Good day, ladies and gentlemen, and welcome to Ichor's Third Quarter 2020 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. Claire, the floor is yours.

Thank you. Good afternoon and thank you for joining today's third 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 COVID-19 on our operations, 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 release, those described in our annual report on Form 10-K for fiscal year 2019 and Form 10-Q for fiscal Q2 2020 on file with the SEC and those described in subsequent filings with the SEC. As noted in those aforementioned filings, we remind you that the COVID-19 pandemic continues to create significant 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 third quarter results and fourth 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 Q3 earnings call. I trust and hope that all of you and your families are staying healthy and safe. Today, we reported another strong quarter of results with Q3 coming in above the midpoint of both revenue and earnings guidance. Revenues were $228 million, up 3% from Q2 and our sixth straight quarter of sequential revenue growth. Gross margin increased 60 basis points, operating margin increased 90 basis points and earnings per share grew 15% over the second quarter. We also had a strong cash flow quarter with free cash flow of $21 million for the third quarter. Our results for the third quarter demonstrate our continued execution of our stated objectives, to outgrow the industry and grow earnings faster than revenues. Year-to-date in 2020, revenues are up 55% and and EPS is up over 120% over the first 9 months of 2019. The global wafer fab equipment, or WFE market, continues to be strong as we near the end of 2020, with full year growth expected to be up around 15% from 2019. We continue to see strong levels of demand from our customers. And at the midpoint of our Q4 guidance, we anticipate a seventh consecutive quarter of sequential revenue growth, and we also expect continued sequential increases in gross margin, operating margin and earnings per share. At the midpoint of Q4 guidance, our revenue growth this year will be 45%, approximately 3x the overall industry growth, and our EPS increase for the full year will be about double the rate of our revenue growth. I continue to be amazed by our employees and the supply chain partners who are working closely together to deliver such strong performance and a record sales year for Ichor in 2020. I want to thank our…

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 Investors section of our website for reference during this conference call. Third quarter revenues were $228 million, up 3% from Q2 and up 47% from the same period last year. We have experienced no additional COVID-related restrictions on our manufacturing sites. And as a result, we came in above the midpoint of revenue guidance due to continued strong levels of customer demand and excellent execution in a challenging operational environment. In spite of these challenges, we reported our sixth straight quarter of sequential revenue growth. We also achieved sequential growth in gross margin, operating margin and earnings per share. Gross margin for the quarter was 14.6%, up 60 basis points from Q2. We continue to face COVID-19- headwinds, which impacted gross margin by about 100 basis points in both Q1 and Q2 and by about 50 basis points in Q3. While the heightened freight and material sourcing costs have largely normalized since the first half, we still face higher costs associated with ensuring the health and safety of our global workforce. We continue to make progress on our ongoing cost reduction programs in order to drive further incremental improvements to our gross margins in a continued healthy customer demand environment and expect about a 50 basis point improvement in gross margin for the fourth quarter. Operating expenses came in a little lower than…

Our first question comes from Craig Ellis with B. Riley Securities.

Congratulations on the nice results and outlook, guys. But Jeff, I just wanted to start by following up on some of your comments on the current environment. So it seems like 3 months ago when you got the crystal ball out, it was pretty accurate for the second half of the year, and I'm wondering if you can provide us any commentary on what you see as you look beyond the fourth quarter in the early calendar '21.

That's a good question, and thank you for your kind words. Yes, I would say, based on what we're seeing today and through the outlook that we have, we see a continued strong quarter as we enter 2021. I mean obviously, it's too early to give specific guidance, but we do see a strong demand environment moving into the -- at least in the first half of next year.

That's helpful. And then, Larry, you wrapped up your comments talking about some of the things that were going to drive gross margin higher in calendar '21: cost reduction, ongoing market share gains and then increased IP quotient and sales. Can you just help us understand the degree to which those can be at play as you go through the year? Are some of them more first half weighted than back half weighted? Or how do we think about their potential impact to gross margin in calendar '21?

