Good day, ladies and gentlemen, and welcome to the Ichor Systems Second Quarter 2019 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, Claire McAdams, Investor Relations for Ichor. Please go ahead..

Thank you, Serine. Good afternoon, and thank you for joining today's second quarter 2019 conference call, which will be available for replay telephonically and on Ichor's website shortly after we conclude this afternoon.

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 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 year 2018 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, and our earnings press release contains a reconciliation of these non-GAAP financial measures to their most comparable GAAP financial measures.

On the call with me today are Ichor's Chairman and CEO, Tom Rohrs; and our President and Chief Financial Officer, Jeff Andreson. Tom will begin with the review of our results, strategy and outlook, and then Jeff will provide further detail regarding our growth initiatives, second quarter results and third quarter guidance.

After the prepared remarks, we will open the line for questions. I'll now turn over the call to Tom Rohrs.

Tom?.

Thank you, Claire and welcome to our Q2 conference call. Ichor continues to operate with strength and profitability in the current industry downturn. Second quarter came in about where we expected with revenue above the midpoint of guidance at $139 million, up 1% from the first quarter.

Our second quarter earnings were $0.23 per share at the midpoint of guidance and still demonstrating solid profitability at these revenue levels. I feel that we have done well adjusting to significantly weakened business conditions as we bounce along the bottom.

We have balanced our resources between the cyclical lows of the first half and the increased sales we expect in the second half of 2019 and our higher run-rate entering 2020. During the quarter, we continue to make progress executing on our strategies to grow our share within our served markets.

Our execution of these market share growth strategies makes Ichor uniquely positioned within the process equipment market to have a stronger second half compared to the first half in calendar 2019.

As we look forward to the third quarter, we expect to grow our revenue sequentially to the higher level of incremental revenues from these market share gains, as well as an uptick in sales to ASML. We believe we will achieve this favorable trend in our results despite the ongoing weakness in wafer fab equipment or WFE spending particularly in memory.

Our incremental revenues from market share gains were about $9 million in Q1 and increased to about $15 million in Q2. As expected, when you exclude the share gains, the base business was down sequentially in Q2 by a few percent due to a one quarter drop in our sales to ASML.

Recent industry reports indicate that WFE spending in 2019 is now even more weighted towards logic and lithography than previously forecasted.

The outlook for lithography and process control has strengthened and foundry and logic spending is gaining momentum but this year the result is that process tools - process tools shipments of etch deposition and CMP tools which benefit more from memory spending are down at least 25% based on the latest reports.

And as much as memory spending was already significantly reduced in the first half of 2019, it will be lower again in the second half of 2019.

Due to recent adjustments and fab spending in 2019 putting even more weight towards lithography and process control particularly in the back half week, we are taking our market share gain outlook down from the $75 million revenue level to about $65 million in 2019.

The modest hair cut is largely due to worsening conditions in memory spending this year as well as the speed in which our customers can burn down the inventory, they hold from the suppliers we are replacing. Jeff will discuss our progress in this area during his prepared remarks.

With this trajectory, we continue to see a stronger second half for Ichor even though process tool shipments are down. I like now to discuss additional growth objectives that will impact our revenue in 2020 and beyond. I’ll start with the liquid delivery module.

The web processing wafer fab equipment market was approximately $7.5 billion in 2018 and this translates to an addressable market for the LDM product of about $400 million. Obviously, this is a large opportunity for us.

We've been shipping the liquid delivery module for over a year now to our initial customer, and while we expect to expand our share of this customer, we are now in a position to expand to other OEMs.

In May we finalized an agreement with a partner in Japan who want to sell our liquid delivery module to those OEMs that manufacture web processes equipment in Japan. Our partner is a well-known supplier to the chemical delivery market and today supplies product to Tokyo Electron, DNS or Dainippon Screen and Ebara.

Japanese OEMs accounted for about $5 billion of the web processing market in 2018 or about two-thirds of the total and therefore serving OEMs in Japan is a significant opportunity for Ichor. We are pleased that we have secured the right partner for our growth strategy in Japan.

We have also added to our IP portfolio in Q2 as we completed the purchase of the mass flow product and intellectual property that was being developed by a late stage private company funded by multiple leading semiconductor device makers in OEMs.

