Ichor Holdings

Good afternoon, and thank you for joining today's third quarter 2021 conference call. As you read our earnings press release, and as you listen to this conference call, please recognize that both contain forward-looking statements within the meaning of the federal securities laws. These forward-looking statements are subject to a number of risks and uncertainties, many of which could cause actual results to differ materially from such statements. These risks and uncertainties include those spelled out in our earnings release, those described in our annual report on Form 10-K for fiscal 2020, and those described in subsequent filings with the SEC. You should consider all forward-looking statements in light of those and other risks and uncertainties. Additionally, we will be providing certain non-GAAP financial measures during this call. Our earnings press release and the financial supplement posted to our IR website Each provide a reconciliation of these non-GAAP financial measures to their most comparable GAAP financial measures. On the call with me today are Jeff Andreessen, our CEO, and Larry Sparks, our CFO. Jeff will begin with an update on our business and a review of our results and outlook, and then Larry will provide additional details of our third quarter results and fourth quarter guidance. After the prepared remarks, we will open the line for questions. I'll now turn over the call to Jeff Andreessen. Jeff?

Thank you, Claire, and welcome to our Q3 earnings call. Q3 revenues were $263 million, which is $27 million below the low end of guidance provided on August 3rd. While the low end of our guidance had factored in the impact of the reduced workforce and the two-week factory shutdown in Malaysia, Our plans to adjust to continued limitations in Malaysia also included shifting supply to our other sites that manufacture weldments. Unfortunately, the plan to fully recover the lost capacity took longer than anticipated. The combination of these had a direct impact on our gas panel integration business and our ability to ship gas panels at the forecasted run rate in September. In simple terms, the $27 million below the low end of guidance equates to approximately one and a half weeks of gas panel output. As for the mid to high end of our revenue guidance range, those had assumed a more aggressive ramp and recovery of the lost capacity. I'd like to take a step back to review a bit more in detail the issues that affected our Malaysian factory over the past several months. In June, the Malaysian government issued an enhanced movement control order that initially limited our workforce to 60%. We saw the COVID cases increasing in early Q2 and built inventory ahead, which enabled us to offset some of the impacts for early July. We operate in the southern portion of the country near Kuala Lumpur, which had a much higher rate of COVID cases, and this led to the government's decision to shut down most businesses in the region in July. We manufacture about 50% of our weldments in this facility, and between the two-week shutdown and prolonged output constraints, we lost about 40% of our output through mid-August. The majority of the output from this facility is used internally by our gas panel integration sites. We were able to utilize our other manufacturing sites to offset a large portion of the lost capacity, but we were not able to offset all of it. And as a result, this impacted our gas panel revenues more than we forecast. During this period of reduced capacity, our focus was working very closely with our customers to meet their critical deliveries and continue to do so, continue to do this as we recover our backlog. Today, because the vaccinated level of our workforce in Malaysia of over 400 people is well over 90%, we are permitted to operate at 100% capacity and are in the process of adding additional capacity. Given our recovery in Malaysia and our estimates of the impacts of the supply chain constraints we see today, we are on track to recover our output and believe we can ramp revenues by about 10% in Q4 versus Q3 levels. With regard to supply chain constraints, for over a year we have extended our purchase orders to the six to nine month range to provide the same level of visibility to our suppliers as our customers are providing to us. One positive aspect of the challenges the entire supply chain is experiencing is that we are all working together to help maximize overall industry output and address customer demand as we all manage through this period. There has been no change to the strong demand environment. In fact, it has continued to strengthen. We continue to expect to set new revenue record in Q4. But the continued challenges in the supply chain have dampened our expectation from what we previously expected to deliver this quarter. The strong demand from our customers indicates sequential growth for Q4 and also into 2022, and the limitations of the supply chain have had the effect of lengthening and prolonging our visibility into what looks like a very, very strong year ahead for 