I think some of the things we've talked about, clearly the cost reduction programs continue quarter-by-quarter, just general operating cost reductions, areas of material savings. There are some logistic savings activities. So those will show up in the first half. We also mentioned last time our plastics business with the shutdown in our Union City facility and kind of our rightsizing cost structure there. We expect in the first half of next year that we'll see some of that benefit. We continue to gain share in the weldments and precision machining areas. Those -- in precision machining in particular, those do take a little bit longer as we have a longer qualification cycle. So we'd expect those to go throughout the year. And the last thing around the proprietary IP, that's a longer play, a multiyear play. Jeff's talked about some of the penetration that we're working with some of the beta sites and other things. But I think to see a meaningful [Technical Difficulty] in gross margin, you'll see that second half of next year and particularly in the years to follow after that.

Got it. If I can just sneak...

What I was just going to say is we're very, very focused on this for obvious reasons. But we do continue to see improving gross margin. We have plans in place to continue to drive this back up.

Yes. Good. And nice progress certainly in the back half here. If I could just follow up the gross margin question with an expense question, Larry. I would expect most companies would be facing [Technical Difficulty] to FICA and maybe just fringe costs in the first calendar quarter. But beyond that, is there anything we should be aware of as we think beyond the fourth quarter with operating expense?

I think there's a few things. Smaller effect of insurance. As you can imagine in this environment, the insurance industry is sort of giving us some pretty sizable increased outlook. The other thing is on our R&D programs. As we penetrate some of these customers, we would expect to be spending a little bit more in R&D for some of the beta units and other investments there. But in general, I think we also have -- next year, as you're probably aware, we have to be SOX compliant. That drives cost both inside the company and then with our external auditors. We would expect that they will charge us more to certify that. I'm expecting that, and we'll be sizing that over the next couple of months here, yes.

Of course, they will. Guys, keep up the good work and the good operations.

Thanks.

Thanks.

Our next question is from Sidney Ho with Deutsche Bank.

I have 2 questions. The first one is, if I kind of look at your third quarter, it's a solid quarter. But it is a little bit -- if I look at other suppliers in the supply chain, they have some more upside to the midpoint of the guidance. So my question here is, how would you describe the linearity of the quarter versus your expectations? Did you see anything in the latter part of the quarter that would suggest some slowdown? And do you think your main customers have caught up with inventory and your revenue now really reflects a more steady-state demand profile?

It's Jeff. I'll try to answer it. One is, I think as companies came out of Q2 and into Q3, we were all at various degrees of recovery. So when you say a little bit more upside, it's hard to judge that. What I would tell you is that the demand environment and the profile of the quarter was, I'd say, slightly more linear than we've seen, but it's still not perfectly linear, and it's -- so we didn't have any softening at the end of the quarter for sure, and we continued with a pretty strong -- more linear outlook as we go into Q4. So the demand environment is still very good.

Okay. That's great.

The last part of the question was around inventory. And so I would say with the gas delivery side of the business, there's not much in the way of any inventory build. Those are very customized products, and they generally cycle to their customers probably somewhere around 2 to 4 weeks once we deliver it. So very little inventory between the 2. And I would say that we're seeing a very small amount of inventory build on the component side of the business, but it's very, very small still.

Okay. Great. Maybe my follow-up question is on your share gain opportunities, particularly in Korea and Japan. Can you walk us through what's happening in Korea? Do you have some qualifications in Japan? You were talking to a number of new customers. But then when you say meaningful contribution in 2021 for both of these, I'm just trying to see the profile. Is it going to be early in Japan? Is it going to be first half versus second half? Is it one customer, say, multiple customers? How do you think about the 2021 kind of revenue ramp for these 2 countries?

