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FormFactor, Inc. (NASDAQ:FORM)

Q1 2012 Earnings Call

May 1, 2012 4:30 pm ET

Executives

Thomas St. Dennis – Chief Executive Officer & Director

Michael M. Ludwig – Chief Financial Officer

Analyst

Patrick Ho – Stifel Nicolaus & Company, Inc.

James Covello – Goldman Sachs

Olga Levinson – Barclays Capital

Terence Whalen – Citi

Tom Diffely – D.A. Davidson

Operator

Welcome everyone to FormFactor’s first quarter 2012 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. The schedule that provides GAAP to non-GAAP reconciliations is available in the press release issued today and also on the investors’ section of FormFactor’s website.

Also as a reminder for everyone, today’s discussion contains forward-looking statements within the meaning of the Federal Securities Law. Such forward looking statements include but are not limited to projections including statements regarding business momentum, demand for our product, and future growth, payment of outer development, introduction, and/or qualification of next generation matrix, or USOC products and statements that contain words like expects, anticipate, believe, possibly, should and the assumptions upon which statements are based.

The forward-looking statements are based on current information, expectations that area 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, provide 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 10K for the fiscal year 2011 as filed with the SEC, subsequent SEC filings and in the press release issued today. With that I would like to turn the call over to CEO Tom St. Dennis.

Thomas St. Dennis

Before Mike Ludwig presents are Q1 results I’d like to make some comments on the probe card market in Q1 and the progress we made operationally through the quarter. Demand for probe cards remained weak at the beginning of Q1 similar to Q4 of 2011. Late in January though, we began to see increased orders that continued to improve throughout the quarter. Unfortunately, the orders came in too late in the quarter to contribute significantly to Q1 revenues, but will be reflected in higher Q2 guidance.

The demand increases appear to be the result of our end customers rebuilding inventories and preparing their new products for the second half of 2012. DRAM pricing appears to have stabilized but we do not have good visibility into end market demand for the second half of the year.

The filing by Elpida in February for bankruptcy protection in Japan, has little effect on our business during the quarter and at this point in time our interactions with Elpida have returned to normal. The SoC market had challenges in Q1 as many manufacturers were cautious regarding capacity increases. For our served SoC probe card markets, we saw revenue increases in automotive applications, micro controllers and image sensors as our 3D MEMS springs gained traction with those customers.

While some customers are forecasting that the second half of 2012 will be stronger and that the first quarter was a bottom for their demand, at this point in Q2 these customers are still investing cautiously. Our overall flash memory probe card sales were down in Q1 compared to Q4. NAND flash revenues and bookings increased in Q1 while NOR flash revenues and bookings decreased. The NAND flash increases are the result of certain customers using more complex probe cards which allows FormFactor to be more price competitive. Entering Q2 we see increased demand for both NOR flash and NAND flash probe cards.

New product development continued in the quarter for both our vertical spring probe card for the SoC market and our next generation matrix product for the DRAM market. The new matrix product will strengthen our DRAM revenue base while the vertical SoC product will open up a new $100 million plus market for FormFactor.

We completed several important milestones in the development of our vertical spring product for SoC during the quarter. In addition, we’ve begun the manufacturing planning and process development in parallel to our product development in order to shorten our time to market once product development is complete.

Two customers that are currently evaluating our next generation matrix products for DRAM and a third customer will receive their first card in June. Our first customer has completed their engineering evaluation successfully and will begin production testing this quarter. Our second customer is continuing their engineering evaluation work which should be completed by the end of this quarter. We expect that both of these products will begin to contribute to revenues in the second half of 2012 and both products are important to grow revenue as well as profits for FormFactor, and we expect them to be important parts of our revenue stream in 2013.

Now, Mike Ludwig will review Q1 and our Q2 guidance.

Michael M. Ludwig

Revenues for Q1 2012 were $34.8 million just above the high end of our guidance and an increase of 15% from Q4 2011. Compared to the fourth quarter, revenues in Q1 increased in DRAM and SoC but declined in flash. First quarter revenues for DRAM products were $21.9 million, an increase of 19% from our fourth quarter. The DRAM industry continued to be negatively impacted in the first half of the quarter by following DRAM device prices and by the limited availability of hard disk drives impacting the PC market which is a significant source of DRAM demand. In the second half of the quarter DRAM device prices improved and stabilized which had a positive impact on orders and revenue.

Flash revenues were $5.1 million for the first quarter, a decrease of 13% from the fourth quarter. Our NAND flash revenues for Q1 were up slightly to $2.7 million but the increase was offset by a large decrease in NOR flash revenues in Q1. SoC revenues were $7.8 million, an increase of $1.8 million or 30% from Q4. As Tom mentioned, we saw revenue increases in automotive applications, microcontrollers, and image sensors.

First quarter 2012 GAAP gross margin was $4.2 million or 12% of revenues compared to -$5 million or -16% of revenues for the fourth quarter of 2011. On a non-GAAP basis, gross margin for the first quarter was $4.7 million or 13% of revenues compared to -$3.8 million or -13% of revenues for the fourth quarter. Non-GAAP gross margin for the first quarter was favorably impacted by approximately $3.4 million from fixed spending leverage on incremental revenues.

