Ichor Holdings Ltd (ICHR) 2017 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Second Quarter 2017 Ichor Systems, Inc. Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to introduce President and CFO, Mr. Maurice Carson. Please go ahead.

Thank you, Andrew. Good afternoon. Thank you, everyone, for joining this conference call, which will be available for replay telephonically and on Ichor's website shortly after we conclude this afternoon. To listen to the webcast replay, please visit Ichor's Investor Relations web page, where you will find complete instructions.

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 are beyond our control, and which could cause actual results to differ materially from such statements. These risks and uncertainties include those spelled out in our earnings press release, those included in our prospectus and those described in our annual report on Form 10-K for fiscal year 2016, which have all been filed with the SEC, and those described in our quarterly report on Form 10-Q for the second quarter of fiscal year 2017, which will be filed with the SEC. You should consider all forward-looking statements in light of those and other risks and uncertainties.

Additionally, I should mention that we will be providing certain non-GAAP financial measures during this conference call and in our earnings press release. Our earnings press release contains a reconciliation of the non-GAAP financial measures to their most comparable GAAP financial measures.

With me today is Chairman and CEO, Tom Rohrs. Tom will give an overview of the results and some industry context, and I'll go over the financials. After the prepared remarks, we will open the line for questions. Tom?

Thank you, Maurice, and thank you all for joining us today for our Q2 2017 conference call. The second quarter of 2017 was another strong growth quarter for Ichor Systems, setting new records for both revenue and earnings per share. The second quarter was our sixth consecutive quarter of sequential growth and our fifth straight quarter of year-over-year revenue growth. Revenues were up 7% from Q1 and up 67% from Q2 of last year. Year-to-date, revenues have increased a remarkable 83% over the first half of last year, and earnings have increased over 250% over that same period, consistent with our stated goal of growing profits faster than revenues.

Since our last call, wafer fab equipment spending forecast have improved, exceeding over $40 billion for this year, due largely to improved spending forecast for the second half of the year, particularly in the memory segment. This has led Lam Research, one of our leading customers, to raise their outlook for the year, with second half shipments now expected to be as strong as the record levels seen in the first half. This will benefit our second half shipment profiles as well.

Our performance is a result of our consistent focus on what we do well. We believe we are differentiated by our skill set in fluid mechanics, and we have expressed this expertise in leading gas and liquid delivery systems today and breakthrough ideas for the future. These gas and liquid delivery systems are used in our customers' deposition tools, etch tools, CMP tools and lithography tools. These processes are differentially benefiting from the semiconductor industry trends towards 3D NAND, multiple patterning and FinFETs. But there are also several specific drivers that encourage us to be optimistic for revenue and earnings growth outperforming the overall industry.

First, we are very excited about our acquisition of Cal-Weld, a company that designs and fabricates high-purity industrial components and subsystems. Cal-Weld expands our capacity and capability in gas delivery tools in the semiconductor manufacturing and also supplements our business in metal component manufacturing. Cal-Weld fits all of our criteria for acquisitions. In addition to being an excellent fit with our strategy, it is also accretive to our gross margins and earnings per share. Maurice will review the financial impacts of Cal-Weld when I conclude my remarks.

Second, we believe wafer fab equipment will continue to be weighted towards the etch, deposition and CMP processes. Our customers are growing faster than wafer fab equipment market because they are the leaders in etch, deposition and CMP. Year-over-year, we have exhibited faster growth than our customers because etch, deposition and CMP processes are intensive users of our gas and liquid delivery systems. This is a great trend for our business.

Third, we continue to see growth beyond our traditional gas panel business. Cal-Weld continues the strong trend in this direction. This quarter, we will recognize the first revenue shipment of our liquid delivery module. This is a breakthrough for us and a forerunner of significant revenue in the coming year.

Fourth, we are seeing increased business beyond our 2 largest customers. Our third- and fourth-largest customers will grow 100% this year -- this fiscal year. One of these customers asked us to redesign their gas delivery systems for better performance and lower costs. Our success has led them to award us the gas panels on 2 of their platforms, which had previously been insourced. Additionally, the work of our design teams was also critical in our win for the next-generation lithography platform.

