Q3 2022 Ichor Holdings Ltd Earnings Call
We exceeded the upper end of our profitability targets and reported record quarterly earnings of $1 22 per share.
Since our last earnings call expectations for levels of wafer fab equipment investments in the coming year have declined significantly.
The initial forecast reductions centered primarily around the increasing softness seen in the memory market and increasingly conservative commentary around memory capex going into 2023.
Yes.
And then in early October news of export restrictions to certain domestic semiconductor manufacturers in China, effectively reduced wf forecast by $8 billion to $10 billion for next year.
We have incorporated the impact of the export restrictions in our outlook and build plans, we estimate that the total impact of these changes to be approximately $20 million this quarter and as such the midpoint of our Q4 revenue guidance represents a 6% decline from our record third quarter.
Our above industry revenue growth expectation for 2022 is unchanged. However, at 20% year over year growth, assuming we come in around the midpoint of our Q4 guidance.
So as we are nearing the end of a record revenue and earnings here, our focus turns to the expected spending environment over the next several quarters and our ability to flex our variable operating model to adjust to lower levels of wip demand in 2023.
I am sure. Many of you recall the last industry downturn, which began in mid 2018 and continued until 2009 late 2019.
This downturn resulted in a 25% decline in our annual revenues in 2019, and yet we generated over $60 million in EBITDA and over $75 million in free cash flow over five quarters of reduced customer demand.
As we look at our business. Today. However, there are number of reasons why we believe our revenues will perform better than the expected 20% decline in overall <unk> next year.
First is the significant reduction in our exposure to the memory market in 2018, our two largest customers comprised 88% of our total revenue.
And based on their combined memory revenues at year, we estimate that about 70% of our sales were from the memory market.
Since then the vast majority of incremental growth in Wip has occurred in the foundry and logic markets and today, we estimate the combined memory exposure for our two largest customers to be less than 45%.
At the same time, our business with other customers has grown from just 12% of our sales in 2018 to now over 20% of our sales in 2020 to the.
The growing share of our business from these additional customers also was far less memory, driven and a portion of our revenues from the <unk> acquisition is completely independent from the semiconductor industry.
So in total for 2022, we estimate that only 35% to 40% of our sales. This year is memory related compared to over 70% back in 2018.
The second reason why we expect our revenues in 2023 to perform better than Wip is because a growing portion of our revenue serves the EV market.
Consistent consistently increasing build rates and higher expected <unk> system shipments next year are resulting in <unk> revenues continuing to grow in 2023, and our own forecast for next year includes a higher level of the related gas delivery business.
Third we expect to benefit from success in gaining market share and winning new product evaluations.
Historically, our customers have taken advantage of temporary slowdowns in industry demand to invest more resources into new product evaluations and qualifications.
Our areas of focus remain qualifying more of our internally developed machining components.
Leveraging our global Weldment footprint to gain additional share qual.
Qualifying our next generation gas panel and moving aggressively to make progress qualifying our chemical delivery system in Japan now that it is open to visitors.
Beyond these opportunities. We recently began working with the customer on a gas delivery solution that serves the growing silicon carbide market.
This is in the very early stages, but fits our capabilities very well.
Lastly, we are not anticipating the same level of impact from inventory reductions as we did in late 2018.
The reason why we expect this dynamic is different today is because our industry has been supply constrained for most of the last two years as with shipping at levels below unconstrained demand through most of 2022.
Therefore, we believe that the inventory levels at our customers for our component products have not grown to the same level as we witnessed in 2018.
At this time with our current visibility we are expecting mid to high single digit percentage declines in our revenues on a sequential basis.
At least for the next couple of quarters.
Again this assumes that the majority of WSI declines will be in the memory segment, which we estimate to comprise just 35% to 40% of our sales in 2022.
Within a backdrop of more stable levels of investment ahead for foundry and logic markets. We also expect to grow our <unk> business in 2023.
We also see opportunities for increased revenues from share gains and growth in non semi markets next year.
In this environment, we believe our business model will continue to demonstrate the improvements we made to our gross margin profile over the last few years.
We have maintained good discipline on discretionary spending through 2022, and we will continue to invest in our R&D programs and the optimization of our capacity in support of the future forecast for a $100 billion plus level W. P.
In summary in this highly dynamic business environment. We are all navigating we believe ichor continues to be well positioned to outgrow the industry.
Over the past seven years <unk> has grown at an annual rate of 16%.
And at the midpoint of our Q4 guidance, our seven year CAGR will be 24%.
This is roughly 50% outperformance this roughly 50% outperformance reflects the strength of our primarily serve markets with nwfp.
