Good day, ladies and gentlemen, and welcome to the Ichor Systems second quarter 2018 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session, and instructions will be given at that time. If anyone should require assistance during the conference, please press star then zero on your touch-tone telephone. As a reminder, this call is being recorded. I would now like to introduce your host for today's conference, Claire McAdams, investor relations counsel for Ichor. Please go ahead.
Thank you. Good afternoon. Thank you for joining today's conference call, which will be available for replay telephonically and on Ichor's website shortly after we conclude this afternoon. If you read our earnings press release, and as you listen to this conference call, please recognize that both they 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 year 2017, which has been filed with the SEC, 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, and our earnings press release contains a reconciliation of these non-GAAP financial measures to their most comparable GAAP financial measures. On the call with me today are Ichor's Chairman and CEO, Tom Rohrs, and our Chief Financial Officer, Jeff Andreson. Tom will begin with a review of the business. Jeff will go over the second quarter financials and outlook for the third quarter of 2018. After the prepared remarks, we will open the line for questions. I'll now turn over the call to Tom Rohrs. Tom?
Thank you, Claire. Good afternoon. Welcome to our second quarter conference call. Our second quarter results, and certainly those of the first half of the year, serve as strong evidence that our strategy and operational excellence efforts are right on target. Our $249 million of revenue is in line with our forecast, down 3.5% from Q1 and up 56% from the same period last year. Our first half revenues totaled $507 million, up 64% from the first half of 2017. This is industry-leading performance. Our earnings per share of $1.02 is essentially flat to our record first quarter and 70% higher than the same period last year. For the first half of 2018, we have increased gross and operating margins by over 200 basis points compared to the first half of 2017. Year-over-year, our first half earnings per share have grown 75%.
We maintained our Q2 cash balances from Q1 levels even after completing $25 million of stock repurchases during the second quarter. We've since completed the entire $50 million program, which Jeff will discuss shortly. We are successfully achieving our goal of outgrowing the rest of the industry. Over the last four years, we have outgrown wafer fab equipment spending, our customers' revenue growth, and the growth of just about every supplier in the WFE market. Despite our excellent performance, our market cap is pretty much where it was a year ago. Last quarter, I thought that one of the issues was that we were not doing a good job of telling our story, but it goes beyond that. SemiCap investors are constantly worried about a downturn in the market.
Many still believe the old cliché that says if semi OEMs catch a cold, then suppliers such as Ichor will catch pneumonia. I have spent a lot of time over the past three months meeting with investors and analysts, explaining why this cliché is no longer true. Now I'm going to discuss what's really happening in Q3 so everyone can understand what industry downturns look like for us and why there is no need to be afraid of them. I will provide a progress report on all the incremental revenue growth drivers I have been discussing since last quarter. Lastly, I will tell you that we are deploying capital in a prudent and strategic way, including through M&A and stock repurchases to increase shareholder value.
Each of these three aspects will hopefully help you understand why Ichor is a great company and a great investment. First, regarding our Q3 outlook. Our expected decline in revenue compared to the second quarter is consistent with all relevant outlooks we've heard in the last two weeks. It's pretty much the same sequential decline seen by our largest customer and the key semiconductor WFE component suppliers. In fact, they have caught a cold and we've caught the same cold, and that's the extent of it. There's no exaggerated impact due to inventory corrections or a drive towards less outsourcing or anything else that may have caused people to think that we would catch pneumonia.
As I said during a conference webcast in June after news of memory capacity pushouts started to percolate through the investment community, if our customers are down a little more in the second half than they expected, we will be, too, and that's exactly what is happening. We also have a very highly variable manufacturing cost structure, which means we can quickly take actions to align our cost structure to the revenue outlook. With a drop in Q3 sales during the trough quarter, our gross margins will end up around 16%, down slightly more than expected as our higher margin weldment and precision machining products are biased towards memory spending. At the midpoint of guidance, we will still be close to 10% profitability in the operating margin.
