Good day, ladies and gentlemen, and welcome to Ichor's first quarter 2023 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. Should you require operator assistance, please press star zero on your telephone keypad. As a reminder, this call is being recorded. It is now my pleasure to introduce your host for today's conference, Claire McAdams, investor relations for Ichor. Please go ahead.
Thank you, Devin. Good afternoon, thank you for joining today's first quarter 2023 conference call. As you read our earnings press release, and as 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 year 2022, 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 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 Andresen, 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 first quarter results and second quarter guidance. After the prepared remarks, we will open the line for questions. I'll now turn over the call to Jeff Andresen. Jeff?
Thank you, Claire. Welcome to our Q1 earnings call. Our first quarter results were pretty closely aligned with our expectations going into the quarter. Revenues of $226 million were just above the midpoint of guidance, representing a 25% decline from Q4. Gross margin of 15.5% came in at the lower end of the range due to a less favorable mix. We were able to closely manage operating expenses during the quarter and achieved about a 10% reduction compared to Q4. As a result, our operating margin of 6.1% was right at the midpoint. Earnings of $0.38 per share was well above the range due a net tax benefit, which, as Larry will discuss later, more than offset the greater FX expense in the quarter.
While our Q1 results were consistent with our expectations, the customer demand environment has further weakened year to date. We witnessed incremental pushouts and order cancellations from most of our OEM customers as we progressed through the quarter, largely as a result of additional reductions in memory investments, as well as some curtailment of spending on leading-edge logic. In particular, the component side of our business, which is largely comprised of weldments and precision machine parts, and which typically represents about a quarter of our revenue, is seeing deeper cuts than we had expected entering the year as our customers work to reduce their inventory levels. This drove the unfavorable mix versus what we anticipated for the first quarter.
In our gas panel business, our expectations for the second quarter sales are lower than what we expected at this time last quarter, with the adjustments to our forecast closely mirroring the expected declines in new system builds of our largest customers. With our current visibility, we are expecting a 20% sequential decline in revenues for Q2, followed by a recovery. We believe Q2 marks the trough quarter for our revenues this year, with both the gas panel and the component businesses expected to grow sequentially in Q3 and Q4. Product mix will again be less favorable with the expected revenue profile in Q2. As Larry will discuss in our detailed guidance, we are expecting gross margins to bottom out in the low to mid-14% level in Q2 before beginning to recover in the second half.
We believe it is well understood at this point that the further softening in semiconductor CapEx expectations this year reflects a 20%-25% decline in total wafer fab equipment spend. Within this range, the non-litho part of the market is now expected to be down by at least 30%. In the face of these significant market headwinds, during our call last quarter, we discussed a few aspects of our business that could help mitigate these significant declines. These include our growing business in the EUV lithography market, which, while still a small portion of our revenues, is a bright spot this year. We also are less exposed to the memory market today than ever before. Based on our customers' revenues by end market, we estimate that memory WFE investments drove approximately 40% of our sales in 2022.
While that marks a significant decline from the 50%-70% levels seen over the prior few years, this segment of our business is now seeing spending cuts of about 50% this year. On the logic and foundry side, we believe our revenue profile is highly leveraged to the most advanced nodes, and the capital investments in this important part of the market have also witnessed incremental reductions year to date. The non-semi portion of our revenue, which comes from the IMG acquisition, addresses areas such as medical, industrial, and aerospace. While still a small portion of our business, these segments previously were expected to perform quite a bit better than WFE in 2023, and now we've seen some additional softness in these non-semi markets that reflect the overall weakness in the macroeconomic conditions.
In the longer term, we believe that each of these markets, in particular advanced node, logic and memory, will provide Ichor with the ability to achieve a strong revenue recovery when the spending environment improves, which is pretty much inevitable, especially with these unsustainably low levels of memories investments. During this time, we will continue to focus on driving share gains for our proprietary products that make investments in new offerings that support our customers' long-term technology roadmaps. We remain focused on utilizing the slowdown to complete qualification of new products to both increase our share of market as well as the internally manufactured content of our existing products.
As a reminder, our areas of focus remain: achieving customer qualifications for our internally developed machining components, leveraging our global weldment footprint to gain additional share, completing the qualifications of our initial next generation gas panels, qualifying our chemical delivery systems, as well as developing new components that address the wet processing market, and qualifying our gas delivery solutions with key customers serving the growing silicon carbide market. We continue to make good progress on all these fronts. We expect to finalize the qualification of incremental machining components business by mid-year, and we'll begin shipping these shortly thereafter. These components will be integrated into our existing gas panels that we manufacture today and will be margin accretive. The next generation gas panel evaluation units that we have shipped are progressing well. We now expect to ship two to three additional evaluation units in the next several months.
