Ichor Holdings Ltd (ICHR) 2017 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Third Quarter 2017 Ichor Systems Earnings Conference Call. (Operator Instructions)

As a reminder, this call is being recorded.

I would now like to introduce your host for today's conference, Mr. Maurice Carson, President and CFO. Please go ahead, sir.

Thank you, Christy.

Good afternoon, everyone. Thank you 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 been filed with the SEC, 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, I should mention that we will be providing certain non-GAAP financial measures during our 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 Ichor Chairman and CEO, Tom Rohrs. Tom will discuss some of the exciting industry [trends] and Ichor news, and I will go over with 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 Q3 2017 conference call.

The third quarter was another growth quarter for Ichor Systems. It was our seventh consecutive quarter of sequential revenue growth and our sixth straight quarter of year-over-year growth.

Year-to-date, revenues are up 72% over the first 9 months of 2016, and earnings have increased over 135% over that same period, consistent with our stated goal of growing profits faster than revenues.

Our recent acquisition of Cal-Weld contributed approximately $23 million of revenue in the last 9.5 weeks of the quarter, and our core revenues were approximately $141 million, in concert with the lower shipment levels of our customers. At the midrange of our Q4 guidance, we expect Cal-Weld revenues to grow to $27 million and our core revenues to grow to $153 million or about 9%.

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 dynamics, and we have expressed this expertise in leading gas and liquid delivery systems today and break-through 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's industry trend towards 3D NAND, multiple patterning and FinFETs.

But there are also several specific drivers that encourage us to be optimistic that our revenue and earnings growth will continue to outperform the overall industry. First, we are executing well against our acquisition strategy that we discussed 11 months ago during our IPO roadshow. At that time, we pointed out that we had good opportunities to buy private companies which would add to our capabilities in fluid delivery systems and move our financials towards our long-term target financial model of 18% gross margin and 10% net profit.

Our recent acquisitions of Cal-Weld and Talon are evidence that our strategy is working. Cal-Weld is already accretive to earnings, and today we announced the acquisition of Talon Innovations, a leader in supplying fluid valves and fittings as well as precision-manufactured components. Talon has been a key supplier to Ichor for years, and we are excited to announce the definitive agreement to purchase the company.

Like Cal-Weld, Talon is an acquisition supported by one of our key customers. Talon expands our capabilities and opens up new market opportunities for Ichor. Both of these acquisitions increase our footprint in gas delivery and bring incremental revenue and margin to that business. Talon also increases our vertical integration, which will help drive margins of our core gas delivery business.

Another driver for outperformance in revenue and earnings growth is our progress expanding our product offerings and several markets -- in several markets evident in the recent announcement regarding our contractual agreement to provide proprietary Liquid Delivery Systems to a key customer. Consistent with my commentary on earlier calls, we added capacity to support this business, and we are pleased to announce the agreement in October. We will recognize a small amount of initial revenue in Q4, with meaningful contributions to revenue expected for the fiscal year 2018. Because we own the IP with this module, we can go after new customers and applications, consistent with our strategy to expand our customer base in our served markets.

The addition of Talon, Cal-Weld and our proprietary Liquid Delivery Module are all accretive to our gross margin and profitability. This has led us to put together a revised target financial model, which Maurice will discuss later. This revised target model reflects our progress and the progress we have made in achieving and in the future exceeding our prior targets by pursuing a strategy which is accretive to our business model.

Along with adding new products, capabilities and capacity, we have been busy adding to our organization. Last quarter, we added Kevin Canty as our Chief Operating Officer, and we also added Marc Haugen as a new board member. Both Kevin and Marc have hit the ground running and have made significant contributions to our results and our future plans.

Let me add a few words about our CFO search.

It's going extraordinary well, and, in fact, we've had more candidates than I had ever expected. We have just extended an offer, so the process is coming to an excellent conclusion. One of the benefits of our lengthy CFO search is that I have had the luxury of working with Maurice for the full quarter. So rather than to reiterate my words of last quarter's call, I will simply and sincerely thank Maurice for his tremendous contribution, dedication and loyalty to Ichor Systems.

