FormFactor Inc (FORM) 2009 Q3 法說會逐字稿

Welcome to FormFactor's third quarter 2009 earnings conference call. On today's call are Chief Executive Officer Mario Ruscev and Chief Financial Officer Jean Vernet.

Before we do 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.

(technical difficulty) GAAP and non-GAAP reconciliation is available in the press release issued today and also on the investor section of FormFactor's Website. Also a reminder that today's discussion contains forward-looking statements and that FormFactor's actual results could differ materially from those projected in the forward-looking statements.

For more information please refer to the risk factors discussion in the Company's Form 10K and subsequent Forms 10-Q and the press release issued today. With that, we will (technical difficulty) over to Mario.

Please go ahead.

Thank you and hello, everyone. During our third quarter we saw improvement across all business segments, resulting in revenues of $43.8 million, an increase of 40% from the second quarter. The improvement was driven by market share gain in DRAM, acceleration in DDR3, positive global DRAM activity and improved results in both Flash and [FSC] market.

We also continued our efforts to transition the back end of our manufacturing to Asia in our third quarter. As we go through our ramp up of our Asia manufacturing (technical difficulty) facilities and our new technology over the new quarters -- over the coming quarters, you'll see our associated costs related to ramp up on the move before we more fully see the benefits of lower manufacturing costs.

Overall, so, we continue to manage costs tightly through our third quarter, resulting in improved gross margins and (inaudible) flat operating expenses from our second quarter. Jean will expand on this later in the call.

But before that, I will provide some quick thoughts on what we saw in DRAM market during the third quarter (technical difficulty), then discuss our product and technology. And I'll close with some sort of where we (technical difficulty).

Our DRAM business benefited during the third quarter from the continuation of (technical difficulty) from DDR2 to DDR3. We are seeing a steady improvement in business activity since the beginning of the year. But most of it has been driven by inventory of (inaudible) and opportunistic buying on behalf of (technical difficulty) of higher memory prices.

DDR3 orders represented the majority of DRAM activity in the quarter. And also we have already seen the crossover from DDR2 to DDR3 in our own order activity. We expect the broad industry crossover point to be in the fourth quarter.

Specialty mobile RAM was also stronger in (technical difficulty) reflecting positive activity in the mobile phone area. Our technology node was six (technical difficulty) during the quarter. We expect to see customer shrink technology notes from 6X to 5X and 4X nanometers through 2010 and (technical difficulty) most of central (technical difficulty) activity (technical difficulty) leading to a higher revenue over time.

We continue to introduce new enhanced product offerings to the market. During the third quarter we reached a major milestone with the Company advanced [tier] technology. We have now shaped over 100 probe cards incorporating this technology.

Advanced theory allows for the optimization of test capacity, extending the life of existing equipment. In addition we have shipped the industry first one third (inaudible) probe card for 300 mm DRAM wafer [soft] testing.

As you have seen by our press release today, we announced availability of our newest platform with the product target of the NAND market called TouchMatrix. We believe TouchMatrix offers a fundamental edge to our customers versus existing probe cards on the market.

This new design significantly improves our manufacturing efficiency and reduces the delivery lead time, allowing customers greater flexibility in choosing the type of volume of product to ramp at the given time.

With the new architecture, probe card repair is also made easier since the card can be easily disassembled and reassembled without planarity or x/y adjustments. The TouchMatrix probe card is designed to enable testing of Flash devices down to 32 nm professional. Including both (technical difficulty) three and four bit memory set architectures.

The card can also be in the hands with FormFactor RapidSoak technology to achieve near zero [soak] time and superb scrub performance. FormFactor's self-cleaning [MEMS] probe type also requires less maintenance (inaudible) expanding test of time and improving test time efficiency.

Within Q4, we will have concurrent evaluation programs for values configurations of these products with the loudest Flash memory suppliers. Also (technical difficulty) revenue in our fourth quarter, we do anticipate considerable revenue growth from this new product in 2010 and look forward to providing future updates of our successes.

In addition, activity for similar introduction of a DRAM product in the market is well on the way.

In addition to our new architecture for the (inaudible) compact to market. We are also introducing a new MEMS spring for the (inaudible) market. This spring was specifically designed with the SOC market in mind and provides greater flexibility to both challenging SoC pad layout with tight pitch, (inaudible).

This new spring now addresses a majority of the high hand wire bond market where higher [palladism] is also prevalent. The very market segment where MEMS spring provides the most value. MEMS spring reach higher pin counts with [moreover] performance at a lower overall cost.