Yes. I would think -- based on what I see today, I would say if we win a position, it'll be in Korea first since we've been working on that the longest. We're in the midst of an evaluation there on their process tool. And that can be meaningful in the fact that, that particular customer has a fairly good position in the claims business. I'd say in Japan, it's a little bit slower. COVID restrictions are very tight in Japan. In other words, our partner still can't do face-to-face meetings. But that's starting to relax a bit. So -- but I'd say the dialogue has continued. It's just a little more difficult just to position a first beta tool. But we have several ongoing discussions with probably 3 or 4 Japanese OEMs, and we'd hope that we get one of those designs and get a beta out there. And then that will give us a little more clarity. But certainly the earliest, I would say Japan in second half of 2021.

Our next question is from Krish Sankar with Cowen and Co.

Jeff, I had a couple of them. First one is, when I look at you and some of your peers, too, over the last 5 years, you guys have outperformed when WFE is up and underperformed when WFE is down. You said that next year, WFE could be up 5% to 10%. Without looking for any guidance, let's say it is true that WFE will be up 5% to 10%, is it fair to assume you could outperform in that environment?

Yes. I mean that would be -- if you ask me, we have put strategies in place. Some of the share gains we have going on this year will affect next year. We have long-term plans in place. So yes, I would expect that we could outperform WFE again next year, particularly because we're going to see a memory recovery. And so based on what we can see -- and we have a Korean operation, so we get pretty good visibility into Korea. We're starting to see the momentum building on the memory side. And memory is very etch and dep centric, and that's very good for us as well as our customers. So we have very good positions in 3D NAND as those investments increase in DRAM. So again, it'll be driven a little bit by what we're actually doing from share gains and other programs as well as just a recovery of memory and the effect that has on dep and etch. And our customers are interested in that.

Got it. That's very helpful. So it looks like it could be a $1 billion revenue year next year, hopefully. I have 2 other questions for you. One is, when I look at your guidance, and I'm not saying [indiscernible] any such thing. But if you compare it to the prior Q, you're kind of getting to similar revenue levels. But arguably, there's still a long runway left for memory. So going back to like early part of 2018 when you're running at like north of $250 million in revenues on a quarterly basis, so now is there a way you can quantify how much incremental share gain you've got or how much has been the market improving, EUV driving? Is there any way you can like help quantify what has driven above-market growth over the last 2 years? And then I've got a follow-up.

Yes. I wouldn't say I'll quantify it specifically, but we did say that we exited 2019 with about a $100 million run rate in share gains. If you think the market is up 15%, then that's now equivalent to about $115 million, and what we pushed through the P&L in 2019 was, say, $70 million. So that's a big chunk of the growth going forward. We have share gains. We haven't quantified this year. That'll have a full effect going into next year. And EUV has been a very -- I would say that customer is pretty transparent. So you guys know the ramp of EUV, and our revenues have probably grown along side that and possibly a little bit higher just as the content has increased from generation to generation as well. So yes, I think we're positioned. I mean kind of the chemical side of our business in Asia is the next -- is another next kind of step function that with a few qualifications can have meaningful revenue into 2021 as well.

Got it. Got it. And then just a final question, Jeff. Is there a way you can -- on the EUV side, is there a way you can quantify what your dollar opportunity per EUV system is?

We can, but we don't do that for obviously competitive reasons. It's a significantly larger unit. It's very specific to the tool. And so it's multiples of a typical gas panel. So -- but we don't generally quantify that.

And our next question comes from Quinn Bolton with Needham & Co.

Great. I had a kind of follow-up on the share gain opportunity. You've said for a while now that you thought the precision machining parts was going to take a little bit longer, and it sounds like that's proving out to be the case. But wondering, as you sit here today, are you starting to see better traction on the precision machining parts side of the business? Or do you think those share gains and the revenue opportunity is still ahead of the company?