In addition, the company reduced its excess inventory charge by $1.6 million compared to the fourth quarter. The company also mitigated customer cancellation charges and significantly reduced inventory costs associated with account penetration efforts at certain customers in the first quarter as compared to the fourth quarter.

Our GAAP operating expenses were $22.1 million for Q1 2012, a decrease of $1 million compared to Q4 2011. Non-GAAP operating expenses for the first quarter were $19.5 million, a decrease of $0.1 million compared to the fourth quarter. The decrease in non-GAAP operating expenses in the first quarter is due to lower professional fees incurred in the quarter partially offset by higher development costs for our next generation matrix product and our vertical spring SoC product.

In the first quarter, the company recorded a tax provision of approximately $100,000 slightly lower than the tax provision recorded in the fourth quarter. Cash, comprised of cash, short term investments, and restricted cash ended the first quarter at $280.6 million, $16.4 million lower than the year end. The company did not repurchase any of its common stock in the first quarter. The company repurchased $7.5 million of its stock in Q4 2011.

Excluding the repurchases of common stock, the cash used for Q1 was $16.4 million compared to $11.8 million for Q4. The additional cash usage was due to an increase in the accounts receivable resulting from the strong shipments in the last half of the first quarter offset to a degree by the increase in accounts payable in the quarter.

Here are some other financial details. Our depreciation and amortization in the first quarter was $2.8 million. Our capital additions in Q1 were $1.8 million compared to $2.8 million in Q4. Our stock based compensation for the fourth quarter was $3 million. As Tom discussed our focus on investments continue to be concentrated on developing and delivering new matrix and SoC vertical technologies to exploit the market opportunities in DRAM as the market returns to better health and in SoC to diversify our revenue base and penetrate the fastest growing segment of the advanced probe card market.

With respect to Q2 we are encouraged by the acceleration in momentum in design activity and booking experience in the back half of Q1 that carried into Q2. As such, we expect second quarter revenues to be in the range of $43 million to $47 million. With respect to gross margin, the increases should have a positive impact on fixed spending leverage. Therefore, we expect our non-GAAP gross margin to be in the range of 22% to 24%. We expect Q2 non-GAAP operating expenses to be roughly equal to our Q1 expenses. We expect Q2 cash burn to be $6 million to $8 million not including any stock repurchase activity.

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

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Analyst for Patrick Ho – Stifel Nicolaus & Company, Inc.

Patrick Ho – Stifel Nicolaus & Company, Inc.

Tom, first on the new next generation matrix product that you talked about in the prepared remarks with two new DRAM customers, can you one give us some of the differentiators between this next generation product from what you’re currently offering and second, when do you believe that you’ll get some of the additional other DRAM customers to begin the evaluation process?

Thomas St. Dennis

The primary differentiation on this is really for the most advanced and highest levels of parallelism for DRAM cards so this is for applications of more than 1,000 devices in parallel, or more than 900 devices in parallel and we see many customers doing planning now that indicates in the 2013 time frame that that will be an important part of their overall test strategy.

In terms of the engagement on it, three out of the four major DRAM companies today have that plan, one does not. Currently we engaged all three of them and have product designs underway or delivered that are giving them a chance to work on this with the more advanced test ATE platforms that are out there.

Patrick Ho – Stifel Nicolaus & Company, Inc.

Maybe a question for Mike in terms of the variables for gross margins, obviously you guys did a nice job this quarter and it’s improving into the June quarter. Is it right to assume that fixed cost absorption is the biggest variable right now? Then the second part of that question is as you get some of these new products out in the second half of the year, what kind of impact will that have to gross margins since they’re new products?

Michael M. Ludwig

So the answer to the first question is yes, probably the greatest leverage we have on the gross margin line is the increased revenues with the good drop through of again, something in the ballpark of 60%. When the new products come online, we actually believe that again, the drop through, we don’t believe it will tick ahead, we expect that depending on the mix of those new products that that will have an influence on how much greater the drop through is with respect to gross margins and incremental revenues.

Operator

Your next question comes from Analyst for James Covello – Goldman Sachs.

James Covello – Goldman Sachs

I was hoping you could talk about the revenues in South Korea, I saw that was up almost three times quarter-on-quarter and I was wondering if you had picked up any share there in the quarter?

Thomas St. Dennis

It’s hard for us to say overall on it. I think there was some share gain. Certainly, in the overall market, South Korea was more aggressive in their investments in the quarter than other regions so participating in that as we did was certainly positive for us but I can’t really give you a specific delta share kind of number from it.

James Covello – Goldman Sachs

On the last earnings call Samsung talked about some excess supply potential in the mobile DRAM segment so I was wondering how that was factored into your outlook, if at all.

