FormFactor's CEO Discusses Q4 2011 Results - Earnings Call Transcript

| About: FormFactor, Inc. (FORM)

FormFactor, Inc. (NASDAQ:FORM)

Q4 2011 Earnings Call

February 7, 2012 04:30 pm ET

Executives

Tom St. Dennis - CEO

Mike Ludwig - CFO

Analysts

Terrence Whalen - Citi

Mark Delaney - Goldman Sachs

Patrick Ho - Stifel Nicolaus

Operator

Thank you. And welcome everyone to FormFactor’s fourth quarter 2011 earnings conference call. On today’s 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 sector 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 demand for our products and future growth, statements about our development, introduction and/or qualification of next generation Matrix or new SoC products.

And statements that contain words like expect, anticipate, believe, possibly, should and the assumptions upon which such statements are based. These forward-looking statements are based on current information and 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 the information provided during today’s call to revise any forward-looking statements or to update the 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 2010 as filed with the SEC, subsequent SEC filings included in the company's Form 10-Qs filed in fiscal 2011 and in the press release issued today.

With that, we will now turn the call over to CEO, Tom St. Dennis.

Tom St. Dennis

Good afternoon. Demand for probe cards remained weak in the fourth quarter, significant drops in DRAM prices caused by DRAM manufacturers to reduce wafer starts and delay introducing new designs. As a result, the demand for DRAM probe cards was reduced by approximately half compared to the third quarter. The impact on the hard disk drive market from the Thailand floods appears to be improving and estimates are that approximately 80% of the manufacturing capacity will be restored by the end of Q2, 2012. We expect to see the market for DRAM probe cards improving later this quarter or early in Q2 as a result of increased hard drive shipments. The market for SoC probe cards also slowed in the fourth quarter although not as significantly as DRAM. IC manufacturers invested cautiously in the fourth quarter due to macroeconomic uncertainty and as a result some of their programs were delayed or postponed.

Operationally we took the opportunity given by the slowdown in Q4 to expand training and to continue to reduce cycle times. We ended Q4 with first [starting] lead times for our Matrix product at approximately 54 days. This is over 30 days less than Q4, 2010. We are continuing to drive lead times down throughout our factory and with our suppliers to achieve a lead time goal of 42 days by the end of 2012.

Our product development programs made solid progress during Q4 as we continue to work closely with our customers. Two customers have installed our next-generation Matrix cards and are evaluating them currently. We are in the process of designing a card for a third customer which will ship in Q2. We expect the next generation Matrix product to begin to contribute to revenues in the second half of this year.

The development of our vertical probe technology for the SoC market continued in Q4 also with solid progress. We’re currently working with our development customers to characterize and evaluate all aspects of performance of this new product. The development phase of this product should be completed in Q2 and then we will begin customer evaluations.

Recently, we’ve begun to make capital investments for production tools that will come online in the second half of 2012. Despite the recent disruptions in the DRAM probe card market, FormFactor’s opportunity for growth in probe cards remained strong. We intend to achieve this growth by increasing our focus and products in the SoC segment of the market. We believe the SoC probe card market is poised to leverage the same technologies that significantly reduce the cost of test for our memory customers.

FormFactor’s products and technologies are well positioned to take advantage of this market opportunity. Revenue growth in the SoC market, on top of the base of revenues from the DRAM market will improve our profitability and the diversification will reduce revenue volatility.

This is our primary focus going in to 2012 and we expect to make significant progress towards this goal. Last Thursday, Jim Prestridge notified FormFactor’s Board that he will not stand for reelection at this year’s shareholder meeting. Jim has served as a Board member for 10 years and was Chairman of the Board for four years.

On behalf of the FFI Board, I would like to thank Jim for his years of service. Now, Mike Ludwig will review Q4 and our Q1 guidance.