Fifth, we continue to leverage our business model, which has allowed us to grow net income faster than we grow revenue, and we expect this will continue to drive our profits and profitable growth. And finally, as our cash balances grow, we will continue to look at potential acquisitions, which would add to our capabilities and would also be accretive to our gross margins and earnings per share.

We are participating in a segment of the supply chain where consolidation is a very important part of our strategy. We work closely with our customers to identify M&A opportunities, which would benefit both Ichor and the wafer fab equipment supply chain. This collaboration grows out of the customer partnerships that have been built over the years. It builds on our strong operational performance and our value-added technical contributions. We see this as an important differentiator for Ichor into the future as well as a catalyst to drive our gross margins and net income.

In summary, we are excited about the future of the wafer fab equipment business. We're optimistic that our ability to add value to our customers will position us well as a key contributor to the growth of this industry.

Now before turning the call back to our President and CFO, Maurice Carson, I wish to congratulate him on his retirement. He has successfully led our company through an IPO and 2 subsequent secondary offerings, both with flawless financial execution, while ramping operations to triple the quarterly run rate over the last 3 years. I, and our entire Board of Directors, have greatly appreciated his leadership and wish him all the best in his retirement.

And now over to you, Maurice.

Well, thank you, Tom, and thank you for those kind words. Let me go through some of the details from the financials for a couple of minutes before we get to questions. Unless otherwise noted, I will be referencing non-GAAP financials in Q2 compared to Q1.

As Tom mentioned, revenue grew quarter-on-quarter by 7%, leading us to another record quarter. There were no significant shifts in product or customer mix during the quarter. Gross margin was down slightly in Q2 at 15.8% compared to 16.2% in Q1. This decline was due to outsourcing parts normally built internally as our capacity additions lagged the significant revenue increase. All of this is behind us as our capacity is all online now, and we do not expect significant outsourcing for the balance of the year.

Operating expenses were essentially flat to the prior quarter. The book tax rate was a little over 3%, and our cash tax rate was less than 1%. Net income came in at 9.7% of revenue. Year-to-date, CapEx, capital expenditures, are at $5.2 million, primarily related to our capacity expansion projects in Singapore, Malaysia and Portland. We have started the next round of capacity expansion that we discussed with you last quarter in Malaysia and expect phase 1 of this project to be complete in Q4, with revenue generation in Q1.

A couple of items from the balance sheet. Accounts receivable was lower, and our DSO returned to the low 20s in Q2, as we forecasted. Inventory was up slightly, and inventory turns were flat. We continue to focus our balance sheet on ensuring that we can support customer growth.

Tom mentioned the very exciting acquisition of Cal-Weld. As we mentioned in our press release, this acquisition is immediately accretive in Q2 after adjusting out the purchase accounting items and will give us between 7% (sic) [$0.07] and 10% -- $0.10 of non-GAAP adjusted EPS just in the last 2 months of the quarter that we'll own the company.

A part of the accretion comes from the fact that we have a good -- very good financing for this transaction. The total consideration was $50 million. We used $20 million of our own cash and $30 million of debt to pay for this. As part of the debt financing, we lowered our overall interest rate, and the result is that our interest expense will remain about the same at 700k per quarter with the additional $30 million of debt. Both transaction, our trailing EBITDA coverage ratio is approximately 1 giving us a very strong balance sheet and significant dry powder to support growth.

With the Cal-Weld acquisition, we are now forecasting our tax rate to be around 6% to 8%. Of course, this was built into the forecasted accretion I mentioned earlier.

Finally, subsequent to the end of the quarter, we conducted a follow-on offering to sell 5.4 million Francisco Partners shares. There were no primary shares sold. This reduces the Francisco Partner ownership from around 48% to 26% and increases our float to close to 18 million shares. We believe that this is overall positive for shareholders and removes some of the overhang that's been on our share price.

With that, we are ready to take questions. Operator, please open the line.

(Operator Instructions) Our first question comes from the line of Sidney Ho with Deutsche Bank.

