Ichor Systems - 10-Q quarterly report FY2018 Q3

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

For the quarterly period ended September 28, 2018

OR

For the transition period from __ to __

Commission File Number: 001‑37961

ICHOR HOLDINGS, LTD.

(Exact Name of Registrant as Specified in its Charter)

Registrant’s telephone number, including area code: (510) 897‑5200

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S‑T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non‑accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b‑2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☒

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b‑2 of the Exchange Act).    Yes  ☐    No  ☒

As of November 2, 2018, the registrant had 22,853,025 ordinary shares, $0.0001 par value per share, outstanding.

TABLE OF CONTENTS

PART I

ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)

ICHOR HOLDINGS, LTD.

Consolidated Balance Sheets

(dollars in thousands, except per share amounts)

See accompanying notes.

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ICHOR HOLDINGS, LTD.

Consolidated Statements of Operations

(dollars in thousands, except per share amounts)

See accompanying notes.

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ICHOR HOLDINGS, LTD.

Consolidated Statements of Shareholders’ Equity

(dollars in thousands)

See accompanying notes.

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ICHOR HOLDINGS, LTD.

Consolidated Statements of Cash Flows

(in thousands)

See accompanying notes.

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ICHOR HOLDINGS, LTD.

Notes to Consolidated Financial Statements (Unaudited)

(dollar figures in tables in thousands, except share and per share amounts and percentages)

Note 1 – Basis of Presentation

Basis of Presentation

These consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the U.S. (“GAAP”). All intercompany balances and transactions have been eliminated upon consolidation. All financial figures presented in the notes to consolidated financial statements are in thousands, except share, per share, and percentage figures.

Year End

We use a 52 or 53 week fiscal year ending on the last Friday in December. The three months ended September 28, 2018 and September 29, 2017 were both 13 weeks. The nine months then ended were both 39 weeks. References to the third quarters of 2018 and 2017 relate to the three months ended September 28, 2018 and September 29, 2017, respectively. References to fiscal year 2018 relate to our fiscal year ending December 28, 2018.

Use of Estimates

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods presented. We base our estimates and judgments on historical experience and on various other assumptions that we believe are reasonable under the circumstances. Actual results could differ from the estimates made by management. Significant estimates include the fair value of assets and liabilities acquired in acquisitions, estimated useful lives for long‑lived assets, allowance for doubtful accounts, inventory valuation, uncertain tax positions, fair value assigned to stock options granted, and impairment analysis for both definite‑lived intangible assets and goodwill.

Revenue Recognition

We recognize revenue when control of promised goods or services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services. This amount is recorded as net sales in our consolidated statements of operations.

Transaction price – In most of our contracts, prices are generally determined by a customer-issued purchase order and generally remain fixed over the duration of the contract. Certain contracts contain variable consideration, including early-payment discounts and rebates. When a contract includes variable consideration, we evaluate the estimate of the variable consideration to determine whether the estimate needs to be constrained; therefore, we include the variable consideration in the transaction price only to the extent that it is probable that a significant reversal will not occur. Variable consideration estimates are updated at each reporting date. Historically, we have not incurred significant costs to obtain a contract. All amounts billed to a customer relating to shipping and handling are classified as net sales, while all costs incurred by us for shipping and handling are classified as cost of goods sold.

Performance obligations – Substantially all of our performance obligations pertain to promised goods (“products”), which are primarily comprised of fluid delivery subsystems, weldments, and other components. Most of our contracts contain a single performance obligation. Product sales are recognized at a point-in-time, generally upon delivery, as such term is definied within the contract, as that is when control of the promised good has transferred. Products are covered by a standard assurance warranty, varying in length by customer, which promises that delivered products conform to contract specifications. As such, we account for such warranties under ASC 460, Guarantees, and not as a separate performance obligation.

Contract balances – Accounts receivable represents our unconditional right to receive consideration from our customers. Accounts receivable are carried at invoice price less an estimate for doubtful accounts and estimated payment discounts. Payment terms vary by customer but are generally due within 15‑60 days. Historically, we have not incurred significant payment issues with our customers. We had no significant contract assets or liabilities on our consolidated balance sheets in any of the periods presented.

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Accounting Pronouncements Recently Adopted

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Updated (“ASU”) 2014‑09, Revenue from Contracts with Customers (Topic 606), which supersedes nearly all existing revenue recognition guidance. Subsequent to the issuance of ASU 2014‑09, the FASB clarified the guidance through several ASUs. We adopted Accounting Standards Codification (“ASC”) Topic 606, Revenue from Contracts with Customers, on December 30, 2017, the first day of fiscal year 2018, using the modified retrospective method. After assessing our contracts with our customers, we determined that there was not a significant change to the nature, timing, and extent of our revenues under the new standard. Accordingly, we did not make a cumulative-effect adjustment to retained earnings on December 30, 2017, as there was no adjustment to be made.