These investments in R&D will leave significant returns (technical difficulty) as we continue to expand our market opportunity and more fully address our entire stock cap markets across DRAM, Flash and (technical difficulty).

Before I turn the call to Jean, I will spend a few minutes on the overall environment. We have seen steady improvement in activity over the course of 2009. Memory prices are (inaudible) and customers are investing in new technology as evidenced by the ramp in DDR3.

Our design stop by plan has been growing quarter over quarter for leading edge nodes, which is a positive indicator for future business at volume ramp. Therefore we (technical difficulty) are in the early stage of the recovery in memory spending with several key growth drivers for DRAMs (technical difficulty) who transition to DDR3. Transition to 5X nanometers followed by four external meters process notes, transition from 1 GB to 2 GB devices.

In addition, our new product and technology (inaudible) spending our addressable market in Flash and SoC. So we remain optimistic of our growth outlook over the next few years.

Over the short term, outside of Korea, we have seen our largest (inaudible) accounts take advantage of current price at both DDR2 and DDR3 at existing 6X nanometers to produce more memory. Their impact on this on FormFactor is lower short-term demand until the ramp of 5X nanometers must begin, which they expect will commence in the first half of 2010.

Because of this we have a reduced revenue outlook and less visibility than we would like. We intend to stay flexible as in our organization to ensure we meet the demand as it materializes. We are continuing to position ourselves to increase market share across all business segments.

With that, let me turn the call over to Jean for more details on the financial.

Thank you, Mario. Let me start with a summary of our third-quarter results.

Revenue was due to sequential improvement in all three areas of our business. Total revenue was $43.8 million, up 40% sequentially. The upside in revenue was driven by higher than expected order activity as customers took advantage of the higher memory prices (technical difficulty) some activity from the fourth quarter.

In addition, we expected $4 million to $5 million in the recognition of deferred revenue from past quarters, but due to some payment deferral in the fourth quarter, we only recognized $2.8 million of that amount in the third quarter.

Third-quarter revenue for DRAM was $36.4 million, up 44% from our second quarter and flat (technical difficulty) third-quarter (technical difficulty) go. The Flash business grew (technical difficulty) in the third quarter. The increase in revenue was due to a pickup in NOR probe card demand.

Flash revenues for the quarter were $2.1 million. Up 13 sequentially -- 13% sequentially, but still down 75% from a year ago. Revenue in the SSE business was up 34% sequentially to $4.6 million due to a pickup in order activity in the microprocessor segment, and an increase in activity coming from the automotive industry.

On a year-over-year basis, the SSE business declined 39%.

For the third quarter, GAAP gross margin was 16.8%. On a non-GAAP basis, gross margin was 19%. The gross margin improvement compared to last quarter and compared to our guidance was mainly due to the higher than expected revenue level, cost control, and a more favorable product mix.

We continue to focus on cost control during the third quarter. On a GAAP basis, operating expense (technical difficulty) totaled $31.1 million. (technical difficulty) expenses were lower by approximately $1.3 million from the second quarter.

Lower GAAP operating expense were due primarily to a reduction in stock-based compensation charges.

On a non-GAAP basis, operating expenses were $27.6 million, up approximately $1.6 million from the second quarter and in line with our expectations. As discussed last quarter, we took in a non-cash charge to tax expense related to a valuation allowance against our net deferred tax assets, which essentially places our tax (technical difficulty) operate at 0%. We had (technical difficulty) tax rate to remain near 0% till we proved the sustainability of a profitable quarterly trend. Therefore the tax rate is likely to stay at or near 0% through 2010.

Fourfold cash investments comprised of cash and short-term investments ended the quarter at $463 million. Approximately $24 million lower than the previous quarter.

As we turn now to the outlook for the fourth quarter, (technical difficulty) to have limited visibility over the near term. We expect our revenue to be down approximately 10% from our third-quarter level. Although a sequential decline from the third quarter is not uncommon for FormFactor, see revenue drivers have more to do with the timing of specific customer ramps and no transitions rather than general seasonality.

Given this, we are subject to more variability (technical difficulty) with an expectation of lower (technical difficulty) in our fourth quarter, gross margin will come down as well. Although as the quarter (technical difficulty) change (technical difficulty) and pricing of (technical difficulty) and unit costs and potentially creates an additional several points of margin variability.

Non-GAAP spending for R&D and SG&A in the fourth quarter should be slightly up, compared to the third quarter. The increase in operating expense from the third quarter is due to operating costs associated with the purchase of EG assets and some investment in R&D, related to new technology areas. Our focus is to maintain the appropriate level of investments to drive our future topline (technical difficulty) while looking for operational improvements that drive efficiency and cost benefits.