That being said, while our variable cost model allows us to take action to reduce costs, we are not cutting to the bone, given that Q4 looks better than Q3. At this point, the relevant players have indicated Q3 will be the trough quarter, with a rebound expected for Q4 and visibility for the first half of 2019 to be stronger than the second half of 2018. Therefore, we have cut Q3 manufacturing headcount by about 20%, but we have refrained from cutting key R&D and marketing resources. Back in my old Applied Materials days, Jim Morgan once explained to me that a downturn was the time to gain market share through product proliferation and qualifications, and that is exactly what we are doing.
This strategy will lead us to deliver about $0.49-$0.57 in earnings per share in Q3, rather than about $0.60 in earnings per share if we were less strategic about our expense management. This is a good time for me to interject a few comments about China tariffs, which is the other key factor that the industry is facing in Q3. While there is still a great deal of uncertainty and doubt about the effects of tariffs, it is becoming clearer that as much as half of all Chinese imports could face a 25% tariff. As most of you know, we do not manufacture any of our products in China, and therefore, we are not faced with any significant direct tariff charges when we sell our customers into their U.S.-based operations.
We do have one significant China supplier who builds precision manufactured parts for us, but thanks to our strategic purchase of Talon, we now have the ability to build these parts, and we will do so if it is necessary. With that as a backdrop, you have now seen the impact on our business that a downturn can have. We will make a significant profit, despite the fact that we are not cutting spending in key areas of engineering, marketing, or sales. We understand that investors will always be concerned about the semiconductor business cycle, but our Q3 outlook demonstrates that these concerns should be mitigated. The downturn of this consolidated wafer fab industry is much shorter and much less painful. Therefore, the near-term pause is actually an excellent opportunity for us to demonstrate the resilience of our operating model.
Now let's talk about what comes after the Q3 downturn, which is the return to better times starting in the fourth quarter and into 2019. Importantly, the moderation of wafer fab equipment growth expectations for 2018 from low double digits to the single digit range, given the pushouts reported in the last couple of months, sets the stage for a potentially sixth straight year of industry growth for 2019. Last quarter, I explained the reasons why we will continue to outperform industry spending and why we believe we can continue to grow faster than the wafer fab equipment market.
These include expanding our footprint and overall market share in precision machining, expanding our footprint and market share in weldments, expanding our footprint and overall market share in our gas panel business by achieving a foothold in South Korea, achieving incremental revenue growth and market share for our emerging liquid delivery business, and finally, continued strong execution in M&A. Today, I will reiterate our incremental growth objectives and give you a progress report on these initiatives. In the areas of weldments and precision machining, we increased our served markets by over $1.5 billion through acquisitions of Cal-Weld and Talon Innovations. Before we acquired these companies, they each basically served one customer. We have significant opportunities to expand our share of these served markets by leveraging our strong relationships with our other four large customers. We expect to achieve market share gains in both weldments and precision machining.
We began initial qualifications last quarter with first revenues now expected at the end of this year and accelerating into 2019. This is happening. We have established new market share agreements and new customer qualifications for these parts of our business. Moreover, much of our additional capacity is being built in Malaysia, which has an ultra-competitive cost structure. Next, through our recent acquisition of IAN Engineering, we now have a beachhead in South Korea, which we will leverage. We will provide weldments and precision machining capabilities to the Korean equipment suppliers, as well as the Korean subsidiaries of other OEMs, which will be an incremental revenue driver for 2019. We have also the opportunity to expand our market share in liquid delivery modules.
Through IAN, we have begun working with SEMES, a $1 billion wafer fab equipment company, to bring our proprietary liquid delivery solution to Korea during 2019. IAN already provides gas panels to SEMES, as well as to Wonik IPS, one of the fastest-growing equipment suppliers, primarily in the CVD segment. This means our overall share of the $1.5 billion gas panel market has increased with this acquisition. Outside our new foothold in Korea, we have multiple opportunities for growth in our liquid delivery business, which is a $700 million market opportunity. We won a substantial award with the U.S. OEM last year, which is now just beginning to kick in and will certainly add incremental revenue growth in 2019 and beyond. Furthermore, we are working closely with additional OEMs to expand our reach in clean, track, and other wet processes, and to further increase our market share.
