Good day, ladies and gentlemen, and welcome to Ichor's Second Quarter 2022 Earnings Conference Call. 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, Devin. Good afternoon, and thank you for joining today's second quarter 2022 conference call. As you read our earnings press release and you listen to this conference call, please recognize that both contain forward-looking statements within the meaning of the federal securities laws. These forward-looking statements are subject to a number of risks and uncertainties, many of which are beyond our control and which could cause actual results to differ materially from such statements. These risks and uncertainties include those spelled out in our earnings press release, those described in our annual report on Form 10-K for fiscal 2021 and those described in subsequent filings with the SEC. You should consider all forward-looking statements in light of those and other risks and uncertainties. Additionally, we will be providing certain non-GAAP financial measures during this conference call. Our earnings press release and the financial supplement posted to our IR website today 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 the prepared remarks, we will open the line for questions. I'll now turn over the call to Jeff Andreson. Jeff?

Thank you, Claire, and welcome to our Q2 earnings call. Q2 revenues were $330 million, at the upper end of our guidance range, and were up 12% from the first quarter. After several quarters of supply chain challenges that limited the industry's availability of components and appreciably constrained our output, we were pleased to see several areas of improvement in Q2. These improvements, along with strong operational execution and improving factory efficiencies enabled us to achieve record output and very strong financial results. As expected, we saw gross margins bounce back to 17%, with the higher revenue volumes now absorbing the investments we have been making to increase capacity across our footprint. These investments include adding to our manufacturing headcount as well as our physical capacity. Given the headcount we have in place today and the sequential growth we see for the remainder of the year, we expect to deliver continued gross margin expansion at these revenue levels. With continued close management of operating expenses, we exceeded the upper end of our profitability targets and reported earnings of $0.98 per share. We completed our clean room expansion in Austin during Q2, and we have enough brick and mortar in place in our weldments business to support the next several years. Selective expansions of capacity for strategic growth areas continue in Portland as well as in our machining business in Minnesota and Mexico, all in support of a $425 million level of capacity per quarter. Compared to a quarter ago, concerns about the sustainability of these unprecedented levels of wafer fab equipment spending have increased. A number of reports since our last call have indicated a slowdown in consumer-driven segments of the semiconductor industry, declining memory prices and an inventory correction, all ahead of an expected recession. Therefore, as a management team, we must balance managing the near-term business outlook while ensuring that we are investing for the future. We are working in lockstep with our customers to plan delivery schedules, optimize the supply chain and meet their end customers' demands. While we are all focused on the long-term demand signals that will impact our outlook for the next 2 to 3 years, given our current visibility, we expect to continue to achieve sequential revenue growth in the third quarter and through the forthcoming quarters as well. Despite the supply chain improvements and higher factory output levels achieved in the second quarter, customer demand continues to outpace supply, and we expect the unmet demand will continue to carry over into the forthcoming quarters until the supply chain catches up with demand. Industry forecasts recently tempered expectations for wafer fab equipment growth in 2022 to now about 9% or 10% growth over 2021 as a result of the limitations within the supply chain. Now that our output levels have picked up considerably and given the continued increases in output expected in both Q3 and Q4 of this year, we are well on track towards achieving our growth objective established earlier in the year of around 20% revenue growth for 2022. Revenue growth for Ichor approaching 20% this year would reflect faster growth compared to overall wafer fab equipment. Given the relatively strong performance of etch, deposition and EUV growth this year as well as the addition of IMG, I'm very pleased with the performance and growth trajectory of our IMG acquisition. They are seeing growth across their customer base, which includes semiconductor, defense and aviation, including commercial space. We now expect IMG to contribute between $75 million and $80 million of revenue for the full year. As I mentioned, as we look ahead to 2023, we are working in lockstep with our customers in planning delivery schedules through the next several quarters. Visibility continues to extend much further than historical cycles. Lead times remain elongated. And even with looming recessionary concerns, the majority of wafer fab equipment purchases are considered critical investments in technology and capacity, and so far, while there are some delivery schedule adjustments to align the supply chain, at this time, we are not seeing any pushouts of demand. Therefore, even though we have not experienced any changes in customer demand so far, we have a variable operating model and can quickly adjust. Should we begin to see any softening in demand or delays in our customers' delivery schedules, we have a number of levers we can utilize to adjust to any changes in volume, and we have a strong track record of managing the company profitably through periods of lower revenues. In the meantime, we continue to focus on investing in strategic and gross margin-accretive capacity additions and close partnerships with our customers in order to expand our share of our served markets, demonstrate strong operational leverage and make continued progress towards our long-term profitability objectives. Now I'll provide a brief update on the progress on some of the new products and in particular, the next-generation gas panel and chemical delivery systems. For our next-generation gas panel, we are still in the qualification phase for our first evaluation unit that shipped to a new customer. We had planned to ship our second beta unit by midyear and now expect to ship it by the end of August. This unit is shipping to an existing customer for a new application that is expected to outgrow the wafer fab equipment market over the next several years. As a reminder, both of these gas panel beta units are fully configured with Ichor content. We would expect both of these evaluations to extend up to a year. We remain confident and highly encouraged by the progress we are making with our customers for these proprietary gas delivery systems. In our chemical delivery business, the evaluations remain underway with a North American customer. We continue to work with this customer as we move through the evaluation phases for both programs. As we said on the last call, these evaluations are expected to be completed in early 2023. In summary, in a very challenging operating environment, the operations team did a very good job of maximizing output to address the customer demand we are experiencing. With our current visibility, we are expecting to report sequential growth in record-setting revenues for the forthcoming quarters. For the full year, we are well on track to deliver on our objective to outperform industry growth and deliver record results for both revenue and earnings per share.