My first question is with regards the Cal-Weld acquisition, can you talk about the potential cost synergies and revenue synergies that you're baking into your revenue and EPS guidance for next year? And maybe, can you compare how this acquisition is different than the Ajax acquisition you did last year?

Yes, Sydney. So a couple of things. One is that there will be significant revenue synergies over time. However, we haven't baked any real synergies into the numbers that we are presenting to you today. Of course, we haven't presented any numbers to you concerning 2018, so it would be premature to talk about that. And so the bottom line of what I've just said is there's opportunity to get even more out of Cal-Weld than what you're seeing in our earnings and guidance for the third quarter and what we wrote when we released the news of the purchase. So I think that the cost synergies would not be significant, because what they are doing is actually additive, if you will, to our -- and complementary to our capabilities as opposed to a duplicate over much of anything we do. Having said that, we do have the capability of taking some of their, shall I say, less-technical products, where we could do them in Asia, perhaps get some cost synergies there and free up capacity for more revenue synergies. So bottom line is there's lots of opportunity with this acquisition, both today and into the future, and you can be sure we're going to take advantage of all of it.

Great. That's helpful. My second question is, in terms -- this is more probably for Maurice, but in terms of your operating model, the first half of this year, you're already pretty close to the margin targets you set out when -- during the IPO process, and I think Q2 was a negative impacted by something on the gross margin side. With Cal-Weld being accretive in many different ways, including margin, how should we think about your operating model going forward?

Okay. So when we put our model out there, I think you'll probably remember, Sydney, that we put the long-term model, a 200 basis point increase in gross profit. And that was driven by a couple of items, specifically, the LDM module that Tom talked about, increased plastic machining and increased metal processing content. So the Cal-Weld acquisition fits exactly into that model and is part of that 200 basis point increase that we forecasted in our long-term model. So consider it -- think of it as step one, complete in that long-term model. And we would anticipate that, yes, you're right, we're bouncing very close to the 10% that we -- of net income percentage that we showed in that model, and consider this as, over time, incremental to that model. Does that answer the question?

Yes. That's great.

Our next question comes from the line of Amit Daryanani with RBC Capital.

I guess, a couple of questions for me. One, could you just talk about, with this deal, how much capacity do you guys currently have? Because I know you guys are adding some extra capacity as well. Just want to get a sense of what your utilization rate, and how much capacity you have to go up to right now.

I'm going to answer that in -- relative to the end of Q2 when all the incremental capacity was online. So where -- with everything new, we're operating at, call it, around 65% of capacity in Singapore, our biggest factory; about 50% in Malaysia after the increase there; and 70% in Portland; and probably a little higher in Austin. So overall, you can say close to 70% capacity utilization, with a very simple fixture build-out, would even give more in Singapore, our biggest factory. So we have plenty of capacity in Singapore, certainly, and Malaysia.

Got it. That's helpful. And I guess, want to just follow up on gross margins. Could -- maybe I missed this, Maurice, but is there a way to qualify how much of a headwind did you have in June from these -- outsourcing some components to the supply inefficiencies that you made in the June quarter? And if I got this model right, I mean, you should be north of 17% gross margin in September. Is that the right way to think about the guide?

In the September quarter?

Yes.

You should think about the guide kind of close to around 17%, and you are correct. So the amount to quantify is, all of the decline in gross margin -- so call it 40 basis point decline in gross margin, was due to the outsourcing and the inefficiencies that came from outsourcing those parts. So the entire piece is related to that, and we're confident to get back to our normal run rate in the low 60s -- 16% before you add Cal-Weld.

Perfect. That's it for me, and best of luck with your retirement, Maurice.

Thank you.

And our next question comes from the line of Edwin Mok with Needham & Company.

This is actually Arthur on for Edwin. Tom, I just had a big-picture question for you. It sounds like the remainder of '17 is shaping out strong for your business. But as you look out into 2018, how sustainable do you see the shift towards increased outsourcing activities?