Long term, we see additional geographic expansion. We are engaged in strategies to expand our market share with equipment OEMs in additional customer markets, particularly in Japan. We are eager to bring our liquid delivery products to some of the largest OEMs there, who have sizable market positions in wet processes such as CMP, clean, and track. These should be a significant source of incremental revenue beginning in 2020. Last quarter, we introduced a new slide in our IR deck that summarizes all these significant opportunities. In total, we have expanded our served markets from a $1.5 billion gas panel market to a $4 billion market opportunity that can be leveraged through our acquisitions, through our geographical footprint, and our proprietary products.
As we said last quarter, for 2019 alone, we have quantified at least $100 million of incremental revenue from these initiatives, and we are progressing well with all of these. This will set the stage for an additional growth and outperformance next year and beyond. Finally, we continue to pursue additional acquisitions which fit our strategy and are accretive to our earnings. We will continue to use our strategy that has been very successful with Ajax Custom Manufacturing, Cal-Weld, Talon Innovations, and now IAN. We will stay within our strategic strengths of fluid delivery in the semiconductor market space. We will work with our growing list of customers. We will buy companies that give us a platform for additional revenue growth, and we will do deals that are accretive.
In summary, here are the key points about our business, which I hope are now well understood by all of our investors. First, our financial performance in Q3 is proving that there is little to fear in downturns as we now know them. They are shallower, shorter, and much more profitable than the downturns of yesterday. Second, we are making solid progress in executing our incremental revenue growth drivers. We have design wins in liquid delivery. We are penetrating new customers in weldments and precision machining. We are landing and expanding with OEMs in Korea, and we are putting pieces into place to address customers in Japan. Third, we are following through on our commitment to deploy capital through organic investments and M&A, as well as by returning cash to our shareholders.
We have returned $50 million through this year's stock repurchases, reducing our share count by 2.2 million shares. As I have said earlier, we have outgrown the wafer fab equipment industry since 2014, with 38% annual growth versus the industry's 14%. We will continue to outgrow the industry. With wafer fab equipment to grow in the single digits in 2018, we will grow at several times that rate, and we could do so again in 2019. You are all aware that Ichor has been executing against our strategic growth initiatives at nearly an unmatched rate, outgrowing the industry and every one of our peers and customers. We hope to gain your confidence in another year of revenue growth, outperforming the industry with expanding gross and operating margins, strong earnings growth, and multiple drivers for incremental revenues beyond 2018.
Our view is we will demonstrate our operational and financial resiliency during this third quarter and emerge stronger than ever. Our current visibility is better for Q4 and revenue strength accelerating from there as we look into 2019. With that, I will turn it over to Jeff to provide more detail about our second quarter financial performance and our guidance for the third quarter. Jeff?
Thanks, Tom. Before I begin my comments, I'd like to remind you that P&L metrics discussed today are non-GAAP measures unless I identify the measure as GAAP-based. These measures exclude the impact of share-based compensation expense, amortization of acquired intangible assets, non-recurring charges, and discrete tax items and adjustments. I'd also like to note that we have added a schedule which summarizes GAAP and non-GAAP financial results discussed on this conference call, as well as key balance sheet and cash flow metrics and revenue by geographic region to the investor section of our website. Second quarter revenues of $249 million were down 3.5% from the first quarter and up 56% over the second quarter of 2017. Our second quarter revenue included approximately $3 million of revenue from our most recent acquisition, IAN Engineering.