In August 2016, the FASB issued ASU 2016‑15, Statement of Cash Flows – Classification of Certain Cash Receipts and Cash Payments. The amendment provides and clarifies guidance on the classification of certain cash receipts and cash payments in the statement of cash flows to eliminate diversity in practice. We adopted ASU 2016-15 on December 30, 2017, the first day of fiscal year 2018, which did not have a significant impact on our consolidated financial statements.

In January 2017, the FASB issued ASU 2017‑01, Business Combinations (Topic 805): Clarifying the Definition of a Business. The amendments in this update clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. We adopted ASU 2017‑01 on December 30, 2017, the first day of fiscal year 2018, which did not have a significant impact on our consolidated financial statements.

In May 2017, the FASB issued ASU 2017‑09, Compensation-Stock Compensation (Topic 718) – Scope of Modification Accounting, which provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. We adopted ASU 2017‑09 on December 30, 2017, the first day of fiscal year 2018, which did not have a significant impact on our consolidated financial statements.

Accounting Pronouncements Recently Issued

In February 2016, the FASB issued ASU 2016‑02, Leases (Topic 842), which consists of a comprehensive lease accounting standard. Under the new standard, assets and liabilities arising from most leases will be recognized on the balance sheet. Leases will be classified as either operating or financing, and the lease classification will determine whether expense is recognized on a straight-line basis (operating leases) or based on an effective interest method (financing leases). The new standard is effective for interim and annual periods starting in 2019. A modified retrospective transition approach is required with certain practical expedients available. In July 2018, the FASB issued ASU 2018‑11, Leases (Topic 842): Targeted Improvements, which provides an optional transition method allowing entities to initially apply the new lease standard at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. We plan to use the optional transition method and apply the lease standard as of December 29, 2018, first first day of our fiscal 2019. We anticipate this standard will have a material impact on our consolidated balance sheet. Although we continue to assess all potential impacts of the standard, we believe the most significant impact relates to recognizing lease assets and lease liabilities on our balance sheet related to our facility leases. We do not anticipate a material cumulative-effect adjustment to the opening balance of retained earnings.

In June 2018, the FASB issued ASU 2018‑07, Compensation-Stock Compensation (Topic 718): Improvements to Non-Employee Share-Based Payment Accounting. This standard is intended to reduce cost and complexity and to improve financial reporting for share-based payments issued to nonemployees. ASU 2018‑07 expands the scope of ASC Topic 718, which currently only includes share-based payments issued to employees, to also include share-based payments issued to nonemployees for goods and services. The provisions are effective for annual periods beginning after December 15, 2018. We do not expect this ASU to have a material impact on our consolidated financial statements.

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Note 2 – Acquisitions

IAN Engineering Co., Ltd.

On April 19, 2018, we completed the acquisition of IAN Engineering Co., Ltd. (“IAN”), a Seoul-based leader in providing locally-sourced design and manufacturing of gas delivery systems to customers in South Korea, for an aggregate purchase price of $6.5 million, inclusive of $5.3 million paid at closing and contingent consideration with a fair value of $1.3 million. Contingent consideration consists of an earn-out liability, included in our consolidated balance sheet, that becomes payable in 2019 and 2020 if certain financial targets are achieved. IAN provides us exposure to and growth opportunities in the South Korean semiconductor capital equipment market.

The following table presents the preliminary purchase price allocation as of April 19, 2018:

We preliminarily allocated $1.6 million to customer relationships with an amortization period of 6 years. Goodwill recognized from the acquisition was primarily attributed to an assembled workforce and expected synergies and is not tax deductible. The allocation of acquisition consideration for IAN is preliminary as we have not obtained all of the information to finalize our procedures on the opening balance sheet or the allocation between goodwill and intangible assets. We have recorded allocations based on information currently available.

Our consolidated statements of operations for nine months ended September 28, 2018 include approximately five months of IAN operating activity, including revenue of $5.8 million.

Talon Innovations Corporation

On December 11, 2017, we completed the acquisition of Talon Innovations Corporation (“Talon”), a Minnesota-based leader in the design and manufacturing of high precision machined parts used in leading edge semiconductor tools, for $137.8 million. Talon expanded our capacity and capabilities in the area of component manufacturing for gas and chemical delivery tools used in semiconductor manufacturing and other industrial applications.