Returning to profitability is the central progress of our effort. We are constantly reviewing our cost structure and making appropriate changes or reductions, based on achieving our long-term objectives.

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

(Operator Instructions). [Christopher Muse] with Barclays.

A question. First question in your prepared remarks you talked about market share gains and DRAM and I guess you know you also focused that it's primarily at 6X.

So I was hoping you could expand on that. I'm assuming that you're (technical difficulty) Japan and not Korea?

(technical difficulty) we have also over the last (technical difficulty) we have also get market share in Korea. But I would say obviously it's -- I always said it is a long road so we are pretty happy with our results. But we still have a way to go and we can continue our path on this one.

This is why (technical difficulty) more sensitive to what is happening to Japan and Taiwan where most of activity is still 6X.

And when you think about 4X, 5X, DDR3 designs, is your competitive advantage really at the 1.6 GHz and above level? Is that when we should start to increase share?

Really in fact if you look at reality, we have seen market share again in all markets and we have gained markets share in Taiwan even on DDR2 products. Now we are also getting -- remember about the India -- India DDR3 now. Most of it was engineering (technical difficulty) nice wins, but now we are waiting to concrete -- to get back to a more concrete one, a big ramp-up out there.

Last question for me. Based on the tax rate at or near zero, are you figuring when your expectations for losing money through it all in 2010?

No, this is not what we meant. It's really as we said last quarter it really has to do with an accounting adjustment.

And as we return it to profitability it will take a few quarters in positive territories before we can build enough history to reverse that adjust (technical difficulty). So we didn't make it any pronouncements on whether we were going to be positive or negative for 2010.

Even whether, if we are in a positive situation (technical difficulty) we will still (technical difficulties) before we reverse that adjustment.

Makes sense. Thank you.

Gary Hsueh with Oppenheimer.

Great. Thank you for taking my question. You guys sound pretty positive in terms of order activity. I heard that mentioned a few times.

I was wondering if you can kind of help us quantitatively with your visibility? Any way you can give us what your order intake was or at this point with revenue declining (technical difficulty) how much backlog you have and being whether or not any orders were canceled at DDR3 given how strong DDR2 pricing is right now?

I would say that the biggest impact on the declining Q4 has to do with some (technical difficulty) orders. Some that we are [pulling] in the third quarter.

At this point, what we have seen parallel (technical difficulty) situation of an uptrend in new designs that have to do with 5X and 4X, which is always good news for the future. What is hard to determine is when are these going to translate into ramps? And there's a couple of reasons to that.

One is that the customer (technical difficulty) might not know the exact timing. They are busily purchasing equipment and fitting out their production line as we speak. So it's going to depend on their timing as well as the fact that cycle time of our business has not to be reduced.

So what we see is a market increase in in quarter orders that we turn around within the quarter. So that is why it is a little hard for us to be very specific beyond Q4. But three months from now, we will certainly be able to give you more color on this.

And just a few quick follow-ups here. John, is there any assumption in that down 10% revenue guidance for deferred revenue recognition in Q4?

So what we expect is that if you take out some recognition of revenue from that what deferred in past quarters, the decline is more like 15% from Q3 levels. So in absolute terms, there is about a couple million dollars of recognition of revenue falling in Q4.

Okay, and more of a strategic question since you mentioned better manufacturing (technical difficulties). Help me understand what this new wafer probe card technology that TouchMatrix in NAND Flash (technical difficulty) pricing. I mean, what should we expect in terms of gross margin improvement? Would that manufacturing efficiency translates to in terms of gross margin and in DRAM and NAND?

You know what I stated already a couple of quarters ago is that we -- if we be specific, we decided to use our technology (technical difficulty) which will allow us to compete in all parts of the markets where we operated on it. We had decent margins I would say. We never said number, but this is basically what it has been designed for.

Okay, great. Thank you.

So Gary, I just had that, you know we reiterate what we say last quarter which is a combination of the transformation of manufacturing should (technical difficulty) in a 15% gross margin increment at a level of revenue which is about $60 million. Right?

Okay. Got it. Thank you.

(Operator Instructions). Jim Covello with Goldman Sachs.

Great. (technical difficulty) Can you hear me now?

Yes sir, we can.

Okay, great. Thank you. Just in terms of visibility for the fourth quarter, you know in terms of the limited visibility you have today (technical difficulty) the metrics should we be looking for, a signpost in the industry that would make you feel better about your visibility as we head into the first part of next year or in 2010?