We are extremely well positioned to finish 2017 on a very high note, and we're really excited about the new opportunities that 2018 will bring us.

In summary, our business has passed through the brief pause of the third quarter, and Q4 is the beginning of a new growth ramp for us. We are pleased that our guidance shows this re-acceleration, and our expectation is that this will continue into 2018.

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

Thank you, Tom.

I also would like to make sure that everybody knows how much I have enjoyed working both for you and with Ichor and all the extraordinary things we've managed to do over the last few years.

Let me go through some of the details on the financials. Unless noted otherwise, I will be referencing non-GAAP financials in Q3 compared to Q2.

Revenue grew quarter-on-quarter by 3%. Tom gave you some of the details on the mix of this, but let me say that this was completely in line with our guidance, but there was significant mix shifts within the final number. Base Ichor was slightly down from initial expectations, but Cal-Weld outperformed in the quarter. In general, it was a difficult quarter, starting very slowly but accelerating through the end, with a significant portion of the quarter shifting in the last 2 weeks. This is consistent with our increased guidance for Q4.

Gross margin was up significantly in Q3 at 16.6% compared to 15.8% in the prior quarter. The addition of Cal-Weld drove this improvement as base Ichor margins were down in the quarter. We made the decision to keep our manufacturing labor force intact in anticipation that the revenue decline would be short lived. As you can see from our guidance, this was the right decision.

Operating expenses without Cal-Weld were essentially flat to the prior quarter. Cal-Weld added $1 million of operating expenses, just what we had anticipated.

The booked tax rate was a little over 2%. Our cash tax rate for the quarter was less than 1%. We had guided to a higher tax rate last quarter with the addition of Cal-Weld and still anticipate this will be the case in the future. However, we do have NOLs that we were be able to use in Q3 and will be able to use in Q4 and into early 2018.

Net income was 10% of revenue.

Year-to-date CapEx is $5.7 million primarily related to our capacity expansion projects in Singapore, Malaysia and Portland. We continue to invest in capacity primarily related to weldments and plastic machining, key areas of growth and margin expansion for Ichor.

A couple of key items from the balance sheet.

Most of our balance sheet accounts were higher with the addition of Cal-Weld. DSO was higher, driven by 2 things: Cal-Weld has generally higher DSO compared to Ichor, and we shipped a higher proportion of the quarterly revenue in the last 2 weeks of the quarter than we have in the past.

Inventory turns were slightly worse as we held inventory in anticipation of Q4 growth.

I will finish with some discussion around Talon.

As Tom mentioned, this is a very exciting acquisition for Ichor. For almost a year, we have been laying out a plan for you where we could -- would continue to grow our key gas delivery business while adding new growth vectors and margin expansion in key areas. We delivered the first piece of this with the acquisition of Cal-Weld, a business that is already contributing revenue, margin and strategic value. We delivered the second piece with the initial shipments of LDM, an extremely important product to Ichor and to the industry.

Today, we announced the third step in this value creation plan by signing an agreement to purchase Talon Innovations. The acquisition of Talon fits exactly into our strategic plan. It is accretive in 2018 at the gross margin, operating margin and EPS line. This is inclusive of the incremental $5 million of interest on the debt added for the financing of this acquisition.

With the acquisition of Talon, it's time for us to update our long-term model.

Since our IPO, we have presented our financial model, long-term model, as 18% gross margin and 10% adjusted net income. With Cal-Weld and Talon, we now believe that we see a path to gross margins between 19% and 20% and net income between 12% and 13%.

We did not include any Talon in our guidance as we are unsure of when the acquisition will close. As we mentioned in the press release, we have filed for Hart-Scott-Rodino clearance and early termination, and we'll update you as soon as that has closed.

On a personal note, I'm pleased that the search for the new CFO is going well, but I'm also happy that we've been able to get Cal-Weld and Talon acquisitions done before leaving. Two reasons: first, both are extremely important to Ichor and fit so well with the vision that Tom and I have been sharing with investors for a year now; second, the management teams of both Cal-Weld and Talon have been great to work with through each process. Both companies have teams that are intensely focused on customer service and are passionate about fluid delivery.