Our Q2 gross margin of 17.8% declined as expected from the first quarter due to the lower revenue level and product mix. As compared to the second quarter of 2017, gross margin improved 200 basis points, driven mainly by the accretive contribution of our acquisitions of Cal-Weld and Talon Innovations, as well as improvements in our other products. Operating expenses were $12.7 million, approximately 5% of revenue, and included approximately $200,000 related to our acquisition of IAN Engineering. Our operating margin of 12.7% decreased slightly from the first quarter record, but increased 220 basis points from the second quarter of 2017 and remained near our long-term model. Our interest expense in the second quarter was $2.3 million. Beyond Q2, assume a range of $2.4 million-$2.5 million in interest expense per quarter, as the LIBOR rates have risen this year.
Our tax rate for the quarter was 9.5%, which included a year-to-date adjustment to the overall tax rate we now expect for 2018. The lower rate, which is a result of the expected reduction in the contribution of profits from our U.S. entities, benefited EPS by approximately $0.03 per share. Net income of $26.7 million was essentially flat to the first quarter, at 10.7% of revenue, and increased 72% over the same period last year. Earnings per share was $1.02 compared to $1.03 in Q1, and $0.60 in the year-ago period. I'll now turn to the balance sheet. Cash of $63.4 million was about the same level as the prior quarter. We had very strong cash flow generation for the quarter, with free cash flow of $25.8 million.
Capital expenditures totaled $5.1 million as we continued to add capacity to support our market share growth opportunities that Tom discussed in his earlier comments. The company used $25 million to repurchase approximately 1.1 million shares, bringing the total amount repurchased to $30 million at the end of the second quarter. Since the beginning of the third quarter, we purchased the remaining $20 million and now have completed the full $50 million share repurchase authorization. In total, we repurchased approximately 2.2 million shares for an average price of $22.78 per share. We also used $4 million to purchase IAN Engineering, with future payments of up to an additional $4 million to be paid if they achieve certain financial and operational milestones.
We will continue to review our capital allocation options, balancing the investments needed to ensure that we develop the products and put the capacity in place to support our growth objectives that Tom discussed earlier, while balancing this with our accretive acquisition strategy, prudent management of our debt level and cash flow generation. Day sales outstanding of 24 days decreased from the first quarter's 27 days. Inventory decreased to $148.1 million, down 10% from Q1, versus a revenue decrease of 3.5% as we made very good progress in managing our inventory levels. In the second quarter, our EBITDA was $33.9 million, and in the last 12 months, we have generated $109 million of EBITDA. With total debt of $190 million, our debt to EBITDA ratio is a comfortable 1.7. Our forecast is for revenues in the range of $175 million-$185 million.
Given these revenue levels, our earnings per share will be in the range of $0.49-$0.57. This assumes a modest decline in gross margin due to product mix and the lower revenue volume, lower operating expenses, a lower effective tax rate, and a reduced fully diluted share count. Our sequential Q3 revenue decline is consistent with our peers and customers. At the midpoint of the Q3 guidance, our revenues will be down 28% from the second quarter of 2018 and up 9% from the third quarter of last year. Our revenue guidance includes about $2 million associated with IAN Engineering. We have a strategy of maintaining a highly variable manufacturing cost structure so that we can quickly adjust to market shifts like we are seeing in the third quarter. We began our rightsizing of the business in late June and completed it in early July.
Our goal was to size the organization at the appropriate resource level needed to support a stronger fourth quarter and deliver sound financial results, while continuing to invest in the business to support the market share growth opportunities we have in front of us. We purposely maintained a higher level of resources in our weldment and machining side of the business to support the market share growth we are working to achieve. This will have a negative impact on our gross margins in Q3 of about 50-60 basis points. The tax rate on an ongoing basis will be approximately 11.5% this year, given the moderation in the U.S. profit contribution we are now expecting. Our cash tax rate will be approximately 5% in 2018. We expect our fully diluted share count to be 24.7 million shares in the third quarter. Operator, we are ready to take questions.
Please open the line.
Finally. Ladies and gentlemen, if you have a question at this time, please press the star, then the number one key on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Your first question comes to the line, Patrick Ho from Stifel. Your line is open.