In other words what kind of things have to happen in the industry for your visibility to stretch out?

Well we know what will happen in the first half of 2010 is our customer will ramp up 5X and 4X.

And this -- I think this is what will have the most impact on our business in 2010. We know it's going to happen. Now again you know exact timing can -- exact timing will have a big influence on the way it happens exactly on a quarter to quarter.

But we know it is going to happen and we do intend to take advantage of it.

And just given everything that is going on with the model and kind of where we are today, do you think any change to the kind of long-term target model is warranted?

So, on this point, we will discuss more in detail probably by the year end about how we will see 2010 and (technical difficulty). What we said last quarter is that after our transition of manufacturing (technical difficulty) completed in the second half of 2010, we see no reason of not reaching historical margin levels.

What we would be looking at is a level of -- on top of that is a level of incremental margin to the growth and some notion of return on capital. So we will communicate more clearly on this probably by next quarter end.

Great. Thank you so much.

Patrick Ho. Stifel Nicholas.

(technical difficulty). A housekeeping question. What was your operating cash burn this quarter and what is your current quarterly revenue breakeven level right now?

So the revenue (technical difficulty) level on an operating cash basis before effective working (technical difficulty) about $54 million. So it is slightly up from last quarter. And this is mainly driven by the speed of some of the ramps we've seen in Q3, which forced us to take the less forced [video]. So less (inaudible).

So on to your question, the cash burn and on the operating level so when you add back working capital was (technical difficulty) about $22 million negative.

Okay, great. That's helpful. Just in terms of a little bit of a disconnect on my end. I hear that (technical difficulty) on the 6X nanometer know, which obviously helped your revenues for this quarter.

Now seeing the outlook on -- in terms of the revenue decline in Q4, are you implying that this -- I guess the memory customers ramp is slowing down in Q4? Or why is there a decline when what we're hearing out in the channels of continued strength and DDR2 which is (technical difficulty) know.

But that obviously has been a lot stronger than people have anticipated. Why are you guys seeing a decline when it seems that segment is actually improving (inaudible) near-term?

What we are seeing in Q3 is a lot of what we call a tuning cycle. So we have a lot of orders for 5X and for 4X, in fact. When people try engineering tools, etc. etc.

Now then, the big money is coming when they start having a really big ramp-up in 5X and 4X. And this is not happening in Q4. This will happen (technical difficulty) our first half of 2010. That is really the reason why we are having disconnection. We did ship a count for engineering. (inaudible) and all that. And I will be honest I never worked with it and depending on -- remember now we don't have that many more customers -- that many customers. So just a change in one of them has quite some impact.

But this is really what is happening for this specific quarter.

I would add to that that we really see the pipeline of requests for new designs. So we see the activity is there. It is going to come. It's just a question of timing.

Okay and then (technical difficulty) my final question on that is, in terms of these 5X and 4X ramps, which I acknowledge and I will admit that it's timing-related. Now is it a number of customers that are holding off on this or is it one customer that is primarily driving I guess this timing issue that we're talking about here?

I would say outside one very large customer in Korea, they are all in the process of doing it basically. And each one has a different timing, but I don't think -- I would not say they are holding up, but remember, many other customers also have their coffers pretty empty so they are also take this opportunity with good pricing to replenish (inaudible) need a little bit more cash.

So we have followed a lot of discussion with it internally and the customer is -- what is a bad timing for them? So this is what makes it and I would say each one is slightly different but, remember, you have a few consolation and each one has his own timing. But it is coming.

Okay. Great. Thank you.

We do see the designs. From our contact we do believe that it is coming and each one has a different timing. But again, because we have been surprised some time by some decision to extend a 6X for one month or something like that. Some time (inaudible) You know our customers have a lot of (inaudible) themselves.

Okay great. Thank you.

(Operator Instructions). Kevin Vassily with Pacific Crest.

Thanks for taking my question. Can you tell me a little bit about what you guys see as the incremental opportunity from DDR3 as compared with DDR2? I know the DDR2 opportunity, relative to the first kind of DDR RAM was about to ask the opportunity in terms of cards. I'm curious -- or actually expressed in terms of revenue. I'm curious what you guys think that opportunity is for DDR3?

Again we did estimate, but remember each time we did an estimate before we were wrong. So I will tell you what it is, but I want to say that before.

Our estimate for DDR3 but it will be (technical difficulty) we think that we will probably go on to 2015. And if you count the total (inaudible) of revenue, it is 1. (technical difficulty) kind of the DDR2 side.