2022. Our progress on gross margin improvements is on track. and we are pleased to report a 16.7% gross margin for Q3 in spite of the revenue shortfall and its impact on our factory efficiencies. Net earnings of 81 cents per share were up over 30% from the same quarter last year, even with the higher share count. For the first nine months of 2021, we have grown net income by over 80% compared to the first nine months of 2020. Now that we are nearly through 2021, it is apparent that the underlying demand for wafer fab equipment, or WFE, continues to be very robust and is expected to continue at these unprecedented levels for the foreseeable future. With semiconductor supply constraints pervasive and ongoing, most major device manufacturers have provided multi-year visibility into their heightened levels of investments, which are being put into place to support ever-increasing demand forecasts. Companies across the supply chain are working to increase capacity, and so are we. Earlier in the year, we talked about our plans to increase CapEx in order to add the capacity that will enable I-Corps to retrieve quarterly run rates in excess of $400 million. We continue to aggressively drive these efforts ahead of a very strong 2022. We continue to believe that 2021 is just the second year of a multi-year growth cycle propelled by the conversions of multiple demand drivers, such as 5G, IoT, AI, high-performance computing and autonomous vehicles, in addition to more recent initiatives in support of domestic semiconductor supply self-sufficiency. Together, all of these drivers are resulting in increased capital intensity for the semiconductor industry and higher levels of investments in fab technologies and capacity. In this extremely healthy business environment, I-Corps plays a critical role, especially as the greater intensity of etch deposition and EUV lithography plays into our focus on fluid delivery for these critical applications for leading edge devices. Now I'll update you on the progress the team has made on our strategy to leverage our engineering capabilities and IP portfolio to develop new products that will result in longer-term expansion of our share of served markets, as well as drive the operating model towards increased levels of profitability. We continue to make progress on our proprietary next-generation gas delivery solution, as well as with our other components we have developed as part of this overall R&D effort. Our first fully configured next generation gas panel was shipped and will start qualification this quarter. The qualification process is expected to take at least six months. We continue to work with two additional customers and given the current demand on their engineering resources during this robust period of WFE investments, we currently expect to ship our second beta systems in early 2022. In our chemical delivery business, we shipped a beta chemical delivery system to a North American customer in the third quarter. We expect this qualification period to extend through this year with first revenues occurring in early 2022. Additionally, we expect to ship another beta unit for an additional application in early 2022. We completed the qualification of our first evaluation unit of our proprietary liquid delivery subsystem to a Japanese customer in the third quarter. As I noted on our last call, the scale of this first opportunity is relatively small, but an important step in penetrating the Japanese market, which is the largest portion of the wet processing SAM, as well as continue to quote opportunities at other OEMs that are larger in scale. In our precision machining business, the two qualifications we highlighted last quarter will begin to see first revenues beginning later in the fourth quarter. These qualifications will both increase our proprietary content on a gas panel and be accretive to our gross margin profile. In summary, in a very challenging operating environment, the team is working extremely hard to ramp the business to address the customer demand we are experiencing. and we expect to return to record-setting revenue levels for the forthcoming quarters. Our fourth quarter revenue guidance of $275 to $305 million indicates our expectation for sequential growth above Q3 and our target to achieve a new revenue record for the company. Given the supply chain challenges, our current forecast for Q4 is not quite as high as we expected a quarter ago. but we have strong visibility for at least six months and anticipate continued sequential growth as we move into 2022. At the midpoint of Q4 guidance, our expected growth in 2021 will be below WFE growth. However, we have consistently outperformed WFE over the longer term and expect to outgrow WFE in 2022. We are also pleased with our gross margin improvements in 2021, and as we look to 2022, we expect strong earnings leverage on the revenue growth forecast as a result of the continued gross margin improvements. Which brings us to Larry's discussions of our financial performance and further details on our outlook. Larry? Thanks, Jeff.

