ICHOR HOLDINGS, LTD. 10-Q

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 unaudited 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 and components for semiconductor capital equipment. Our product offerings include gas and chemical delivery systems and subsystems, collectively known as fluid delivery systems and 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 systems and subsystems precisely blend and dispense the reactive liquid chemistries used in semiconductor manufacturing processes such as chemical-mechanical planarization, electroplating, and cleaning. We also manufacture precision machined components, weldments, and proprietary products 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 processes. Any malfunction or material degradation in fluid delivery reduces yields and increases the likelihood of manufacturing defects in these processes. Most OEMs outsource all or a portion of 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 costs and development time, as well as provide growth opportunities for specialized subsystems suppliers like us. We have a global footprint with production facilities in California, Minnesota, Oregon, Texas, Singapore, Malaysia, the United Kingdom, Korea, and Mexico. The following summarizes key financial information for the periods indicated: Three Months Ended March 26, 2021 March 27, 2020 (dollars in thousands) Net sales $ 264,566 $ 220,028 Gross profit $ 39,512 $ 28,774 Gross margin 14.9 % 13.1 % Operating expenses $ 21,255 $ 23,274 Operating income $ 18,257 $ 5,500 U.S. GAAP net income $ 14,638 $ 3,399 Non-GAAP net income (1) $ 21,725 $ 12,058 U.S. GAAP diluted EPS $ 0.51 $ 0.15 Non-GAAP diluted EPS (1) $ 0.76 $ 0.52 (1) Please see “Non‑GAAP Results” within Item 2 of this report for a reconciliation of U.S. GAAP net income to Non‑GAAP net income. 11 COVID-19 Pandemic and Market Conditions Update The COVID‑19 pandemic and related economic repercussions have created, and are expected to continue to create, significant volatility, uncertainty, and turmoil in our industry. While our facilities are currently not subject to any site-wide government shutdowns, “social distancing” guidelines are resulting, and will continue to result in, reduced factory output. In addition, an increase in direct costs within our factories associated with employee personal protective equipment (“PPE”), facility cleaning and layout changes, together with increases in logistics costs and employee labor costs, as well as other operating inefficiencies have resulted in, and may continue to result in, lower revenues and operating margins. The extent and duration of these impacts cannot be specifically quantified given the dynamic nature and breadth of the pandemic’s impact on our operations and that of our customers and suppliers. 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. Three Months Ended March 26, 2021 March 27, 2020 (in thousands) Consolidated Statements of Operations Data: Net sales $ 264,566 $ 220,028 Cost of sales 225,054 191,254 Gross profit 39,512 28,774 Operating expenses: Research and development 3,515 3,322 Selling, general, and administrative 14,349 16,618 Amortization of intangible assets 3,391 3,334 Total operating expenses 21,255 23,274 Operating income 18,257 5,500 Interest expense 1,919 2,374 Other expense (income), net 185 (31 ) Income before income taxes 16,153 3,157 Income tax expense (benefit) 1,515 (242 ) Net income $ 14,638 $ 3,399 The following table sets forth our unaudited results of operations as a percentage of our total sales for the periods presented. Three Months Ended March 26, 2021 March 27, 2020 Consolidated Statements of Operations Data: Net sales 100.0 100.0 Cost of sales 85.1 86.9 Gross profit 14.9 13.1 Operating expenses: Research and development 1.3 1.5 Selling, general, and administrative 5.4 7.6 Amortization of intangible assets 1.3 1.5 Total operating expenses 8.0 10.6 Operating income 6.9 2.5 Interest expense 0.7 1.1 Other expense (income), net 0.1 0.0 Income before income taxes 6.1 1.4 Income tax expense (benefit) 0.6 (0.1 ) Net income 5.5 1.5 12 Comparison of the First Quarter of 2021 and the First Quarter of 2020 Net Sales Three Months Ended Change March 26, 2021 March 27, 2020 Amount % (dollars in thousands) Net sales $ 264,566 $ 220,028 $ 44,538 20.2 % The increase in net sales from the first quarter of 2020 to the first quarter of 2021 was primarily due to increased demand from our customers as a result of growth in the global wafer fabrication equipment market, as well as share-gains at our largest customers. On a geographic basis, sales in the U.S. increased by $18.3 million to $139.1 million, and foreign sales increased by $26.2 million to $125.4 million. Cost of Sales and Gross Profit Three Months Ended Change March 26, 2021 March 27, 2020 Amount % (dollars in thousands) Cost of sales $ 225,054 $ 191,254 $ 33,800 17.7 % Gross profit $ 39,512 $ 28,774 $ 10,738 37.3 % Gross margin 14.9 % 13.1 % + 180 bps The increase in cost of sales and gross profit from the first quarter of 2020 to the first quarter of 2021 was primarily due to increased sales volume. The increase in our gross margin from the first quarter of 2020 to the first quarter of 2021 was primarily due to increased factory utilization, as a result of higher overall volume, and product mix, partially offset by $2.5 million in costs recorded in connection with the planned closure of our Union City, California facility. These costs, which relate to inventory write-down and severance costs, resulted in an approximate 95 basis point reduction in our