Good day, ladies and gentlemen and welcome to Ichor's Third Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct the question and answer session. And instructions will be given at that time. As a reminder, this conference is being recorded. I would now like to introduce your host for today's conference, Claire McAdams, Investor Relations for Ichor. Please go ahead.

Thank you, Victoria. Good afternoon and thank you for joining today's third quarter 2022 conference call. As you read our earnings press release and you listen to this conference call, please recognize that both contain forward-looking statements within the meaning of the federal securities laws. These forward-looking statements are subject to a number of risks and uncertainties, many of which are beyond our control and which could cause actual results to differ materially from such statements. These risks and uncertainties include those spelled out in our earnings press release, those described in our annual report on Form 10-K for fiscal 2021 and those described in subsequent filings with the SEC. You should consider all forward-looking statements in light of those and other risks and uncertainties. Additionally, we will be providing certain non-GAAP financial measures during this conference call. Our earnings press release and the financial supplement posted to our IR website today, each provide a reconciliation of these non-GAAP financial measures to their most comparable GAAP financial measures. On the call with me today are Jeff Andreson, our CEO; and Larry Sparks, our CFO. Jeff will begin with an update on our business and a review of our results and outlook and then Larry will provide additional details of our third quarter results and fourth quarter guidance. After the prepared remarks, we will open the line for questions. I'll now turn over the call to Jeff Andreson. Jeff?

Thank you, Claire, and welcome to our Q3 earning call. Q3 revenues were a record $356 million at the upper end of our guidance range, and up 8% from the second quarter, similar to last quarter, we experienced continued improvement in components supply. Our gross margin improvement in the quarter was well above forecast, improving 100 basis points over Q2. And as a result, we exceeded the upper end of our profitability targets and reported record quarterly earnings of $1.22 per share. Since our last earnings call, expectations for levels of wafer fab equipment investments in the coming year have declined significantly. The initial forecast reductions centered primarily around the increasing softness seen in the memory markets and increasingly conservative commentary around memory CapEx going into 2023. And then in early October, use of export restrictions to certain domestic semiconductor manufacturers in China effectively reduced WFE forecasts by $8 billion to $10 billion for next year. We have incorporated the impact of the export restrictions in our outlook and build plants. We estimate that the total impact of these changes to be approximately $20 million this quarter. And as such, the midpoint of our Q4 revenue guidance represents a 6% decline from our record third quarter Our above industry revenue growth expectation for 2022 is unchanged, however, at 20% year-over-year growth, assuming we come in around the midpoint of our Q4 guidance. So as we are nearing the end of a record revenue and earnings year, our focus turns to the expected spending environment over the next several quarters and our ability to flex our variable operating model to adjust to lower levels of WFE demand in 2023. I am sure many of you recall the last industry downturn, which began in mid 2018 and continued until late 2019. This…

Thanks, Jeff. First, I would like to remind you that the P&L metrics discussed today are non-GAAP measures. These measures exclude the impact of share based compensation expense, amortization of acquired intangible assets, non recurring charges and discrete tax items and adjustments. There is a very helpful schedule summarizing our GAAP and non-GAAP financial results, including the individual line items for non-GAAP operating expenses such as R&D and SG&A in the investor section of our website for reference during this conference call. Third quarter revenues were a record $356 million, up 8% from Q2 and 35% higher than Q3 of last year. With revenues at the upper end of expectations gross margin of 18% exceeded our forecasts for the quarter and was up 100 basis points from Q2. About half of the sequential increase was due to factory volume leverage. With the other half resulting from the recovery of some of the cost increases we've incurred over the past year or so. Q3 operating expenses were $22.8 million, a bit lower than forecasts due to the timing of R&D and other investments shifting to Q4. The resulting operating margin was 11.6%, up 160 basis points from Q2 and about 120 basis points higher than the midpoint of our guidance. As a result of higher interest rates, interest expense increased to $3.2 million in line with our expectations. While Our effective tax rate was lower than expectations at 7.5% reflecting the revised full year effective rate of about 10%. The resulting EPS for Q3 was $1.22, $0.11 cents above the high end of guidance. The primary driver of the earnings beat was our gross margin performance well ahead of forecast, followed by revenue volume at the high end of the range. The lower tax rate for the quarter have benefited earnings…

Thank you. We will now be conducting a question and answer session. [Operator Instructions] Our first question comes from Quinn Bolton with Needham & Co. Please go ahead.

Hey, Jeff, and Larry, congratulations on the nice and record third quarter results. I guess, Jeff, you went through a lot of reasons why you think you could outperform WFE next year? I guess my basic question is if you think WFE is down 20%, do you think Ichor is down 10% to 15%? What kind of outperformance might you expect given the four or five drivers that you went through in the script?