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. Second quarter revenues were a record $330 million, up 12% from Q1 and 17% higher than Q2 of last year. Revenues increased in every business segment and with every key customer, both sequentially and year-over-year. With revenues at the upper end of expectations, gross margin of 17% also reflects the higher end of our guidance and a 100 basis point improvement over Q1. Q2 operating expenses were $22.9 million, in line with our forecast and up about 2% from Q1. The resulting operating margin was 10%, up 160 basis points from Q1. Interest expense was $2.1 million, largely as a result of higher interest rates, and the increase was partially offset by positive foreign exchange adjustments as a result of the strengthening U.S. dollar. The total interest and other expense was $1.5 million. Our tax rate was 10% for the quarter, lower than forecast, which drove upside in earnings per share above the high end of our guidance range. The resulting earnings per share was $0.98 for Q2, $0.04 above the high end of the guidance range. Now I will turn to the balance sheet. As expected, cash conversion of working capital improved in the second quarter compared to Q1. Inventory turns were flat quarter-over-quarter and receivables DSO improved 4 days to 44. We generated $9.4 million in cash flow from operations. With $11 million of CapEx in the quarter, free cash flow was slightly negative. We increased borrowings on our revolver, and the net increase in total debt was about the same as the net increase in total cash at $13 million and $12 million, respectively. Going forward, we expect strong free cash flow generation given the revenue forecast, along with the working capital investments we've made year-to-date. Now I will turn to our third quarter guidance. With revenue guidance in the range of $320 million to $360 million, our Q3 earnings guidance is $0.85 to $1.11 per share. At the midpoint of $340 million in revenue, which is up 3% sequentially and up 29% year-over-year, we are expecting gross margin improvement of about 30 basis points compared to Q2. Our Q3 operating expenses are expected to be approximately $500,000 higher than Q2, consistent with prior expectations that our quarterly OpEx run rate would be moving up a bit with incremental investments in R&D, audit and IT. We expect our interest expense will be approximately $3 million in the third quarter, reflecting the recently announced increases in interest rates. Our tax rate in Q3 is expected to be in the range of 11% to 12%, and we estimate our fully diluted share count to be approximately 29.1 million. Finally, we continue to expect CapEx to be around 3% of revenues for 2022, which reflects the higher levels of investments required to support our machining business. We expect to deliver improving free cash flow performance as we move through 2022.

Our first question comes from Tom Diffely with D.A. Davidson.

