Good day, ladies and gentlemen, and welcome to the Ichor Second Quarter 2020 Earnings Conference Call. At this time, all parties are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. As a reminder, this conference 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, operator. Good afternoon and thank you for joining today's second quarter 2020 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, including those made about the impact of the ongoing COVID-19 pandemic on our operations and the industry at large, are subject to a number of risks and uncertainties, many of which are beyond our control, 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 2019 and form 10-Q for fiscal Q1 2020 on file with the SEC and those described in subsequent filings with the SEC. As noted in those aforementioned filings, we’d remind you that the COVID-19 pandemic continues to create significant volatility and uncertainty in our industry, limiting our ability to provide longer-term forward-looking statements. 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 Larry Sparks, our CFO. Jeff will begin with an update on our business and a review of our results and outlook, and then, Larry will provide additional details of our second quarter results and third quarter guidance. After their prepared remarks, we will open the line for questions. I'll now turn over the call to Jeff Andreson. Jeff?

Thank you, Claire. Welcome to our Q2 earnings call. I trust that all of you and your families are staying healthy and safe today. Today, we reported second quarter financial results at the upper end of expectations. When we provided guidance in early May, we expanded the ranges of revenue and EPS, given the level of uncertainties related to COVID-related constraints in our manufacturing sites and the global supply chain. We noted that at the high end of the range, we assumed no additional restrictions on our manufacturing sites and a quicker than anticipated recovery of our weldment capacity. We are very pleased to report that easing restrictions and a rapid improvement in our weldment capacity enabled us to deliver total revenues of $222 million and $0.54 per share in earnings in the second quarter. The global wafer fab equipment, or WFE, market has shown itself to be fairly resilient and continues to be strong in this dynamic and rapidly changing COVID environment. We continue to see strong levels of demand from our customers. In Q2, we achieved sequential growth in revenues, as well as increases in gross margin, operating margin, and earnings per share. Year-to-date, in 2020, we have grown revenues by 59% and EPS by over 120% versus the first half of 2019. Our foremost priority is to ensure the health and safety of our employees and their families, and our performance in the second quarter is a testament to the dedication, commitment, and ingenuity of our workforce in delivering exceptional service to our customers during this unprecedented and challenging time. We entered the second quarter with shelter-in-place and distancing requirements and, in fact, have had an effect at all of our manufacturing locations. These impacted our capacity levels as you would expect. Our largest challenge was the shelter-in-place order in our Malaysia weldment operation that affected most of April. We all know these are unprecedented times, which require a certain degree of out-of-the-box thinking to adjust to the new requirements that we must follow. We have had to redesign workflows, work schedules, and factory spacing within our factories to maximize our productivity across all operations. Additionally, all employees who can perform their jobs remotely are continuing to do so. Our operational capabilities and supply chain have largely recovered from the significant constraints experienced earlier this year, but we remain vigilant and continue to take all appropriate actions to protect our people and safely maintain business operations globally. I continue to be amazed by our employees and supply chain partners who have worked closely together to keep our business operating at a high level during these unprecedented challenges. I want to thank our employees and partners for their incredible contributions as we navigate the impacts of COVID-19. Turning to the demand environment, beyond keeping our employees and their families safe, our second priority is to maximize our output and support our customers' delivery requirements while continuing to drive our strategic growth initiatives. Since February, we've been working tirelessly to ensure that we support our customers' strong level of shipments in light of the challenges the entire industry is facing, both in capacity as well as the global supply chain. Our Q2 guidance range assumed we would continue to face these challenges throughout the quarter, and output would be constrained, giving us the visibility to predict sequential revenue growth for the September quarter. Our quicker than expected recovery resulted in revenues exceeding expectations at the high end, and with continued strong levels of demand from our customers, we continue to forecast sequential growth at the midpoint of our September guidance. This outlook equates to 55% revenue growth year-over-year for the first three quarters of 2020, and about double that rate in earnings per share growth. We will continue to have an expanded range, however, given the level of uncertainties and risks related to COVID-19 that can change on very short notice and rapidly impact our business. Nonetheless, at this point, we see strong levels of customer demand continuing in the fourth quarter. We are well on track for a record revenue year with year-over-year growth far exceeding that of the overall industry, a testament to our success in expanding our served markets and increasing our share within those markets. This brings me to a review of the progress we're making against our revenue growth objectives for the year. In gas delivery, we are continuing to work with our customers on opportunities to increase their share by leveraging our global manufacturing and engineering footprint. In weldments and precision machining, after multiple new qualifications in 2019, we're moving forward with additional new qualifications, which will see first revenues in a later part of this year. Additionally, we're also benefiting from the continued ramp of EUV lithography, with year-over-year growth in our gas delivery shipments expected for both 2020 and 2021. Each of these factors is enabling us to achieve revenue growth outperforming the overall industry. Another revenue growth driver will be our success in penetrating new customers, principally in Asia. The second-largest served market for chemical delivery is with customers in Japan and Korea. We have added capability and capacity in our Korean operation, which we acquired in mid-2018. In Japan, we have partnered with a value-added reseller who is actively marketing our liquid delivery module. We continue to work with our Korean customer who is evaluating our liquid delivery module, and in Japan, we are actively in discussions with several potential new OEM customers. Both of these will position us for meaningful contributions from this region starting in 2021. Furthermore, we continue to make progress on our strategy to leverage our engineering capabilities and IP portfolio to develop new proprietary products to drive longer-term expansion of our share of our served markets, as well as to drive the operating model towards increased levels of profitability. We continue to invest in this area and are making good progress in the development of our proprietary next-generation gas delivery solution and expect to have our first beta units delivered this year. Before turning the call over to Larry, I'll make a few final comments related to other recent announcements, including our filings today as a universal Shelf Registration Statement for up to $200 million. This filing is a component of our strategic growth initiatives, increasing the flexibility available to us with our current capitalization structure and enabling us to be nimble and act quickly when strategic opportunities arise. In late June, we announced that we made the decision to close our plastics manufacturing facility in California. We made this decision in order to streamline our operations and improve our asset utilization within this business. We remain committed to our chemical delivery business and have ample capacity in other operations to address the growth opportunities we see for this business. We are targeting to have this restructuring completed by the end of the year and are working with our customers to qualify these products at other sites. To summarize the second quarter, the team did a great job in managing through the challenges we encountered as a result of the pandemic to deliver sequential growth in revenues, gross margin, operating margin, earnings per share, while making good strides against our strategic growth initiatives. We continue to operate in a strong demand environment and have outperformed the industry growth with a 59% year-over-year increase in revenues to date in 2020, and with our current visibility, we are forecasting second half revenues to be stronger than the first half. The longer-term growth drivers for fluid delivery serving critical semiconductor processes, such as edge deposition and CMP, remain firmly intact. Now, I'll turn the call over to Larry to provide an update on our financial performance and outlook.

