UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

(Mark One)

For the quarterly period ended September 28, 2018

OR

 

For the transition period from __ to __

 

Commission File Number: 001‑37961

 

ICHOR HOLDINGS, LTD.

(Exact Name of Registrant as Specified in its Charter)

 

 

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

 

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

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

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

 

 

 

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

 

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

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

 

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TABLE OF CONTENTS

 

 

 

 

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PART I

ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)

ICHOR HOLDINGS, LTD.

Consolidated Balance Sheets

(dollars in thousands, except per share amounts)

 

See accompanying notes.

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ICHOR HOLDINGS, LTD.

Consolidated Statements of Operations

(dollars in thousands, except per share amounts)

 

See accompanying notes.

 

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ICHOR HOLDINGS, LTD.

Consolidated Statements of Shareholders’ Equity

(dollars in thousands)

 

See accompanying notes.

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ICHOR HOLDINGS, LTD.

Consolidated Statements of Cash Flows

(in thousands)

 

See accompanying notes.

 

 

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ICHOR HOLDINGS, LTD.

Notes to Consolidated Financial Statements (Unaudited)

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

Note 1 – Basis of Presentation

Basis of Presentation

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

Year End

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

Use of Estimates

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

Revenue Recognition

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

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

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

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

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Accounting Pronouncements Recently Adopted

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

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

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

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

Accounting Pronouncements Recently Issued

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

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

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Note 2 – Acquisitions

IAN Engineering Co., Ltd.

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

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

 

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

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

Talon Innovations Corporation

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

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

 

 

Cal-Weld, Inc.

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

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

 

 

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Note 3 – Inventories

Inventories consist of the following:

 

 

Note 4 – Property and Equipment

Property and equipment consist of the following:

 

 

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

Note 5 – Intangible Assets and Goodwill

Definite‑lived intangible assets consist of the following:

 

 

 

 

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

 

 

Note 6 – Commitments and Contingencies

Operating Leases

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

Litigation

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

Note 7 – Income Taxes

Income tax information for the periods reported are as follows:

 

 

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

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

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

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

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

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Note 8 – Employee Benefit Programs

401(k) Plan

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

Medical Insurance

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

Note 9 – Long-Term Debt

Long‑term debt consists of the following:

 

 

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

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

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

Note 10 – Shareholders’ Equity

Share Repurchase Program

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

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

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Note 11 – Share‑Based Compensation

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

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

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

Stock Options

The following table summarizes stock option activity:

 

 

Restricted Shares

The following table summarizes restricted share activity:

 

 

Employee Share Purchase Plan

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

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

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Note 12 – Segment Information

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

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

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

 

 

Note 13 – Earnings per Share

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

 

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

Note 14 – Discontinued Operations

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

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

 

 

The following table represents results of our discontinued operation:

 

 

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

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

Overview

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

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

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

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Results of Operations

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

 

The following table sets forth our unaudited results of operations as a percentage of our total sales for the periods presented.

 

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Comparison of the Three and Nine Months Ended September 28, 2018 and September 29, 2017

Sales

 

The increase in net sales from the third quarter of 2017 to the third quarter of 2018 was primarily due to an increase in volume from our acquisitions of Cal‑Weld, Talon, and IAN in July 2017, December 2017, and April 2018, respectively, partially offset by industry contraction. On a geographic basis, sales in the U.S. increased by $1.6 million in the third quarter of 2018 to $103.6 million; foreign sales increased by $9.1 million to $71.6 million.

The increase in net sales from the nine months ended September 29, 2017 to the nine months ended September 28, 2018 was primarily related to an increase in volume resulting from industry growth, our acquisitions of Cal‑Weld, Talon, and IAN, and market share gains. On a geographic basis, sales in the U.S. increased by $148.6 million in the nine months ended September 28, 2018 to $417.2 million; foreign sales increased by $60.7 million to $265.0 million.

Cost of Sales and Gross Profit

 

The increase in cost of sales and gross profit from the three and nine months ended September 29, 2017 to the three and nine months ended September 28, 2018 was primarily due to increased sales volume.

The 140 basis point increase in our gross margin during the third quarter of 2018 compared to the third quarter of 2017 was primarily due to a $3.0 million charge to cost of sales that occurred in the third quarter of 2017 as a result of recording acquired inventory from our acquisition of Cal-Weld in July 2017 at fair value that did not repeat in the third quarter of 2018. The impact of this charge accounted for a 180 basis point decrease in reported gross margin for the third quarter of 2017. Adjusting for this discrete charge, gross margin decreased by 40 basis points in the third quarter of 2018 compared to the third quarter of 2017.