Appreciate the chance to ask a question today. So Larry, maybe first on the guidance. So obviously, revenue up 3% or so quarter-over-quarter, EPS flat. It looks like that's a combination of slightly higher expenses and a slightly higher tax rate. Are those the main drivers?

That and also the interest expense is up approximately $900,000 quarter-to-quarter.

Okay. And then what's driving the increase in the margin itself? Is that mix? Or is it efficiencies?

There's a little bit of efficiency there, a little bit of volume and also our mix as we continue to drive machining revenue higher.

Great. Okay. And then, Jeff, maybe just a clarification first. You gave guidance for hitting the 20% target for this year's revenue growth ahead of the industry. Does that include the IMG, $75 million to $80 million? Or is that excluding that?

That includes it. We're operating in a constrained environment, so I believe those results are quite strong. We're really pleased with what's happening at IMG, as they are now performing at the upper end of our expectations, which were $75 million to $80 million coming into the year.

Are there particular capacity constraints there?

No, we're doing pretty well there. I think we have some more capacity to get there. We've added some capacity also in there as part of our investments this year as well.

Great. And then as my final question, when you look at the beta system shipping here in August or later in August, does that system reflect kind of the full Ichor content over time? Or will it continue to rise as you add developed individual components?

Yes. The first two have about as many components as we are going to drive to, and most of the higher IP value-added parts or things we have designed, like flow control valves and blocks.

Great. Okay. That's nice to hear. And you said it was going to take about 1 year, you thought, for the beta sites to turn the volume.

As you know, you put them on a lab tool and they've got to run for up to a year as long as they need to run across different processes and things like that, and we'll keep you up-to-date as we progress through those.

Our next question comes from the line of Patrick Ho with Stifel.

Jeff, regarding the current demand environment and supply limitations, you mentioned in your prepared remarks that supply constraints are affecting deliveries. From your viewpoint at Ichor, how significantly do you think these supply constraints are impacting your potential revenue for 2022?

We haven't specified an exact number, but it's significant enough that it will take us a few more quarters to increase supply. The supply constraints have mainly narrowed to electronic components, and we are still dealing with some challenges in that area. While I can't provide a specific figure, I believe we will be close to resolving these issues by the end of the year, assuming we continue to see sequential growth. This is of course dependent on current conditions remaining stable, and we don't anticipate major changes at this moment. However, the situation can be unpredictable, so it might extend into the first quarter of next year, depending on how fast other suppliers respond.

Great. That's helpful. And maybe as my follow-up question for Larry, in terms of the supply constraints and the moving pieces with gross margins, what would be the biggest variables or the biggest impact for continuing improvement through the rest of this year? Is it simply the efficiencies really coming into play? Or are there absorption benefits? What's going to be the biggest influence on potential gains through the rest of this year?

I believe it's a mix of volume efficiencies and leverage that will become more apparent as we move into the upcoming quarters. Additionally, the logistics costs, which are likely the largest factors influenced by COVID or supply chain issues, seem to be improving slightly. When considering our current position and outlook, along with the ongoing supply chain challenges, we often expedite shipments. While we can recover some of these costs from our customers, we do share some of the burden. Therefore, I think these factors are the primary contributors to the improvement, alongside our efforts to enhance the components and machining business.

Our next question comes from the line of Trevor Janoskie with Needham.

This is Trevor Janoskie on for Quinn Bolton. I wanted to clarify the outlook for the sequential growth in the coming quarters. Did you mean fourth quarter greater than third quarter and first greater than fourth? How far out does that comment extend?

We see sequential growth as we approach the end of the year. There is a lot happening in 2023, but currently, we are experiencing some sequential growth. It may not be a significant leap, but our outlook indicates continued sequential growth.

Okay. And as my second question, I'm wondering if recent conversations point towards your customers becoming more cautious with respect to the current memory spending outlook.

