FormFactor, Inc.
Q3 2012 Earnings Call Transcript

Published: 2 Nov 2012

[Operator:]

Welcome everyone to FormFactor’s Third Quarter 2012 Earnings Conference Call. On today’s conference call are Chief Executive Officer, Tom St. Dennis and Chief Financial Officer, Mike Ludwig. Before we begin, let me remind you that the company will be discussing GAAP P&L results and some key non-GAAP results to supplement understanding of the company’s financials. A schedule that provides GAAP to non-GAAP reconciliations is available on the press release issued today and also on the Investor section of FormFactor’s website. Also a reminder for everyone, that today’s discussion contains forward-looking statements within the meaning of the Federal Securities Laws. Such forward-looking statements include, but are not limited to projections, including statements regarding business momentum in macroeconomic conditions, demand for our products and future growth. Statements about our development, introduction, and/or qualification of next generation matrix products, statements about the company’s recent merger with Astria Semiconductor Holdings, Inc. such as projected technology and product further development. Results and/or synergies and statements that contain words like expect, anticipate, believes, possibly, should and assumptions upon which such statements are based. These forward-looking statements are based on the current information and the expectations that are inherently subject to change and involve a number of risks and uncertainties. FormFactor’s actual results could differ materially from those projected in our forward-looking statements. The company assumes no obligation to update information provided during today’s call, to revise any forward-looking statements or to update reasons, actual results could differ materially from those anticipated in forward-looking statements. For more information, please refer to the Risk Factor discussions in the company’s Form 10-K for the fiscal year 2011, as filed with the SEC, subsequent SEC filings and in the press release issued today. With that, we will now turn the call over to CEO, Tom St. Dennis.

[Thomas Dennis:]

Good afternoon. FormFactor’s revenue in the third quarter of 2012 was down significantly from our second fiscal quarter, consistent with our guidance in July. There are two key factors that led to this decline. The first key factor is the macroeconomic uncertainties facing companies and consumers globally. This impacted all of our customers in both the memory and logic businesses and appears to be continuing into the fourth quarter. The second key factor is the structural change that the personal computing industry is going through as personal computers, especially desktop PCs decline and are replaced by mobile computing devices. This has had a severe negative impact on DRAM demand and pricing. As a result, our customers substantially reduced their purchases of DRAM probe cards in the quarter. Looking ahead, there are demand drivers for DRAMs that are growing rapidly and should play a significant role as macroeconomic conditions improve. Smartphones and tablets in particular represent a rapidly growing market for mobile DRAM and could replace a meaningful portion of the PC DRAM market declines over the next 2 to 3 years. The sever market for DRAMs appears to be growing strongly, and notebook PCs are still growing although more slowly. FormFactor has continued to improve its operational performance throughout this year and our result in Q3 reflected that progress. On a non-GAAP basis, gross margins in Q3 were 9 points higher compared to Q1 2011 when we had similar revenues. This improvement reflects the continued progress that we made in both direct and indirect costs. Operating expenses have declined 35% in the past eight quarters and will continue to improve in Q4. During Q3 we took further restructuring steps by closing our manufacturing activity in Japan and reducing headcount related to memory technology. Our next generation matrix card was successfully qualified for production at three advanced DRAM customers during the third quarter. These were the most advanced probe cards that we’ve ever built and they were successfully qualified in the most advanced DRAM processes in the industry. We’ve engaged with the customers on follow-on design and expect to see this product begin to contribute to revenues as early as this quarter. The structural change in the computing industry from a PC centric world to a mobile computing centric world, was the key factor in our decision to merge with MicroProbe. This merger enables a transformation of the company from a primarily DRAM focused business, with 65% to 70% of revenues from DRAM alone to a company with over 50% of revenues from logic and SOC, and less than 40% of revenues from DRAM. The combination of FormFactor and MicroProbe has created the largest probe card supplier in the semiconductor industry. With industry leading technologies across the SOC and memory markets. The two companies are very complimentary with virtually no product overlap, which allows us to move forward together immediately with no customer confusion about product direction. Combined we have the broadest portfolio of products and the largest customer service and support organization in the industry. On October 16th we completed the first step of this transformation by closing the merger with MicroProbe and since then we have been working with the worldwide organization to combine our capabilities in technologies. We have already identified several products and manufacturing opportunities that we expect will improve product performance reduce costs or shorten lead times. We are still early in the merger process but I’m very impressed by the combined capabilities of the new organization and I feel we are very well positioned going into 2013. Mike Ludwig will now review our Q3 performance and discuss the guidance for the fourth quarter.