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

(Operator Instructions) Our first question is from Karl Ackerman of Cowen.

I have 2 questions. I appreciate the long-term model and the acquisition of Talon. That's wonderful. As you look into the December quarter and perhaps, more importantly, in 2018, I'd love to hear your thoughts on your expectation for incremental revenue opportunities at your third and fourth largest customers, who appear to be in the earlier stages of outsourcing key gas and chemical subsystems to merchant suppliers like yourself. And I have a follow-up, please.

Yes, sure, Karl. Thank you. So I think I have mentioned a couple of times that while our third and fourth largest customers have had trouble kind of reaching the upper echelon, if you will, because the base business has been growing so fast that this year, 2017, they're going to about double from last year. And we anticipate that next year, 2018, they will double from this year. As you know, both of these customers are, I would say, in the top 5 or 6 of all of wafer fab equipment companies, certainly after Tokyo Electron and KLA but probably very close by. So they're major customers. We're very happy with the way we're moving with them. We're very happy with the acceleration and the continued growth. So it's a very good news story. And when all is said and done, a very positive influence for us in terms of our overall business.

Great. I guess maybe more of an industry question. While your business is certainly impacted by the absolute level of WFE spending, which 2018 looks to be another very healthy year, I think one of the misconceptions is that if WFE mix shifts away from memory toward foundry and logic next year on the ramp towards 7-nanometer, your business may face headwinds. Could you comment on the opportunity you have in foundry and logic and maybe how the capital intensity increases with greater adoption of FinFET transistors and eventually EUV?

Yes. Well, first of all, let me comment on the EUV. As I think you may know, we are making the gas delivery systems for EUV, so we're very close to that activity. And certainly, that activity is accelerating. Having said that, I think you also hit the nail on the head in terms of the logic devices using the same types of 3D approaches that memory and especially 3D NAND use. And this has manifested in the FinFET architectures that are now being seen in a lot of the logic devices. So the bottom line is that first of all, I'm not sure I would say that the memory aspect of the business is in fact going to slow down next year. And I really don't want to get into trying to get into a conversation about that, but I think 3D NAND and certainly DRAM will remain strong. But I also believe that the FinFET devices and even multiple patterning will continue to grow and affect the logic devices. Bottom line is, we see wafer fab equipment growing next year in a positive way. And when all is said and done, I believe that most of our customers will probably be saying the same thing.

Our next question is from Edwin Mok of Needham.

I wonder [ECOB] -- maybe dive into kind of (inaudible) in a little bit more -- trying to understand -- I think you mentioned that they're your supplier. So I'm just trying to understand what they supply to you, right. And I assume the revenue number you provide on ECOB , that's -- factor in that intercompany transfer. And then, I guess beyond -- since what they supply to you in terms of the -- in the gas delivery, what are the machine part they sell within semi and also outside of semi?

So specifically, they make a number of components that we buy, including valves and fittings that are part of the gas delivery system. And we are buying approximately 25% of their total output at this point. And that will, of course, help us from a vertical integration standpoint because it will be accretive to our gross margin as we make those products ourselves after buying Talon. They also make specific components. These are components, some of which are proprietary to Talon, called the Talon Module System (sic) [Talon Modular System]. They're similar to the blocks used in the construction of a gas panel called the K1S blocks that we had designed here at Ichor. These are the structural components that are used as the substrates, if you will, onto which the valves and the fittings and the MFCs are attached. And so they're very, very, very highly precisioned manufactured parts. Actually, very few people are able to do it, and Talon may probably be, if not the best, among the best of those who do, do it. So it's a very important acquisition both in terms of the critical components that are being manufactured there but also in terms of our ability to also get involved in the valves and fitting parts of the business, which add to our vertical integration.

If I could add just one thing, Edwin. Yes, the intercompany revenue is reflected out of our guidance for the revenue that we've put in the press release. So we have taken in -- that into account, to your second part of your question.

