ICHOR HOLDINGS, LTD. — Q3 2019 Form 10-Q
Reporting period: Third quarter and first nine months of fiscal 2019, ended September 27, 2019. The quarter comprised 13 weeks. Amounts below are in U.S. dollars; financial statement figures are converted from thousands to millions where applicable.
Business context
Ichor designs and manufactures fluid-delivery subsystems and related components used in semiconductor manufacturing equipment. Management attributed lower sales primarily to a cyclical downturn in the global wafer-fabrication equipment market. Lam Research and Applied Materials were the company’s two largest customers in all periods presented. Ichor operates as one reportable segment.
Financial results and year-over-year changes
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net sales | $154.5m | $175.2m | $431.5m | $682.2m |
| Gross profit | $20.7m | $28.2m | $60.4m | $114.7m |
| Gross margin | 13.4% | 16.1% | 14.0% | 16.8% |
| Operating income | $3.3m | $11.5m | $9.3m | $58.0m |
| GAAP net income | $0.9m | $9.6m | $2.8m | $54.4m |
| GAAP diluted EPS | $0.04 | $0.39 | $0.12 | $2.11 |
| Non-GAAP adjusted net income | $6.7m | $13.6m | $17.4m | $67.8m |
| Non-GAAP diluted EPS | $0.30 | $0.55 | $0.77 | $2.62 |
- Sales fell 11.8% in Q3 and 36.8% for the first nine months. Gross margin contracted 270 basis points and 280 basis points, respectively. Management cited customer/product mix and lower factory utilization for margin pressure.
- Q3 operating expenses rose to $17.4m from $16.7m; nine-month expenses declined to $51.2m from $56.7m, primarily reflecting lower prior-year executive transition costs and reduced employee-related, legal and consulting expenses.
- Interest expense increased to $2.7m in Q3 and $8.2m for the nine months, partly reflecting higher weighted-average interest rates. Q3 rate was 4.83%, compared with 4.56% a year earlier.
Cash flow, balance sheet and debt
- Nine-month operating cash flow was $25.0m, versus $27.4m in 2018. Accounts receivable consumed $36.9m of cash, partly offset by higher accounts payable and lower inventory.
- Investing activities used $16.5m: $8.3m of capital expenditures and $8.1m to acquire developed technology. Financing activities used $22.2m, including $23.6m of net debt repayments and $1.6m of share repurchases, partly offset by share-plan proceeds.
- Cash was $30.2m at September 27, down $13.7m from December 28, 2018. Current assets were $218.2m and current liabilities $115.0m. Accounts receivable was $77.1m, up from $40.3m at year-end; inventory was $105.8m, down from $121.1m.
- Debt principal totaled $181.2m, including $164.1m under the term loan and $17.2m on the revolving facility; $8.8m was due within 12 months. Debt matures February 15, 2023. The term loan and revolver bore variable rates of 4.83% and 4.66%, respectively. A hypothetical 1% rate change would affect quarterly interest expense by about $0.5m.
- Operating lease adoption added $14.9m of right-of-use assets and $15.3m of lease liabilities at quarter-end. Management said cash, revolver availability and operating cash flows should cover anticipated needs for at least the next 12 months.
Outlook, risks and unusual items
- The filing provides no quantitative revenue or earnings guidance. Management described the sales decline as a cyclical market downturn; its forward-looking statements are subject to risks and actual results may differ materially.
- A targeted supplier-impersonation phishing fraud led to transfers to unauthorized bank accounts. An external forensic review found no information-system breach; all transferred funds were recovered, and no financial loss was recorded. Management identified a material weakness in controls over supplier banking changes and concluded disclosure controls were ineffective as of September 27, 2019. Remediation steps were initiated, but operating effectiveness had not yet been validated.
- Management reported no material changes to previously disclosed risk factors other than the updated internal-control risk. Routine legal matters were not expected to have a material adverse effect. The company had approximately $1.9m of unrecognized tax benefits; it was not under tax examination.
- Non-GAAP adjusted net income excludes items including intangible amortization, share-based compensation, selected non-recurring costs and tax adjustments. The company cautioned that this measure has limitations and is not a substitute for GAAP results.
Most important facts for investors to verify
- Whether remediation of the cash-disbursement control weakness is completed and independently shown to operate effectively.
- Whether customer demand, factory utilization and gross margins recover from the cyclical downturn, especially given dependence on two major customers.
- Whether the sharp increase in receivables converts to cash and operating cash flow remains adequate as sales change.
- Debt repayment capacity and sensitivity to variable interest rates, alongside actual revolving-credit availability and covenant requirements.
- The composition and recurrence of adjustments in non-GAAP results versus GAAP earnings.