The 160 basis point increase in our gross margin during the nine months ended September 28, 2018 compared to the nine months ended September 29, 2017 was primarily due to the accretive impact of our acquisitions of Cal‑Weld and Talon in the second half of 2017. The increase was additionally impacted by (1) a charge to cost of sales of $4.8 million and $3.0 million in the nine months ended September 28, 2018 and September 29, 2017, respectively, due to recording acquired inventory at fair value, resulting in a decrease to reported gross margins of 70 basis points and 60 basis points for the nine months then ended, respectively; and (2) a $1.75 million charge to cost of sales in the second quarter of 2017 from an error correction relating to translated inventory balances at our Malaysia and Singapore subsidiaries using an incorrect foreign currency rate, resulting in a decrease to reported gross margin of 30 basis points in the nine months ended September 29, 2017. Adjusting for these discrete charges, gross margin increased by 130 basis points in the nine months ended September 28, 2018 compared to the nine months ended September 29, 2017.

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Research and Development

 

The relatively flat research and development expenses from the third quarter of 2017 to the third quarter of 2018 was primarily due to incremental employee-related expenses from our acquisition of Talon, offset by a decrease in research and development materials costs.

The increase in research and development expenses from the nine months ended September 29, 2017 to the nine months ended September 28, 2018 was primarily due to incremental expenses from our acquisition of Talon, increased share-based compensation expense, and an increase in headcount and consulting expense to support additional projects.

Selling, General, and Administrative

 

The decrease in selling, general, and administrative expense from the third quarter of 2017 to the third quarter of 2018 was primarily due to a $1.1 million decrease in acquisition-related expenses, a $1.0 million charge in the third quarter of 2017 from a final arbitration ruling on our working capital claim with the sellers of Ajax, a $0.5 million decrease in employee-related expenses, and $0.5 million in expense incurred in the third quarter of 2017 associated with the secondary offering of our shares by affiliates of Francisco Partners (“FP”), partially offset by $1.9 million in incremental operating expenses from our acquisitions of Cal‑Weld, Talon, and IAN and a $0.4 million increase in share-based compensation expense.

The increase in selling, general, and administrative expense from the nine months ended September 29, 2017 to the nine months ended September 28, 2018 was primarily due to $8.6 million in incremental operating expenses from our acquisitions of Cal‑Weld, Talon, and IAN, a $4.0 million increase in share-based compensation expense (inclusive of $2.9 million associated with modifying our former CFO’s equity awards in the first quarter of 2018), and an additional $1.1 million incurred in the first quarter of 2018 due to the separation of our former CFO, partially offset by a $1.0 million charge in the third quarter of 2017 from a final arbitration ruling on our working capital claim with the sellers of Ajax, $1.0 million in expense incurred in 2017 associated with the secondary offerings of our shares by affiliates of FP, and a $0.8 million decrease in acquisition-related expenses.

Amortization of Intangible Assets

 

The increase in amortization expense from the three and nine months ended September 29, 2017 to the three and nine months ended September 28, 2018 was due to incremental amortization expense from intangible assets acquired in connection with our acquisitions of Cal‑Weld and Talon in the second half of 2017 and IAN in the second quarter of 2018.

The fair value assigned to intangible assets acquired in connection with our acquisitions of Talon and IAN is still preliminary. Amortization of intangible assets may change in future periods depending on the final fair value assigned to the acquired intangible assets.

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Interest Expense

 

The increase in interest expense from the three and nine months ended September 29, 2017 to the three and nine months ended September 28, 2018 was primarily due to an increase in the average amount borrowed. Our weighted average interest rate increased by 90 basis points during the third quarter of 2018 compared to the third quarter of 2017 and decreased by 10 basis points during the nine months ended September 28, 2018 compared to the nine months ended September 29, 2017.

Total borrowings outstanding at September 28, 2018, net of debt issuance costs, were $190.8 million, compared to $67.7 million at September 29, 2017.

Other Expense (Income), Net

 

The change in other expense (income), net for the third quarter of 2018 was primarily due to exchange rate fluctuations on transactions denominated in the local currencies of our foreign operations, principally the Singapore Dollar, Malaysian Ringgit, and British Pound.

The change in other expense (income), net for nine months ended September 28, 2018 was primarily due to exchange rate fluctuations on transactions denominated in the local currencies of our foreign operations, principally the Singapore Dollar, Malaysian Ringgit, and British Pound, and a gain of $0.2 million on the sale of our cost method investment, CHawk Technology International, Inc. (“CHawk”) in the first quarter of 2017 that did not repeat in the first quarter of 2018.