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The following table presents the preliminary purchase price allocation as of December 29, 2017 and September 28, 2018, as well as measurement period adjustments recorded during the nine months ended September 28, 2018. Measurement period adjustments primarily relate to the fair value of Talon’s opening balance of accounts receivable, inventory, income taxes payable, deferred taxes, developed technology, and other working capital amounts.

Cal-Weld, Inc.

On July 27, 2017, we completed the acquisition of Cal‑Weld, Inc. (“Cal‑Weld”), a California-based leader in the design and fabrication of precision, high purity industrial components, subsystems, and systems, for $56.2 million. Cal‑Weld expanded our capacity and capabilities in the area of component manufacturing for gas delivery tools used in semiconductor manufacturing.

The following table presents the preliminary purchase price allocation as of December 29, 2017 and the final allocation on June 29, 2018, as well as measurement period adjustments recorded during the six months ended June 29, 2018. Measurement period adjustments primarily relate to the fair value of Cal‑Weld’s opening balance of inventory, income taxes payable, and other working capital amounts.

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Note 3 – Inventories

Inventories consist of the following:

Note 4 – Property and Equipment

Property and equipment consist of the following:

Depreciation expense was $2.0 million and $0.9 million for the third quarter of 2018 and 2017, respectively, and $5.9 million and $2.5 million for the nine months ended September 28, 2018 and September 29, 2017, respectively.

Note 5 – Intangible Assets and Goodwill

Definite‑lived intangible assets consist of the following:

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The following table presents changes to goodwill during the nine months ended September 28, 2018:

Note 6 – Commitments and Contingencies

Operating Leases

We lease offices under various non-cancellable net operating leases expiring through 2024. In addition to base rental payments, we are responsible for utilities and our proportionate share of operating expenses. Escalating rental payments are recognized on a straight‑line basis over the lease term. As of September 28, 2018, our future minimum rental payment obligation was $17.5 million.

Litigation

We are periodically involved in legal actions and claims that arise as a result of events that occur in the normal course of operations. The ultimate resolution of these actions is not expected to have a material adverse effect on our financial position or results of operations.

Note 7 – Income Taxes

Income tax information for the periods reported are as follows:

Our effective tax rate for the third quarter of 2018 differs from the statutory rate due to taxes on foreign income that differ from the U.S. tax rate and a change in our expectation of full-year 2018 income that occurred in the third quarter of 2018. Our effective tax rate for the nine months ended September 28, 2018 differs from the statutory rate due to taxes on foreign income that differ from the U.S. tax rate and the release of a valuation allowance against our foreign tax credit carryforwards.

Our effective tax rate for the three and nine months ended September 29, 2017 differs from the statutory rate due to a full valuation allowance that was provided against our U.S. net deferred tax assets, taxes on foreign income that differ from the U.S. tax rate, and discrete tax benefits recognized in connection with our acquisition of Cal‑Weld and our re-characterization of intercompany debt to equity.

During the second quarter of 2018, we determined that we would be able realize our foreign tax credit carryforwards as a result of additional analysis of the Tax Cuts and Jobs Act (the “Act”). As such, we recognized a $4.1 million discrete tax benefit in the second quarter of 2018 associated with the release of the valuation allowance on those credits. As of September 28, 2018, our accounting for the Act was not complete. We are still evaluating other changes under the Act, including the impacts of mandatory repatriation and the tax rate change. We expect to finalize these items in the fourth quarter of 2018.

The ending balance for the unrecognized tax benefits for uncertain tax positions was approximately $2.2 million at September 28, 2018. The related interest and penalties were $0.1 million and $0.4 million, respectively. The uncertain tax positions that are reasonably possible to decrease in the next twelve months are insignificant.

As of September 28, 2018, we were not under examination by tax authorities.

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Note 8 – Employee Benefit Programs

401(k) Plan

We sponsor a 401(k) plan available to employees of our U.S.‑based subsidiaries. Participants may make salary deferral contributions not to exceed 50% of a participant’s annual compensation or the maximum amount otherwise allowed by law. Eligible employees receive a discretionary matching contribution equal to 50% of a participant’s deferral, up to an annual maximum of 4% of a participant’s annual compensation. Matching contributions were $0.3 million and $0.1 million for the third quarter of 2018 and 2017, respectively, and $1.1 million and $0.4 million for the nine months ended September 28, 2018 and September 29, 2017, respectively.

Medical Insurance

We sponsor a self‑insured group medical insurance plan for our U.S. employees and their dependents. The self‑insured plan is designed to provide a specified level of coverage, with stop‑loss coverage provided by a commercial insurer, in order to limit our exposure. Expense incurred related to this plan was $2.4 million and $0.6 million for the third quarter of 2018 and 2017, respectively, and $7.5 million and $2.0 million for the nine months ended September 28, 2018 and September 29, 2017, respectively.