gross margin for the first quarter of 2021. The facility ceased operations shortly after the close of our first quarter. Research and Development Three Months Ended Change March 26, 2021 March 27, 2020 Amount % (dollars in thousands) Research and development $ 3,515 $ 3,322 $ 193 5.8 % The increase in research and development expenses from the first quarter of 2020 to the first quarter of 2021 was primarily due to increased employee-related expense, as we expand our engineering team, and materials associated with our new product development programs. Selling, General, and Administrative Three Months Ended Change March 26, 2021 March 27, 2020 Amount % (dollars in thousands) Selling, general, and administrative $ 14,349 $ 16,618 $ (2,269 ) -13.7 % The decrease in selling, general, and administrative expense from the first quarter of 2020 to the first quarter of 2021 was primarily due (i) $1.8 million in executive transition costs associated with the transition of our former CEO to Executive Chairman in the first quarter of 2020 that did not repeat in the first quarter of 2021 and (ii) $0.6 million in decreased share-based compensation expense as a result of non-recurring charges in the first quarter of 2020 that did not repeat in the first quarter of 2021. 13 Amortization of Intangible Assets Three Months Ended Change March 26, 2021 March 27, 2020 Amount % (dollars in thousands) Amortization of intangibles assets $ 3,391 $ 3,334 $ 57 1.7 % The increase in amortization expense from the first quarter of 2020 to the first quarter of 2021 was primarily due to incremental amortization expense from the acquisition of a customer relationship intangible asset in December 2020 in connection with our acquisition of a precision machining operation in Nogales, Mexico. Interest Expense Three Months Ended Change March 26, 2021 March 27, 2020 Amount % (dollars in thousands) Interest expense $ 1,919 $ 2,374 $ (455 ) -19.2 % The decrease in interest expense from the first quarter of 2020 to the first quarter of 2021 was primarily due to a 114 basis point decrease in our weighted average interest rate, from 4.44% to 3.30%, partially offset by a $7.5 million increase in our average amount borrowed during the first quarter of 2021 compared to the first quarter of 2020. Other Expense (Income), Net Three Months Ended Change March 26, 2021 March 27, 2020 Amount % (dollars in thousands) Other expense, net $ 185 $ (31 ) $ 216 n/m The change in other expense, net from the first quarter of 2020 to the first quarter of 2021 was primarily due to currency exchange rate changes during the quarter as a result of transactions denominated in the local currencies of our foreign operations. These local currencies consist primarily of the Singapore dollar, Malaysian ringgit, and euro. Income Tax Expense (Benefit) Three Months Ended Change March 26, 2021 March 27, 2020 Amount % (dollars in thousands) Income tax expense (benefit) $ 1,515 $ (242 ) $ 1,757 n/m The increase in income tax expense from the first quarter of 2020 to the first quarter of 2021 was primarily due to increased taxable income in the U.S. in 2021, as well as a decrease in the release of certain tax reserves related to statute of limitations expirations or settlements compared to the first quarter of 2020. 14 Non ‑GAAP Results Management uses non-GAAP metrics to evaluate our operating and financial results. We believe the presentation of non-GAAP results is useful to investors for analyzing business trends and comparing performance to prior periods, along with enhancing investors’ ability to view our results from management’s perspective. Non-GAAP net income is defined as: net income excluding (1) amortization of intangible assets, share-based compensation expense, and non-recurring expenses, including contract settlement losses and divestiture and facility shutdown related charges; and (2) the tax impacts associated with our non-GAAP adjustments, as well as non-recurring discrete tax items. Non-GAAP diluted EPS is defined as non-GAAP net income divided by weighted average diluted ordinary shares outstanding during the period. The following table presents our unaudited non‑GAAP net income and a reconciliation from net income, the most comparable GAAP measure, for the periods indicated: Three Months Ended March 26, 2021 March 27, 2020 (dollars in thousands, except per share amounts) Non-GAAP Data: U.S. GAAP net income $ 14,638 $ 3,399 Non-GAAP adjustments: Amortization of intangible assets 3,391 3,334 Share-based compensation 2,415 2,865 Other non-recurring expense, net (1) 278 2,690 Contract settlement loss (2) — 1,386 Facility shutdown costs (3) 2,510 — Fair value adjustment to inventory from acquisitions (4) 211 — Tax adjustments related to non-GAAP adjustments (5) (1,718 ) (1,616 ) Non-GAAP net income $ 21,725 $ 12,058 U.S. GAAP diluted EPS $ 0.51 $ 0.15 Non-GAAP diluted EPS $ 0.76 $ 0.52 Shares used to compute diluted EPS 28,729,112 23,181,127 ( 1 ) Included in this amount for the first quarter of 2021 are (i) non-capitalized costs incurred in connection with our implementation of a new ERP system and a Sarbanes-Oxley (“SOX”) compliance program and (ii) a non-recurring settlement charge. Included in this amount for the first quarter of 2020 are (i) a $1.8 million bonus payment to our former CEO in connection with his transition to executive chairman, (ii) acquisition-related expenses, comprised primarily of expense associated with a two-year retention agreement between the Company and key management personnel of IAN (the “IAN retention agreement”), which we acquired in