No. 2020 includes some share gains that we've gotten out of our -- we call our precision machining side of the business. They're not insignificant. There are qualifications that are deep in the cycle as we speak today that can be multiple million dollar wins as we go forward. So probably, those will be late -- earliest is late Q4, but they'll be kind of a 2021 -- largely impact 2021 versus 2020. And so we continue -- and then on the weldment side of the business, it's basically just leveraging our operational capabilities in the market for all the opportunities that come up, drive for incremental market share gains, which we've done pretty well on again this year.

And I'm sure I'm not going to get you to size it, but just order of magnitude, do you think that the revenue opportunity for precision machining is -- is that accelerating in 2021 or is that opportunity just growing in line with WFE then?

Oh, it should outpace WFE. As we win these positions, they'll layer on. And again, as you guys know, it's -- our precision machining generally is in the flow of gas. So it's pretty sticky demand. So once you win it, it stays with you for a long, long time, and it's very customized by process tool. So no, that could -- that's part of the strategy that Larry talked about. We want that mix to outgrow just the growth of the overall industry, and that's where we get the margin accretion, too.

Great. Second question, it sounds -- obviously, I think you're seeing and your customers have already seen some strength in the NAND side of the business. Your comments sound like you've got pretty good visibility for the memory to continue to be healthy into the first half of 2020. But just wondering, do you think that, that's sort of now reached the sort of a steady -- not a steady state but sort of more of a stable level where it will continue at sort of current levels into the first half? Does the momentum appear to be growing as you look at the quarterly run rate in the first half of '21 versus '20, the fourth quarter of '20?

Yes. I think we've seen very good growth from first half of 2020 to 2021. And I would say, based on what we're seeing just out of our Korean operation, that we see a similar positive and slight positive growth in that side of the business as we go into 2021. In particular, that application, as we've said before, is pretty NAND centric. So that's good to see, that spending start, again as well. And we do see DRAM investments both in the fourth quarter and going into the first quarter of next year in that particular region where we have pretty good visibility. So I think you've seen the pricing environment stabilize, and that usually triggers the recovery in memory. And I think we'll see a good, strong year in memory next year. Whether I can pick the peak, probably not close enough to it. You'd have to kind of ask our customers who are close enough.

Got it. Got it. And then last one for Larry. Larry, cash flow. It has been pretty strong over the last couple of quarters. I think you're sitting on nearly $80 million in cash, and it sounds like you project cash to go up again in the fourth quarter. How should we think about that cash? Do you think of the opportunity to get a little bit more aggressive with paying down debt now that the COVID is hopefully, at least, stabilizing? Do you keep that cash on the balance sheet just given uncertainty or perhaps fund M&A? How should we be thinking about cash as we head into '21?

I think in general, we're keeping -- well, keeping our flexibility we put in the shelf. We have some flexibility on our revolver. I think in general, our thought is to hold on to it for the time being, and the interest rate on that borrowing is down in the 4% range overall. So I think we want to maintain our flexibility. We want to be ready if there's M&A opportunities that we can execute on and then just continue to focus on operational execution. And at some point, if we see an excess cash position, we might do something different. But I think now, we're sort of keeping it steady state. And we're pretty comfortable with where we are on our debt position, and we're comfortable with the fact that we've been able now to generate some pretty good cash flow and look to do that again in Q4.

Our next question is from Mitch Steves with RBC Capital Markets.

I had a few. But I wanted to start on the gross margin line first. Just looking at the guide, you're talking about a 50 basis points improvement from September to December. But prior to this, when you're kind of like at the $240 million range sort on revenue, I mean, your gross margins are up like 16%-plus. So I'm just curious if that $15.1 million implied guide includes a 100 basis point impact from COVID, if you're going to start to see some improvements there. Any sort of information would be helpful.