[Michael Ludwig:]

Thank you Tom. Revenues for Q3 were $41.3 million, a decrease of $13.5 million or 25% versus Q2 2012. Compared to the second quarter revenues decreased in all markets, DRAM, Flash, and SOC. Third quarter revenue for DRAM products were $26 million, a decrease of 32% from our second quarter. The decrease in DRAM probe card demand resulted from an oversupply of DRAM devices, DRAM device price declined, a reduced demand for PCs in the quarter, all negatively impacting our customer’s DRAM production. We do, however, continue to see an increased percentage of DRAM probe card revenues from customers that are transitioning to 4 Gig devices and 3X nanometer nodes, our probe card for mobile devices continue to be a strong revenue component. Flash revenues were $8.4 million for the third quarter, a decrease of 13% from the second quarter. Our NAND Flash revenues for Q3 were flat compared to Q2 at $5.3 million while our NOR flash revenues decreased $1.3 million in the quarter to $3.1 million. SOC revenues were $6.9 million, a decrease of $0.2 million or 3% from Q2. Third quarter GAAP gross margin was $8.2 million or 20% of revenues, compared to $16.2 million or 29% of revenues for the second quarter of 2012. On a non-GAAP basis, gross margin for the third quarter was $8.7 million or 21% of revenues compared to $16.9 million or 31% of revenues for the second quarter. Non-GAAP gross margin for the third quarter was unfavorably impacted by lower fixed spending leverage from the much lower revenue levels and an unfavorable product mix. As lower margin NAND Flash revenues comprised a higher percentage of revenues in the third quarter. Our GAAP operating expenses were $20.2 million for Q3, a decrease of $2.3 million compared to Q2. Non-GAAP operating expenses for the third quarter were $16.6 million, a decrease of $3.1 million compared to the second quarter. The decrease of non-GAAP operating expenses in the third quarter was due to reduced R&D project spending, reimbursement for test vehicles for our next generation matrix product, increased savings from additional time off and reduced incentive compensation charges. In addition, our trade components audit with the foreign jurisdiction that commenced in Q3 2011 is concluding, resulting in a reduction of our non-GAAP OPEX expenses of $0.6 million in the third quarter. In the third quarter the company commenced the execution of a plan to reduce our cash flow breakeven target to $50 million of revenue from the previous $54 million to $56 million level. A significant action taken as part of the planned reduction included reducing our manufacturing footprint in Japan and moving the equipment capacity back to Livermore. The transition is underway and will be completed in the fourth quarter. When all actions are completed we will have reduced our headcount by approximately 65 positions including regular employees and contract positions as well as taken certain actions to reduce other discretionary spending. The actions will be completed by the end of 2012. The company recognized $2.5 million of restructuring cost in the third quarter resulting from the actions and expects to save approximately $5 million per quarter or $20 million annually. The company realized approximately $1 million of benefit in Q3 related to these actions. In the third quarter the company recorded a tax provision of $0.2 million compared to a tax benefit of $1.6 million in Q2. The benefit in the second quarter was derived primarily from the expiration and the federal statutory limitations around specific uncertain tax positions. Average weighted shares outstanding from the third quarter were 50.2 million shares compared to 49.8 million in Q2. The company did not repurchase any of its common stock in the third quarter. GAAP loss per share was $0.29 in Q3 compared to a loss of $0.08 per share in Q2. Non-GAAP loss per share was $0.15 in Q3 compared to a