Ichor Holdings, Ltd. (NASDAQ:ICHR) Q3 2023 Earnings Call Transcript

Ichor Holdings, Ltd. (NASDAQ:ICHR) Q3 2023 Earnings Call Transcript November 6, 2023

Operator: Good day, ladies and gentlemen, and welcome to Ichor’s Third Quarter 2023 Earnings Conference Call. [Operator Instructions]. I would now like to introduce your host for today’s conference, Claire McAdams, Investor Relations for Ichor.

Claire McAdams: Please go ahead. Thank you, operator. Good afternoon, and thank you for joining today’s third quarter 2023 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 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 described in our annual report on Form 10-K for fiscal 2022 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 conference 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 Andreson, our CEO; and Greg Swyt, our incoming CFO. Jeff will begin with an update on our business, and then Greg will provide additional details about our results. After the prepared remarks, we will open the line for questions. I’ll now turn over the call to Jeff Andreson.

Jeff Andreson: Thank you, Claire, and welcome to our Q3 earnings call. Our third quarter revenues came in at the upper end of our expectations at a $197 million, up 6% from Q2, due primarily to a rebound in our core gas delivery business. Reflecting that the trough quarter for semiconductor process equipment is behind us. Earnings of $0.07 per share were aligned with our expectations, as we were able to offset some headwinds in gross margin during the quarter with lower Opex and higher net tax benefit, which Greg will discuss in his remarks. After two quarters in a row of revenues at the upper end of our expectations, at this time, our Q4 revenue forecast is fairly similar Q3 levels, and therefore, our revenue outlook for the full year remains consistent with the expectations we’ve shared throughout the year.

Last quarter, we described the factors that are causing our expected revenue decline in 2023 to be a bit steeper than the overall market versus our relative customer and end market exposure, which is more weighted towards the areas seen in the bulk of the softness this year, especially process tools for the NAND Memory segment. As the year has progressed, it has become increasingly clear that the strong growth witnessed and action deposition over the last few years has been largely fueled by the capacity expansions underway at the 5 leading manufacturers of 3D NAND and in 2023, this segment has witnessed spending declines of as much as 75%. We estimate that memory WFE has declined to represent just about 1/4 of our total revenues in 2023. Furthermore, the component side of our business has witnessed deeper and more prolonged cuts as our customers work to reduce their inventory levels.

The bright spots for us this year are definitely within the growing market segments of WFE, such as EUV, lithography, and new customer design wins such the 4 Epi system for silicon carbide. We continue to expect to add a third 10% customer for fiscal 2023. As we look ahead to a relatively stable demand environment in our served markets for the next few quarters, we are also just beginning to see the emergence of new technology drivers and progress inflection that require increasing use of applications that are more highly dependent on the accuracy and repeatability of the gas delivery system. These include etch and deposition techniques, such as atomic layer deposition, selective etch, and low K and nitride films. In lithography, we see opportunities to expand our gas delivery role in next generation platforms including high NA.

As EUV adoption continues to proliferate across multiple device types, our process tool our process tool customers are also witnessing the need for more etch and deposition steps to help create smooth patterns and reduce line width roughness. Additionally, expectations for WFE growth I had reflect a significant expansion in the industry’s deployment of advanced packaging techniques, which have their own particular process challenges. These require better film stress management, improved defectivity, enhanced uniformity, and increased material selectivity, all of which are enabled by more precise control of gas and fluid delivery. Outside of Semiconductors, specifically for our IMG business, we are also driving cross selling opportunities at our historical gas panel customers as well as opportunities to offer Ichor’s various fluid delivery products and capabilities to IMG’s customer base in medical aerospace and defense.

As these new technologies and drivers evolve and proliferate, we see opportunities for Ichorto expand our revenue potential and continue to add breadth and diversification to our customer base. All of these factors build a strong story for Ichor’s revenue growth as the industry recovery accelerates. Furthermore, out business model and financial profile tend to generate significant operating leverage as revenues grow. Current expectations the Q4 industry spending levels to stay fairly consistent through the first half of 2024, followed by the beginning of a revenue ramp in the second half in advance of an expected strong recovery year in 2025. We expect to be able to deliver significant earnings growth as revenue volumes increase which is why we continue t make critical investments in our business in support of our future growth.