Mike Ludwig

Thank you, Tom. Revenues for Q4 were $30.2 million, a decrease of 42% from Q3 2011 and 31% from Q4 2010 respectively. The revenue decline from the third quarter came from all sectors of the business. Fourth quarter revenues for DRAM products were $18.4 million, a decrease of 50% from our third quarter and a decrease of 32% versus the fourth quarter a year ago. The DRAM industry continued to be hit hard in Q4 by falling DRAM device prices, by the limited availability of hard disk drives impacting the PC market which is a significant source of DRAM devices and by the EU debt crises weighing on the global economy.

Flash revenues were $5.8 million for the fourth quarter, a decrease of 21% from the third quarter and 37% compared to the fourth quarter of 2010. Our NAND Flash revenues for Q4 were $1.7 million and NOR flash revenues for Q4 were $4.1 million. SoC revenues were $6 million, a decrease of $2.3 million or 27% from Q3 and a decline of 22% versus the fourth quarter of last year. As Tom mentioned in his remarks SOC IC manufacturers invested cautiously in the fourth quarter.

Fourth quarter GAAP gross margin was negative $5 million or negative 16% of revenue compared to $12 million or 23% of revenue for the third quarter. On a non-GAAP basis, gross margin for the fourth quarter was negative $3.8 million or negative 13% of revenue compared to $12.7 million or 24% of revenue for the third quarter. Non-GAAP gross margin for the fourth quarter was negatively impacted approximately $14 million by lower absorption of fixed cost and direct labor for measurably lower revenue levels. In addition the company incurred a $1.7 million increase in excess inventory charges compared to the third quarter. Customer cancelation charges and inventory costs associated with account penetration efforts of certain customers.

Our GAAP operating expenses were $23.1 million for Q4, an increase of $1.1 million compared to Q3. Non GAAP operating expenses for the fourth quarter were $19.6 million, an increase of $0.6 million compared to the third quarter. The increase in non-GAAP operating expenses in the fourth quarter is due to increased professional fees incurred in the quarter.

In the fourth quarter the company recorded a tax provision of approximately $150,000 consistent with the charge incurred in Q3. Cash comprised of cash, short-term investments and restricted cash ended the year at $297 million, $19.3 million lower than the third quarter. The cash used included $7.5 million for the repurchase of common stock during the fourth quarter compared to $5.5 million of stock repurchased in Q3.

Excluding the repurchases of common stock the cash used for Q4 was $11.8 million compared to $3.1 million for Q3. The additional cash usage was due to lower cash collections resulting from lower shipments in the fourth quarter. Our stock repurchases for the fourth quarter were slightly over 1,250,000 shares at an average price of $5.98 per share compared to just under 700,000 shares repurchased in the third quarter.

Since inception of the program, we have repurchased just over 2.4 million for $17 million, at an average price of $7.08 per share .We are authorized to purchase an additional $33 million worth of shares through October 2012.

Here are some other financial details. A depreciation and amortization in the fourth quarter was $2.2 million. Our capital additions were $2.8 million. Capital spending for all of 2011 was $7.7 million compared to $30.9 million in 2010. Our stock-based compensation for the fourth quarter was $4.2 million including an additional 0.3 million for certain terminations.

The company reduced its manufacturing and OPEX cost structures measurably over the past year and half in an effort to lower our cash flow breakeven revenue level. As discussed in Tom’s comments our focus in investments continue to be concentrated on developing and delivering new metrics in SoC vertical technologies to exploit the market opportunities in DRAM as the market returns to better health and SoC to diversify our revenue base and penetrate the fastest growing segment of the advanced probe card market. Hence we do not have plans to make additional significant cost structure reductions.

Although our turnaround is not complete, the company made considerable progress in 2011. Our revenue has declined 10% to $169.3 million, SoC revenues increased 6% compared to 2010.

For 2011 our GAAP gross margin was $21 million or 12% of revenue compared to negative $2.3 million or negative 1% of revenue for 2010. Our GAAP operating expenses were $91.3 million in 2011 compared to $194.9 million in 2010, which include a $52 million charge for enterprise-wide impairment.