Continued share gains and strategic M&A.
Furthermore, our annual growth in net income over this period is 27% demonstrating our successful track record in growing earnings faster than revenues.
We expect to continue executing on our strategies to outgrow the industry and we are confident that we will show strong financial results during 2023, which by the way is expected to be the third largest <unk> year in our industry's history.
And with that I'll now turn the call over to Larry Larry.
Thanks, Jeff.
First I would like to remind you 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 very helpful schedule summarizing our GAAP and non-GAAP financial results, including the individual line items for non-GAAP operating expenses, such as R&D and SG&A in the investors section of our website for reference during this conference call.
Third quarter revenues were a record $356 million up 8% from Q2, and 35% higher than Q3 of last year.
With revenues at the upper end of expectations gross margin of 18% exceeded our forecast for the quarter and was up 100 basis points from Q2.
About half of the sequential increase was due to factory volume leverage with the other half, resulting from the recovery of some of the cost increases we've incurred over the past year or so.
Q3, operating expenses were $22 8 million.
A bit lower than forecast due to the timing of R&D and other investments shifting to Q4.
The resulting operating margin was 11, 6% up 160 basis points from Q2, and about 120 basis points higher than the midpoint of our guidance.
As a result of higher interest rates interest expense increased to $3 2 million in line with our expectations, while our effective tax rate was lower than expectations at seven 5%, reflecting the revised full year effective rate of about 10%.
The resulting EPS for Q3 was $1 and 22 <unk>.
<unk> <unk> above the high end of guidance.
The primary driver of the earnings beat was our gross margin performance well ahead of forecast followed by revenue volume at the high end of the range.
The lower tax rate for the quarter benefited earnings by about <unk> <unk> per share and lastly, Q3, EPS also benefited from slightly lower opex.
Now I will turn to the balance sheet.
As expected cash conversion of working capital improved in the third quarter, and we generated $11 $5 million of free cash flow cash.
Cash from operating activities was $19 6 million and Capex for the quarter was $8 million.
Inventory of $291 million was flat quarter over quarter with turns remaining at four.
And receivables DSO were 47 days compared to 44 in Q2.
Total cash was $56 5 million at quarter end up about $10 million from Q2, and total debt was $304 million down about $2 million from Q2.
Now I will turn to our fourth quarter guidance.
With revenue guidance in the range of $315 million to $355 million. Our Q4 Q4 earnings guidance is <unk> 80.
To $1 <unk> per share.
The midpoint of revenue guidance at $335 million reflects about a 6% sequential decline from Q3 as a result of the recent export restrictions.
At this revenue level, we are expecting gross margin of approximately 17, 2% representing a slight improvement compared to similar revenue volumes as Q2.
This is aligned with our objective to continue to increase gross margin by about 20 basis points a quarter through our ongoing cost reduction programs and growth in our components businesses.
Given the timing of our R&D expenses and higher audit fees versus Q3, we expect Q4 operating expenses to increase slightly to approximately $23 2 million.
As a reminder, we typically see some seasonal increases in Q1 each year.
We are also looking at areas, where we can reduce costs in order to offset some of these typical increases early in 2023.
We expect our interest expense will be $4 2 million in the fourth quarter, reflecting the recently announced increases in interest rates.
Our tax rate in Q4 is expected to be 10% to 11% and we estimate our fully diluted share count to be approximately $29 1 million shares.
Operator, we are ready to take questions. Please open the line.
Thank you we will now be conducting a question and answer session.
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All participants using speaker equipment, it may be necessary to be copied zawislak question Nicky.
One moment, please while poll for questions.
Our first question comes from Quinn Bolton with Needham <unk> co. Please go ahead.
Hey, Jeff and Larry Congratulations on the nice and record third quarter results I guess, Jeff you went through a lot of reasons. Why you think you could outperform wf fee next year I guess my basic question is if you think <unk> is down 20% do you think <unk> is down.
10% to 15% what kind of outperformance might you expect given the four to five drivers that you went through in the script.
Thanks Glenn.
Good question.
If I had to put a number on it today I'd, probably say about 5% better so.
We're working on another grouping of share gains and obviously with the growing that that helps buffer. It may have some opportunities like we talked about in our.
Our IMG acquisition in that.
<unk>.
Probably our memory exposure is down tremendously so.
We're still seeing strength in foundry and logic, both that kind of the leading edge and at the trailing edge.
There so that I think bodes well as well, but if you had to pin me into a number I'd, probably say about 5% or so.
