Maurice Carson - President & CFO Tom Rohrs - Chairman & CEO.

Sidney Ho - Deutsche Bank Amit Daryanani - RBC Capital Karl Ackerman - Cowen Patrick Ho - Stifel.

Good day ladies and gentlemen, and welcome to the Second Quarter 2017 Ichor System’s Inc. Earnings Conference Call. [Operator Instructions] I would now like to introduce turn 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 webpage where you will find the 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 and Federal Securities Laws.

These forward-looking statements are subject to a number of risks and uncertainties meaning of which are beyond our control and which could cause actual results to differ materially from such statements.

These risks and uncertainties including those that are 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 the most comparable GAAP financial measures. With me today is Chairman of CEO, Tom Rohrs. Tom will give you an overview of the results and some industry context and then I’ll go over the financials. After the prepared remarks we will open the lines 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 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 improve spending forecast for the second half of the year particularly in the memory segment.

This has led to 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 level seen in the first half. This will benefit our second half shipment profiles as well. Our performance is a result of our consistent forecast 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 break through ideas for the future. These gas and liquid delivery systems are used in our customer’s deposition tools, edge tools, CMP tools and lithography tools.

These processes are differentially benefitting from the semiconductors 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 sub systems. Cal-Weld expands our capacity and capabilities in gas delivery tools in the semi conductor 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 that 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 a 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 two 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 cost. Our success has led them to award us the gas panels on two of their platforms which had previously been in sourced. Additionally, the work of our design teams was also critical in our win for the next generation lithography platform.

This 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 will also be accretive to our gross margins and earnings per share. We are anticipating 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 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 in our value-added technical contributions.

We see this as an important differentiator for Ichor into the future as well as the catalyst to drive our gross margins and net income. In summary, we are excited about the future of the wafer from equipment business.

We are 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 two subsequent secondary offerings, both with flawless financial execution, while ramping operations to triple the quarterly run rate over the last three years. I, and our entire Board of Directors have greatly appreciated his leadership and wish you 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 Q1. As Tom mentioned, revenue grew quarter-on-quarter by 7%, leading us to another record quarter.

There were no significant shifts in product for 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 lag the significant revenue increase.

All of this is behind us as our capacity is all online now and we do expect significant outsourcing for the balance of the year. Operating expenses were essentially flat to the prior quarter. The book tax rate with 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 expenditure 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 completing 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 a very 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% and 10%, $0.10 of non-GAAP adjusted EPS just in the last two months of the quarter that will own the company.

A part of the accretion comes from the fact that we had a very good financing for this transaction. The total consideration was $50 million; we had $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.

Post transaction, our trailing EBITDA coverage ratio is approximately one 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% [ph]. 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 Partner shares. There were no primary shares sold. This reduces the Francisco Partner ownership from around 48% to 26% and increases our flow to close to 18 million shares.

We believe that this is overall positive for shareholders and removes some of the overhang that -- are 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. Your line is now open..

Thanks for taking my question.

My first question is with regard to the Cal-Weld acquisition, can you talk about the potential cost synergies and revenue synergies that you are 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 Sidney, 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 just said is there is opportunity to get even more out of Cal-Weld than what you are 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 are going to take advantage of all of it..

Great. That’s helpful. My second question is, in terms of this is more probably for Maurice, but in terms of your operating model, the first half of this year, you are already pretty close to the margin targets you set out during the IPO process and I think Q2 was negative influence 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?.

So we put our model out there. I think you’ll probably remember Sidney that we put the long term model at 200 basis point increase in gross profit, and that was driven by a couple of items specifically the LBM 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 forecast in our long-term model, so consider it, think of it as a 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% 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. Thank you very much..

Thank you..

Your next question comes from the line of Amit Daryanani with RBC Capital. Your line is now open..

Thanks a lot. Good afternoon, guys. I guess, couple of questions. One, could you just talk about with this deal, how much capacity do you guys currently have, I know you guys are adding some extra capacity as well.