We are maintaining our focus on driving share gains for our proprietary products and making investments in new offerings that support our customers’ long term technology roadmaps. These periods of lower demand provide both Ichor and our customers the ability to work on new qualifications. We continue to make very good progress in our key focus areas. These include our next generation gas panel, qualifications of our proprietary machine components, and our silicon carbide gas panel. I’m very pleased with our progress in customer evaluations of our new gas panel. As a reminder, the new gas panel contains about 75% proprietary Ichor content compared to just 10% today, which could drive significant expansion of our gross margin profile. We have completed the qualification of our gas panel for 3 process applications and in the next two quarters, expect to ship gas panels that will support 5 additional systems for end user customer tool evaluations.

This is a major milestone for the program. Our best estimate of when production shipments will begin is late 2024, which is when we would expect the end-customer evaluations to be successfully completed. We continue to work with 3 additional customers that are evaluating our technology. In Ichor proprietary machine components, we continue to win new qualifications across our customer base. In Q3, we completed several new component qualifications and expect to begin initial shipments later this quarter. We also expect to integrate incremental proprietary components into our existing gas panels, but this will take some time as our customers continue to work through the existing inventory on hand. Similar to our next generation gas panel, all of these qualifications and new customer wins will be margin accretive.

And lastly, we continue to ship production volume gas panels for the silicon carbide market and have now been qualified on the next generation systems as well. We estimate the silicon carbide [Indiscernible] for gas delivery to be around $60 million in 2023 but a decent tailwind for our revenue growth as the overall industry rebounds in the latter half 2024 and 2025. In summary, I’ll remind everyone here today that our revenues tend to recover more sharply when industry spending rebounds and our business model enables earnings growth well in excess of revenue growth. In the meantime, we are managing through the lower demand environment by focusing on delivering solid financial results as the business recovers and proving our operational capabilities, qualifying our internally developed products and developing new products that align with our customers need for both technology and cost.

With that, I’ll turn it over to Greg to recap our Q3 results and provide further details around our Q4 outlook.

Greg Swyt: Thanks, Jeff. To begin, I would like to emphasize 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, nonrecurring charges, and discrete tax items and adjustments. There is a useful financial supplement available on our investors section of our website that summarizes our GAAP and non-GAAP financial results. As well as summary balance sheet and cash flow information for the last several quarters. In the third quarter, our revenues were $197 million at the upper end of guidance and increase [Technical Issues] from the second quarter. Our Q3 gross margin was 13.1%, which was lower than our expectations, primarily due to the additional inventory provisions recorded during the quarter as well as a less favorable product mix compared to our forecast.

With close control of spending, Q3 operating expenses of $21.3 million declined from Q2 levels. The resulting operating margin for Q3 was 2.2%. Our net interest expense was $5 million and our non-GAAP net income tax benefit for the quarter exceeded our forecast at $2.9 million. Consequently, our net earnings for the quarter came in at the midpoint of Q3 guidance at $0.07 per share. Now turning to the balance sheet. At the end of the quarter, our cash and equivalents totaled $76 million, a $9 million decrease from Q2, primarily due to our net debt reduction of $12 million. We generated $4 million in cash flow from operations and after deducting $2.4 million of capital expenditures, our free cash flow for the quarter was $1.6 million. This was below our expectations for free cash flow given the back end loaded revenue profile of the quarter, which drove an $8 million increase in accounts receivable.

Inventory remained flat at $267 million. Day sales outstanding increased by 1 day to 48 and inventory turnover stood at 2 6. We are continuing to reduce our net debt levels given the higher interest rate environment, and our net debt coverage ratio currently stands at 2.6 times. Now let’s discuss our guidance for the fourth quarter. We anticipate revenues in the range of $190 million to $205 million. We expect that our gross margins will improve to approximately 14% plus or minus 50 basis points. Our fourth quarter gross margin expectations reflect somewhat more favorable product mix as well as some improvement in the level of inventory reserves forecasted. As we enter 2024, we expect to be solidly back on track with our 25% flow through at similar revenue levels when compared to our second quarter gross margin performance.