I think the outlook for 2018, in general, right now is quite positive. Before I get into any details, I think we're seeing increased numbers for overall wafer fab equipment, from '17 to '18, and we're seeing the trends towards more etch, more deposition, more CMP continuing from '17 to '18. So that's very positive. And the kind of early peeks we get into what some of those details behind that look like, are also quite positive. So overall, on a business outlook, I'm quite optimistic and certainly more optimistic than I think I've ever been in this industry. With regard to the outsourcing itself, we talk about this quite a bit. In our liquid delivery space, there's very little insourcing done, and so it's kind of all outsourced now. We've told you a number of times that it's made up of more smaller players. And over time, just like when we bought Ajax, we may be looking at other opportunities. But you should also understand that we're building internal capacity in the plastics area, which serves the liquid delivery markets. So the combination of those things kind of says there's no more outsourcing to be done in liquid delivery except for a small amount around the edges. The gas delivery side, we're seeing a couple of things: One is, at one of our customers, they're basically 100% outsourced and have been on the gas side. And that customer, we kind of split the market 50-50 with a competitor, who you know well. And on the other big customer, on their semiconductor side, they still do about 1/3 of it inside. And that trend has been for them to do a little more each quarter, it seems, on the outside. So we're their partner on the semiconductor side and our business has been inching up to a higher and higher share, not in great leaps and bounds, but when you look at it year-over-year, it adds up to maybe about 5% a year, is the way it's been moving. So that will continue for a while, but it won't be material in terms of changing any time soon. And then I should add the other significant player in the industry in Japan, still does almost 100% insourcing. And we continue to investigate opportunities to enter into Japan in what we would imagine would be some kind of appropriate partnership with a Japanese player.

The next question is just on the Cal-Weld acquisition. Could you just provide some color on the customer base, on the degree of overlap that Cal-Weld may have with your own customer base, and if Cal-Weld is a supplier to Ichor, and there could be a risk of revenue cannibalization?

So Cal-Weld is not a supplier to Ichor with 1 or 2 exceptions, which is they have actually built some portions of the test stations that we use. And obviously, that has nothing to do with our revenue. So there's no real, like, revenue overlap, nothing to really worry about there. From a customer perspective, the bulk of their revenue goes to one of our customers. And so from our perspective, we know obviously very well that customer. We know very well the expectations of that customer. From a synergy perspective, we don't -- we expect there to be kind of knowledge synergy where what we know will help them be a better supplier under us. And obviously, since the majority of their revenue is going to one of our customers, that presents us with a huge opportunity down the road into the future to get similar products sold to the other big customer we have. And as I mentioned, I think, in the first question, we have included none of that potential into any of our numbers.

And just last question. Yesterday, you announced the addition of Kevin Canty as your Chief Operating Officer for the company. Can you just quickly go over what his role will be in the company? And what responsibilities he'll be assuming?

Yes. And so if I can go back just a step, so Maurice has been our President and CFO. We're all familiar with his CFO role, and he have -- also had the additional responsibilities of running all of our operations, which consists of all of our supply chain and logistics activities, all of our manufacturing and assembly opportunities and all of our fabrication capabilities with our sites in Union City, Austin and Portland, Singapore and Malaysia. So Kevin will take over all of those responsibilities, and all of the operational activities of the company will report into him. And then I should say, we're conducting a separate search for a CFO. That search has begun. We have a number of interesting candidates. They have gone -- they have been vetted by the search firm that we have contracted with, and myself and the interviewing team will begin interviewing some of those players probably starting around next week.

And our next question comes from the line of Karl Ackerman with Cowen.

If I can just move back to the Cal-Weld business, I appreciate how accretive that business is to your overall company. But how do you see the Cal-Weld business expanding your share of gas delivery beyond your core customer set? And I guess, are there any longer-term opportunities to leverage that business into your existing chemical product offering?