Once these ship, we will be actively engaged with three customers. With the successful completion of each of these evaluations and expected subsequent qualifications, we expect initial revenues for our next generation gas panel to begin in the first half of 2024. The new gains in our chemical delivery business are progressing, but at a slower pace than our gas delivery products. We remain confident that our new chemical delivery module will gain additional traction later this year. Finally, we are pleased to report that we have completed delivery and customer qualification of our first gas panels for the silicon carbide market and will begin volume production by mid-year 2023. Before turning the call over to Larry, I'll remind everyone here today that our revenues tend to recover more sharply when industry spending rebounds.
As I mentioned, with our current visibility, we see revenues bottoming out in Q2, followed by the beginning of a recovery. Depending on the slope of the recovery, we see a material improvement in customer demand for [for year end]. In the meantime, we are managing through the lower demand environment by focusing on delivering solid financial results as the business recovers in the second half, improving our operational capabilities, qualifying our internally developed products, and developing new products that align with our customers' needs for both technology and cost. With that, I'll now turn the call over to Larry. Larry?
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's 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 Investors section of our website for reference during this conference call. First quarter revenues were $226 million, slightly above the midpoint of guidance and down 25% from Q4. Gross margin of 15.5% was at the lower end of the range due to the less favorable mix of revenues in the quarter.
As expected, gross margin flow-through improved to 20% compared to approximately 25% in the prior quarter as a result of the cost reductions implemented over the last two quarters. Q1 OpEx were below forecast at $21.2 million and were down approximately 10% from Q4. The resulting operating margin of 6.1% was at the midpoint of guidance. As a result of higher interest rates, net interest expense increased to $4.6 million. Other income and expense was much higher than average at $0.8 million due to unfavorable foreign exchange. Finally, we ended up recording a net tax benefit rather than the 10% expense included in our forecast, and this benefited EPS by approximately $0.12, driving our earnings above the high end of the guidance range at $0.38 per share.
Now we'll turn to the balance sheet. Total cash and equivalents at quarter end were $68.8 million, and total debt was just over $300 million. We currently have $90 million available on our revolver. Our net debt coverage ratio remains below 1.6x , and we have no exposure to any liquidity risks with our bank financing. Free cash flow for the quarter was a negative -$17.7 million, which reflects a use of cash from operations of $10.9 million and $6.8 million of CapEx. In working capital, we reduced balances of both receivables and inventory during the quarter, but days were modestly higher. Due to the faster drop in revenue.
Notable in our cash flows in Q1 was the use of $43 million to reduce accounts payable, which was a result of a highly front-end-weighted quarter for material receipts. We'll turn to our second quarter guidance. With revenue guidance in the range of $170 million-$190 million, our Q2 earnings guidance is approximately breakeven ±$0.08 per share. The midpoint of revenue guidance at $180 million reflects about a 20% decline from Q1. At this revenue level, we are expecting gross margins in the low to mid 14% range, which incorporates our cost reduction actions and continued improvements in flow-through to just under 20%.
At this time, we expect operating expenses to remain relatively flat to Q1 levels of $21.2 million as we continue to prioritize our R&D investments in support of new product programs and maintain the critical infrastructure that will enable us to quickly respond to customer demand when the spending environment recovers. We currently expect our quarterly OpEx run rate to be up slightly in the second half of the year to support the expected recovery in revenues. We expect our net interest expense will be $4.9 million in the second quarter, reflecting the continued increases in interest rates. With breakeven earnings, we anticipate no tax expense recorded for Q2. Our guidance on taxes as we move through 2023 will reflect the expectation of a net tax benefit to be recorded for the full year.
Although we are expecting pre-tax income globally for the year, at this time, we expect a full-year pre-tax loss in the U.S., resulting in an expected tax benefit in the range of $5 million-$6 million. A significant amount of this benefit was already recorded in Q1. A large portion of our fixed cost structure, including interest expense, is in the U.S., which does not change with customer volumes. We expect to be able to utilize these U.S. tax credits as we return to more normalized revenue volumes in 2024. Therefore, your model should reflect the 10% expense returning starting next year. Operator, we are ready to take questions. Please open the line.
Thank you. We will now be conducting a question-and-answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment please while we poll for questions. Our first question comes from the line of Brian Chin with Stifel. Please proceed with your question.
Hi there. Good afternoon. Thanks for letting us ask a few questions. Yeah, maybe, Jeff, to kick things off, you know, the revenue guide for the June quarter, a little bit worse than you'd anticipated. Although, you know, if you kinda look at some of your peers out there, you're kind of towards the lower end of a range that different companies have provided. Kind of, you know, bigger picture, and actually more importantly, in terms of the amount of inventory burn off that your direct customers are doing incrementally, what gives you and your peers kind of confidence there that the June quarter will sort of be the trough, and that you'll start to see some improvement off that level and sort of, you know, and tie that into sort of your, what your customers have told you about their inventories and how long it'll take for them to sort of bleed down to where they wanna be, and what's driving that sort of second half uptick as well?