Thanks, Quinn. Good question. If I had to put a number on it today, I'd probably say about 5% better or so. We're working on another grouping of shared gains. And obviously, with EUV growing that helps buffer it. And we have some opportunities, like we talked about, and our IMG acquisition, and that, are -- probably our memory exposure is down tremendously. So, we're still seeing strength in foundry and logic at both kind of the leading edge and at the trailing edge. There so that I think bodes well as well. But if you had to pin me into a number, I'd probably say, about 5% or so.

Perfect. And this is related question for Larry, I know you mentioned the goal is to gain or to improve gross margin about 20 basis points through product mix, as well as cost reduction activities. But there's a big leverage component to the business. And so if sales are down mid teens in 2023, how would you expect gross margin to perform in that environment?

We'd probably expect about a 25% gross margin flow through. If you look at a drop in revenue into 2023, it's slightly higher than maybe in the last downturn, because we have a little more investment in our machining business, which does help us drive more share and hopefully higher margins, but does bring with it a certain increase in fixed costs.

Got it. And then maybe Lastly, for me, Jeff. Any updates on just the next generation gas panel evaluations that are in the field?

Yes. Like we talked about, we've got two out there. One are the new customer one and one are the existing customer there. They're moving along. These usually takes nine months to 12 months. So, we're probably in the first three innings or so both of these, one a little farther than the other. And so, they're just progressing. And we're pretty hopeful that one of these will get accepted and the second half of next year we'll start to see first revenues from it.

Perfect, thank you. I'll get back in queue.

Thank you, Quinn.

Next question comes from Craig Ellis with B. Riley Securities. Please go ahead.

Thank you. And guys, congratulations on the nice execution in the quarter. I wanted to follow up on one of the items, the gross margin. So Larry, great to see the 18%. The question is this. I think you noted that there was both volume and reduced input or other cost pressures for that latter item. How much of the increase in gross margin was it? And as we look out over the next couple of quarters, given trends in the supply chain, what would you expect plus or minus from that variable as we look ahead?

Yes. So let me just describe what happened there. I think we had increases over the last probably 12 months of freight expedites choosing different suppliers, working with our customers to find alternatives and also between some overtime and other things that we've done in support of delivering product and kind of meeting customers flexibility regarding what to ship to them. And this quarter we actually completed kind of our cost sharing discussion with them. And I'd say that, if you look at the margin improvement from last quarters, 70% to this quarters, 80%, probably around half of that was related to kind of this catch-up of cost recovery, with the remaining balance being some cost management and then just volume leverage inside the organization. So, if you take, kind of strip out some of that, you get us round 17.4%, approximately, which if you look at where we are, where we've been, that's continuing on that 20 basis point trendline that we'd like to stay on.

Got it. And then the follow up, Jeff, nice to get the macro color from you. Seems like you always have a good grasp on that. The question is related to the comment that revenues might be down low to mid singles, I think it was sequentially over the next couple of quarters. One, can you just talk about the visibility that you have in the business? And if you've got particular conviction about where we might see revenues drop out whether it'd be the second quarter, third quarter, just the contour of how things are unfolding would be helpful? Thank you.

Yes. I would say that, if you asked me three months ago, I would have said visibility was out kind of nine months plus, I'd say we're getting kind of into the six month plus confidence level of visibility and things. So it's hard for me to make a call on the shape of the recovery. But I do think Q1 will be down a little bit from Q4. Obviously, we're still working through a lot of adjustments. And from the China exports and things, we think we've largely coordinated all of that through our build plans and information from our customers. So -- and then, I think we'll just have to wait maybe till the next call to give you a better view of what we think the shape is.

Got it. And then, just lastly, for me. As we look back over the last 12 months, one of the things we've wanted to see as some of the higher margin products, not just the custom design products, but things like weldments, come back et cetera. Can you just talk about how happy you are with mixing the business and any particular thoughts on mix as you look out over the next six months where you do have that visibility?

Yes, I think when we talk about like, I'll call it outperformance in a down market. But some of those share gains are definitely in the components side of the business. I'd say pretty large percentage of them. We've already gotten some in places. We kind of execute Q4. I don't want to be specific, obviously, where those things are coming from. But -- so, we're pretty confident that there's some upside to what we could potentially see on the machining side if we get some more qualifications and what we build out of our North American operations. And that would help mute some of the gross margin tailwinds in the down environmental as well. And then there's still some in gas delivery that we're working on as well. And largely, if you think about it with EUV growing that in and of itself gives us kind of a larger share of the existing TAM we operate in.

Got it. Thank you very much. I'll hop back in the queue.

Thanks, Craig.