First, I would like to remind you that the P&L metrics discussed today are non-GAAP measures. These measures exclude the impact of share-based compensation expense, amortization of acquired intangible assets, non-recurring charges, and discrete tax items and adjustments. There is a very helpful schedule summarizing our GAAP and non-GAAP financial results, including the individual line items for non-GAAP operating expenses, such as R&D and SG&A, in the investor section of our website for reference during this conference call. Third quarter revenues were $263 million, up 15% year over year, but a 7% decline from Q2, due to the limitations in Malaysia and supply chain challenges Jeff discussed, and the resulting impact these had on our overall gas delivery subsystem output. Given the challenging operating environment, we are pleased with our gross margin and profitability performance in the quarter. Gross margin of 16.7% was similar to last quarter, as continued cost reduction programs and favorable product mix were offset by labor and efficiencies due to the lower factory volume. Compared to the third quarter of 2020, gross margin increased 210 basis points and the flow through on the incremental revenue volumes year over year was above 30%. COVID related impacts on our gross margin continue and are primarily related to higher freight and logistics costs. The impact of these higher costs on our gross margin remains around 50 basis points and are expected to persist for the foreseeable future. Q3 operating expenses were $16.3 million, slightly below forecast due to the timing of new product engineering materials purchases. Operating margin of 10.5% was 65 basis points below Q2 and 220 basis points above Q3 of last year. For the nine months of 2021, operating margin has increased 300 basis points over the same period last year. Interest expense for Q3 was $1.5 million, down slightly from Q2 due primarily to a lower overall effective interest rate. Our tax rate for the quarter was 11%, reflecting a true-up to a slightly lower expected tax rate of 12% for the year, given the lower expected U.S. income and geographic mix. We reported earnings per share of 81 cents, 9 cents below Q2 as a result of the 7% decline in revenues and very similar operating performance. For the first nine months of 2021, net income increased 82% compared to the same period last year. Now I will turn to the balance sheet. We ended the quarter with cash and investments of $227 million, which was a $20 million decline from Q2. as a result of cash use and operations of $14 million, capex of $3 million, and a debt reduction of $2 million. A large portion of the use of cash can be attributed to the increase in inventory, which was driven by higher purchasing activity aligned with strong customer demand while our output was constrained. The resulting inventory turns for Q3 were 4.9 compared to turns of around six on average for the past year. Q3 day sales outstanding increased slightly to 42 days due to the higher volume of late quarter shipments. We finished the quarter with total debt of $166 million. Last week, we completed a refinancing and a $100 million expansion in our borrowing capacity from our existing credit facility from $300 million to $400 million. This facility will have a $150 million term loan and a $250 million revolving credit facility. The new credit agreement extended the maturity date from February 2023 to October 2026 and decreased the overall interest rate, resulting in a forecasted Q4 interest cost savings of approximately $300,000. Given the debt refinancing and expansion, we now have more capital available for acquisitions and investments supporting our strategic growth initiatives. Now I will turn to our fourth quarter guidance. With revenue guidance in the range of $275 to $305 million, our earnings guidance is $0.82 to $0.98 per share. I mentioned earlier that our solid margin performance in Q3 benefited from favorable product mix at these revenue volumes. In Q4, we will see a higher mix of gas panels, roughly offsetting the benefit of higher revenue volume, so we are expecting similar gross margins in Q4. We continue to drive improvements to our gross margin profile. Our key strategies to drive gross margin higher are through incremental cost reduction programs, growing our share within our higher margin components businesses, and increasing our content of proprietary IP within our products. We are on track with our gross margin improvement plans and expect to continue to deliver on greater margin leverage as we progress into 2022. Our Q4 operating expense forecast is $17.5 million, with the majority of the increase due to the extra week this quarter. We continue to make incremental investments in R&D supporting our new product development programs, the new ERP system, and additional costs associated with becoming SOX compliant this year. We expect our interest expense will come down to $1.2 million in the fourth quarter, our tax rate to be approximately 12%, and our fully diluted share count to be approximately 29 million. Our tax planning rate over the next couple of years continues to be in the range of 12% to 13% given current tax policy. Finally, as Jeff mentioned, we are stepping up capacity investments this year to support the strong demand forecast for the next couple of years and expect CapEx to be around 2.5% to 3% of revenues for 2021. In spite of the higher CapEx, we expect to deliver strong free cash flows in 2021. For Q4 specifically, we expect to generate strong cash flow from the P&L and also generate cash flow from working capital as we show improved cash conversion metrics compared to Q3. Operator, we are ready to take questions. Please open the line.