Thanks, Jeff. First, I would 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. 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 Investor Section of our website for reference during this conference call. Second quarter revenues were $222 million, up slightly from Q1 and up 59% from the same period last year. As Jeff mentioned, the high end of our guidance range for the second quarter assumed no additional restrictions on our manufacturing sites and a quicker than anticipated recovery of our weldment capacity. We actually came in above the high end of the range in revenues due to strong execution in a challenging operational environment. In spite of these challenges, we reported our fifth straight quarter of sequential revenue growth as customer demand has remained strong. We also achieved sequential growth in gross margin, operating margin, and earnings per share. Gross margin for the quarter was 14%, up 20 basis points from Q1. We continued to face a number of COVID-19-related headwinds impacting gross margin in Q2, such as increased freight and material sourcing costs, as well as costs associated with ensuring the health and safety of our global workforce. These higher costs impacted second quarter gross margin by about 100 basis points consistent with our expectations discussed in May. In the current operating environment, we expect these costs to come down a bit with the gross margin impact moderating to approximately 50 basis points in Q3. Operating expenses came in as expected at $14.5 million, down slightly from Q1, and we expect to remain around this level through the second half of 2020. Operating margin improved 30 basis points in the quarter, and operating income was up 5% over Q1. Our interest expense in the second quarter declined to $2.3 million, and our tax rate increased slightly to 11.5% compared to 10.2% in Q1. Our planning rate for tax over the next couple of years continues to be in the range of 10% to 13%. With revenues just above the high end of the range, a 20 basis point improvement in gross margin, and relatively stable expenditures, EPS of $0.54 was at the high end of our guidance range. Year-to-date growth in earnings per share has doubled the rate of our revenue growth. Now, I will turn to the balance sheet. We ended the quarter with $57 million of cash compared to $42 million last quarter. The increase in cash was primarily due to increased borrowings on our revolving credit facility, with our total debt balance of $23 million over Q1. We generated approximately $15 million of cash from the P&L during Q2, but this was offset by a significant increase in receivables that resulted from the upside in revenues occurring late in the quarter. As a result, day sales outstanding increased to 43 days from 36 days in the prior quarter. Inventory turns declined slightly to 5.2. We are very focused on ensuring adequate liquidity to support projected long-term business growth. We are comfortable with our debt levels and capitalization given our current outlook. With $64 million of EBITDA over the last 12 months, we are well below our three times coverage covenants at the current debt balances. Even with the increased debt level, we have secured more favorable terms and expect interest expenses to decline in the third quarter. While the revolver gives us significant flexibility, the S-3 Shelf Registration Statement filed today will offer us additional optionality, enabling us to be opportunistic with strategic growth initiatives and improve upon our current capitalization structure. Now, I will turn to our third quarter guidance. With revenue guidance in the range of $210 million to $240 million, our earnings guidance of $0.50 to $0.70 per share reflects an improvement in gross margin and a similar level of operating expenses compared to Q2. We are forecasting interest expenses to decline to about $2 million per quarter and our full-year tax rate to be around 11%. We are assuming approximately 23.5 million diluted shares outstanding for the third quarter. Given that we are operating in a dynamic and rapidly changing environment with continued COVID-related restrictions and constraints in place, we expect to face some level of gross margin headwinds for the foreseeable future. That being said, we anticipate sequential improvement in gross margin again for the fourth quarter. Our historical gross margin flow-through is in the low 20s, and the longer-term goal remains to drive greater gross margin accretion through incremental cost reduction programs, growing our share within higher margin components markets, and increasing our proprietary IP content within our products.