Next question comes from Krish Sankarwith Cowen. Please go ahead.

Hi. This is Robert Burns on the line on behalf of Krish. Thanks for taking my question. I guess, just first around the portion of the business tied to EUV. Have you broken out what level that is for this year or anything in the past and sort of how to think about modeling that next year, I know you broke out the portion tied to memory. But just trying to think about the foundry and logic space and what portion is just taken up with EUV specifically?

Yes. We haven't sized that for the investment community. I mean, I think you can go look at some of our distribution of revenue and figure out from that the exposure we have in Europe is our third and fourth largest customer. So, both of those have been growing nicely as well. And as we noted that our customer concentration, of our two largest customers has gone from down to from 12% to 20% or something are the new -- are the other customers. So we haven't sized that. They haven't popped above a 10% customer. So they're not disclosed. So that will give you a little bit of a framework to figure that out.

Okay. Thank you. And just quickly in terms of the interest expense for next quarter, you mentioned going up a bit, is that just sort of how we should think about it into next year, just that kind of run rate maybe a bit higher?

Well, I think it's all dependent on what our Fed does. I mean, this reflects what Larry can see in the fourth quarter, and we'll have to see about the first quarter. If rate goes up, we've we have a floating rate. So it'll naturally go up with what you say maybe with a little bit of lag, because we do lock it in for a period of time.

Now, the only other comment I'd make is, as we expect to generate cash flow going into next year, through working capital improvements, we will be evaluating whether it makes sense to pay down some of that debt. So certainly, if the interest rates keep going up, it becomes more attractive option perhaps for us.

Okay. Thank you. Appreciate it.

Thank Rob.

The next question comes from Hans Chung with D.A. Davidson. Please go ahead.

Hi. Thank you for taking my question. So regarding the commentary about the five percentage outperformance to WFE for 2023. So how does that imply the IMG business in 2023? Does that imply it to be flat scores or maybe done slightly?

Well, good question, Hans. I'll give me a little bit of color on it. I mean, I think for IMG, maybe around 55% of their business is semi. That will probably come down a little bit. The rest of them, it'll probably be a slight growth year-over-year. So they'll see a very muted revenue level. But I do think it'll be down a little bit.

Got it. Thank you. And then next, regarding the operating expense. So, how should we think about the model? Let's say, if we see the 2023 to be down [ph], let's say 15%? Then how do we think about the deleverage on the OpEx?

Well, as we said, will be 23.2 [ph] in Q4. We'll have our normal seasonality in Q1, which we're going to try to offset. We'll continue to invest in R&D and expect that going into 2023 that spending will continue to go up slightly as we continue to penetrate with new opportunities, I think on the remaining spending areas, we're looking right now at discretionary spending around furthers travel, variable compensation, some of the other controllable spending items. I'd say, if the business drops in the 15% range that Jeff's talking, will take spending down, but it'll be -- it won't be reasonably to revenue, it will be significantly less than that. And we're still kind of working through that plan, as we finalize our outlook especially for the second half of next year. But our plans now are to keep focused on R&D investment, and we still have to maintain our Sox compliance in some of our ERP investments as well. So that's our plan for now.

Yes. And then, as we discussed back to a prior question about duration really as the revenue goes, we'll get a good view of that. And then we have a playbook that we would have to do. Obviously, we go after discretionary spending. There are certain areas that we've kind of moved into what I would call more of a BPO kind of approach to some of the transactional side of G&A and Larry work to align those with revenue levels that we say. And then there's other variable components that we can do to try and manage that number through this cycle.

Got it. That's helpful. So lastly, regarding a supply chain, so where do we still see the current trends? And then, where do we see the decrease headwinds just regarding the supply chain dynamics?

Yes. I think they improve again, obviously. I would not say that they supply chain constraints are gone. I think they'll rear its head here and there depending on where the supplier is located potentially, but we still are -- we are still working some issues where not all the supply that's needed is predictable at the component level to some of our sub tier suppliers. But it is improving a lot. So we would hope that those can take advantage of a little bit of a breathing room here and get caught up and then be behind us, but they're largely behind us now. But there's still some out there that will work.

Got it. Great. Thank you.

There are no further questions at this time. I would like to turn the floor back over to Jeff Andreson for closing comments, please go ahead.

Thank you for joining us on our call this quarter. I'd like to thank our employees, suppliers and customers for their ongoing dedication support as we continue to navigate this highly demand dynamic business environment. Our upcoming investor activities include the New York City Summit on December 13, and the Needham Growth Conference in January. We also look forward to our next earnings call scheduled for early February. Operator, this concludes our call.

Thank you. This concludes today's conference call. You may disconnect your line and have a great day. Thank you for your participation.