Thank you very much. Tom, congrats on a nice quarter and for the detailed analysis on the operating model on the environment. Maybe first off, as you talked about flexing your manufacturing capacity to meet, the current demand trends, given that we look like we're only in a one-quarter pause, especially for the businesses you've just acquired, the Cal-Weld and the Talon, how do you adjust their capacity to kind of adjust for these changing circumstances, given that the gas delivery system business has been yours for a while, and you obviously have made moves there, throughout the cycles. How do you get the new businesses to kind of flow into your operating model targets?
Hi, Patrick. Thanks for that question, it's a very good one in that, when we bought Cal-Weld and, Talon, they had somewhat different operating models than we did. As a result, we did have to make a few adjustments in how we dealt with it. The bottom line is, and I think Jeff did refer to this, while we did cut back our capacity in both Cal-Weld and Talon, it was to a lesser degree. The reason is that in both of those areas, and I refer to this, we're already in the middle of doing significant amounts of qualifications for incremental revenue. Even while we see a more robust Q4 in front of us across the board, we also see opportunity for incremental market share and revenue at both Cal-Weld and Talon. Last quarter, I mentioned we thought that was a 2019 effect.
At this point, we're now beginning to see there may be some of that hitting as early as Q4 this year. Bottom line is, we did cut back in both of those entities, not as much as we did in the gas panel part, largely because we see the opportunity for incremental market share there going forward.
Great. That's helpful. Maybe as a follow-up question, given that you're getting the adoption or at least the strong interest from additional customers in the weldments and the precision machining, what's been the variable that's changed some of those other customers' behavior? Because as you noted, in your prepared remarks, they were primarily very one customer centric. What's been the variable that's gotten the other customers interested in these offerings?
Yeah. What's happened is when they were operating as standalone companies, they had long-term individual relationships with a particular customer that were built around a particular one-to-one kinds of relationships. What we've been able to do is take advantage of our relationships across the board with other customers. By doing that, number one, and by number two, having a very good reputation for very high quality and on-time delivery, we've been able to then go to these other customers, and they have chosen to start to put some business into our sites. I will say, one of the things that has held up Cal-Weld under Talon before is that, during the previous ramp, they had a little bit of issues just keeping up, and working with the teams there, and they're both really excellent teams.
As we ramped in Q1, as you remember, our business in Q1 went from about $183 million to about $160 million. As we were ramping up in Q1, not only did we ramp up their business, but we got them on a close to 100% on-time basis. That also makes it a lot easier for other people to want to basically take part in their capabilities.
Great. Thank you very much.
You're welcome.
Thank you.
Your next question comes from the line of Karl Ackerman from Cowen. Your line is open.
Hey, good afternoon. I had two questions. Tom or Jeff, I think we all appreciate the flexibility of your financial model, given your outlook for September. First of all, where are we in the integration with Talon and Cal-Weld relative to your objectives a year ago, now that you're still going through that? Secondarily, given your commentary that shipments should be higher in December and perhaps higher as well in the first half of 2019, how should we think about OpEx beyond the September quarter?
Let me answer the first part. In terms of integrating, from a standpoint of organizations, people, operating in any kind of day-to-day activity. In essence, they're as close to about 100% integrated as you can be. Just to give you a little backdrop of that, we have a functional organization. We don't organize by product line, we don't organize by geography, we don't organize by customer. We organize by function. We have an operations function, a finance function, an engineering function, a marketing and sales function. When we buy a company, we, in essence, no longer run them as a standalone business. We take each of their key people, the key finance people will work for the CFO, the key operation people will work for our COO, key engineering people will work for our Chief Technology Officer, et cetera.
Operationally and organizationally, that makes it quite easy to integrate. The area where we still have some work to do is more on the systems side in terms of the EDP, ERP systems, et cetera. They're still running with some of their old, I shouldn't say old, but some of their legacy systems. With that, we integrate it after rather than during the actual building of a product. That's something that we're now looking at and beginning addressing, et cetera. Overall, if you look at the company, and I think if you asked our customers about it, they would say they're really well integrated at this point.