loss of $0.01 per share in Q2. Cash, comprised of cash, short term investments and restricted cash ended the third quarter at $276.5 million. $1.6 million lower than Q2. The company used approximately $700,000 of cash from operations in the quarter. However, cash of $5.8 million was provided from decreases and current asset investments as a result of strong cash collections in the quarter coupled with decreased shipments. Here are some other financial details. Our depreciation and amortization in the third quarter was $2.6 million, consistent with the second quarter. Our capital additions in Q3 were $2.2 compared to $2.1 million in Q2. Our stock based compensation expense for the third quarter was $3 million compared to $3.5 million in the second quarter. On September 3 we announced the acquisition of MicroProbe’s parent company, Astria Semiconductor Holdings for $100 million of cash and just over 3 million shares of FormFactor stock. As Tom mentioned this transaction was transformational for both companies will be immediately accretive to FormFactor. FormFactor incurred $1.2 million of expenses in Q3 for this transaction. These expenses were excluded from our non-GAAP operating expenses. The company acquired approximately $21.6 million net book value of tangible assets in the transaction including net current assets of $18.3 million. Cash of approximately $4 million is included in the net current assets. Post acquisition, the combined company has approximately $181 million of cash in short term investments and restricted cash. With the actions that FormFactor has taken to reduce its cash flow breakeven, we expect the combined company to be cash flow breakeven at the $68 million to $70 million levels in the first half of 2013. While there is virtually no product overlap, the company is aggressively pursuing synergies to reduce OpEx expenses, most notably in the SG&A areas. In the fourth quarter we expect to realize over $1 million of savings from OPEX synergies. We expect the OpEx synergies to approximately double by the end of 2013 and we will update our progress in subsequent communications. Additionally, the combined companies have identified several opportunities to leverage the supply base to reduce product cost, as well as leverage design and factory automation to achieve greater efficiencies and reduce Xcost. These opportunities are in the early phases of discovery. We will update you on their progress going forward. With respect to Q4 our guidance will reflect results from the combined company but Microprobe business consolidated into our results and guidance from October 17th through December 29th. We continue to experience demand contractions particularly in the memory market, similar to that experienced by some of our customers resulting from market uncertainty and depressed pricing for memory devices. As such we expect fourth quarter revenues to be in the range of $46 million to $51 million. We expect memory revenues to be $20 million to $23 million and SOC revenues to be $26 million to $28 million, with Microprobe’s SOC business contributing $21 million to $23 million. With respect to gross margin the decreased revenues and unfavorable products mix for the FormFactor business will have a negative impact on fixed spending leverage and factory utilization. Therefore, we expect to combine non-GAAP gross margin to be in the range of 11% to 17% for the fourth quarter. We expect Q4 non-GAAP operating expenses to be approximately $23 million to $24 million. With the reduced revenues and demand for the FormFactor business we expect Q4 cash usage will be $12 million to $14 million from the combined operation. The company will also spend approximately $5 million to $6 million onetime payment for acquisition and restructuring costs, therefore all cash usage for the fourth quarter will be $17 million to $20 million. With that let’s open the call for Q&A. operator.