Income Tax Benefit from Continuing Operations

 

The decrease in income tax benefit from the third quarter of 2017 to the third quarter of 2018 was primarily due to discrete tax benefits recognized in the third quarter of 2017 relating to the reversal of previously accrued withholding taxes from our re-characterization of intercompany debt to equity and our acquisition of Cal‑Weld and a valuation allowance against our U.S. deferred tax assets that was present in 2017 but not in 2018, partially offset by excess tax benefits from share-based compensation.

The decrease in income tax benefit from the nine months ended September 29, 2017 to the nine months ended September 28, 2018 was primarily due to discrete tax benefits recognized in the third quarter of 2017 relating to the reversal of previously accrued withholding taxes from our re-characterization of intercompany debt to equity and our acquisition of Cal‑Weld and a valuation allowance against our U.S. deferred tax assets that was present in 2017 but not in 2018, partially offset by excess tax benefits from share-based compensation and the release of a valuation allowance against foreign tax credit carryforwards in the second quarter of 2018.

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Non‑GAAP Results

Management uses non-GAAP adjusted net income from continuing operations 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 adjusted net income from continuing operations is defined as: (1) net income from continuing operations; (2) excluding amortization of intangible assets, share-based compensation expense, non-recurring expenses including adjustments to the cost of goods sold, and the tax adjustments related to those non-GAAP adjustments; and (3) non-recurring discrete tax items including tax impacts from releasing a valuation allowance related to foreign tax credits. Non-GAAP adjusted diluted EPS is defined as non-GAAP adjusted net income from continuing operations divided by weighted average diluted ordinary shares outstanding during the period.

The following table presents our unaudited non‑GAAP adjusted net income from continuing operations and a reconciliation from net income from continuing operations, the most comparable GAAP measure, for the periods indicated:

 

 

Included in this amount for the nine months ended September 28, 2018 are (i) separation benefits for our former CFO that became effective in January 2018 and (ii) acquisition-related expenses.

Included in this amount for the third quarter of 2017 are (i) expenses incurred in connection with the secondary offering of our ordinary shares by FP and (ii) acquisition-related expenses.

Included in this amount for the nine months ended September 29, 2017 are (i) expenses incurred in connection with the secondary offerings of our ordinary shares by affiliates of FP, (ii) acquisition‑related expenses, (iii) a refund from FP Consulting, and (iv) a gain on sale of our investment in CHawk.

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Non‑GAAP adjusted net income from continuing operations has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for net income or any of our other operating results reported under GAAP. Other companies may calculate adjusted net income differently or may use other measures to evaluate their performance, both of which could reduce the usefulness of our adjusted net income as a tool for comparison.

Because of these limitations, you should consider non‑GAAP adjusted net income from continuing operations alongside other financial performance measures, including net income from continuing operations and other financial results presented in accordance with GAAP. In addition, in evaluating non‑GAAP adjusted net income, you should be aware that in the future we will incur expenses such as those that are the subject of adjustments in deriving adjusted net income and you should not infer from our presentation of adjusted net income that our future results will not be affected by these expenses or any unusual or non‑recurring items.

Liquidity and Capital Resources

We had cash of $33.0 million as of September 28, 2018. Our principal uses of liquidity are to fund our working capital needs, purchase new capital equipment, and our share repurchase program. The net decrease in cash of $36.3 million during the nine months ended September 28, 2018 from December 29, 2017 was primarily due to cash flow from operations of $27.4 million, proceeds from the issuance of ordinary shares under our share-based compensation plans of $6.1 million, and net borrowings on long-term debt of $5.4 million, offset by share repurchases of $60.3 million, capital expenditures of $11.4 million, debt modification costs from the refinancing of our credit facilities in February 2018 of $2.1 million, and net cash paid in connection with acquisitions of $1.4 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

 

Operating Activities

We generated $27.4 million from operating activities during the nine months ended September 28, 2018 due to net income of $54.4 million and net non-cash charges of $18.2 million, partially offset by an increase in our net operating assets and liabilities of $45.2 million, net of acquired assets and liabilities. Non-cash charges primarily consist of depreciation and amortization of $17.4 million and share-based compensation of $6.3 million, partially offset by deferred income taxes of $6.2 million. The increase in our net operating assets and liabilities, net of acquired assets and liabilities, was primarily due to a decrease in accounts payable of $48.1 million and an increase in accounts receivable of $14.6 million, partially offset by a decrease in inventories of $22.6 million.

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Investing Activities

We used $12.8 million in investing activities during the nine months ended September 28, 2018 due to capital expenditures of $11.4 million and net cash paid in connection with acquisitions of $1.4 million.