Now we've talked about -- the $15.1 million, we still have around a 50 basis point headwind due to COVID between PPE and the -- we have to hire more people. We're obviously changing our shift strategies and other things. So that'll continue, I think, until there's a vaccine or a significant change in protocol around social distancing and the things we have to do there. So that's still a headwind. And until the COVID situation changes, we sort of expect that to continue at least through the beginning of 2021. The other things that we've had that have impacted us, we've talked about these before, one is we gained a fair amount of share in gas panels in our #2 customer. And that's changed our mix. As you know, our gas panels in general are below the corporate average in margin. And that share, that's a little bit of a headwind not on an absolute dollar perspective but clearly on a percentage perspective. We also added a lot of capacity between 2018 and now. We've talked historically about having brick-and-mortar capabilities to go north of $300 million in revenue per quarter. And until we get there, we're sort of ready for the growth, but it does create a little bit of a headwind for us on margins. And then finally, I think the other thing we've talked a little bit about is the plastics business, and we're working on rightsizing the cost structure and working on some products that will improve that as well.

Understood. And then turning over to ASML and kind of the comments you guys made there about EUV ramping up. They've already stated that 2020, some units got pushed to '21. So I'm curious as to how -- like what the scale of the ramp is there. I know ASML has always been kind of a, call it, mid to high single customer. Is that going to continue to improve as a percentage of revenue? Or is DRAM going to improve at such a rate that you don't think that ASML will become a bigger customer for you next year?

Yes. It's Jeff. So Mitch, with ASML, I'd say they're pretty transparent. But one thing to keep in mind, we build probably about 5 months before they can deliver. We go in early in the build cycle and the qualification cycle. So what we're building in the second half pretty much is addressing the front half. I can't be specific, obviously, for the customer, but we see steady growth going into next year. And so ASML is -- just think of it as a steady grower. But for it to become a 10% customer, it would have to get significantly bigger than it is today mainly because as you look at our outlook, is -- if you take the midpoint of guidance, around $900 million, so that's a pretty big number going forward for them to cross. So they'd have to grow quite a lot.

Okay. And then just last one just in terms of the DRAM versus NAND side. I mean there's been a clear debate on the NAND side that for kind of its level, it can't much higher than this. And then DRAM side, you're starting to see some green shoots, whatever you'd like to call it, in terms of improving demand there. So maybe you can just help us understand what you guys think '21 looks like for you guys in terms of what end market, DRAM or NAND, in terms of scale of revenue growth is going to look like.

Yes. So just to be clear, we don't get to see all of the applications for the gas panels that we ship, so we're not the perfect one to ask about magnitude of DRAM versus NAND. We get more visibility in Korea because we have an operations there. So we do see both investments in 3D NAND picking up and DRAM picking up in that region. But I'm probably not the best one to call it for the full year next year.

Our next question is from Tom Diffely with D.A. Davidson.

This is Franco on behalf of Tom today. I have a few questions. So I want to start on the last topic that you talked about, the DRAM side. I know that in the past, you've kind of expressed your desire to gain more exposure on DRAM, particularly with your liquid delivery module gaining traction in Asia. Can you perhaps give us sort of an update on the progress on this effort?

So yes, sure. But I -- just maybe to be a little more specific, it's -- liquid delivery is not -- I'm not sure if you inferred that or not, if I misunderstood, but it's not a DRAM application per se. It can address any wet chemistry application, so it can go across all of the different applications. Today, we're qualified on one large customer through one of our OEM customers today in the U.S. We have a beta in process in Korea with probably the third or fourth largest clean manufacturer. And again, in Japan, as I said on the call, we're kind of in the early innings. But I'm pretty happy with the level of engagement we're having with some of the largest OEMs in Japan through our partner there.

Okay. No, that's helpful. And then I have one for Larry. You talked about the R&D pushout. I guess do you have any details on that, on what the push out was regarding to? And then when you're looking into 2021, how should we think about your R&D investment?