[Operator:]

[Operator Instructions] One moment please. Our first question comes from James Covello from Goldman Sachs. Your line is open.

[Mark Delaney:]

Hi this is Mark Delaney calling on behalf of Jim Covello. Congratulations on getting the MicroProbe deal closed. If you could just talk a little bit about the top line drivers of the MicroProbe segment. Yeah I know it’s historically been dead growth in part of transition in DRAM and hoping you can provide some color on what the similar dynamics would be for the SEC business.

[Thomas Dennis:]

Sure the MicroProbe’s products served and are really targeted at the mobile application process or space. So it’s all of the computing processors both PC server as well as mobile applications but the strongest growth of course is in smartphones, tablets, etc. and that’s where there are – that’s where they have the greatest product traction, that’s where their growth has come from, and with forecasts for substantial continued growth in those markets I think it bodes well for their product and for our opportunity there.

[Mark Delaney:]

Got it. In terms of the memory segment, specifically DRAM industry growth forecast are for DRAM growth to be in line or maybe below what it was in 2012 and 2013, so if that is true, what would that imply for the DRAM probe card TAM for next year?

[Thomas Dennis:]

I don’t think we’ve really got a good sizing together today on what that will look like. With the reductions that the customers have taken in the third quarter and the fourth quarter, I would think that we would see some strength as we get into 2013 and as they tool up for new nodes and for some of the mobile applications. But, we don’t have a 2013 forecast for it.

[Mark Delaney:]

Got it, thank you. Good luck.

[Operator:]

Thank you. Our next question comes from Vernon Essi, Needham & Company. Your line is open.

[Vernon Essi:]

Thank you very much, and I’ll echo the congratulations on the MicroProbe acquisition. I was wondering, Mike, if you could elaborate a little more about the restructuring and this $5 million and quarterly savings and sort of how that gets spread across cost of goods and OpEx on a go-forward basis.

[Michael Ludwig:]

Yeah. I would say Vernon that about half of that is associated with people, reduction of people, and the other is really sort of reduction in discretionary spending and then also we exit Japan certainly will have less facility cost associated with that. So, the $5 million I would expect somewhere around $2 million to be roughly in the cost of goods area and about $3 million to be in the OpEx area.

[Vernon Essi:]

Okay. You had said, just so I understand correctly, and I apologize. How much – was it a million that you said was a result in the third quarter of savings already?

[Michael Ludwig:]

Yes, I think we probably had about $1 million savings from the actions and most of that would have been discretionary spending and a lot of that was within the R&D area.

[Vernon Essi:]

Okay, and then just to back up a step and – I may go back in the queue and ask more questions on microphone, but I want to first address the DRAM side of things. You had the same situation I guess happen in the fourth quarter last year where memory, well, memory in general, but DRAM presumably dropped sequentially in the fourth quarter. I know you cited the combination of all these things, however you talked about new qualifications on your next generation. Can you sort of discuss I guess the give and takes between the two, and if there is perhaps a cannibalization going on there of the new product taking over from the old and if that’s going to be a new driver, and I was thinking how that’s going to play out maybe even into the first quarter without being too specific. That would be helpful.

[Thomas Dennis:]

The next generation card is really targeted at the high end applications in DRAM and we’ll go forward in combination with the current matrix card as it really is serving a particularly high parallel portion of the DRAM card market. I would expect it to ramp slowly. The reason for that is that these cards are targeted at some of the most advanced testers that are out there from Advantest and Teradyne and all. They, for the most part frankly, there is not very large installed base of those testers out there. So, you will see both products co-exist, you will see the nextgen product begin to ramp up as we go into 2013. It is important and it does get us qualified with one of the key DRAM customers and gets us in a position where we can bid on more business opportunity as we go into Q4 and into Q1, so it opens up an incremental market opportunity for us there. But the two will co-exist over time and it’s really not a cannibalization really, it’s a portion of the market that the current matrix products didn’t serve well, and this opens up that higher end albeit smaller force.

[Vernon Essi:]

Okay. And sort of a housekeeping question. Do you have any idea how much of the DRAM business was mobile related in the third quarter?

[Michael Ludwig:]

Yes Vernon, our mobile related business was mid 30s in terms of percentage of our DRAM business, mid 30%.

[Vernon Essi:]

Okay, thank you very much.

[Michael Ludwig:]

You are welcome.

[Operator:]

Thank you. Our next question comes from CJ Muse from Barclays. Your line is open.

[CJ Muse:]

Thank you for taking my question. First question is when you think about the two combined companies today and alluded to it briefly on your prepared remarks regarding supply chain and commonality on the design side, when do you think you’ll have a better vision of what cost savings might look like as a combined entity?

[Thomas Dennis:]

Well, we have got some insight on this as we go forward in the year ahead and expect that we should be able to realize a couple of million dollars a quarter on those things that we see immediately. I think that some of the more complex parts of it with regards to things like supply chain and some of the design activities will take us – I think it will take us till the second half of 2013 to see the best way forward on those and how we can get the most leverage.

[CJ Muse:]

That’s helpful. And then as you think top line synergies, now that you have MicroProbe in the house, is there anything that you see today that could be a real opportunity in here? I am thinking maybe embedded memory in SOC where you combine both. Anything on that front where there would be an opportunity for you guys?