For 2011, the company used $50.9 million of cash, including $16.4 million for stock repurchases compared to $100.2 million, including $0.6 million for stock repurchases in 2010.

With respect to Q1, we are encouraged by recent momentum in design activity and bookings. However, the momentum is occurring too late in the quarter to have a measurable impact on first quarter revenues. Consequently, we expect first quarter revenues to be in the range of $30 million to $34 million.

With respect to gross margin, the low volumes will again put pressure on our gross margins. Our non-GAAP gross margin will be in the range of negative 10% to breakeven. We expect Q1 non-GAAP operating expenses to be roughly equal to Q4 expenses at $19.5 million.

While we will not have the additional week of payroll expense that we experienced in the fourth quarter, the first quarter has incremental benefit and payroll tax expenses compared to the fourth quarter. Employees have been asked to take additional time off to lower our first quarter expenses.

A significant reduction in shipments in Q4 and early Q1 will have a negative impact on cash usage for the first quarter. We expect Q1 cash usage to be $16 million to $18 million, not including any stock repurchase activity.

With that, let’s open the call for Q&A. Operator?

Question-And-Answer Session

Operator

(Operator Instructions) And our first question comes from Terrence Whalen with Citi

Terrence Whalen - Citi

Hi, good afternoon. Thanks for taking the question. This relates to one of the comments you made later on the script, Mike. You had mentioned that bookings activity had picked up pretty considerably but that it wouldn’t be enough to turn in the March quarter that it would need the shipments in the June quarter. Can you just dig into little bit more detail. Where are you seeing that activity in terms of customer base and in terms of what nodes you are seeing that activity at and then also, it sounds like from the statement you have some visibility into the June quarter or at least some dynamics into the June quarter? Could you share with us what you are observing there? Thanks

Michael Ludwig

I think, we wont get into specific customers but I will say we are seeing a pick up certainly in the DRAM bookings activity and the other one thing that we wanted to be careful about is I don’t know that we necessarily then have much visibility into the second quarter. The one thing that we would say is we saw a similar activity early in Q3 and then it dropped off pretty dramatically.

So I am not saying that is what is going to happen here but we are seeing some good activity now, but I am not at this point tell you that would continue on. We are certainly more hopeful that it will but I am not forecasting that at this point in time.

Terrence Whalen - Citi

Okay, fair enough. And then if I could ask as a follow up may a higher level question is like everyday we hear news and rumors of consolidation in the DRAM industry. Can you just share with us your observations of maybe how things have progressed there and in terms of your expectations of how that industry perhaps restructures throughout 2012 and then also conclude by just giving us an understanding of what your perspective is and how consolidation in DRAM will affect the spending? Thank you?

Tom St. Dennis

Well, I think that you can see that throughout 2011 the DRAM industry was reducing wafer starts, certainly in the second half of the year to try to get a balance between supply and demand. I think any consolidation that goes on will help to bring that into a balance. All that said, it’s not clear at this point in time, what’s going to happen, how that is going to go forward. Right now it’s a rebalancing of production capacity against demand with uncertainty about what’s going to happen with Elpida or Micron and others. So I can’t really say, until we really understand what the structure is going to be, what the overall impact would be. We’ll just have to wait and see how things unfold.

Operator

Our next question comes from the line of Jim Covello with Goldman Sachs.

Mark Delaney - Goldman Sachs

This is Mark Delaney calling in for Jim Covello. Thank you very much for taking the question. I guess, so maybe you could talk a little bit more about the DRAM market that Samsung and others are expecting a 30% growth for 2012? And if the supply environment does end up materializing as they are expecting, do you think you can be profitable and at those types of levels and you know so how can you get there, maybe on those dynamics?