This technology will complement and support the next generation proprietary gas delivery systems we have been developing. In addition to the IP and patents we also added their innovative engineering group that will complement the existing team we have in place.

We are in the early stages of our proprietary gas delivery system development and we have only a limited amount of customer engagement. However, we expect the additional IP will serve to expand our value-added margins in the future. We will provide updates as this program moves forward.

These factors all demonstrate our continued execution of our strategies for growth and contribution to our optimism that our revenue run rate as we exit the year should be a positive indicator for a much stronger period of financial performance ahead.

And now I'll turn over the call to Jeff to provide an update on the progress made in the second quarter on our key business initiatives before he concludes our prepared remarks with the financial guidance of the second quarter results and the Q3 guidance.

Jeff?.

Thanks Tom. As Tom mentioned our outlook for our share gains this year is now expected to be about $65 million. We continue to be pleased with our gains and the reduction is largely a result of the softer memory market and our customer's ability to burn down the current suppliers’ inventory prior to moving the demand to Ichor.

This is a delay of about one quarters ramp as the specific share gains, we have won are in place and will strengthen as business conditions improve. We continue to expect our share gains to be backend loaded this year and will exit the year at an annualized rate well above the $65 million we will see in 2019.

With our peers and customers seeing decline in build rates for the third quarter, our ability to grow sequentially is largely due to our share gains.

In our gas delivery business, these gains are largely in place and will now fluctuate with product demand in the second half a note that we've gained share - we have share gains that both of our largest customers.

In weldments we have the majority of the qualifications complete that we expected to win this year and the revenue ramp will now be a function of the timing of the transition by our customer and a recovery in the memory segment of the market. The largest growth driver for our chemical delivery business remains a proprietary liquid delivery module.

As Tom discussed earlier, we now have a partner in Japan that will be addressing the largest geographical segment of the web processing market.

We also are continuing to work with our Korean customer and expect to have a beta unit delivered this year, and finally we are continuing to work with our initial customer on qualifying additional customers of theirs. We made solid strides in our geographic expansion strategy this quarter with the finalization of our partner in Japan.

Our Korean gas panel business continues to be negatively impacted by the lower level of memory spending in South Korea this year where utilizing the downturn to work on penetrating additional OEMs, as well as expand within the customers we have today.

To summarize, we made solid progress in our incremental revenue initiatives with our gas delivery in weldments shares largely in place. Revenues from these share gains are expected to strengthen in the third quarter and our second halfway did in 2019 position us well for stronger second half and into 2020.

And now I’ll discuss our financial performance and the third quarter outlook. First, I'd like to remind you that the P&L metrics discussed today are non-GAAP measures unless I identify the measure as GAAP based.

These measures exclude the impact of share based compensation expense, amortization of acquired intangible assets, nonrecurring charges and discrete tax items and adjustments.

I’d also like to note that the schedule would summarizes our GAAP and non-GAAP financial results, as well as key balance sheet and cash flow metrics and revenue by geographic region can be found on the investor section of our website.

Second quarter revenues of $139 million increased 1% from the first quarter and were down 44% from the second quarter of last year. Our second quarter gross margin of 14.2% declined slightly from the first quarter but was largely in line with our outlook entering the quarter.

The decline from the first quarter was primarily due to a less favorable product mix and lower volumes in our plastics business which continue to experience the effects of the slower memory spending recovery.

Operating expenses of $11.6 million remained relatively flat from the first quarter and included the addition of approximately $200,000 associated with our recent IP purchase in which we also absorb a small engineering team.

Operating margin of 5.9% represented a 50 basis point decrease from the first quarter as a result of the lower gross margin and a relatively flat revenue environment. Our interest expense in the second quarter remained flat at $2.8 million.

Our tax rate for the quarter was 5.5%, the lower rate was due to a year-to-date adjustment for the lower full-year rate that we are now forecasting. Second quarter net income of $5.1 million was equal to 3.7% of revenue, earnings per share was $0.23. I’ll now turn to the balance sheet.

Cash of $41.5 million increased $9.8 million from the first quarter driven by strong free cash flow generation of $19.7 million. During the quarter, we completed the purchase of a patent portfolio another IP for $8.1 million and repaid $2.2 million on our term loan. Day sales outstanding of 27 days declined from 36 days in the prior quarter.