We are ready to take questions. Please open the line.

Hey, guys. Congratulations on the nice results and outlook. Larry, I just wanted to start with your gross margin comments. You said that the COVID-related impact should decrease from about 100 basis points in the second quarter to only 50 in the third quarter. Should we be thinking, with revenue levels roughly flat quarter-on-quarter that gross margin in Q3 is somewhere around 14.5%, or are there other mix-related or operational efficiencies that could drive a better than 14.5% gross margin?

I think we'll be in the range of, as you mentioned, around 14.5%.

Okay. Great.

Mix is about significant.

Looking back to the peak in 2018, gross margins are likely a couple hundred basis points lower than what was achieved in the last cycle. Can you explain what has changed? Is it related to some of the challenges on the plastic or liquid side of the business, or should we still consider the possibility of returning to a gross margin of around 16% to 17%, assuming that low 28 fall-through on incremental revenue?

Well, Quinn, I'll start. I think we've discussed this previously. We've increased our capacity since the last peak, which is impacting our gross margin until we reach revenue levels of around $250 million. That's part of the situation. Additionally, we are facing some challenges; the plastics segment hasn't ramped up as we expected. We're currently working on improving the efficiency of that operation and pursuing other gross margin initiatives. While there are obstacles, I believe they will resolve as we navigate through the pandemic. I would be disappointed if we didn't recover those 200 basis points by the time we address these issues in the coming quarters.

Some of the share gains we experienced last year were in the integration area, which typically has lower margins compared to the aggregation of companies. We are moving forward with that. In the long run, we want to adjust that mix to focus more on weldments and machining, which will provide us with more favorable conditions.