Mike Ludwig

Yeah, this is Mike. When we look at, so certainly for us to become profitable the DRAM market is going to have to, we’ll say be somewhat consistent with where it was at early Q3. As you recall, while we weren’t profitable per se we were close to cash flow breakeven at $52 million of revenue in Q3. So certainly, it’s important that the DRAM market comes back to those types of levels for us to approach profitability.

In addition to that, we’ll have to see a little bit of growth in our current SoC product offering excluding any benefit that we might get from the vertical technologies that we’re developing in SoC. So I think that’s what it’s going to take for us to really kind of get back to cash flow breakeven and turn the corner.

Mark Delaney - Goldman Sachs

And then just following-up on the DRAM market, I know there has been lot of moving parts, this may be some of that companies have acquired probe card companies, they even did some equity investments and some of them manufacture themselves and but its also the opportunity that you talked last call about higher throughput requirements next year-end in DRAM. So just, as you start looking at your design traction, how do you think all that plays out for your DRAM market share?

Tom St. Dennis

Well, I think it’s promising for us this year; we got to see what unfolds obviously with the whole market. We were successful in getting back into full normal operations if you will with three out of the four DRAM customers, our next-gen product is currently in at the fourth DRAM manufacturer and as that gets through qualification we’ll be able to get that, some portion of their business back into our DRAM revenue stream, so that will help to strengthen share there as we have not been providing them any meaningful amount of production over the last, almost two years now.

With regards to what really happens overall in demand in the market; I think that capacity choices and manufacturing strategies vary amongst all four major suppliers and they tend to choose and invest in and ramp at different rates and depending on who is ramping, certainly has an impact on what kind of revenue opportunities we get. Currently, it would seem like everyone has seen something that is positive and they are looking to put in place capacity that will be there going into Q2.

Mark Delaney - Goldman Sachs

And then just finally, I know in the past maybe you guys have talked about what your expectations are just in terms of you are certain of available market for the SoC business. Do you kind of have any update on kind of how big that opportunity is and when you might be able to, you maybe get a little bit larger revenues in that business? Thanks very much.

Tom St. Dennis

So we expect that the SoC market will be the highest growth segment of the advanced probed card market over the next four years, looking at it through 2015. It will exceed, currently it exceeds the DRAM market or the flash market. Our current product offering only serves a relatively small portion of that market, perhaps around 25% of that. The vertical card that, technology that we’re developing should open up 25% to 30% more of that advanced SoC probe card market. And as I said, we intend to see some revenue of that in the latter part of this year and the second half of 2012 with momentum building as we go into 2013.

Operator

Our next question comes from the line of Patrick Ho with Stifel Nicolaus.

Patrick Ho - Stifel Nicolaus

Tom, maybe can you give a little bit of color in terms of the next generation Matrix and how there may be I guess from your standpoint totally different manufacturing processes maybe improved supply chain and lead times; can you discuss how that will be different from your current Matrix products?

Tom St. Dennis

Well, we look at the market requirements for lead time and everything irrespective of what our products are. So our next-generation product needs to flow into our overall manufacturing processes and cycles to match-up with our lead time goals and that’s part of what we are working through right now to begin to transition that into a volume manufacturing if you will, depending getting through all the final qualifications with customers currently.

The product itself is targeted at the high-end of DRAM market where higher parallelism and higher performances required and we see today that DRAM companies are investing in the next-generation of test capability and capacity which will be able to use the higher levels of parallelism that our next-generation Matrix card will be able to provide. So I would expect to see it begin to grow in its volume again in kind of second half of this year, but inline with some of the more advanced tester, and as they are more advanced in tester installed base growth.

Patrick Ho - Stifel Nicolaus

And maybe following-up on that question, in terms some of the capital investment you mentioned in your prepared remarks, are those capital investments to support the next generation matrix and what I am getting by that is now that you are starting to see some signs of life coming back from I guess the recent events in Thailand you've got the capacity in place for that, is the additional capacity that you are putting in place the kind of supplement when second half ’12 rolls around, that's the support the roll out of the next gen product?