And so first, Karl, glad to have you as one of the analysts following us. And we appreciate your work and look forward to working with you. The -- a couple of points. There will be very little leverage from Cal-Weld into the chemical delivery or the wet processing areas. As I think I've mentioned, the majority of the products that we build into that space are plastic manufactured parts, which is not something that Cal-Weld does. So I don't expect to see Cal-Weld leveraging the chemical delivery space. On the gas side, I think I mentioned that in and of itself, when we sized the company for you -- and I've told you that most of that revenue comes from one of the companies that we supply. And so you can imagine that the other company that we supply presents a perhaps a similar-sized opportunity to us down the road. And obviously, we'd be happy to -- and we will be anxious to find ways to make that happen. With regard to expanding the actual gas delivery boxes, I think there's perhaps a loose but not a definitive correlation between that business -- owning that business and us shipping more gas boxes. And I think the easiest way to understand what I'm saying is, not owning the business didn't cost us market share in gas boxes. So the fact that we own that piece of the business, I don't think will directly relate to an increase in gas box market share. I hope that answer makes some sense to you, and let Maurice add a couple of thoughts.

I just wanted to add one thing. There is a market share increase that comes out of this, though, for direct sale weldment, a market that we have spoken to you guys about in the past where we've underserved proportionate to our market share in gas boxes. And Cal-Weld will help us to grow that market over time, and all of that would be incremental revenue and incremental share for us.

Understood. If I could go back to one of the questions on growth. When you look into the second half of the year, how much visibility do you have, particularly in the December quarter? And if I could take that a step further, when you think about your growth opportunity next year, could you at least bucket the opportunity you see relative to share gains from peers, share gains from customers and market growth?

So a couple of things, and you know that we don't comment on, and won't comment on the Q4 revenue at this point and obviously won't comment on growth rates into 2018. I told you that I'm optimistic about 2018 based on the high-level numbers that we all see. And that I think there's reason for all of us to be optimistic about 2018, no reason not to be right now. So -- but I think that'll have to suffice in terms of trying to think about what it looks like in growth rates, et cetera. The point about where the growth will come from, it will be broken into segments, although I won't attempt to put a percentage on each one of them, but there will be growth just with the overall industry. There will be growth on the liquid delivery side. I mentioned, we're seeing our first revenue shipment of our proprietary liquid delivery module this quarter. We've been talking about this for a couple of quarters. It's becoming real, and it has a chance to be a measurable, incremental amount of business for us into 2018. Obviously, having Cal-Weld for a full year, even at its current levels, will be incremental growth for us in 2018. Should we succeed in getting some additional share at, let's just say, the second customer, that would be additional revenue for 2018. We are in fact, working on a number of items with regard to our new -- we have 2 customers. I mentioned on the #3 and #4 customers, they're actually growing 100% this year. You don't tend to see that. I told you we grow our revenue in the first half, 83%, and something can be doubling underneath that, and it doesn't make a wave in the percentages. But it's not the be overlooked, the great success we're having there. So that can have an incremental growth into 2018 as well. My only point in going through this is, we have a lot of different growth vectors that are active and that are helping us grow the business. But more importantly, most of them are also going to be incrementally helpful to our gross margins and, of course, our earnings per share. So I'm quite optimistic when you put that all together and put a big red bow around it.

(Operator Instructions) Our next question comes from the line of Patrick Ho with Stifel.

Tom, when you look at Cal-Weld, and given that you're increasing capacity for your own gas panel delivery systems business, does Cal-Weld need investments to expand their capacity? Or is there run room to increase it, particularly at the elevated demands, and maybe even down the road as you potentially add that second customer?

So Cal-Weld has been running much closer to their capacity limit than we have, and we have already begun to make investments to expand that capacity. And we've also, as I mentioned briefly, will use other ways of moving some of the more straightforward weldments to our facility in Malaysia and then using that capacity for the more challenging and technically difficult weldments that Cal-Weld is excellent at doing. So they -- we will be able to increase their capacity through the efforts that we've made with regard to our own capacity and kind of moving the easier stuff to Malaysia and moving the harder stuff into Cal-Weld. That's number one. We have added -- we're beginning to add capacity already. I should say that when we look at this kind of right off the bat, when we've always talked about adding capacity from a capital equipment perspective, we've always talked in terms of about 1% of revenue a year. And right now, I don't see that picture changing dramatically with Cal-Weld. It may be slightly higher than that 1%. It's not going to be dramatically higher though. And so we see opportunities to continue to grow their capacity and opportunities, as I said now a number of times, to extend their business reach into our entire customer set.