Great. And just maybe one last question from me. With revenue increasing nicely, how do you feel about overall revenue capacity from the facilities? Do you believe you have the right infrastructure in place? Will you need to start adding more manufacturing capacity if the cycle continues into 2021, which it seems likely to do?

We have added sufficient capacity to manage our needs for the foreseeable future. Our plans are in place, and we can quickly activate additional capacity in under six months. Currently, the market outlook suggests that the second half will have a stronger wafer fabrication environment compared to the first half of the year, particularly with improvements in the memory sector. It looks like 2021 will experience growth compared to 2020. I believe we are well positioned for at least the next year in terms of capacity, and we can increase it with minimal capital expenditure if necessary.

Great. Thank you.

Yeah.

Thank you and congratulations on the good execution. My first question is regarding the anticipated strength that you mentioned will likely continue into Q4. Is that typical visibility for you considering your relatively short timelines, or is it simply due to the backlog and longer lead times affecting strength? Additionally, could you elaborate on which areas you expect to see strength in Q4? How does foundry/logic compare to memory, and how does that relate to your expectations from a quarter ago? Thank you.

In Q4, we usually have strong visibility for about three months and fairly good directional visibility for six months from our customers, which gives us confidence. We are noticing a recovery in the memory space. While we might not be the best source for details on this, our Korean operation provides us with enough insights to observe memory strengthening. There are ongoing technology transitions and developments in 3D NAND that we can recognize. Although we haven't seen a significant increase in wafer starts for the second half, we expect the foundry and logic market to remain strong and solid, even with a slight decrease compared to the first half.

That's helpful. My follow-up question is about the gross margin. There's a lot of interest in the near-term gross margin trajectory, but looking beyond the COVID issues and focusing on the longer term, we have previously discussed various components that drive gross margin improvement. Can you help us rank the biggest drivers outside of just revenue growth? Is it the cost reduction programs you mentioned, the higher margin business, or the products with more proprietary IP? Maybe if I specify a timeframe of the next 12 to 24 months.

We are clearly concentrating on expanding the component segment of the business, which has higher incremental margins compared to the company's average. Our goal is to continue gaining market share in that area. We are also optimizing our plastics operations, which will be beneficial. We have ongoing cost reduction initiatives within the company that will contribute to this effort. I anticipate that the main benefits from streamlining our plastics division will be realized in 2021, although we may see some positive effects sooner. Additionally, we have other strategies planned this year to enhance gross margins that will support our efforts to increase margin levels. Hopefully, within the next 12 to 18 months, we will return to more normalized margin levels.

Great. Thank you.

Our next question comes from Chris with Cowen and Company. Please proceed with your question.

Hi, thanks for taking my question. Two of them. Jeff, can you just say a little bit about the strengths you see in your product line? Is it mainly gas delivery? Is it across the board? Can you just give some color on that?

It's generally across the board. As I mentioned, we have a preference for depth and agile process tools, including CMP. We're observing significant strength in those specific types of applications. There seems to be a bit of a stronger memory performance in the latter half compared to the first half, although the first half was also quite strong. Additionally, we're seeing growth in foundry and logic as well. Overall, we're experiencing growth in all areas of our business.

That's really helpful. You mentioned that any traction on the Korean semiconductor capital equipment market is more of a story for 2021. Do you believe you will have equal opportunities in both NAND and DRAM, or will it primarily focus on one over the other among some of the Korean semiconductor capital companies?

I believe we are mainly focused on 3D NAND at this time, hoping to collaborate with a customer. While we do have exposure to both 3D NAND and DRAM, our revenue in Korea, which is relatively small, is primarily centered on 3D NAND at this stage. We are in the process of qualifying a liquid delivery module that will be integrated into a cleaner, which we anticipate will help us enter the DRAM market. Additionally, we are collaborating with other OEMs on deposition gas panels, primarily on the edge side. Currently, we are engaging with three or four local OEMs, and this is primarily a 2021 initiative for us.

Got it.