Okay, that's helpful. Is there a way to describe -- (inaudible) the 75% they didn't sell to you, right, that they (inaudible) sell to a indiscernible] customer, is there a way to describe how much of that is semi versus non-semi? And in non-semi, what -- who do they sell to?

Yes. They probably are somewhere around 85% to 90% semi. They have a part of their business that they sell to industrial customers. And we are obviously taking a look at that, and we'll decide strategically whether that is something that we think is a positive or perhaps we might actually use that capacity for more semiconductor output. So that's to be decided.

I see. Okay, that's helpful. And then maybe kind of looking a little bit beyond -- obviously, you guys provide a nice fourth quarter guidance. In fact, that business is improving. And we've heard from your customer that -- how shipment are likely to be higher in the first half of '18. To the extent you can provide any color on the industry, any kind of visibility you guys can -- on the industry demand you can provide? And then how is the component shortage? We've heard that before. Is that -- anything -- there a creep up that you're seeing right now in the market on that end?

Well, let me comment that -- and you know, Edwin, that we do not give guidance for Q1. However, we've had this conversation before. I can remember a couple of times last year when we would describe our feeling about the future quarters. And right now, I can describe our feeling as very, very optimistic. And one way to look at that, which we, again, talked to you about last quarter and it seemed to be a reasonable precursor, is the amount of monies we're spending on additional capacity. And maybe, Maurice, you want to talk about that a little bit.

So yes, Edwin, we told you before about -- or not just you, everybody, about the fact that we built out capacity in Malaysia, Singapore and Portland to support the business growth this year. We also are building out additional capacity to that in Malaysia. We've talked to you about that. That's well underway to support significantly more growth in weldments and plastic for all parts of the business, and additional growth in Portland to support both gas delivery and weldments. So we continue to focus on capacity as our customers have asked us to.

Okay, great. That's great color. I assume that there's no update or no change in the (inaudible) situation, there's no real -- that's behind us?

No. Right now, it's quite good. And bottom line is -- our expectations are that, and you can see this, we are at a position where we, under normal conditions, have a little more inventory than we would like to have. But it's exactly the right thing to do given what we're seeing into the future.

Our next question is from Amit Daryanani of RBC Capital Markets.

I guess couple of questions from me. Maybe first, to start with, the updated gross margin -- net income, margin guidance you guys just provided, just help me understand, the uptick that you guys are doing on gross and net income, how much of that is in the better organic fundamentals versus acquisitions? And then is there a revenue run rate you need to get to these targets?

So I think -- I just want to make sure I understand the question. In the new model that I just went through, that gets us up to the 19% to 20% gross margin, your question is how much of that is driven by the base business and how much through the acquisitions?

Right. So you -- basically, the gross margin will be about 150 basis points. I'm just trying to get a sense what's driving it, and then what's the revenue run rate you need to get there, you think.

So the primary driver of that continues to be the acquisition and the growth that we will have in weldments, machining and then also organically from LDM, which we've always talked about, Amit, is an important part of our margin expansion as we go to market with a proprietary product (inaudible) . The base line businesses for gas delivery will move up but not significantly compared to those other items.

Got it. And -- got it, yes.

And I would say, to the other part of your question, Amit, the volumes are based on essentially the volumes that we are building into our plan for next year.

Yes

Got it. What -- I guess could you help baseline that number? Is that like a $200 million a quarter, don't you think?

I prefer not to do that.

I figure it's always worth a shot.

Yes, it's always a good idea.

I used -- and maybe just going back to some of the discussion you had on your September quarter performance. I think you talked about the core business being a little bit slower at the start and then it picked up. What exactly happened there? What drove that slowness? And the pickup that you've seen in -- towards the end of September, it sounds like, do you expect that to sustain as you go through the December quarter?