Financing Activities

We used $50.8 million in financing activities during the nine months ended September 28, 2018 due to share repurchases of $60.3 million and debt modification costs in connection with the refinancing of our credit facilities in February 2018 of $2.1 million, partially offset by proceeds related to issuances of ordinary shares under our share-based compensation plans of $6.1 million and net borrowing on long-term debt of $5.4 million.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses. On an ongoing basis, we evaluate our judgments and estimates including those related to revenue recognition, impairment of goodwill and intangible assets, income taxes, advertising expense, and share‑based compensation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.

The accounting policies we believe to be most critical to understanding our financial results and condition and that require complex and subjective management judgments and estimates 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 29, 2017 (our “Annual Report”).

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Foreign Currency Exchange Risk

Currently, substantially all of our sales and arrangements with third‑party suppliers provide for pricing and payment in U.S. dollars and, therefore, are not subject to material exchange rate fluctuations. As a result, we do not expect foreign currency exchange rate fluctuations to have a material effect on our results of operations. However, increases in the value of the U.S. dollar relative to other currencies would make our products more expensive relative to competing products priced in such other currencies, which could negatively impact our ability to compete. Conversely, decreases in the value of the U.S. dollar relative to other currencies could result in our foreign suppliers raising their prices in order to continue doing business with us.

While not currently significant, we do have certain operating expenses that are denominated in currencies of the countries in which our operations are located, and may be subject to fluctuations due to foreign currency exchange rates, particularly the Singapore dollar, Malaysian Ringgit, British Pound, and Euro. Fluctuations in foreign currency exchange rates may cause us to recognize transaction gains and losses in our statement of operations. To date, foreign currency transaction gains and losses have not been material to our financial statements, and we have not engaged in any foreign currency hedging transactions.

Interest Rate Risk

We had total outstanding debt of $195.0 million as of September 28, 2018, exclusive of $4.2 million in debt issuance costs, of which $8.8 million was due within 12 months. The outstanding amount of debt included elsewhere in this report is net of debt issuance costs.

We do not enter into investments for trading or speculative purposes and have not used any derivative financial instruments to manage our interest rate risk exposure. We have not been exposed to, nor do we anticipate being exposed to, material risks due to changes in interest rates. The interest rate on our outstanding debt is variable based on LIBOR, the Prime Rate, or the Federal Funds Rate. A hypothetical 1% change in the interest rate on our outstanding debt would have resulted in a $0.5 million change to interest expense during the third quarter of 2018, or $1.9 million on an annualized basis.

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ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

As required by Rule 13a‑15(b) under the Exchange Act, we carried out an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a‑15(e) and 15d‑15(e) under the Exchange Act) as of the end of the period covered by this report. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives. We evaluated the effectiveness of our disclosure controls and procedures as of September 28, 2018, with the participation of our CEO and CFO. Based on this evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective as of September 28, 2018.

Changes in Internal Control Over Financial Reporting

A company’s internal control over financial reporting is a process designed by, or under the supervision of, a company’s principal executive and principal financial officers, or persons performing similar functions, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with GAAP. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. In addition, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with policies or procedures may deteriorate. If we cannot provide reliable financial information, our business, operating results and share price could be negatively impacted.

In connection with the adoption of new revenue recognition accounting standards, as codified in ASC Topic 606, we implemented certain internal controls to ensure we adequately evaluated our contracts with our customers and properly assessed the impact of the new revenue recognition accounting standards on our financial statements to facilitate its adoption at the beginning of our first fiscal 2018 quarter. There were no significant changes to our internal control over financial reporting due to the adoption of the new accounting standards.

PART II—OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

For a discussion of legal proceedings, see “Note 6 – Commitments and Contingencies” in the Notes to Financial Statements (Unaudited) included in this report.

ITEM 1A. RISK FACTORS

There have been no material changes in our risk factors from those disclosed in our 2017 Annual Report. These risk factors could materially and adversely affect our business, financial condition and results of operations, and the trading price of our ordinary shares could decline. These risk factors do not identify all risks that we face – our operations could also be affected by factors that are not presently known to us or that we currently consider to be immaterial to our operations. Due to risks and uncertainties, known and unknown, our past financial results may not be a reliable indicator of future performance and historical trends should not be used to anticipate results or trends in future periods.

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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Share Repurchase Program

Information related to repurchases of our ordinary shares during the nine months ended September 28, 2018 is as follows:

 

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. OTHER INFORMATION

None.

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ITEM 6. EXHIBITS

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

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