Great. That's helpful. And Tom, maybe as a follow-up question. Given your experience and your days at Applied Materials, and how they were an early entrant into China, given that the equipment industry is still at the very early stage, but there are players, like AMEC that are out there that are growing, how do you see the potential opportunities for Ichor in that emerging marketplace?

So ironically enough, my -- personally, my first trip to China with Applied Materials was 2000, and a gentleman who worked for me at the time was kind of taking me by the hand. His name was Gerald Yin. And he, of course, is the CEO of AMEC, which you just mentioned. So I probably know more about AMEC than most of the other people on this call. And he's doing very well. He's been at it for quite a while, and now they're getting some traction, especially in the MOCVD space. There's no doubt about that. Having said that, the majority of the equipment for the Chinese expansion when it begins -- and most people begin to think that it may be beginning next year, most of that equipment's going to come from the traditional suppliers. AMEC is probably the biggest, most competent equipment supplier in China. And they're kind of -- and they're small. They're small. So most of the equipment will come from the companies we know and love, companies who we service on a daily basis. And I expect, for the vast majority of it, we'll be beneficiaries. Having said that, we'll also be talking to our friends in China and working with them to see what we might be able to do together to take another bite out of the apple.

Great. And final question for me, just quickly go over your liquid delivery system, Maurice. Typically, new products have lower gross margins, particularly as they ramp up. Is there going to be any effect from that over the next quarter or 2? Or given that Cal-Weld is so accretive, you won't really see the impact of a new product ramp in your margins.

No, you won't see that, not because of Cal-Weld, but because the manufacturing start-up costs for this are very low. And we've already done most of that work in terms of fitting out the factory where it's going to be built, and it'll be a small part of our expansion in Malaysia. So the answer is, much of it's been done, and it's small enough that you won't see any effects over the next couple of quarters.

Yes, we've been shipping prototypes, pilot runs, alpha builds, beta builds for this year. We work with a very good relationship, of course, with our customer, who understand that those original units, which I think you're referring to, that are not really for shipment but for development, do cost more. They've work well with us to help us with that. And I think as Maurice said, I expect to see, on the contrary, help to the gross margin as opposed to hurt over a reasonable short period of time.

I'm showing we have a follow-up question from Sidney Ho with Deutsche Bank.

This may be a similar question that Patrick just asked, but last quarter, on the call, you mentioned that there's maybe some gross margin pressure from new products in the near term. And if you look at -- I think, Maurice, you mentioned the 40 bps decline quarter-over-quarter is all coming from this outsourcing thing. And next quarter, on the organic basis, should be in the low 16%. Doesn't seem to like there's any pressure in terms of the new products that you talked of last quarter. Am I getting it right?

You are correct. Almost all. Certainly, there's no significant or material effect left from that. I did talk about one customer coming up with very low start margins due to start-up costs. Almost all of that is behind us, and that customer's approaching their long-term margin profile. So you're right, Sidney.

Okay. And then the second question's on the operating expenses side. I think this quarter, the Q2 came in a little lower than I expected. But with Cal-Weld in the books next quarter, how should we model that for, like, for OpEx?

Yes, we haven't completely sorted all of that out yet because there's a little bit of GAAP, non-GAAP that we'll have to work through. But let me just look at the number and tell you approximately what to use for this. The overall expense base should be slightly under $1 million a quarter, with an opportunity that maybe not all of that's really going to be a -- some of that may be GAAP or stuff that we haven't completely identified. So -- and that's built into -- by the way, just to be clear, that's built into our accretion forecast already.

At this time, I'm showing no further questions. So with that, I'd like to turn the call back over to CEO, Mr. Tom Rohrs, for closing remarks.

Thank you, Andrew. So let me thank you once again for joining us on this call. And we are looking forward to a very profitable and exciting Q3 and a fine Q4, and we'll be talking to you again in about 3 months. Thank you.

Thanks, everyone.