Inventory decreased 5% from the first quarter or $5.7 million to $108 million at quarter end. Inventory turns further improved to 4.3, the highest level we’ve seen since the second quarter of 2018. Now I’ll turn to the third quarter guidance. Our forecast is for revenues in the range of $145 million to $155 million which is up 4% to 11% from Q2.

Our earnings guidance of $0.25 to $0.31 per share reflects an improved operating profitability inclusive of the headwinds in our plastics business and a slightly increased level of operating expenses related to our recent IP acquisition compared to the second quarter.

We expect our tax rate will be between will be between 7% and 8% compared to 5.5% in Q2. Operator, we're ready to take questions please open the line..

[Operator Instructions] Your first question comes from the line of Quinn Bolton from Needham. Your line is open..

Congratulations on the nice results and the outlook for stronger second half in this tough WFE environment.

Wanted to start with the outlook for the third quarter, if I just do some quick math it looks like the share gain opportunities are probably run rate in about $20 million a quarter in the second half, so up about $5 million quarter-to-quarter, if I just use the midpoint.

Your guidance for the entire business is up about $11 million, I think if am doing the math right, which implies the core business is actually going to grow sequentially.

Wondering, if that's all ASML driven or whether you're seeing strengths in other part of the business?.

It’s largely ASML driven Quinn..

Okay.

And is that I assume knowing ASMLs guidance were pretty backend loaded, second half that that you would expect that strength to continue into Q4?.

Yes, we would expect so. Yes..

Okay.

On the IP acquisition you mentioned a couple hundred thousand of OpEx in the second quarter, can you give us sort of what you think a full quarter affect would be because it sounds like that’s the big delta quarter-on-quarter and in terms of some OpEx?.

Yes, I mean, quarter-on-quarter it was almost all of it. It will be a little bit higher than that probably around 300,000. It may have some fluctuation because we're now developing a proxy to get some R&D material in there but 300,000is a good number..

And then my last question just on the signing of the Japanese partner for the liquid delivery module have that contract in place, how long does it take to go to market to fill that channel, how confident I guess are you that this recognize revenue from that partnership in calendar 2020?.

I think we have plans in place to achieve some revenue and 2020 I will tell you that this was done within the last month or so and the energy level is good on both sides of this. They are very excited partner and so I really think that we can do some good stuff together. And as Tom talked in his comments.

This is a well-known business in Japan and they already work in the kind of web processing tool space. So we’re more excited to kick this thing off and it’s well underway..

I think that’s a great point. This company is already supplier to the people, the OEMs as I mentioned and an important thing, Japan.

So they come with readymade relationships if you will and moreover, they chose nature shows that they wanted to represent and distribute our product, which is a very nice acknowledgment of the work we've done and the product we have. So we feel very good about. And overall, we have been working on.

Now that the deal was done in the last month or so we've been working on it for quite a while and we’ve spoken to you on a couple quarters now. We’ve been around long enough to know that you just don't sent to Japan and end up with a lot of business very, very quickly.

So there'll be some more work to be done and some more learning to be done but we're quite optimistic about the partner we've been able to work with..

Your next question comes from the line of Craig Ellis with B. Riley FBR. Your line is open..

Thanks for taking the questions and congratulations on the good execution and ability to grow in the second half when many others cannot.

First is just a clarification Jeff, on the gross margin point you made in the second quarter, you identified two things that were play one was I believe volume and other was plastic mix and in the latter items sounds like it's impacting the third quarter.

Can you provide a little bit more color on that and what are the implications beyond the third quarter for that item?.

Well, I think in Q2 it was really the lower level of revenue we had with our lithography customer.

That was the biggest mix piece and then in our plastics business, it's been affected by the memory reduction more than other pieces of our business and that it just run in a much lower volumes and we’re trying to maintain an infrastructure for future growth.

So what has impacted the level of the gross margin and it will continue to have some affect in Q3, which mutes a little bit of the market share gain upside..

Yes, I think that’s right Craig. We need to remind you that along was etch and deposition when 3D NAND was hot CMP was very hot as well. And as the memory business has cooled off, we don’t know about that. And we think of etch and deposition. But it has also has cooled off CMP.