Hey, Brian. Thanks. Good questions. What I would tell you on the inventory burn is that I, you know, I think on prior calls I talked about chasing demand, so I didn't think it would be as large as it was. Do I think it'll be done by the end of the second quarter? I think largely, but there may be some pockets that leak into the second half. You know, it's hard to turn the machine off because as this kind of fell kind of quickly towards the end of Q4, it's just resulted in a longer thing. The second half recovery, as we look at it, we have seen strengthening kind of across a little bit across the board.
We don't get perfect visibility at the memory logic segment, but we've seen some recovery and some shipments that are destined for China, for example. I think one of our customers talked about that on their call as well, and we've seen some strengthening again in kind of the logic area. You know, I think the view of memory is kind of holding on. I think those two are the larger pieces that give us confidence in the second half, and we've seen our outlook for Q3 and Q4 kind of strengthen over the last several weeks. That's what gives us confidence to talk about Q2 being our trough.
Okay. That's helpful. sort of from like a full year perspective, and thinking about sort of the EUV gas panel business that you do, what can you say about sort of the direction of that business this year relative to maybe your expectations three months ago?
I think it's held on pretty solidly actually. There's been a little jiggering, but I would say that's schedule related more than demand related. They have a tremendous amount of backlog as you know. Anything that s hifts in the schedule, it's, you know, it's kind of the next one fills it right in. It's stayed very stable for us from the beginning of the year, through today. You know, it's becoming a bigger piece of our business, so it's good to see.
Okay. All right. Thanks for the answers.
You bet. Thank you.
Thank you. Our next question comes from the line of Craig Ellis with B. Riley. Please proceed with your question.
Yeah, thanks for taking the question. Jeff, I wanted to start with a question that goes back to some of your prepared remarks and just understand the opportunity that you see with silicon carbide gas panels. Can you just talk about how big you believe that market is now, what the competitive landscape looks like? As you look out over the next 2 to 3 years, what's the growth potential in that market for you and the industry?
Yeah. I wish I could answer the industry question. I'm not that versed in silicon carbide. For us, this is largely focused at one customer. There are several people out there or companies out there that are addressing the silicon carbide market, some of it with existing tool sets. As we kind of look at this first one, I would say kind of on an annualized run rate, it's somewhere between $5 million-$10 million a year. If you win each one of these kind of applications, you can see that they kind of continue to build up. We've had conversations with a couple of other players, but we're pretty much in the early innings on those.
Got it. That dovetails into my next question. One of the things that came up on a couple of recent calls from some of the larger cap companies is that the mature nodes areas have been areas of particular strength, and a lot of that demand is from China, but it's clear that that's a strong global trend. The question is, what exposure does Ichor have to mature nodes? Is it material? Is it mostly something like silicon carbide can just flesh out what's existent or what might be a future opportunity in that area?
Well, I think the way I would answer this is that we benefit from the mature nodes. Quite honestly, most of those are new tools. If they're new tools, they follow through with the gas panel shares that we have today. We'll get our, call it, fair share of it. I think if it's a purely refurbished tool, we have less exposure to that. You know, anything, there's some of these are 300 millimeter, 200 millimeter, 6 inch, you know, they vary. If they're kind of older, 8 inch and 6 inch, we probably get a little less exposure, but the kind of the newer 300 millimeters, we get the same exposure we have today.
Got it. Good to hear. Larry, flipping over to you. On the cash side, you mentioned that there was $17 million used in the first quarter. Can you talk about the gives and takes in the second quarter, given the earnings guidance for the business? What do you expect to either use or generate, and then, what does that mean for some of the supplemental resources, that you have, like the revolver?
I think that we would expect to generate cash flow in Q2. I think if you look at the payables drop in Q1, which was pretty significant. I think if you look from the first quarter to the second quarter with our current receipts outlook, other than that, you won't see a lot of change there. I think on the receivables side, we had a lot of churn inside the customer base. Even though we hit the revenue number, there was a lot of work that went on at the back end of the quarter. We shipped a lot of kind of those last, you know, five weeks, six weeks of the quarter.
We ended up with a little bit higher receivables balance than you would expect to have on a normal basis, and as we see happening in Q2. I think we're, you know, we expect to generate positive cash flow in Q2 where we sit today.
Good to hear. If I could, I'll just do one last one for Jeff. Jeff, going back to one of Brian's questions about the view for Q2 being a bottom, just given the state of the macro environment, if things prove to be a little bit more U-shaped and we bounced along the bottom through the third quarter, what would be the one or two factors in your view that would catalyze such a trend versus a nice V shape that you were discussing?