Just try to get a sense what your utilization rate and how much capacity you have to go up till right now?.

I’m going to answer that relative to the end of Q2 and all the incremental capacity was online. So, we're with everything, we’re operating it call it around 65% capacity.

In Singapore our biggest factory, about 50% in Malaysia after the increased there, and 70% in Portland, and probably little higher in Austin, so, overall you could 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, let’s just follow-up on gross margins, maybe I miss this Maurice, but is there way to quantify how much of the headwind did you have in June from these outsourcing some components and supply chain inefficiency that you made in the June quarter and if I get this model right, you should be north of 17% gross margins in September.

Is that the right way to think about the guide?.

In the September quarter, you should think about the guide kind of close to around 2017 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 relating to that and we’re confident to get back to our normal run rate in the low 60s before you -- 16th before you Cal-Weld..

Perfect. That’s it from 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. Your line is now open..

Hi, everyone. This is actually [Indiscernible] for Edwin. Thanks for letting us to ask some questions.

Tom, I just had a big picture question for you, it sounds like your remainder 2017 is shaping up strong for your business, but as you out in 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 2017 to 2018 and we’re seeing the trends towards more etch, more deposition, more CMP continue from 2017 to 2018, so that’s is very positive.

In the kind of early peaks 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 in-sourcing 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 is no more outsourcing to be done in liquid delivery except for a small amount around the edges.

The gas delivery side, we are seeing a couple of things; one is – one of our customers there basically 100% outsourced and have been on the gas side and that customer we kind of split the market 50-50 with the competitor, who you know well.

And on the other big customer on their semiconductor side, they still do about one-third of it inside and that trend has been further for them to do a little more each quarter it seems on the outside.

So, where their partner on 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 ends up to maybe 5% a year the way it's been moving.

So, that that will continue for a while, but it won't be -- that won't be material in terms of changing anytime soon.

And then I should add the other significant player in the industry in Japan, still does almost 100% in sourcing and we continue to investigate opportunities to enter into Japan and what we would imagine would be sometime appropriate the partnership with the Japanese player..

Great. That was a great color. The next question is just on the Cal-Weld acquisition.

Could you just provide some color on the customer base, the degree of overlap that Cal-Weld may have your 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 one or two exceptions which is they have actually built some portions of the test stations that we use, and obviously that is nothing to do with our revenue. So there's no real 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 so that customer from a synergy perspective we don't --we expected to be kind of knowledge synergy where 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've included none of that potential into any of our numbers..

Got it. Thanks. And just last question. Yesterday you announce addition of Kevin Canty as your Chief Operating Officer for the company.

Can you just quickly go over what his role would be in the company and what responsibilities he will be assuming?.

Yes. And so, if I can go back just the step, so Maurice is been our President and CFO.

We’re all familiar with his CFO role and he 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 the company will report in to 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 in the interviewing team will begin interviewing some of those player probably starting around next week..

Wonderful. Thank you. And congrats on the great quarter..

Thank you..

And our next question comes from the line of Karl Ackerman with Cowen. Your line is now open..

Hi, gentlemen. Maurice, first I like to give you my congrats on your retirement and wish you best in your future endeavors..

Thank you..

If I could just move back to the Cal-Weld business, I appreciate how accretive that business is to your overall company. But how do you see 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 analyst following us, and we appreciate your work and look forward to working with you. 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 it in and of itself and 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 not shipping more gas boxes. And I think the easiest way to understand what I'm saying is not owning then business didn't cost market share in gas boxes.

So the fact that we on that piece of the business, I don't will directly relate to an increase in gas box market share. I hope make that answer make some sense you. And l let Maurice, he had a couple of thoughts..