April 2018, and (iii) non-capitalizable costs incurred in connection with our implementation of a new ERP system and a SOX compliance program. (2) During the first quarter of 2020, we reached a mutual settlement with the counterparty of a contract dispute and, accordingly, recorded a $1.4 million contract settlement loss to cost of sales. (3) Included in this amount for the first quarter of 2021 are write-off costs associated with inventories determined during the quarter to be obsolete and severance costs associated with affected employees of $2.2 million and $0.2 million, respectively. These charges relate to the planned closure of our manufacturing facility in Union City, California, which we ceased operations in shortly after the close of our 2021 first quarter. (4) As part of our purchase price allocation for our acquisition of a precision machining operation in Mexico in December 2020, we recorded acquired-inventory at fair value, resulting in a fair value step-up of $0.2 million. This was subsequently released to cost of sales in the first quarter of 2021 as acquired-inventory was sold. ( 5 ) Adjusts U.S. GAAP income tax expense (benefit) for impact of our non-GAAP adjustments, as defined, including the impacts of excluding share-based compensation, amortization of intangible assets, and other non-recurring expenses. This adjustment also excludes the impact of non-recurring discrete tax items. Non-GAAP results have limitations as an analytical tool, and you should not consider them in isolation or as a substitute for our results reported under GAAP. Other companies may calculate non-GAAP results differently or may use other measures to evaluate their performance, both of which could reduce the usefulness of our non-GAAP results as a tool for comparison. 15 Because of these limitations, you should consider non-GAAP results alongside other financial performance measures and results presented in accordance with GAAP. In addition, in evaluating non-GAAP results , you should be aware that in the future we will incur expenses such as those that are the subject of adjustments in deriving non-GAAP results and you should not infer from our presentation of non-GAAP results that our future results will not be affected by these expenses or any unusual or non-recurring items. Liquidity and Capital Resources We ended the first quarter of 2021 with cash of $242.9 million, a decrease of $10.0 million from the end of the prior quarter. The decrease from the end of the prior quarter was primarily due to payments on long-term debt of $32.2 million, of which $30.0 million was a paydown on our revolving credit facility, and capital expenditures of $5.4 million, partially offset by cash provided by operating activities of $25.6 million and net proceeds from the issuance of shares under our share-based compensation plans of $2.0 million. We believe that our cash, the amounts available under our revolving credit facility, and our cash flows from operations will be sufficient to meet our anticipated cash needs for at least the next 12 months. Cash Flow Analysis The following table sets forth a summary of operating, investing, and financing activities for the periods presented: Year Ended March 26, 2021 March 27, 2020 (in thousands) Cash provided by (used in) operating activities $ 25,648 $ (21,036 ) Cash used in investing activities (5,400 ) (2,470 ) Cash provided by (used in) financing activities (30,201 ) 4,477 Net decrease in cash $ (9,953 ) $ (19,029 ) Operating Activities Our cash provided by operating activities of $25.6 million for the first quarter of 2021 consisted of net income of $14.6 million, net non-cash charges of $8.8 million, and a decrease in our net operating assets and liabilities of $2.2 million. Net non-cash charges primarily consisted of depreciation and amortization of $5.7 million, share-based compensation of $2.4 million, and deferred taxes of $0.5 million. The increase in our net operating assets and liabilities was primarily due to an increase in accounts payable of $22.1 million, partially offset by increases in inventories and accounts receivable of $9.3 million and $7.7 million, respectively, and a decrease in accrued liabilities of $3.5 million. Investing Activities Our cash used in investing activities of $5.4 million for the first quarter of 2021 consists of capital expenditures. Financing Activities Our cash used in financing activities of $30.2 million for the first quarter of 2021 consists of payments on long-term debt of $32.2 million, of which $30.0 million was a paydown on our revolving credit facility, partially offset by net proceeds from the issuance of shares under our share-based compensation plans of $2.0 million. Critical Accounting Policies Our consolidated financial statements have been prepared in accordance with U.S. GAAP. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, sales, expenses, and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances. We evaluate our estimates and assumptions on an ongoing basis. Actual results may differ from these estimates. To the extent that there are material differences between these estimates and our actual results, our future financial statements will be affected. The critical accounting policies requiring estimates, assumptions, and judgments that we believe have the most significant impact on our consolidated financial statements are identified and described in our annual consolidated financial statements and the notes included in our Annual Report on Form 10‑K for the year ended December 25, 2020 (our “Annual Report”). 16