Hey, thanks for taking my question. I had two. The first one is just really going back to the gross margin question here. You're talking about kind of improving revenue trends going forward, the gross margins being up in December versus September. So, the way that I'm thinking about if revenues continue to go up and you had a plant closure as well, shouldn't you see kind of operating margins expand at a faster rate? So, you're going to see more leverage off the operating margin line, or am I thinking about this incorrectly on a go-forward basis?

Yes, the simple answer is yes. As we streamline operations, it's not a very large operation. You can gauge it from the headcount mentioned in the 8-K, but I won't discuss specifics on this call. It's relatively small, yet it will have a positive impact. We're also looking for growth in the components business to start accelerating. Earlier this year, we noticed a quicker growth rate in gas panels, and now we hope the components business will catch up, especially as they begin to build inventory, which we've already seen a bit of.

Got it. Understood. The second point is about the shift to high tech. It seems like more companies are moving towards cutting-edge technology. Does this impact your value proposition? If they sell higher-end semiconductor capital equipment and you sell into that market, would that increase the average selling prices or the value of the content you provide, or is it not the case that the higher-end solutions would add value for you?

No. I believe that with the introduction of newer high-end solutions, you will observe an increase in the number of gases used per gas panel. This will lead to higher average selling prices for us as the quantity of gases increases. Along with these gases, there will also be flow control and other necessary components, contributing to an increase in our average selling prices over time. I can't provide a precise number of new gases at the moment, but I am aware that modern semiconductors require an increasing variety of gases for each gas panel.

Just to clarify that real quick. So, if you know the number of gas panels or gas valves, whatever phrase you want to use, in the higher end, can you maybe give us what that ASP would be versus kind of a more standard unit? I'm not sure how to phrase it. I'm not looking for the exact mix, because that's pretty much impossible for this, but what's the gas different than the content.

I think it's difficult for us to provide a specific range because it depends on the number of gases being added. If it's one or two, the increase in average selling price won't be very significant in absolute terms, but it varies by deposition application and each of our OEM customers. Therefore, it's challenging to offer guidance on average selling price for that particular inquiry.

Okay. Thank you.

Yeah.

Our next question comes from Tom Diffely with D.A. Davidson. Please proceed with your question.

Yes. Good afternoon. Maybe another question on the closure of the plastics facility. Was that driven at all by demand either being less than you thought, or geographically different than you thought, or was it purely just a cost savings restructuring program?

Well, I think the answer is it's a little bit of all. I mean, that part of the business wasn't scaling as quickly as the other gas delivery versus chemical delivery. We looked at the capacity that we have. We manufacture plastics in four sites. So, we had enough capacity such that we could go ahead and make the decision to close this between now and the end of the year and work to move those products into other facilities.

Okay. And then Jeff, what do you think you guys are as far as the EUV rollout does for gas panel revenues to your company? Are you still in the early innings? Are you getting close to kind of a steady state?

No. I believe we have low pressure gas delivery for every EUV tool, so we are involved with each of them as they are manufactured. We are currently working on at least three different types of products that they have: 34, 36, and 5000. We continue to collaborate closely with our customer in this regard.

Okay. And then finally, has any of the commerce department rulings impacted your discussions with the Korean or Japanese suppliers as far as not wanting to have U.S. content?

No. Not of any significance yet. Obviously, we read everything you guys read, and there could be maybe a net benefit to some of the local Korean OEMs. But I think when it comes to more advanced applications, I think they still have to rely on our other larger customers. Okay. Great. Thank you. You bet.

Our next question comes to Craig Ellis with B Riley. Please proceed with your question.

Yeah. Thanks for taking the question, and congratulations on the nice execution. Jeff and Larry, my first question was just clarifying gross margin. So, I think what I heard is that gross margins will rise in the third quarter and in the fourth quarter. And is the fourth quarter rise really on the last 100 basis points of COVID headwinds coming out of gross margin, or is that something else that's driving the sequential gross margin improvement?

I think there's a little more of some of our cost improvement initiatives in the fourth quarter and a little bit of product mix as we ship some more machining and components business. At least that's our expectation. COVID I think until we see a change in the distancing requirements and the restrictions and the cleaning, the extra cleaning we have to do today, I think that's going to be with us until that situation changes.