[Thomas Dennis:]

Nothing immediately on it. As I said the product overlap is really de minimis In the – so far as combining memory and logic needs together, there are some product application areas that I think our memory product architecture combined with the probe technology that MicroProbe has, could play out in time. But I think that’s probably a 2014 thing if it works out. But there is a couple of areas that we’ve had some kind of out of the box thinking.

[CJ Muse:]

Okay, that’s helpful. And then I guess lastly from me on the financial side, can you share with us what pro forma share count in combined D&A is for, your actual Q4 and then what you think it is for full quarter in Q1?

[Michael Ludwig:]

What was the second part? The first part was the share count. What was the second part of this?

[CJ Muse:]

D&A.

[Michael Ludwig:]

Oh yeah. On the share account I think we are going to be ballpark around 54 million shares for Q4. I would expect Q1 to be somewhere in that same ballpark. But, again, $3 million – or assuming 3 million shares higher than maybe where we were in Q3. So it’d probably be 54 to 54.5. On depreciation and amortization, that one’s tough because again we have to go through the valuation exercise. I am not sure what intangibles or the value of the intangibles that will come out of there that will be amortized. I think – so depreciation is probably going to be somewhere in the 3.5 million range but it’s hard to say what the amortization of the intangibles will be.

[CJ Muse:]

So this is why I guess when you talk about 68 to 70 million cash flow breakeven in the first half of ’13, what assumptions are you making? So how do we back into what that breakeven looks like on a net income basis?

[Michael Ludwig:]

I can't get it to you on the net income again because – I can get it to you on sort of a non-GAAP but I can't get the net income on a GAAP basis. Because again I just don’t know what the amortization of the intangibles are or what the intangibles are going to be at that point in time. And in addition to that we also have a stock-based compensation that we will be changing as a result of issuing shares in our issues to the MicroProbe employees, so that still is yet to be worked out.

[CJ Muse:]

Okay, thank you very much.

[Operator:]

Thank you. Our next question comes from Patrick Ho of Stifel Nicolaus. Your line is open.

[Patrick Ho:]

The manufacturing processes going forward. I know the industry has obviously slowed down in the meantime because of the overall market. But as the industry transitions from sort of 30 nanometer node to the 20 nanometer node, and given some of the manufacturing challenges that are dissipated at that node, does that help you guys at all in terms of I guess expanding the TAM or expanding the opportunities for probe cards at the 20 nanometer node?

[Thomas Dennis:]

Well, the transition itself will drive new designs and new probe card opportunities there. So we will see that. I think the growth of mobile as a percent of the total DRAM market and now it’s considered to be at 50% or perhaps even slightly higher than that. Mobile has a higher number of designs which doesn’t necessarily increase the total number of probe cards but we will drive it up marginally as there is a greater percentage of the overall mobile market. I think the more interesting thing is that the next kind of 2X nanometer shrink could very well be the last available DRAM shrink until EUV is a mainstream production and at that point in time big growth is going to come from wafer start growth and we could see some upside from that.

[Patrick Ho:]

Great, that’s helpful. In terms of on the finance side, the gross margin variable that you gave for the fourth quarter is a little bit wide in terms of the 11% to 17%. Is that range assuming cost savings or synergies that you are going to be trying to get there in the quarter or is it more of a product mix issue for at least the fourth quarter?

[Michael Ludwig:]

Yeah, it incorporates some of the savings that we will get as a result of the actions that FormFactor took. It does not incorporate any synergies as a result of combining the two companies Patrick and the range is wide because when you look at the FormFactor piece of that revenue it’s relatively low when we get down to that level you are talking about. Some fairly low numbers and a lot of leverage on low numbers, and you talk about factory under-utilization. Some of those are a little bit more difficult to predict. So it’s probably more – the FormFactor business is the reason why the range is wide.

[Patrick Ho:]

Okay, great. A final question from me on the OpEx. You mentioned some of the cost savings that you are going to try and get from the combined company. As I look at specifically the R&D line, I know it’s still early in the integration phase but have you guys seen opportunities there were – there could be duplicate projects that both companies were working on that you could savings out of the R&D line by eliminating some of those duplicate development projects on both companies?