Okay, perfect and just a related question for Larry I know you mentioned the goal is to gain or to improve gross margin about 20 basis points through product mix as well as cost reduction activities, but theres, a big leverage component to the business and so if sales are down.
Mid teens in 2023, how would you expect gross margin to perform in that environment.
We probably expect about a 25% gross margin flow through if you look at.
A drop in revenue into 2023, it's it's slightly higher than maybe in the last downturn, because we have a little more investment in our machining business, which.
It does help us drive more share than.
Hopefully higher margins, but.
Does bring with it does to a certain increase in fixed fixed cost.
Got it and then maybe lastly for me Jeff.
Any updates on just the next generation gas panel evaluations that are in the field.
Yes, we talked about we've got two out there wanted a new customer wins and existing customer they're there they're moving along.
These usually take.
Nine months to 12 months. So we're probably in the first three innings or so both of these one a little farther than the other.
And so they're just progressing and we're pretty hopeful that one of these will get accepted in second half of next year, we'll start to see first revenues from them.
Perfect. Thank you I'll get back in queue.
Thank you Quinn.
Next question comes from Craig Ellis with B.
The security.
Go ahead.
Thank you and guys congratulations on nice execution in the quarter.
Wanted to follow up on one of the items the gross margin to Larry great to see the 18% the question.
You noted that there was both volume and.
And reduce <unk>.
Put or other cost pressures.
That latter item.
How much of the how much of the increase in gross margin was it yes.
As we look out over the next couple of quarters given Bryan.
And the supply chain.
What would you expect plus or minus from that variable. That's good luck ahead.
Yes, So let me just describe.
What happened there I think.
We had we had increases over the last probably 12 months of <unk>.
It Expedites.
Choosing different suppliers working with our customers to find alternatives.
It also between some overtime and other things that we've done in support of delivering product and kind of meeting customers flexibility regarding what to ship to them.
And this this.
This quarter, we actually completed our cost sharing.
Discussion with them and I would say that if you look at the margin improvement from <unk>.
Last quarter's 17% to this quarter's 18% probably around half of that was related to kind of this catch up of cost recovery.
The remaining balance being some cost management and then just volume leverage inside the organization. So.
If you take kind of strip out some of that.
Get us.
Round 17, 4% approximately.
Which if you look at where we are where we've been.
<unk>.
Continuing on that 20 basis point, a trend line that we'd like to stay on.
Got it and then the follow up Jeff.
Nice to get the.
The macro color from you seems like you guys have a good grasp on that the question is related to the comment that revenues might be down.
Low to mid single so I think it was sequentially over the next couple of quarters. One can you just talk about the visibility that you have in the business.
If you've got particular conviction about where we might see revenues drop out whether the second quarter third quarter just the contour.
Thanks, Sean clothing would be helpful. Thank you.
Yes.
I would say that if you asked me three months ago has had visibility was.
Kind of nine months, plus I'd say, we're getting.
Kind of into the six months plus confidence level of visibility and things. So it's hard for me to make a call on the shape of the recovery, but I do think Q1 will be down a little bit from Q4, obviously, we're still working through a lot of adjustments.
From the China exports and things, we think we've largely coordinated all of that through our build plans and information from our customers. So.
And then I think we'll just have to wait maybe till the next call to give you a better view of what we think the shape is.
Got it and then.
Just lastly for me.
As we look back over the last 12 months one of the things. We wanted to see is some of the higher margin products not just the custom designed products, but things like <unk> come back et cetera can you just talk about how happy you are with mix in the business in any particular thoughts on mix as you look out over the next six months, where you do have that visibility.
Yes, I think when we talk about.
I'll call it outperformance in the down market, but.
Some of those share gains are definitely in the components side of the business.
I would say.
Pretty large percentage of them, we've already we've already gotten some in places we kind of exit Q4.
I don't want to be specific obviously, where those things are coming from but.
So we're pretty confident that there is some upside to what we could potentially see on the machining side, if we get some more qualifications.
What we build.
Out of our North America operation So.
And that would help mute some of the gross margin.
<unk> in a down environment as well and then there is still some in gas delivery that we're working on as well.
If you think about it with.
The growing that in and of itself gives us a kind of a larger share of the existing Tam we operate in.
Got it. Thank you very much I'll hop back into bed.
Thanks, Craig.
Next question comes from Chris <unk> with Cowen. Please go ahead.
Hi, This is Robert Mertens on the line on behalf of Krish. Thanks.
Thanks for taking my question I guess, just first around the push on at this time.
Have you broken out.
What level that is for this year or anything in the past.
Sort of how to think about modeling that next year.