We plan to carefully manage operating expenses to $21.4 million level, give or take $200,000. As we continue to prioritize our R&D investments for new product programs and maintain the essential infrastructure that will enable us to ramp revenues in response to more significant upticks in customer demand in the quarters ahead. Net interest expense is expected to be approximately $5 million. The non-GAAP income tax benefit we expect at the midpoint of Q4 guidance is approximately $1 million. For fiscal 2023, we expect to recognize a net tax benefit of approximately $7 million, which is higher than our previous forecast. Looking ahead to 2024, we anticipate incurring a nominal non-GAAP tax expense each quarter and for modeling purposes, you should assume a 5% to 10% non-GAAP effective tax rate.

Operator, we are ready to take questions. Please open the line.

See also 25 Most Dangerous Cities in the US andTop 25 Most Educated Countries in the World.

Q&A Session

Operator: Thank you. We will now be conducting a question and answer session. [Operator Instructions]. Your first question comes from Charles Shi with Needham & Company.

Charles Shi: Hi, thanks for taking my question. Good afternoon, Jeff. I want to start the first question, in terms of the first half 2023. I heard you talk about the first half 2024, maybe that’s an industry comment. You’re expecting a consistent with that Q4 level, for the first half 2024. I wonder, what do you see the Ichor business going to 2024 and I think it’s tied to this question that, how much inventory do you think your customers are still holding at this point of your products and, whether they have included caution to be depleted, which actually could, lead to a slightly higher steadier growth for Ichor business going to first half 2024.

Jeff Andreson: All right, Charles. Thanks for the questions and if I miss any piece of it, just remind me. We I think what we see looking into 2024 are very similar levels of revenue, kind of bounce along the bottom here. I think in, an outlook for WFE, I would say, in general, I think that kind of mirrors what most people are expecting, I think, in the market with an inflection beginning in the second half. In general, it’s going to have to inflect, sometimes near to the fourth quarter unless the 2025 outlook changes materially, but I think most people are looking at a very strong 2025, similar. Now your question around inventory, how much? We don’t know. We don’t have that visibility, but we can tell from the order patterns that were still at, I’ll call it muted levels versus where we would have expected to be through this quarter and probably will last and be a bit of a headwind as we go even into next year and the reason we can stay relatively flat, I think, over the next couple of quarters is we are bringing in some incremental share gains to offset some of that.

Did I did I miss any other pieces?

Charles Shi: No. Yeah. Thanks. Thanks very much. Jeff, that that was a very good answer. So maybe the next question, I want to, ask a little bit more about the gross margin, performance over the last quarter because you did highlight, right, if I heard you correctly, the two items there, one is the, maybe the product mix was not as favorable, but you actually pointed to the rebound of a gas panel business, somewhat of a rebound, but the other thing, is about inventory reserve. I just want to ask, what was that inventory reserve that you took in Q3? Why was a little bit higher? Sounds like it’s a little bit higher than you previously expected. Why did you take that action and well, what’s behind that?

Jeff Andreson: Can I start with the product mix and I’ll let Greg answer the reserve level. With the product mix, I would say as we entered, the quarter, in our machining side of the business, we expected some relatively decent growth, not super, but it just stayed relatively the same and actually declined slightly. So this is what leads us to believe that we still have inventory in the channel that has to get burned off before we start to see an inflection and that’s primarily where you saw the mix. We offset that obviously with the gas panel integration business, which comes lower margins versus our machining margin and then I’ll let Greg talk a little bit about inventory reserves, and it’s a complex subject. I’ll leave it at that.

Greg Swyt: Okay. Thanks, Jeff. Hey, Charles. Regarding the inventory reserves in Q3, you know, we saw some headwinds in our various business units of inventory using our normal E&O inventory reserve process and as we do our lookbacks, we had some inventory roll off, from prior quarters that we had to take some additional reserves for. That was predominantly the driver for Q3 and we do expect to see some benefit in Q4 as we worked down some of that inventory that we had reserved, but we do expect it to return back to some level of normality as we exit the year, for 23.