Okay, on the operating expenses for Q4 and ongoing, maybe I'll answer it this way. One is we're not really providing specific OPEX guidance, but I think when you take the comments that we made in the earnings per share, you'll see that there's a pretty significant drop from Q1, some drop in Q2, and Q3 will have another implied reduction. We're really working hard to keep those very tightly controlled. What I would say is we would not expect anything beyond maybe the normal increase in Q4 that you get for sometimes your audit and things like that. Other than that, we're going to hold them as flat and as tight as possible as we go into the end of the year.
You said you had another question, Karl.
Yes. As a follow-up, you've been pretty vocal on how your acquisition of IAN Engineering enables you to sell your existing product portfolio at the two indigenous South Korean equivalent providers. As design wins at these customers translate into revenue for you in 2019, would your bookings run rate lead you to conclude these two companies combined could be perhaps 10% of your revenue next year?
No, I don't see that. There are a couple of reasons why. One of this I've said all along, we're a significant supplier to ASML, they're having quite a terrific year this year. Our business there is growing faster than our business anywhere else. Having said that, they're not going to get close to 10% because the rest of the business, A, started a lot bigger, B, is also growing. It's just a matter of math. If you start out at a small percentage, even if you're doubling every year, if the other person is growing by 20% or 30% every year, it's going to take you quite a few years to get to be 10%. No, next year they will not be 10%.
Perfect. Thank you.
You're welcome.
Thanks, Karl.
If you would like to ask a question, please press star, then the number 1 on your touch-tone telephone. Your next question comes to the line of Sidney Ho from Deutsche Bank. Your line is open.
Thanks for taking my question. Just on your Q3 revenue guidance, the decline shouldn't really be a big surprise by now. Can you talk about what you expect the relative growth rate between your gas panels and chemical delivery products, as well as your welding and precision machining products? Are any of them going to grow faster than others? Specifically, I'm interested in your comments on the ramp of your chemical delivery business, whether that's proceeding according to your plan.
Sidney, we never break out individual pieces of the business in terms of revenue by quarter. Obviously, if we're not going to break out individual pieces in terms of revenue per quarter, we're not going to break out the growth rates by quarter either. At the beginning of this year, I did make it a point to say, as we were going from Q4 to Q1, that a big part of that growth was in fact due to our core business as opposed to our acquisitions. I did that because at that point, both Cal-Weld and Talon were relatively new, and I didn't want people to think that the core business was just flat and they're the ones doing all the growing. I did make that point at that time.
As a rule, we don't break out what we're doing in terms of revenue for any one of the particular product lines we have.
Okay, that's fair. Maybe my follow-up is that you seem to agree with your key customer that Q3 is the trough. Tom, you mentioned your visibility is better for Q4. Are you in a position to talk about what kind of magnitude of a recovery you expect in Q4? How do you get comfortable that there is not too much inventory in the supply chain exiting this quarter, whether that's at your customers or elsewhere in the supply chain?
Yeah, again, we're not going to guide to Q4. I said quite a bit about it in my prepared remarks, I kind of went about as far as I'm comfortable going in terms of my feelings about it. I think it was very clear, though. I think my statements were quite clear in terms of us seeing an upturn in Q4 from where we are. Let's leave that as it is. What was the second part of your question?
That was how do you get comfortable that there's not still inventory in the supply chain?
People are constantly worried about that. That would be something that would be affecting us right now. In other words, if there's inventory in the supply chain during the down quarters, the period of time where the customers would actually use that inventory in lieu of placing new orders with us, that was always done in the old days, if you will. That's why when the customers went down 25% or 30%, the suppliers would go down 50% or 60%, because the first part of their requirements would come out of inventory before they would place new orders. Obviously, as we predicted during, as you know, Sidney, any number of different meetings with analysts and investors, that is not the case this time around.
