under the borrowing arrangement with one bank(“Loan Agreement”) provides senior secured credit facilities in an aggregate principal amount of up to $32.5 million, consisting of a $25.0$25 million revolving line of credit ($10.010 million of which may be used for the issuance of letters of credit) and a $7.5 million term loan. The aggregate amount of the credit facilities is also subject to a borrowing base equal to 80.0%80% of eligible accounts receivable and is secured by substantially all of our assets. Each of the credit facilities will expire on June 29, 2009 and containcontains certain financial covenants, including minimum profitability and liquidity ratios. In addition, the term loan is subject to monthly amortization payments in 36 equal installments. The interest rateIn December 2007, we paid down the balance of this loan by an additional amount of $5.0 million. Interest rates on one of the outstanding loans under the credit facilities is based on a financial ratio established by the lender and provides an interest rate at Prime plus 0.50% or Prime plus 0.75%. Interest rates under the credit facilities ranged from 7.7%6.5% to 8.3% per annum during the year ended December 31, 2006,28, 2007 and ranged from 7.7% to 8.3%were 6.5% per annum as of December 31, 2006.28, 2007. The equipment loan is a 5 year, $5.05-year, $5 million loan that is secured by certain equipment. The interest rate on the equipment loan was 7.3% per annum7.6% as of December 31, 200628, 2007. The balances owingcombined balance outstanding on the borrowing arrangement and equipment loan at December 31, 2006 were $26.5 million and $4.5 million, respectively.28, 2007 was $22.2 million.

Obligations under the loan agreement are securedWe anticipate that we will continue to finance our operations with cash flows from operations, existing cash balances and a combination of long-term debtand/or lease financing and additional sales of equity securities. The combination and sources of capital will be determined by a lienmanagement based on substantially all of the assets of our domestic subsidiaries. The obligations are guaranteed by us,then-current needs and such guarantees are secured by a lien on substantially all of our assets.prevailing market conditions.

DuringAlthough cash requirements fluctuate based on the first quartertiming and extent of 2005, we entered into a loanmany factors, management believes that cash generated from operations, together with the liquidity provided by existing cash balances and security agreement providingborrowing capability, will be sufficient to satisfy our liquidity requirements for a borrowing facility of up to $3.0 million with a bank in China. The borrowing facility is secured by our standby letter of credit

Market risk represents the risk of changes in value of a financial instrument caused by fluctuations in interest rates, foreign exchange rates or equity prices.

 

During the first quarter of fiscal 2005, we entered into a loan and security agreement providing for revolver loans of up to $3.0 million with a bank in China. As of December 31, 2006, the28, 2007, we had no such balance outstanding under athe revolver loan was $0.6 million. Ifunder such agreement. However, if we enter into future borrowing arrangements or borrow under our existing revolving credit facility, we may seek to manage our exposure to interest rate changes by using a mix of debt maturities and variable- and fixed-rate debt, together with interest rate swaps where appropriate, to fix or lower our borrowing costs. We do not make material sales in currencies other than the United States Dollar or have material purchase obligations outside of the United States, except in China where we have purchase commitments totaling $3.0$0.8 million in United States Dollar equivalents. We have performed a sensitivity analysis assuming a hypothetical 10-percent movement in foreign currency exchange rates and interest rates applied to the underlying exposures described above. As of December 31, 2006,28, 2007, the analysis indicated that such market movements would not have a material effect on our business, financial condition or results of operations. Although we do not anticipate any significant fluctuations, there can be no assurance that foreign currency exchange risk will not have a material impact on our financial position, results of operations or cash flow in the future.

 

Our interest rate risk relates primarily to our third party debt which totals $31.6$22.2 million and carries interest rates pegged to the LIBOR and PRIME rates. An immediate increase in interest rates of 100 basis points would increase our interest expense by approximately $78,000$56,000 per quarter. This would be partially offset by increased interest income on our invested cash. Conversely, an immediate decline of 100 basis points in interest rates would decrease our interest expense by approximately $78,000$56,000 per quarter. This would be partially offset by decreased interest income on our invested cash.

We have audited the accompanying consolidated balance sheets of Ultra Clean Holdings, Inc. and subsidiaries (the “Company”) as of December 31,28, 2007 and December 29, 2006, and 2005, and the related consolidated statements of income, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2006.28, 2007. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Ultra Clean Holdings, Inc.the Company at December 28, 2007 and subsidiaries as of December 31,29, 2006, and 2005, and the results of theirits operations and theirits cash flows for each of the three years in the period ended December 31, 2006,28, 2007, in conformity with accounting principles generally accepted in the United States of America.

As describeddiscussed in Note 7 to the consolidated financial statements, effective December 30, 2006, the Company adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes — an Interpretation of FASB No. 109. As discussed in Note 1 to the consolidated financial statements, effective January 1, 2006, the Company adoptedchanged its method of accounting for stock-based compensation in accordance with guidance provided in Statement of Financial Accounting Standards No. 123 (revised 2004)123(R),“Share BasedShare-Based Payment” effective January 1, 2006..

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2006,28, 2007, based on the criteria established inInternal Control — Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 29, 200712, 2008 expressed an unqualified opinion on management’s assessment of the effectiveness of the Company’s internal control over financial reporting and an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.