[Thomas Dennis:]

Well like I said the product overlap was relatively small. There is a couple of areas of development that we are looking at closely right now and in fact maybe also complimentary if you will from that standpoint. There were some development activities in areas of automation and such that I think we’ll get some early leverage out of and some reduced spending and some synergies on that. So, we will get some of those here early on. We’ve also seen a number of opportunities where we’ve got chances for product cost reductions because of the supply chain position that FormFactor had or the volume that FormFactor had. So we’ll work on some things in the cards area that should be kind of first six months type opportunities for us to realize supply chain synergies if you will from that standpoint.

[Patrick Ho:]

Great, thank you.

[Operator:]

[Operator Instructions] Our next question comes from Tom Diffely from D.A. Davidson. Your line is open.

[Tom Diffely:]

Yeah Good afternoon. Maybe first on the next generation matrix product, with the success there and the qualifications, do you now serve all the major memory players?

[Thomas Dennis:]

Yeah that product has opened up our opportunity to participate with all the major memory players, yes.

[Tom Diffely:]

Okay. I just wanted to confirm to that. The Matrix 2 is going to work for mobile DRAM as well as just the commodity DRAM?

[Thomas Dennis:]

Yeah we have been doing qualifications on both commodity as well as on mobile and – a little bit more on mobile actually.

[Tom Diffely:]

Okay. I think you said that mobile is only 30% of the DRAM. Would you expect that to go up quite a bit over the next year as both the market I guess goes more towards mobile and your penetration with some of the big mobile players goes up?

[Thomas Dennis:]

Yeah I would absolutely expect that.

[Tom Diffely:]

Okay. And then when you look at the MicroProbe business over time, is there a seasonality with that core business or is it purely just product cycle driven?

[Thomas Dennis:]

I would say that today its – or in the last year it’s been product cycle driven. In terms of prior years I think the company has been growing so successfully and the rate of growth of mobile application processors has been so high that it’s been just a real driving engine for quarter over quarter growth. All that said, there are for sure product cycles of the big or mainstream processors that drive demand for them and so the short answer I guess is it’s really a product cycle market as opposed to some of the more kind of seasonal things that we have seen.

[Tom Diffely:]

Okay. And it sounded like your comments about what different DRAM makers are doing at this point that – I guess the feeling is that the fourth quarter looks like the trough here?

[Thomas Dennis:]

Well that’s good to know. I am glad to hear you say that. Different people have been saying that fourth quarter would be a trough on it. It seems to be that inventories are still pretty high. I think that probably DRAM inventories are a great indicator of how things are going. As those start to burn down, that will start to drive higher production, more probe cards and we’ll go out of that. But I haven’t seen DRAM inventories decreasing at this point in time which would be kind of an indicator to me that we are starting to come out of it.

[Tom Diffely:]

Okay. I guess I was thinking more along the lines of with some of the new Matrix 2 coming out as well as the move to more mobile. But even if the core business did at the low level your overall business would be going up?

[Thomas Dennis:]

We have seen more and more shift out towards mobile. I think that certainly helped. That’s what's underpinned the revenue to-date on it. But I think that the drops on the commodity DRAM or the PC kind of DRAM part of it had been so significant that they have offset some of the gross we have seen on the mobile side. So while mobile is 50% on a – perhaps headed that way on an annual basis within some quarters I don’t know. I think it for some customers it could be substantial harder because the DRAM dropped off so much, the PC DRAM’s dropped off so much.

[Tom Diffely:]

Okay. And then you gave some guidance for opEx 23 to 24. How does that split between R&D and SG&A at this point? Is it pretty evenly split?

[Michael Ludwig:]

I would say it’s going to be – R&D is probably in the ballpark of right around $10 million, 10 to 11.

[Tom Diffely:]

Okay, thank you.

[Operator:]

[Operator Instructions] Ladies and gentlemen this concludes the FormFactor third quarter conference call. Thank you for your participation.