I don't know how steep the V would be. I think, you know, the way we're seeing it and the outlooks that we're having, we're seeing kind of a 5%-10% increase from quarter two to quarter three today, and then something similar in quarter four. I mean, to pull those down, you'd probably have to have the macro environment kind of go further south than we're already seeing today. Again, you know, we're at levels of the lowest levels of memories WFE spend in a long, long, long time, so how long can they keep those down before they have to continue to invest in these more advanced nodes? I, you know, I'm feeling better about the second half, clearly, as you can hear from our outlook, so.
Yep. Agree that it's a multi-decade historic plunge in memory. Okay. Thanks for all the help, guys. Really appreciate it.
Thanks, Craig.
Thank you. Our next question comes from the line of Quinn Bolton with Needham & Company. Please proceed with your question.
Hey, guys. Maybe just follow up to Craig's question there. If I do the quick math of up, you know, 5% to 10% in Q3, Q4, if I just take the midpoint of those, you know, percentage growth rates, looks like you're gonna be almost flat, half over half, maybe down a smidge in the second half of 2023 versus the first half. Just wanna make sure that that's kind of consistent with how you're seeing things?
You did the math quickly and accurately. You know.
Go ahead.
... I think, you know, I think as we entered this, we thought that, you know, we would see a more back-end loaded, but it's, you know, it's softened enough in the first half that, they're gonna be pretty close to equal.
Got it. For Larry, you know, you talked about the, you know, reduced incremental flow-through as revenues have declined. You were at 20% in Q1. You think it might be a little bit less than 20% in Q2. As you start to see revenue recover in Q3 and Q4, do we go back to a 25% flow-through of the higher revenue as you begin to recover, given some of the cost reduction actions you've taken?
I think given where we are today and the variable spending that we've taken out and people that we've taken out, I think 25% is reasonable for the back half of this year, assuming the revenue that Jeff mentioned and what we see in the way of mix between machining and our gas panel, the integration business, that's a reasonable model.
Got it. A follow-up question on the China business. I think a number of the larger OEMs in their earnings calls have talked about the clarification of export controls around DRAM shipments appears to have, you know, benefited some of your larger OEMs. I assume that you would see that growth, you know, as they're able to ship those tools they got clarification on?
Yeah. Yeah, definitely. I mean, I would say that we've seen it. Some of the strengthening in the second half has come from that. We don't get all the sell-through information, but we get enough to know it seemed to have aligned with some of the comments made by the larger OEMs in the industry.
Great. Then lastly, maybe I missed it, but Jeff, did you talk about the type of tool that you have a gas panel for silicon carbide? Is this an etch or a dep tool, or is this perhaps more on the epitaxy side of things?
I haven't been able to comment on that, Quinn, and if I did, you'd probably figure out who it was we were working with. It's one of those three.
Okay. Fair enough. I tried. All right. Thank you very much, Jeff.
Yeah.
Thank you. Our next question comes from line of Krish Sankar with Cowen. Please proceed with your question.
Hi, this is Robert Mertens on for Krish. Thanks for taking my questions. First, could you provide just some of your high-level expectations for the IMG business this year, how the demand environment's changed over the past quarter, and what sort of visibility you have? I have one follow-up.
Yeah, I think we don't actually break it out, but what I'll give it to you at kind of a more qualitative. I would say the semi side of the business is seeing something pretty similar to what we've experienced in our outlook. The we talked about a little more softening in their non-semi market. We had entered the year with that expected to grow. I would say that's probably gonna be more flat. It's not going down anywhere like the semi business, but the semi business they have is softening. Having said that, you know, we're similar in their side of the business. We do see the second half strengthening for them, so.
Got that. That's helpful. Then maybe just a follow-up, on how your outlook this year for the EUV business. Has it changed any over the past few months? I know that, the total revenue from that side was less than 10% last year. Is there any sort of timeframe where you think that threshold would be crossed, you know, assuming no major SKU change with memory coming back in the second half?
Yeah. I mean, I think I commented earlier, our EUV forecast has held up quite nicely. I would say almost no change from where we're at entering the year. You know, based on our kind of Q1 and Q2, I would expect them in those quarters, even though we don't report it quarterly, they're 10% customers in the first half of the year for sure.
Got it. All right. Thank you so much.
You bet.
There are no further questions at this time. I'd like to turn the floor over to Jeff Andreson for closing comments.
Thank you for joining us on our call this quarter. I'd like to thank our employees, suppliers, and customers for their ongoing dedication and support as we continue to navigate this highly dynamic business environment. Our upcoming investor activities include the B. Riley conference in L.A. on May 24th, the Cowen tech conference in New York on June 1st, the Stifel Cross Sector conference in Boston on June 6th, and the CEO Summit in San Francisco on July 12th. We also look forward to our next quarterly earnings call scheduled for early August. Operator, that concludes our call.
This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation. Have a wonderful day.