So it has lowered the business through that site and as you recall this was a site, we acquired back in 2016 and is been performing very well for us and we’re very happy with it. But it is also one of the more capital intensive sites that we have. So there is more fixed cost in plastic, machining and then there is in a lot of the other things we do.

So when the CMP business goes down along with the memory business, we do see an effect there and that's exactly what we’re reporting to you now..

That makes sense. Thanks for the color. Following up with the next question.

Tom, a quarter ago I think you expressed satisfaction with where inventory levels were large customers given the moment that we’re seeing in the mix of spending in the middle of the year and into the back half of the year are you still comfortable with where inventory level stand?.

Yes, I am. I think we see now and we mentioned this last quarter, a lot of those adjustments are over and done with to a reasonable extent whatever decreases in the main business and the base business is the single-digit kinds of decreases. And so inventory levels are not dropping dramatically at our customer site.

And we think the alignment is actually quite good. I did make a reference though to Will, we’re gaining market share and especially in the weldment side. And the customers are changing from supplier A to supplier B. It’s very different than when they are just changing from low volume - from high volume to low volume.

And then tend to build off but that of the safety stock of supplier A’s inventory before they turn on supplier B. In this case we are supplier B, which is the one you want to be. I think probably missed a little bit on our calculation as to how long we would build up that safety stock for this transition period.

So we are seeing some things there that we didn’t quite expect but those as Jeff mentioned quite correctly. Those are simply yet timing episodes and they will work their ways through the system in due time..

And then lastly for me. And it maybe first you related that the comment that you just made. I’m still looking for a very strong 65 million in share gain this year. The variance between that and the prior 75, would we expect that 10 million to come to Ichor in the first half of 2020 or how do we think about that variant.

And when its realized that its realized? Thanks.

Yes, we should and we do. Some of it is still to what I just explained in terms of some of those shares. Even if we win them don’t hit the P&L quite as quickly as we had hope but they will eventually.

And the other is we have mentioned all along that there is been the toughest ones to do early is the one who had the deep qualifications which are the precision machining ones. We expect the first qualifications to be done in this quarter or its shipments beginning next quarter.

Having said that, again, those - the timing of those were a little bit slower than we had hoped. Bottom line to your question, yes, we expect total of those share gains to hit in 2020..

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

Jeff or Tom, of the 65 million of incremental revenue you expect this year.

Is that primarily from a logic market or are there other opportunities you see in the September quarter and I have a follow up?.

To be clear Karl, it’s really hard for us to distinguish that component part level where the end use - with the end use device has been end up being whether ICE or a NAND. Obviously, in some cases it’s a little bit easier so for sure.

You know there's some parts that we know are going to be for memory and some but it’s really hard for us to distinguish.

The only thing we can say is that over the course of the year memory has gotten progressively weaker and logics has gotten progressively stronger albeit deal for all wafer fab equipment markets still looks like it’s going to be down 15 to 20.

So in terms of the effect on the business, I don’t think it’s all about credit go what the end use of the device happens to be..

I guess, as you think about your longer-term revenue opportunity from these new products that are beginning to just ramp today.

Is there any change to your outlook for revenue opportunities that Japanese equipment suppliers from the increased trade tension between Japan and South Korea and because they were to intensify, it would seem that the opportunity for you would be or perhaps or is a magnitude lower? So I guess, how do we think about the ramifications of that?.

That’s a good question. Since we are shipping to OEM, who are the ones shipping to the device makers who are the ones eventually shipping to the users. We are kind of at the back end of the supply chain, which means that market affecting our activities are quite a bit removed from us.

And you know we don’t necessarily get an opportunity to talk to the people who are the ultimate users of the device. And what we do get to do is keep our eyes open in our and turn up in terms of what’s actually going on. So there are two things that kind of work opposite each other.

One is that, obviously Korea and Japan are having a bit of a trade themselves that doesn't on the surface of it I think we can all say that the trade war does not help us regardless of who's in it, but the flipside is we also know that the U.S. and China in a trade war.