Michael M. Ludwig

At this point in time it really doesn’t have a significant impact. The customers move around between mobile and commodity or main memory type allocations for wafer starts so we see a certain amount of dynamics in designs in which ones they’re choosing to ramp or not ramp. But in terms of the overall forecast, it’s all factored into kind of the start dynamics that are laid out by the customers.

Operator

Your next question comes from Olga Levinson – Barclays Capital.

Olga Levinson – Barclays Capital

Specific to the gross margins, you reported very strong results, relative to your expectations coming into the quarter where you expected negative gross margins, what was the biggest area of surprise that drove the higher gross margins? Was it just the incremental revenues or did something new emerge during the quarter that drove the upside?

Michael M. Ludwig

There were two areas that were primarily responsible to the upside. One, was the reduction in the excess and obsolete charge so in Q4 we had an excess and obsolete charge of $3 million and in Q1 we had an excess and obsolete charge of $1.4 million as a result of a much better demand outlook going into Q2 and Q3 this year versus the demand outlook going into Q1 and Q2 that we looked at in Q4.

The second area that was much improved was what we call some new customer penetration charges that were incurred in Q4 and we thought maybe we would incur less in Q1 but we incurred much less than what we had originally anticipated. So those were the two primary areas for benefit relative to the gross margin improvement.

Olga Levinson – Barclays Capital

Then within your guidance for June quarter revenues you talked about expectations for both NOR and NAND flash to recover. How much growth, or what directionality do you expect on the DRAM side and the SoC side?

Michael M. Ludwig

At this point in time I think we’d have to say that the SoC market looks to be flat quarter-over-quarter. There may be some changes late in the quarter, but at this point it looks flat. For both DRAM and flash we see them both growing in the quarter on a quarter-over-quarter basis and as I said, both NOR and NAND are showing increased demand right now.

Olga Levinson – Barclays Capital

Just as a final question, you talked about design wins within logic on automotive in your [inaudible] and MCUs. Out of your SoC revenues currently in your expectations for June, how many customers are embedded in that?

Thomas St. Dennis

Probably seven to 10. We have several customers but some more than others, but I think the answer is about seven to 10 customers probably represents that segment for us at this time.

Operator

Your next question comes from Terence Whalen – Citi.

Terence Whalen – Citi

The first question is in the past you talked a lot about putting effort forth to gain share at a large Korean DRAM maker. I want to understand if this quarter’s large step up in South Korean revenue was a reflection of the fruition of those efforts or whether it was just a cyclical bounce back from one or two customers?

Thomas St. Dennis

I think I’d have to characterize it as more the latter of your comment – I don’t know a cyclical bounce back but it didn’t reflect a significant shift in share on our part for DRAM. It was consistent with our share balance, if you will, between the two major suppliers in Korea as it’s kind of been over the last few quarters. There was some specific differences between them but it doesn’t represent a change in share there, we’re still working through product evaluations and engineering tests on cards there to strengthen our share with both customers.

Terence Whalen – Citi

Then on the SoC side, you talked about the vertical probe card test product, when is that product going to be launched and when will it contribute to revenue and exactly what area of SoC tests is the target?

Thomas St. Dennis

It’s focused on the flip chip market and all the variations that go within that but probably it’s the flip chip market. In terms of revenue contribution it’d be in the latter half of the second half of 2012.

Terence Whalen – Citi

If I could just squeeze in one last follow up, I think you said your cash burn you expect about $6 to $8 million. If I model sort of the midpoint of your income statement the net income is about $12 million. Are we going to see neutral working capital? Is that your expectation next quarter after the increases we saw in inventory and accounts receivable this quarter?

Michael M. Ludwig

I think even with the uptick in revenue for Q2 that we guided to, I believe that we will look to keep the working capital basically cash flow neutral in Q2.

Operator

(Operator Instructions) Your next question comes from Tom Diffely – D.A. Davidson.

Tom Diffely – D.A. Davidson

Mike, first another question on the margin side, the 22 to 24 do you consider that a normal margin for this revenue range or are we still getting an impact from the excess and obsolete inventory as well as [inaudible] NAND or NOR taking it down a bit?

Michael M. Ludwig

No, I don’t think Tom that this is about what we expect for this revenue range.

Tom Diffely – D.A. Davidson

When you look at the cap ex of $1.8 is that mainly just for new equipment to help the new products coming out?

Michael M. Ludwig

Yes. What we look for is generally cap ex in about the $10 to $12 million range for the year so $1.8 is probably a little light. I would expect Q2 maybe to be slightly higher as Tom said – well Q2 and Q3 will be slightly higher as we prepare for production of both the new matrix platform as well as the SoC vertical card.

Tom Diffely – D.A. Davidson

And the new products both the DRAM and the SoC that are coming out, are those kind of going to be line with corporate averages for margins or do you expect those to help margins overall?

Michael M. Ludwig

Well, it depends on the mix but I would expect they will have a slight benefit to margin as we go forward.

Operator

Ladies and gentlemen this concludes our question and answer session on today’s conference call. Thank you for your participation. You may now disconnect.

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