Well, the second part of the answer is yes, and we've already seen that. So that's kind of easy to say. In the third quarter, we knew that our customers, and they announced this, so you knew it also, were dropping their shipment levels. It was actually pretty well discussed. It was discussed during our earnings call in the second quarter. It was discussed during our secondary roadshow back in July. And it was pretty commonly understood. Lam was very specific about it in terms of their percentages. Applied less so. But the bottom line is that their shipments were lower. And I think we would describe it as essentially a pause in the overall ongoing ramp, and that's what we saw. Now as a result of that, we did end up, and they ended up [just] placing orders on us a little later in the quarter than they normally would. And that, as Maurice very well said, leads to positions where you can't receive all their receivables because you've shipped very late in the quarter. Bottom line is that we've certainly got through that particular pause without doing any damage, if you will and fundamentally see this as we've guided: The fourth quarter moving up, and it continues to look very, very, very good. So we're very happy about it.

Got it. And then just finally for me, inventory. I think it's up about 15% sequentially. Just talk about what drove that uptick. And how do you see cash cycle broadly trending into December?

Yes.(inaudible)

So Amit, the uptick was due to Cal-Weld. The baseline business for Ichor was actually down in inventory quarter-on-quarter a small amount. But Cal-Weld drove that increase. And their -- quite honestly, their business has been booming also, and they have the right inventory -- forward-looking inventory for the increased growth that they're going to experience.

Yes. And normally, when you buy a company, you're worried about them stripping out the working capital. In this case, the working capital is very robust both in terms of receivables and inventories. So it's actually a very good thing, but it skews our numbers a little bit, and we will have to normalize that for you guys.

Our next question is from Patrick Ho of Stifel.

Patrick?

Yes. First off, as it relates to your capacity expansion plans, and I know you've had Cal-Weld basically for only about a quarter or so, how do you evaluate given their strong demand trends that you just mentioned and the potential for additional capacity expansion for that piece of the business?

I'm really glad you mentioned that, Patrick, because part of the capacity expansion that I just referenced is for Cal-Weld as we integrate their growth with our growth in weldments and expand their presence worldwide. So I would say probably 1/4 to 1/3 of our plans for -- that we've already announced or just talked about are related to Cal-Weld, which is a key part of our overall weldment strategy.

Great, that's helpful. And maybe as a follow-up question in terms of the Talon acquisition and the opportunities ahead for the company. You obviously mentioned it was part of the vertical integration. Cal-Weld, if we look at that deal, was probably more of a market expansion opportunity. How do you evaluate those different opportunities of, call it, more vertical integration, more synergy versus market expansion opportunities that you're getting from something like Cal-Weld? I guess ultimately, how do you decide to bring 1 of those 2 variables into the larger Ichor fold?

Right. The bottom line is, and we've mentioned this, I think, a few times, Patrick, when we're looking at acquisitions, we're not necessarily looking at this has to be a market expansion acquisition or this could be a little more of a vertical integration expansion. We're looking at a number of things. One is, how does it fit in with what our customers are doing and what they want us to be doing? It's a very important point. And it de-risks our acquisitions dramatically when we have the full-throated support of our customers behind it, as you can well imagine. So that's a critical element. The second is that we financially want to make sure that it's going to be accretive both to the gross margin and to the bottom line. The third thing is that we also want to make sure that it, in and of itself, has some future growth opportunities. And both Cal-Weld and Talon fit all 3 of these elements. I would say while Talon does have a vertical integration element to it, it's not a pure vertical integration play by any stretch. There is also a market expansion aspect to it. But again, that's not really the key point. The key point is that it kind of clicks all those boxes appropriately. And in both cases, we were able to purchase the company at an EBITDA multiple which -- we like to be around the 5x EBITDA range. Sometimes, it's a little more, sometimes it's a little less. But we've successfully done that in these cases. So we're very happy with both of them.

Thank you. And that concludes our Q&A session for today. I'd like to turn the call back over to Mr. Maurice Carson for any further remarks.

Thank you very much. We appreciate everybody's call-in and time today. Tom, do you have anything you'd like to add at the end here?

Yes. Again, thank you all, and I look forward to a good quarter and good -- looking forward to seeing you all in the New Year. Thank you very much.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program, and you may all disconnect. Everyone, have a great day.