I think it's because, as I have said, the relationships between the OEMs and the suppliers, and I'll speak specifically for Ichor obviously, the relationships are such that there's a lot more trust, a lot more understanding. In fact, many of our orders are actually almost in the area of just-in-time orders, where we literally merge our products, they call it merge and shipment. We literally merge the products on the way to the customer site, much less send them to inventory at the OEM and wait to be integrated. I think this is just a very good way of seeing what we had been talking about, that we really expect any downturns to be very much aligned with what our customers are and certainly not any kind of order of magnitude larger.
In a weird way, we're happy to get the opportunity to prove that point.
Great. Yeah.
I would add as well, as you asked, how confident are we? I think in our guidance, you could see that our revenue is very much aligned with what the industry is seeing. That's where our confidence comes from as well. Hopefully yours will too.
That's fair. If I can squeeze in maybe one more question on the capacity side, following up an earlier question. You mentioned there are some adjustments to your capacity recently. Can you remind us your capital expansion plans and what kind of revenue can you support when the current plan is fully executed?
I remember, I think we started talking about this maybe even as we entered the year, that we were going to spend somewhere between 1.5% and 2% of revenue on CapEx this year. We're being very prudent with that, but we're not stopping the programs that would allow us to gain the market share. Market share opportunities in front of us, I think Tom said, was about $100 million. I think also we said it was about that same range that the capacity increases could handle. We'll bring those online as we need them. They don't just all come on all at once. It's a pretty large chunk.
Great. Thank you very much.
Thanks, Sidney.
Your next question comes to the line of Edwin Mok from Needham. Your line is open.
Hey, guys. Thanks for taking my question. Wanting to understand, Tom, all the opportunities you talk about precision machining, weldment. Is any of that started to contribute to growth in the second half of this year or are these all 2019 kind of growth opportunity?
I mentioned in my remarks, Edwin, that at this point Let me go back. When I talked about them a quarter ago, I thought it would all be 2019 phenomena. With regard to some of the precision machining and maybe a little bit of the weldments, we're now thinking we might see some in the fourth quarter of this year. Anyway, if anything, we're getting a little more optimistic about it, which is always a good sign.
Just to clarify that incremental number, that incremental revenue that you believe you can potentially capture as these four drivers ramp in 2019. Is that fair?
I think I've been very consistent with the $100 million kind of opportunity. We haven't broke it up against all of those incremental drivers. We've been very consistent talking about that is for next year. To Tom's point is a little bit will probably happen this year, but it's going to begin slow and then grow.
Jeff, I guess you answered my next question, which is that you're not going to break it out between the four opportunities.
No.
Okay. All right. That's helpful. Can you talk about the margins? Obviously it's down this quarter because of kind of the slowdown, and we expect business to improve in the fourth quarter, so hopefully recover a little bit. Is there a way to kind of think about longer term how your margin can trend? I think in the first quarter and second quarter is, first quarter actually operating margin of 13% and even this quarter was a little bit less than that.
Yeah.
Is there a way to think about your long-term margin targets for the model?
Yeah. I think that the way you should think about it is, obviously, Tom talked about 16% gross margin and last quarter was about 18%. We have a model, and if you look at it, you'll see that the incremental margin flows through above those. Whatever you model into Q4 for our revenue number, you'll see that the incremental margin, I'm not going to give you an exact number, but it will be north of 20% and south of 25%, just depending on the mix, because our component side, precision machining and weldments carry a higher incremental margin because of their fixed cost structure versus the gas panel business. You'll see the leverage in the model, and like Tom said, I think we're continuing to drive all of our operational initiatives to hopefully drive those incremental margins up. With any increase, it's going to recover.
Also remember, we're carrying some excess resources in this period that we would expect to lever more into next period. I've already made the comments on OpEx. We're going to be very prudent there as well.
Okay, great. That's all I have. Thank you.
Thanks.
Again, ladies and gentlemen, if you would like to ask a question at this time, please press star, then the number one on your telephone keypad. Again, that was star then number one on your telephone keypad. There are no further questions at this time. I'll turn the call back over to Tom Rohrs.
Great. Ed, thank you all for joining us for our call this quarter. We look forward to updating you on our third quarter call in November. Thank you.