Makes sense. Thanks, Larry. And then, a large U.S. manufacturer pushed out a 7-nanometer project time, admittedly it was planned for next year. So, it's a ways away. But what if any impact is there for Ichor from that move?

I believe that if there is an impact on the amount of equipment sold by our customers, we will certainly feel some effects. The real question is whether that demand shifts elsewhere or if it is simply a delay in timing. I think the fundamental demand for the products remains strong.

Got it. Got it. And then lastly guys, just on the filing today, so nice to have that incremental $200 million of flexibility. But what was the specific trigger for doing so now? Is it that you feel like you have enough demand visibility that being able to move strategically, it's much more feasible? Is it something that you see with the opportunity set? Just if you could help fill in what the driver is to the current timing, that would be appreciated. Thanks, guys.

I think it's just something that the company has been discussing for a period of time. We wanted to consider putting a shelf out there just to ensure we had some flexibility should there be an opportunity that we couldn't fund, either from ongoing cash generation or the revolvers we had today and other kind of optionality to our capital structure. So, I wouldn't read much into the specific timing on this, other than we generally have some strategic discussions at the board level, and that decision was made here recently.

Got it. Thanks, Jeff.

You bet.

Thank you very much and congrats on a nice quarter. Jeff, I apologize if you've gone through this a few times already. But with the gross margins at where they are today and some of the improvements you see on a going-forward basis in terms of revenue growth being a contributor, what are some of the other key variables that are weighing on it today that you can, I guess, drive or help improve upon? Are there anything you're doing? You mentioned, I guess, the plastics restructuring and things of that nature, but what other efforts can you do internally to get gross margins up about 200 basis points as you go forward?

Well, I'll start and then maybe Larry can finish up. I think on the product side, we're trying to drive the growth in our components business. And in the initial phase of this particular ramp that we're seeing, we've seen our gas panel business outgrow our components business to some degree. That'll normalize as we start to see inventories recover in our customers. We saw a little bit of that, but largely any kind of inventory growth that we're seeing in our customers today is probably a little bit more around just the timing of everybody's recovery from COVID. So, we're going to drive incremental higher margin product growth. Obviously, we've done something on the plastic side from restructuring. We're driving other internal cost reduction programs. We will see some improvement quarter-over-quarter, and we continue to just drive it relentlessly within the company. And with that, maybe if Larry has any other comments.

No. You mentioned the product mix. The new products, including the next-generation gas panels, are important. If we can get those qualified and included in our revenue mix, that's likely the most significant long-term strategic move. Although it's a 2021 initiative, it's one of the aspects that Jeff highlighted.

Great. That's helpful. And maybe, Jeff, as a follow-up question, regarding the EUV lithography opportunities you mentioned in the past. As your customer transitions to its next-generation system and ultimately to the high-end A systems, how much additional content do you believe you can introduce as they progress to those next-generation systems?

What I mentioned earlier is that we are fulfilling every EUV tool they send us. We have the low-pressure gas ready, but the high-pressure gas requires more engineering and different expertise due to the varying pressure levels. This represents a long-term opportunity for us, but in the near term, there are other machining parts and weldments we could focus on instead. The average selling price of the gas distribution system is significantly higher than that of a process tool or edge tool due to the size and complexity of our work for them. As they advance technologically, we are seeing some appreciation in average selling prices, but not significantly, as the unit does not change much with each new generation.

Great. Thank you very much.

Okay.

Ladies and gentlemen, we have reached the end of our question-and-answer session. And I would like to turn the call back over to Jeff Andreson for any closing remarks.

Thank you for joining us on our call this quarter. I'd like to thank our employees, suppliers, and customers for their support as we manage through these challenging times. We look forward to updating you again on our next earnings call in early November. In the meantime, we were scheduled to participate in virtual conferences hosted by Needham next week and by Citi and Deutsche Bank in September, which will be available via webcast on our IR website. Operator, that concludes our call.

This concludes today's teleconference. You may now disconnect your lines at this time. Thank you for your participation, and have a wonderful day.