Note 9 – Long-Term Debt

Long‑term debt consists of the following:

On February 15, 2018, we amended and restated our credit agreement (the “amendment”), which replaced our existing credit facilities with a $175.0 million term loan and a revolving credit facility (the “revolver”) allowing for borrowings up to $125.0 million. Additionally, the amendment reduced our borrowing rate, depending on our leverage ratio, and extended the maturity date. We incurred debt issuance costs of $2.1 million in connection with the amendment. The amendment did not meet the definition of an extinguishment and was accounted for as a debt modification.

Interest is charged at either the Base Rate or the Eurodollar rate (as such terms are defined in the credit agreement) at our option, plus an applicable margin. The Base Rate is equal to the higher of i) the Prime Rate, ii) the Federal Funds Rate plus 0.5%, or iii) the Eurodollar Rate plus 1.00%. The Eurodollar rate is equal to LIBOR. The applicable margin on Base Rate and Eurodollar Rate loans is 0.75‑1.50% and 1.75‑2.50% per annum, respectively, depending on our leverage ratio. We are also charged a commitment fee of 0.20%-0.35% on the unused portion of our revolver. Base Rate interest payments and commitment fees are due quarterly. Eurodollar interest payments are due on the last day of the applicable interest period. At September 28, 2018, the term loan and revolver bore interest at the Eurodollar rate option of 4.48% and 4.25%, respectively.

Term loan principal payments of $2.2 million are due on a quarterly basis. The term loan and revolver mature on February 15, 2023.

Note 10 – Shareholders’ Equity

Share Repurchase Program

In February 2018, our board of directors authorized a share repurchase program up to $50.0 million under which we may repurchase our ordinary shares in the open market or through privately negotiated transactions, depending on market conditions and other factors. Ordinary shares repurchased are recorded as treasury shares using the cost method on a first-in, first-out basis. In August 2018, our board of directors authorized a $50 million increase to the share repurchase program.

During the nine months ended September 28, 2018, we repurchased 2,681,964 ordinary shares for a total cost of $60.3 million at an average price of $22.49 per share. At September 28, 2018, $39.7 million remained available to repurchase ordinary shares under the repurchase program.

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Note 11 – Share‑Based Compensation

The 2016 Omnibus Incentive Plan (the “2016 Plan”) provides for grants of share‑based awards to employees, directors, and consultants. Awards may be in the form of options, tandem and non‑tandem stock appreciation rights, restricted share awards or restricted share units (“restricted shares”), performance awards, and other share‑based awards. Awards generally vest over four years, 25% on the first anniversary and quarterly thereafter. Upon vesting of restricted shares, employees may elect to have shares withheld to cover statutory minimum withholding taxes. Shares withheld are not reflected as an issuance of ordinary shares within our consolidated statements of shareholders’ equity, as the shares were never issued, and the associated tax payments are reflected as financing activities within our consolidated statements of cash flows.

Share‑based compensation expense across all plans for stock options, restricted shares, and employee share purchase rights was $1.3 million and $0.6 million for the third quarter of 2018 and 2017, respectively, and $6.3 million and $1.5 million for the nine months ended September 28, 2018 and September 29, 2017, respectively.

On January 18, 2018, in connection with the resignation of our former Chief Financial Officer, certain separation benefits became effective, which includes a vesting acceleration of all outstanding and unvested stock options and restricted shares. Consequently, 88,445 stock options and 39,175 restricted shares vested on January 18, 2018. This was accounted for as an equity award modification under ASC Topic 718, resulting in $2.9 million in share-based compensation expense.

Stock Options

The following table summarizes stock option activity:

Restricted Shares

The following table summarizes restricted share activity:

Employee Share Purchase Plan

The 2017 Employee Stock Purchase Plan (the “2017 ESPP”) grants employees the ability to designate a portion of their base-pay to purchase ordinary shares at a price equal to 85% of the fair market value of our ordinary shares on the first or last day of each 6 month purchase period. Purchase periods begin on January 1 or July 1 and end on June 30 or December 31, or the next business day if such date is not a business day. Shares are purchased on the last day of the purchase period.

During the nine months ended September 28, 2018, 29,377 ordinary shares were purchased by eligible employees under the 2017 ESPP. As of September 28, 2018, 2.5 million ordinary shares remain available for purchase under the 2017 ESPP.