I think the way you think about the memory spending outlook is that, yes, there's some caution there, but there's also a lot of this unmet demand is in other segments. And so as we kind of look at it, there's a little bit of softening in memory. And obviously, we listened to the Micron call today, and everybody on this call, I'm sure, has too. So we know that some of the DRAM pricing in memory is clearly softening. But there's strength in other areas. And as we kind of said in our prepared remarks, a lot of this is being driven by both incremental demand in foundry and logic, which is just remaining very, very strong as they kind of migrate down the node. And you're seeing increases in the total amount of equipment they need to put out the same wafer. So there's still a lot of things moving. Way too early to tell you about 2023 much other than my prior comments to the outlook that I just mentioned. So I think through this year, we'll see sequential growth. Right now, we believe that Q1 will be larger than Q4, but things can change between now and then. So I'm not ready to guide all of 2023's outlook.

Our next question comes from the line of Krish Sankar with Cowen.

This is Robert Mertens on behalf of Krish. I guess just first, could you provide an update on the IMG business? Did you mention what the contribution was in the quarter? I'm just trying to break out away from the $70 million to $80 million full year comment.

No. What I did mention was that we expected the revenue to be in the range of $75 million to $80 million, which is in the upper half of our initial forecast for the year. We haven't discussed specifics regarding profitability, but you can assume it will be similar to what we mentioned for our machining business, which is in the high 30s to low 40s, depending on the product and mix.

Okay. That's helpful. And then just in terms of the margins, the target getting back towards the 18% sort of exiting that year, is that still sort of how you're thinking about it?

Well, obviously, that's what we're driving to. I think when you look at a lot of what we see as the unfulfilled demand, that is in the gas integration space, and so those carry kind of lower margins. So mix will have an impact. If we kind of see our revenue continue to grow, as Larry alluded to, on the machining business, we could get there. But I think at this point, it might be a bit of a stretch given just some of the constraints we see. And as they improve, we're just going to catch up on the gas box. So the mix might hurt us a little bit. But it's not out of the question.

Our next question is a follow-up question from the line of Tom Diffely.

So Jeff, a quick question. If memory does slow and demand shifts from memory to logic next year, I assume your combination of inventory and capacity are pretty fungible, but I wanted to double check and see that was indeed the case.

Yes, it's entirely interchangeable since every site can support all major areas. I would say Singapore has a larger etch component compared to some other sites, but overall, everything is largely interchangeable.

Okay. And then finally, when you look at the CHIPS Act, is there any direct assistance to you? Or is it going to be indirect through your customers?

Well, that's a good question. I haven't dug through the specifics of what might be available to us. We'll be doing that now that it's been signed and passed. I think that, in general, you'll see a bit of a tailwind. How big it will be and over how many years? I don't know, but I think it's just additive to what we're seeing today. So it's a good step forward, and it's not going to have any negative impact on us. Either way, we're going to end up with some favorable tailwinds out of that.

Our next question is from the line of Michael Mani with B. Riley.

This is Michael Mani on behalf of Craig Ellis. My question is about your capacity increases over the next few quarters. I understand you mentioned a target of $425 million per quarter in terms of capacity. Could you detail when you anticipate achieving that goal and what milestones are necessary to reach it, particularly with your facilities in Mexico and elsewhere?

Yes. I mean I think that when you look at kind of the footprint, most of the brick-and-mortar plans are kind of in place. So now it's about fit up and fill up. And so those can be toggled with the outlook faster or slower. And that's how we kind of think about it. We want to look at the brick and mortar and make sure it's there. A great example is, in the last downturn, we did a bunch of the facilitization of an incremental floor in our Singapore facility. And then as we needed it, we turned it on. So that's kind of how we approach our capacity add. So to give you a specific time is probably middle of next year is probably as fast as we can move to get all of that in place, and it will be coming into place as we go along.

There appear to be no further questions at this time. I'd like to turn the floor back over to Jeff Andreson for closing remarks.

Thank you for joining us on our call this quarter. I'd like to thank our employees, suppliers and customers for their ongoing dedication and support as we continue to execute against this historically strong demand environment for our industry. Our upcoming investor activities include the D.A. Davidson Big Sky Summit on August 22, the Needham Virtual SemiCap Conference on August 25 and the Jefferies Annual Semiconductor Conference in Chicago on August 30th. We also look forward to our next quarterly call scheduled for early November. Operator, that concludes our call.

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