Okay.
Portion tied to memory, but just trying to think about the foundry logic space. What portion is just taken up with EV specifically.
Yeah, we haven't sized that.
For the investment community I mean, I think you can go look at some of our distribution of revenue and figure out.
From from that the exposure we have in Europe .
As our third and fourth largest customers so.
Both of those have been growing nicely as well and as we noted at our customer concentration.
Our two largest customers has gone from down two from 12 to.
20% or something are the new or the other customers. So we haven't sized that they haven't popped above the 10% customer. So theyre not disclosed so that will give you a little bit of a framework to figure that out.
Okay. Thank you and just quickly in terms of the interest expense.
For next quarter, you mentioned going up a bit is that just sort of how.
We should think about it into next year, just that kind of run rate maybe at the higher.
Well I think it's all dependent on what our fed does that mean.
This reflects what Larry you can see in the fourth quarter and we'll have to see about the first quarter if rate goes up.
We have a floating rate so it will naturally go up with what you see maybe with a little bit of lag because we do lock it in for a period of time.
Yes, I think the only other comment I'd make is as we expect to generate cash flow going into next year.
Through working capital improvements.
We will be evaluating whether it makes sense to pay down some of that debt. So.
Especially if the interest rates keep going up but becomes more a more attractive option perhaps for us.
Okay. Thank you I appreciate it.
Thanks, Rob.
The next question comes from Hans Chung Li D. A Davidson. Please go ahead.
Hi, Thank you for taking my question so for.
Regarding the commentary about the.
<unk> five percentage outperformance.
For 2019, so how does that imply.
<unk> business.
In 2000.
They imply it could be flat growth or maybe down slightly.
Well good question, Hans I'll give you a little bit of color on it I mean I think.
For IMG.
Maybe around 55% of their business is semi.
That'll that'll probably come down a little bit the rest of it will probably be a slight growth year over year, so they'll see a very muted.
Revenue level, but I do think it'll be down a little bit.
Got it thank you and then.
Regarding knee.
Operating expense so how should we think about that.
The motto, let's say, if we see that 20 <unk> to be down.
15% then.
How should we think about the deleverage on the Opex.
Yeah.
Well, we as we said we'll be.
23, two in Q4, we will have our.
Normal seasonality in Q1, which we're going to try to.
Offset will continue to invest in R&D and expect that going into 2023 that.
That spending will continue to go up slightly as we continue to penetrate with new opportunities.
I think on the remaining spending areas.
We're looking right now at discretionary spending around.
Travel variable compensation some of the other controllable spending items.
I'd say if.
If the business drops in the 15% range that Jeff's talking.
We'll take spending down but.
It will be.
Well it won't be ratably to revenue will be <unk>.
Significantly less than that and we're still kind of working through that plan as we finalize our outlook.
Especially for the second half of next year, but our plans now or to keep focused on on R&D investment and we still have to maintain our sox compliance in some of our ERP investments as well so thats our plan for now and then.
As we this goes back to a prior question about duration really is.
The revenue goes we'll get a good view of that and then we have a playbook that we would have to do we obviously we go through discretionary spending there are certain areas that we've kind of moved into what I would call more of a bto kind of.
Approach to some of the transactional side of <unk>, G&A and Larry will work.
Align those with revenue levels that we see and then theres other variable components that we can we can do to try and manage that number.
Through this.
Cycle.
Got it that's helpful. So lastly.
Scott in your supply chain, so where do we see the comp trends and then where do we see the decrease in <unk>.
Regarding the supply chain dynamics.
I think they improved again, obviously I would not say that they supply chain constraints you've gone.
I think the Delaware its head here and they're dependent on.
Whether suppliers located potentially but we still are we're still working some issues where not all of the supply that's needed as predictable at the component level to some of our sub tier suppliers.
But it is improving a lot. So we would hope that those can take advantage of a little bit of breathing room here and get caught up and then be behind us, but they're largely behind us now, but there's still some out there that will work.
Got it great. Thank you.
Awesome.
Okay.
There are no further questions at this time I would like to turn the floor back over to Jeff and Jason for closing comments. Please go ahead.
Thank you for joining us on our call this quarter I'd like to thank our employees suppliers and customers for their ongoing dedication support as we continue to navigate this highly demand dynamic business environment.
Our upcoming Investor activities include the New York City Summit on December 13th.
And the Needham growth conference in January we also look forward to our next earnings call scheduled for early February operator. This concludes our call.
Thank you. This concludes today's conference call you may disconnect your lines and have a great day. Thank you for your participation.
[music].
Okay.