Theoretically that could do some things to help a Japanese supplier Tokyo Electron into China. And so how those end up sorting themselves out, Karl I do not know but I do know whether it’s the same as we think it is today or worse or better regardless it’s going to be a significant opportunity.

Its either going to be significant opportunity, a very significant opportunity, or a company making kind of significant opportunity. So with that said, we are happy about it. We're really excited about it, we are going work forward aggressively and will let the geopolitical shifts for where there may..

Sure, I appreciate that one more if may.

Jeff may you discuss your lead times are your top customers entering the September quarter and whether you think they are now approach - whether you think your own shipments are now approaching customer shipments or if they are actually somewhat disconnect from an inventory overhang within the supply chain? Thank you..

I think Tom alluded to, I mean on the gas delivery side and for that matter chemical I think you know with any of the LDMs we do they are very closely aligned from a lead perspective. We probably deliver say a month five weeks before they probably ship a tool. Sometimes we do merchant transits but we don't always know when that is occurring.

So they’re pretty closely aligned. We may lead by four or five weeks on gas delivery and I think the lead times, our lead times are not that long but from where we might ship something out of precision machinery and weldment might be just slightly earlier than that, that helps..

Our next question comes from the line of Sidney Ho with Deutsche Bank. Your line is open..

This is Jeff on for Sidney.

Have you guys seen any change in kind of your conversations with your largest customers, are there any increased optimize that the memory market is stabilized and the that we're prepared for a recovery going into 2020?.

I would say this, I think most of our customers feel like there about at the bottom, but I wouldn't say that they are seeing the turn yet. And so we all been observing is that as we went into this year, we thought the second half of this year would be the time when memory turned.

It’s obviously not the case, so we are hearing some talk that the first half of next week might be that period. We still haven’t seen any definitive evidence that is the case.

Nor have I believed our customers have seen that and so I think the situation right now reached to one where we’ve all put ourselves into an operating position that we feel as capable of being run profitably.

In our case we are augmenting that with taking this opportunity to gain share and also taking this opportunity to invest and to move ourselves into new market spaces or new geographies. I am sure our customers are doing the same type of thing.

But I suspect most of them will tell you that there not that sanguine about a first half of recovery at this point in time..

And just following up has your visibility into customers’ orders and kind of outlook improve at all over the first half of the year?.

Yes, first half was pretty bleak..

Well I mean we can tell a little bit around just the amount of what you would call churn in a quarter and we’d say that’s stabilized to a large degree for us. So it's much more predictable who we ship and when and stuff so that that means the visibility is better..

Our last question comes from the line of Mitch Steves with RBC Capital Markets. You’re now live..

Just the first one in terms of the gross margin profile particularly was down sequentially but based on commentary it sounds like the second half is going to better.

So if I assume that gross margins have potentially bottom, would that be a fair characterization or aggressive?.

Relatively fair I’ll say, and we don’t guide our gross margin you can think a lot that it will start as we get kind of bigger chunks up in revenue that well our flow through will help drag that up and right now we’re just kind of dealing with a little bit of headwind in our plastic business that’s muted here in Q3 and slightly in Q4..

Yes, we said one or two things we talked about the plastics I think that’s well understood. The other aspect the share gains that have shown up have been the lower margins ones first. So the gas delivery market share gain showed up first that's not basically different from our ongoing gas delivery gross margins.

The weldments will start to kick in now that will be helpful. The larger margins will be on the precision machining type products. They will kick in some of the Q4 spillover but they’ll mostly the ones that spillover into next year.

And so the profile of that has been a little lower in the beginning then we might have hope but it will still all work out through the course of the next three or four months..

And then secondly just given the color that ASMOs were brought a few times and we know that [indiscernible] coming down revenue why this year.

Is there potential for ASMO to be a 10% customer this year just trying to get an idea of scale here in terms what how much they are ramping up?.

Hope not..

Yes, because it wouldn’t be on ASMO..

We don’t want to be 10% based on the denominator..

Yes, I wouldn’t - we want to think that because given the outlook that you guys are probably putting it together, it's still got ways to go to get there..

There are no further question at this time. I will now turn the call back over to Tom Rohrs..

Well thank you for joining us on call this quarter. And we look forward to updating you again on our Q3 call in November. Thank you..

This concludes today teleconference. You may now disconnect..