Ichor Holdings, Ltd. — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017; comparable periods ended June 24, 2016. Figures are unaudited. Dollar amounts below are in millions unless stated otherwise.
Business context
Ichor designs and manufactures fluid-delivery subsystems and components used in semiconductor manufacturing equipment. The company operates globally, with production facilities in Malaysia, Singapore, and California. Its two largest customers were Lam Research and Applied Materials. Management attributes demand growth to semiconductor-industry expansion and increased share of purchases at those customers.
Financial results and liquidity
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net sales | $159.7 | $95.4 | $308.4 | $168.7 |
| Gross profit | $23.5 | $15.2 | $47.5 | $27.1 |
| Gross margin | 14.7% | 15.9% | 15.4% | 16.1% |
| Operating income | $11.8 | $4.9 | $25.4 | $7.5 |
| Continuing-operations net income | $10.5 | $3.3 | $23.4 | $5.1 |
| Total net income | $9.9 | $1.0 | $22.7 | $1.1 |
| Diluted EPS, total | $0.38 | $0.02 | $0.88 | $0.02 |
- Sales increased 67.5% year over year in Q2 and 82.9% for the first half. Continuing-operations sales growth was primarily volume-driven, including greater customer purchases and increased market share.
- Gross margin declined 120 basis points in Q2 and 70 basis points for the first half. The $1.752 million inventory-translation correction reduced reported margin by 110 basis points in Q2 and 60 basis points year to date. Capacity constraints, outsourced components, and production inefficiencies also weighed on margins; management said internal capacity was brought online and significant further outsourcing was not expected for the rest of 2017.
- Adjusted net income from continuing operations, a non-GAAP measure, was $15.5 million in Q2 and $30.1 million for the first half, versus $7.0 million and $11.5 million, respectively. Q2 adjusted diluted EPS was $0.60 versus $0.29.
- Cash and restricted cash totaled $66.8 million at June 30. Current assets were $208.5 million and current liabilities $116.2 million. Six-month operating cash flow was $7.5 million; capital expenditures were $5.2 million. Receivables and inventory rose $13.4 million and $26.1 million, respectively, as the business supported higher demand.
- Debt was $39.8 million before unamortized issuance costs ($38.2 million carrying value), with no amount due within 12 months. The term loan carried a 5.15% rate at quarter-end; the revolving facility was $20 million. Q2 net interest expense fell to $0.7 million from $1.2 million.
Material changes, outlook, and risks
- The company corrected an accumulated inventory overstatement of approximately $1.75 million related to foreign-currency translation in Malaysia and Singapore. It recorded the correction as Q2 cost of sales, assessed the prior-period error as immaterial, and said it did not expect recurrence.
- The correction arose from a material weakness in internal control over financial reporting. Disclosure controls were deemed ineffective at quarter-end. The company re-implemented Oracle and added an inventory reconciliation control, but said the measures must operate for a reasonable period before remediation can be established.
- Management stated that cash, revolving-credit availability, operating cash flows, and IPO proceeds were expected to cover working capital and capital expenditures for at least the next 12 months. No quantified operating or earnings guidance is provided in the filing.
- After quarter-end, on July 27, the company agreed to acquire Cal-Weld for $50 million, subject to customary adjustments, funded with approximately $20 million cash and $30 million incremental borrowing. The credit amendment added $20 million of term borrowing and $20 million of revolver capacity and reduced the borrowing rate.
- A preliminary August 8 arbitration judgment concerning the Ajax acquisition working-capital claim was under review. The company said additional payments could increase by up to an amount then expected not to exceed $1.1 million; the final outcome was not settled.
- The discontinued Kingston, New York operation generated a $0.6 million Q2 loss. The company accrued remaining occupancy costs through the lease’s February 2018 expiry and did not anticipate subleasing the facility.
- Customer concentration, semiconductor-industry demand, execution of capacity plans, foreign-currency exposures, and the identified control weakness are notable risks. Management reported no material expected adverse effect from ordinary-course litigation.
Important facts for investors to verify
- Whether the new inventory systems and reconciliation controls operate effectively and fully remediate the material weakness.
- How the Cal-Weld acquisition, its incremental borrowing, and the amended credit facilities affect post-quarter liquidity and leverage.
- The final Ajax arbitration judgment and any resulting charge or payment.
- Whether gross-margin pressures ease as internal capacity catches up with demand, and how much of recent growth depends on the two largest customers.
- The sustainability of cash generation given rising receivables and inventories, and the distinction between GAAP earnings and management’s non-GAAP adjusted results.