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Note 12 – Segment Information

Our Chief Operating Decision Maker, the Chief Executive Officer, reviews our results of operations on a consolidated level and executive staff is structured by function rather than by product category. Therefore, we operate in one operating segment. Key resources, decisions, and assessment of performance are also analyzed on a company‑wide level.

Foreign operations are conducted primarily through our wholly owned subsidiaries in Singapore and Malaysia. Our principal markets include North America, Asia and, to a lesser degree, Europe. Sales by geographic area represent sales to unaffiliated customers.

All information on sales by geographic area is based upon the location to which the products were shipped. The following table sets forth sales by geographic area:

Note 13 – Earnings per Share

The following table sets forth the computation of basic and diluted earnings per share and a reconciliation of the numerator and denominator used in the calculation:

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An aggregated total of 532,848, 178,136, 427,599, and 226,607 potential ordinary shares have been excluded from the computation of diluted net income per share and diluted net income from continuing operations per share for the third quarters of 2018 and 2017 and the nine months ended September 28, 2018 and September 29, 2017, respectively, because including them would have been antidilutive.

Note 14 – Discontinued Operations

In January 2016, we made the decision to shut down our Kingston, New York facility as this location consumed a significant amount of resources while contributing very little income. We completed the shutdown of the operations of the New York facility in May 2016 through abandonment as a buyer for the facility and operation was not found. In 2017, we accrued for remaining costs to occupy the facility through its lease expiration in February 2018. The discontinued operation was deemed to be fully disposed of at December 29, 2017. Accordingly, there was no activity associated with the discontinued operation during the nine months ended September 28, 2018.

The following table represents the carrying amounts of the major classes of assets and liabilities of our discontinued operation:

The following table represents results of our discontinued operation:

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with our consolidated financial statements and related notes included elsewhere in this report. The following discussion contains forward‑looking statements based upon our current plans, expectations, and beliefs that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward‑looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this report, particularly in “Risk Factors.”

Overview

We are a leader in the design, engineering and manufacturing of critical fluid delivery subsystems for semiconductor capital equipment. Our primary offerings include gas and chemical delivery subsystems, collectively known as fluid delivery subsystems, which are key elements of the process tools used in the manufacturing of semiconductor devices. Our gas delivery subsystems deliver, monitor, and control precise quantities of the specialized gases used in semiconductor manufacturing processes such as etch and deposition. Our chemical delivery subsystems precisely blend and dispense the reactive liquid chemistries used in semiconductor manufacturing processes such as electroplating and cleaning. We also manufacture certain components such as weldments and precision machined components for use in fluid delivery systems for direct sales to our customers. This vertically integrated portion of our business is primarily focused on metal and plastic parts that are used in gas and chemical systems, respectively.

Fluid delivery subsystems ensure accurate measurement and uniform delivery of specialty gases and chemicals at critical steps in the semiconductor manufacturing process. Any malfunction or material degradation in fluid delivery reduces yields and increases the likelihood of manufacturing defects in these processes. Historically, semiconductor OEMs internally designed and manufactured the fluid delivery subsystems used in their process tools. Currently, most OEMs outsource the design, engineering and manufacturing of their gas delivery subsystems to a few specialized suppliers, including us. Additionally, many OEMs are also increasingly outsourcing the design, engineering, and manufacturing of their chemical delivery subsystems due to the increased fluid expertise required to manufacture these subsystems. Outsourcing these subsystems has allowed OEMs to leverage the suppliers’ highly specialized engineering, design, and production skills while focusing their internal resources on their own value-added processes. We believe that this outsourcing trend has enabled OEMs to reduce their fixed costs and development time, as well as provided significant growth opportunities for specialized subsystems suppliers like us.

We have a global footprint with volume production facilities in Malaysia, Singapore, Korea, Oregon, Texas, California, and Minnesota. In the third quarter of 2018 and 2017, our two largest customers by sales were Lam Research and Applied Materials. During the third quarter of 2018 and 2017, respectively, we generated sales of $175.2 million and $164.5 million, gross profit of $28.2 million and $24.2 million, net income from continuing operations of $9.6 million and $14.3 million, and adjusted net income from continuing operations of $13.6 million and $16.3 million. Adjusted net income from continuing operations is a financial measure that is not calculated in accordance with generally accepted accounting principles in the U.S. (“GAAP”). See “Non‑GAAP Results” for a discussion of adjusted net income from continuing operations, an accompanying presentation of the most directly comparable financial measure calculated in accordance with GAAP, net income from continuing operations, and a reconciliation of the differences between adjusted net income from continuing operations and net income from continuing operations.

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Results of Operations

The following table sets forth our unaudited results of operations for the periods presented. The period‑to‑period comparison of results is not necessarily indicative of results for future periods.