Well, I think in general, some of the new programs, there's nothing -- there wasn't a specific program pushout in R&D. It's just the timing of when we're bringing in some consultants and some engineering materials. So it's nothing specific around a specific product. I think going into 2021, overall, we expect our OpEx to run sort of what it's been doing, which is about half the growth -- about half the rate of the revenue growth. And I think if you look at R&D, we would expect that piece of R&D and that OpEx to at least be that. I think as we penetrate new products, we're going to be ready to make the investments we need to drive these new products successfully into the market to help drive up our margins. So you can think of R&D getting not necessarily the lion's share, but it probably is going to be the biggest percentage grower within that 50% of revenue growth model.

Our next question is from Patrick Ho with Stifel.

Jeff, maybe just going back to the mix of your business as you look at the December quarter. Obviously, demand continues to be strong. That's probably going to increase the number of gas delivery system. But can you talk about a little bit of the mix of weldments and precision machining? Are they increasing at the same rate? So you're going to see the same, I guess, percentages of the business you saw in the September quarter? Or is the mix shifting a little more to some of the other products aside from gas delivery systems?

Yes. I think, Patrick, it's a good question that might take 3 parts to answer, but I'll give it a shot. So if you look at this year, we're going to do, say, around $900 million given our Q4 guidance. Our last peak was in the low 800s. We know we've layered on about $115 million or so of market share gains, plus the market has grown. So the gas panel side of the business is kind of -- was one of the bigger chunks of that market share gain. So -- but I would say over the last quarter or so, we were pleased with the performance that we got out of and the growth out of both our precision machining and weldments side of the business. So now that we've kind of won that last big piece and -- on the gas side, we're going to see the mix now improve for the component side of the business. I can't give you the specific numbers, but that is part of our gross margin accretion plan. It's been part of our strategy to outgrow the market, and we've done very, very, very well so far. Much longer qualifications, obviously, for precision machining measured in months and months and months, whereas you can do much faster on the weldment side. So we do see those weldment wins happening, I'd call it, pretty ongoing now. In precision machining, you're trying to qualify maybe a family of parts or something like that, and so those will come with bigger chunks. So I like where we're at in the progress of both those businesses.

Great. And maybe just as a follow-up to that, Jeff. The 2 of us have been in this industry a long time. With the precision machining business, the qualification that you just said take a longer time. Are there ways for you to "qualify" multiple, I guess, components or parts on that side of the business? Or is it usually kind of step-by-step you have to get this qualified first and then it goes to step B and then, I guess, step C to get other parts qualified?

No. You can get family of parts qualified provided they're very similar manufacturer. If there's any significant changes in the manufacturing process, you might have to do them differently. But some of the qualifications we're doing now are for, I call them, part families. So there'll be many, many part numbers.

Great. And final question from me for Larry. Inventory turns still pretty stable. But some of your leading customers have talked about, I guess, kind of building a little bit of inventory for themselves given the demand environment as well as the uncertainty in the market. Has that impacted your procurement of inventory on your end?

No. I don't think so. I think we were at 5.4 turns. We're not seeing, I think as Jeff mentioned, a ton of inventory growth. So people may talk about it, but we're not seeing a lot of it. I think in general, though, we want to stay within our kind of turns range, grow it a little bit more. And -- but we haven't seen any material change in behavior.

Yes. I mean the customer -- the inventory that the customers are holding -- we're still in a pretty good demand environment. And while we're all feeling good about where we're at, we're still -- there's not the ability to just build inventory on their side. We are building our consignment-level inventory. And so some of -- even though our inventory went down, there was actual growth there. So we've done a really pretty good job of becoming more efficient within our manufacturing process and as well as supporting our customers' needs for the inventory we put on site for them.

Ladies and gentlemen, we have reached the end of the question-and-answer session, and I'd like to turn the call back 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 support and strong execution in this operationally challenging environment, but with -- but very strong growth here in 2020. We look forward to updating you again on our next earnings call in early February. In the meantime, we are scheduled to participate in virtual conferences hosted by Stifel, RBC, UBS and D.A. Davidson, as well as a Virtual CEO Summit during Q4. Operator, that concludes our call.

All right. Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank you, everyone, for your participation.