ICHOR HOLDINGS, LTD. — Q3 2017 Form 10-Q
Business and period: Ichor designs and manufactures fluid-delivery subsystems and components for semiconductor equipment. This unaudited report covers the 13 weeks ended September 29, 2017, and the 39 weeks ended that date; comparisons are to the corresponding periods in 2016. Amounts below are in millions of dollars unless noted.
Financial performance and position
| Metric | Q3 2017 | Q3 2016 | First 9 months 2017 | First 9 months 2016 |
|---|---|---|---|---|
| Net sales | $164.5 | $105.7 | $473.0 | $274.3 |
| Gross profit / margin | $24.2 / 14.7% | $16.9 / 16.0% | $71.7 / 15.2% | $44.0 / 16.0% |
| Operating income | $8.6 | $6.7 | $33.9 | $14.2 |
| Net income from continuing operations | $14.3 | $7.7 | $37.7 | $12.8 |
| Net income | $14.3 | $7.7 | $37.0 | $8.7 |
| Operating cash flow | Not reported by quarter in this filing | $0.9 | $4.0 |
- Q3 sales rose 55.7%; nine-month sales rose 72.4%. Management attributed growth to industry demand, market-share gains, and acquisitions, including Cal-Weld and Ajax.
- Gross margin declined 130 basis points in Q3 and 80 basis points for the nine-month period. Q3 results included a $3.0 million Cal-Weld acquired-inventory fair-value charge, which management said reduced margin by 180 basis points. The nine-month margin also reflected a $1.75 million inventory translation correction, a 40-basis-point impact; Cal-Weld contributed accretive margins, partly offset by lower manufacturing efficiencies.
- Q3 operating expenses increased to $15.6 million from $10.2 million, including higher SG&A, acquisition costs and acquired operations. Nine-month SG&A also included an approximately $1.0 million charge following an Ajax working-capital arbitration ruling.
- Reported tax benefits were unusually large: $6.6 million in Q3 and $5.6 million year to date. Q3 included a $5.3 million benefit from releasing a valuation allowance following the Cal-Weld acquisition and a $1.6 million benefit from recharacterizing intercompany debt as equity. Management’s non-GAAP adjusted net income from continuing operations was $16.3 million in Q3 and $46.4 million for nine months, versus GAAP continuing-operations income of $14.3 million and $37.7 million, respectively.
- At September 29, cash was $42.0 million, restricted cash $0.9 million, and total debt principal $69.5 million ($67.7 million net of issuance costs); $1.2 million was current. Debt carried a 3.28% variable rate and the credit facility matures in August 2020. Cash less debt principal was approximately negative $27.5 million.
- Current assets were $216.5 million and current liabilities $106.4 million. Receivables were $59.4 million and inventory $110.6 million, up from $26.4 million and $70.9 million, respectively, at year-end 2016.
- Nine-month operating cash flow was only $0.9 million despite $37.0 million of net income, principally reflecting increases in receivables and inventory. Investing cash outflow was $53.7 million, including $49.5 million for Cal-Weld; financing cash inflow was $43.0 million. Cash and restricted cash declined $9.8 million to $42.8 million.
Material developments, outlook, and risks
- On July 27, 2017, Ichor acquired Cal-Weld for $56.9 million; reported Q3 results included about two months of its operations, contributing $23.4 million in sales and $1.4 million in continuing-operations income. Purchase-price allocation remained preliminary.
- Subsequent to quarter-end, Ichor agreed to acquire Talon for $130 million, subject to customary conditions and regulatory approval, with closing expected in Q4 2017. The company anticipated funding approximately $120 million with incremental term borrowing and $10 million with cash. This proposed transaction would materially increase debt.
- Management said available cash, revolving-credit availability, and operating cash flows should cover anticipated working capital and capital expenditures for at least 12 months. The filing provides no numerical earnings or revenue guidance.
- Customer concentration is significant: Lam Research and Applied Materials were the two largest customers in Q3, though the filing text does not provide a clear percentage of sales attributable to them. Growth, semiconductor-industry demand, customer purchasing, and manufacturing execution are relevant risks.
- Disclosure controls were deemed ineffective because of a material weakness in controls over translation of Malaysia and Singapore inventory balances. The company corrected a $1.75 million overstatement and implemented system and reconciliation changes; management said these controls needed time to demonstrate effective operation.
- Purchase orders outstanding for raw materials and components totaled $78.9 million. Operating-lease obligations were $10.7 million. The company continued to bear costs for its closed Kingston, New York facility through a lease expiring in February 2018; it did not expect to sublease it.
- The company reported no material change to previously disclosed risk factors and said ordinary-course legal matters were not expected to have a material adverse effect. It was not under tax examination; uncertain tax benefits were approximately $1.6 million.
Investor verification priorities
- Assess the sustainability of growth and margins, including the contributions from market-share gains, industry demand, acquisitions, and acquired-inventory charges.
- Evaluate underlying earnings apart from the discrete tax benefits and other items excluded from management’s non-GAAP measure.
- Monitor conversion of receivables and inventory into cash, given low operating cash flow and substantial working-capital investment.
- Verify Talon’s closing, financing terms, integration costs, and resulting leverage; review available revolver capacity and debt covenants.
- Track remediation and testing of the material weakness, as well as completion of Cal-Weld’s preliminary purchase-price allocation.