Tom St. Dennis

The comments that I made were specifically about capital investments that we are making now for production on the vertical SoC cards. We have some longer lead items that we need to get in place to support production in the second half of the year. All that said, we are also making capacity investments and purchasing capital to support the next gen matrix cards. So we are investing in both.

Patrick Ho - Stifel Nicolaus

Okay, great. And a final question for me in terms of the near-term environment again you are starting to see some signs of life. How quickly can you I guess satisfy customer needs if they ask for expedited orders, if they decide to start pulling in, I guess are your capabilities ready to handle those types of demand?

Tom St. Dennis

Well, that's what we've worked on through the year to shorten cycle time and responsiveness and we have worked through the most recent slowdown that really started, kind of, in the September timeframe of last year. We have been focused on training and working closely with our suppliers on cycle time.

So we would like to think that we are well-positioned to take advantage of a sharp recovery or a strong recovery and so far so good and we are just trying to stay in touch with the customers as they make their decisions.

I am afraid that in the last six months we have seen an awful lot of volatility from DRAM manufacturers and where they have given some start and stop signals that were only four weeks apart as they were trying to figure out which way to go. So we are being cautious but we are currently able to satisfy the demand and are ramping to make sure we can meet any increases from there.

Operator

Our next question is a follow up from Terrence Whalen with Citi.

Terrence Whalen - Citi

Hi, thanks for fitting me in on the follow up. I don’t know if you would address this but I think in the past you talked about $50 million being a breakeven level on the cash side of the business, can you just revisit whether you are there yet or what needs to be done on the cost side and if that target is all applicable in the next several quarters? Thank you.

Mike Ludwig

Yes, Terrence. This is Mike. So at the end of the third quarter, I think at our third quarter call, we actually had changed that number from $50 million and gave another range that was $54 million to $56 million. And at this stage we do not see anything that would suggest that we are outside of that range. So despite the challenges in Q4, we still believe the $54 million to $56 million is appropriate with respect to cash flow breakeven.

Terrence Whalen - Citi

Okay, terrific. And then a follow up question I have is on, there is one customer in particular in DRAM that you have not penetrated but there is obviously lots of engagement. I am just wondering if you can point to any indications that you think you can make progress in that one customer you haven’t penetrated and whether you have any sort of confidence, whether that second half of ’12 or the timing on that engagement? Thank you.

Tom St. Dennis

Well, I am encouraged by the level of engagement or reengagement that we’ve had. They’ve got high performance standards and so we’ve been working to really optimize various parameters on our cards to meet their specific requirements; they are unique compared to other DRAM manufacturers. But at this point, I think we have a clear path to get that done and we expect to get those qualifications done in the first half of the year and participate in some of their volume as we go in the second half of the year. We’ll know more in the next quarter as we go along.

Terrence Whalen - Citi

And then, I am sorry, my final question; in order to get DRAM back up above you know $35 million per quarter, do you think it’s more going to be a factor of demand resurfacing, including the levitation of the hard drive problem in addition to just a little bit better consumer spending or do you think it’s going to be more based on structural changes to the industry. I was wondering whether you had a view of getting back to that 35 level, whether it would be based more on supply, a reorganizing or whether it’s totally dependent on demand? Thanks.

Tom St. Dennis

I think at this point in time that we need to see it get back to normal levels and I think that those levels don’t exist yet today at least, you know Western Digital on their call said that they would achieve 60% by the end of Q1, and its near as I can tell, they’ve got about 50% of the market. So I think the demand is still held back from a PC standpoint.

Now perhaps Q1 is seasonally low point for different parts of the industry and perhaps that will mitigate things there a little bit. But, we need to see the DRAM demand come back to normal levels more consistent with probably the first half of 2011 for us to get back into that $30 million or $35 million range.

Operator

Ladies and gentlemen, this concludes the FormFactor fourth quarter conference call. Thank you for your participation.

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