I just want to add one thing. There is the market share increase that comes out of this 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 and 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 back to one questions on growth, you know when you’re looking at 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 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 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 I will have to suffice in terms of try 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 customer – we have two customers like I mentioned them the number three and number four customers. They are actually growing 100% this year. You don’t tend to see that.

I told you we grew a little 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 to be overlooked a great success we’re having there. So, that could have incremental growth into 2018 as well.

My only point in going through this as we have a lot of different growth factors that that are active and that are helping us grow the business, but more importantly most of them are also 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..

Understood. Thank you very much..

You bet..

Thank you..

[Operator Instructions] Our next question comes from the line of Patrick Ho with Stifel. Your line is now open..

Thank you very much. And I also like to extend my best wishes to Maurice on your impending retirement. .

Thank you, Patrick..

You’re welcome.

Tom, when you look at Cal-Weld and given that your increasing capacity for your own gas panel delivery systems business, does Cal-Weld need investments to expand their capacity or is there one to increase particularly of 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 than we have and we have already begun to make investments to expand that capacity and we’ve also as I mentioned briefly we’ll use other ways of moving of some of more straight-forward weldments to our facility in Malaysia and then using that capacity for more challenging and technically difficult Weldment that Cal-Weld is excellent at doing.

So, 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 always talk about adding capacity from the capital equipment perspective we've always talked in terms of about a percent of revenue a year. And right now I don't see that picture changing dramatically with Cal-Weld that may be slightly higher than that 1%, it's not 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 expand 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 stages, 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 ship to China is with the Applied Materials was 2000 and gentlemen who work for me at the time was kind of taking me by the hand. His name is [Indiscernible] and he, of course, is the CEO of AMEC which you just mentioned. So I probably know more about AMEC than mostly other people on this call.

And he is doing very well. His been added for a quite a while and now they’re getting some traction especially in the MOCVD spaces, 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 maybe beginning next year.

Most of that equipments going to come from the traditional suppliers. AMEC is probably the biggest most competent equipment supplier in China and there are small. So most of the equipment will come from the companies we know and love, are company who we service on a daily basis and I expect for the vast majority of it will be beneficiaries.

Having said that, we will 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 from me just quickly go over your liquid delivery system Maurice, typically new products have low gross margins particularly as they ramp up.

Is there going to be any effect from that over the next quarter or two? 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 not because Cal-Weld, but because the manufacturing startup cost for this are very low and we’ve already done most of that work in terms of fitting out the factory, where its going to be built, and it would be a small part of our expansion in Malaysia.

So answer is must of it’s been done and it's small enough that you won't see any effect 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 that are not really for shipment, but for development do cost more. They 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 reasonably short period of time..

Great. Thank you again..

Thank you..

Thank you..

And I’m showing, we have a follow-up question from Sidney Ho with Deutsche Bank. Your line is now open..

Great. Thanks for taking my follow-up. This maybe a similar question that Patrick just ask, but last quarter on the call you mentioned that there is maybe some gross margin pressure from new products in the near term and if you look at, I think Maurice mentioned the 40 bps decline quarter-over-quarter is all coming from this outsourcing thing.

And next quarter on organic base it should be in the low 16%.

Doesn’t seem 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 material affect left from that. I did talk about one customer coming up with very low stock margin due to startup cost. 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 questions on the operating expenses side, I think this quarter, the Q2 came a little lower than I’ve expected, but with Cal-Weld in the books next quarter how should we modeled for OpEx?.

We haven’t completely sorted all of that, because there’s a little bit of GAAP, non-GAAP that we’ll have to work through, but I mean, just look at the number and tell you approximately what’s used for this.

The overall should expense base should be slightly under a $1 million a quarter, with an opportunity that maybe not all of that's really going be a non – some of that maybe GAAP, or stuff that we haven't completely identified. So, and that’s build in to – just to be clear, that’s built into our accretion forecast already..

Okay. That’s helpful. Thank you very much..

Thank you..

Thanks..

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 three months. Thank you..

Thanks everyone..

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