Okay. Question on the new NAND product.

(inaudible).

Yes. You -- and I guess the prior attempt at penetrating the NAND product, and the market was a little less than desired. I think you guys would agree. (technical difficulty) into 2010 you referenced a considerable growth (technical difficulty) associated with that.

Do you size the NAND market any differently in terms of opportunity and at what kind of multiple would it be normalized growth for the DRAM market would you see NAND as you ramp this product?

So I will estimate for the NAND market in 2010 which is recovering is about $100 million.

And we plan to as we go through the year to hand up with -- you know I would say this in [fraction] of it. It will take some time. It won't happen overnight. But you know we do not plan to hand off the year at only 10% of market share. We expect something much better than that.

But just give an idea of what that (technical difficulty) this year?

This year it was below $100 million. I would say more like $70 million, $75 million this year. And it is expected to grow. So I mean in 2010 we expected to be above $100 million from $110 million, $120 million. And then by 2012 probably to grow at least to $200 million.

Okay. Thank you very much.

Christopher Muse.

Just a quick housekeeping. I was hoping you could shed light on what stock-based comps will be?

So the-based comp was 4.5 this quarter and I don't think we gave specific numbers, but I would expect these numbers to be fairly stable, slightly down from the next quarter.

Thank you.

Timothy Arcuri with Citi.

This is Brian calling in for Tim. I'm sorry if this has already been asked, but it seems like there is obviously a lot of new order activity here around DDR3. So I am wondering why has the ramp there not been more impactful yet? You know is there pricing fresh and cannibalization issues? Anything there that maybe you can talk to that, kind of help me reconcile what you are seeing, kind of real time in terms of new design orders and the ramp that is going on there?

We know in reality, if you look at the results that were in Q3 were mostly due to DDR3. And you know if you look at the other I see a nice increase from last quarter. So it was really -- we did ship 80% of our shipment in DRAM in Q3 was DDR3. In commodity.

So we did have this impact and now people are just running them. So what I say is but (technical difficulty) that we also are going to happen in 5X and 4X (technical difficulty). So this is where -- this is what we are waiting to see (technical difficulty) impact on our business.

Okay. So (multiple speakers).

Remember that our business drivers is not a quantity of weather, it is also pretty fresh and of design so more new design which is very important factor for our activity.

Okay. Well I guess given your limited ability into Q (technical difficulty) maybe help us understand (technical difficulty) what are the main moving pieces here in Q4 that could ultimately provide some upside strength or maybe even for the weakness into the quarter, (technical difficulty) recent design wins in Taiwan and Korea ramped into volume? Can you maybe just talk around what some of those (technical difficulty) are?

Okay and so just before I go to that I would also like to remind (technical difficulty) one other thing (technical difficulty) the 18 month (technical difficulty) lead time well are now well within the quarter. We treated, our customer (technical difficulty) place order at the last minute because it makes them more efficient, which means that we really see this movement in our bookings much later than we would see them (technical difficulty).

So that is one of the reasons why we have [less] visibility than before. So that (technical difficulty) you know the big movement at (inaudible) is (technical difficulty) stop running up to 5X on 4X for some other customer. This is when we really will see the thing starting to move.

Okay, well -- okay.

And we expect that to happen in between Q1 and Q2 next year.

In the quarter when you look at bookings, did you have any 10% customers this quarter?

I would add to what Mario says, what we have seen in this current market where you must admit that there is not a broadband and market recovery. You see that some of our customers are reacting very, very fast to certain opportunities. And actually sometimes competing for the same business.

So we have a very dynamic situation. We saw that in the past couple of quarters and (technical difficulty) add to the lack of visibility.

Last thing for me. I might've missed it, but was there a specific gross margin guide for Q4 done?

No, the margin would be down from this quarter due to volume. So I can give you a little bit of color.

As Mario said in his prepared comments, we are ramping up the move to our facility in Singapore. So we are going to have some costs related to this transition that starts to come up in the fourth quarter. We estimate those costs to be about $2.1 million.

So if I dug that out from the gross margin, we should be at about 10% roughly 10% gross margin.

Okay. After stripping that out?

Yes.

Gentlemen, as we have no further questions this afternoon, Mike, I'd like to turn the conference back to you.

Thanks. We would now like to conclude the call. Thanks again for joining us everyone and we look forward to speaking to you again next quarter.

Again, ladies and gentlemen, that will conclude our conference call. I would like to thank you all for joining us. (technical difficulty) great afternoon. Goodbye.