FormFactor Inc (FORM) 2010 Q4 法說會逐字稿

Thank you and welcome, everyone, to FormFactor's fourth-quarter and fiscal 2010 earnings conference call. On today's call are Chief Executive Officer Tom St. Dennis and Chief Financial Officer Rich DeLateur.

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 Investors 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; demand for our products and future growth; statements that contain words like expects, anticipates, believes, 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 2009 fiscal year as filed with the SEC, subsequent Forms 10-Q, SEC filings and in the press release issued today.

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

Good afternoon. The fourth quarter of 2010 represented another positive step forward in the turnaround of FormFactor's performance. The Company continued to make progress on reducing expenses and cash flow while improving gross margins. On-time delivery performance improved significantly over Q3, while leadtimes decreased by approximately 10%. We expect all of these trends to continue in the coming quarter.

As we indicated in our December call, we expect our Q1 revenues to be down significantly from Q4. The quarter-over-quarter decrease is due primarily to late product qualifications at key customers and cautious spending at DRAM manufacturers due to recent ASP declines.

Additionally recent changes in the DRAM market have caused our customers to re-prioritize their manufacturing capacity to pursue specialty markets for consumer and mobile, further impacting our qualification cycles. We expect to complete several critical qualifications this quarter, and as a result, we expect Q1 to be the low point in our revenues for this year.

Overall we expect the advanced probe card market to grow in 2011, driven primarily by increased demand for NAND Flash and SoC or system-on-chip cards, while the DRAM portion of the market is uncertain based on current trends.

As the NAND Flash market moves to the 2X technology node, we see opportunities to grow market share, driven by increased PIN count per device under test, shrinking pad sizes, and increased test complexity. These characteristics align very well with the capabilities of our TouchMatrix product line. Some customers are currently evaluating TouchMatrix for these applications with qualifications expected in Q1.

In the SoC market, we have begun to ship our TrueScale Matrix product to customers with qualifications beginning this quarter. Our SoC revenues have been growing over the past few years, and we expect further growth this year in this high-growth portion of the advanced probe card market.

Going forward our focus remains to continue improving execution across all areas of FormFactor. Our first goal is to structure FormFactor to be cash flow breakeven at a revenue level of $50 million per quarter. This requires further improvements in our product cost structure, as well as operating expenses. In manufacturing we will further reduce lead times while improving on-time delivery and quality. In product development, we have a solid pipeline of new products that will be released this year and will ensure that they hit the ground running.

The past year has been a period of significant changes and challenges for FormFactor. The Company's revenue grew 39% on a year-over-year basis; however, we fell short in many areas of product and operational performance. The process of turning our performance around began seven months ago with solid progress in many areas, and today FormFactor enters 2011 in far better shape than we were entering 2010. We will continue to improve our performance as we move through 2011 and position the Company for growth and success. I appreciate the support we have received from our customers, our shareholders and our employees as we build the Company for the future.

Now I will turn it over to Rich to go through our operational performance and our Q1 guidance.

Thank you, Tom. For the fiscal year 2010, revenue was $188.6 million, an increase of 39% over fiscal 2009 revenues. The results for our fourth quarter are as follows.

Total revenue was $43.9 million, down 7% sequentially and up 33% on a year-over-year basis. The revenue decline for the fourth quarter came primarily from the DRAM sector of the business. The details are as follows.

Fourth-quarter revenue for DRAM products was $26.9 million, down 11% from our third quarter and up 14% versus the fourth quarter a year ago. The lack of qualification of the SmartMatrix family for certain applications continues to dampen our DRAM revenues. Flash revenue was $9.2 million, an increase of 2% from Q3 and 241% versus the fourth quarter a year ago.

NOR revenue increased significantly, while NAND revenue decrease. NOR revenue was $8.4 million.

SoC revenue was $7.8 million in the fourth quarter, down 5% sequentially and up 16% versus the fourth quarter a year ago. Revenue from our new product architecture, SmartMatrix and TouchMatrix, was $15.8 million, which represents 81% of our full wafer contact business. As a result of the transition to SmartMatrix at year-end from Harmony, our gross margin percent was positively impacted.

Fourth-quarter GAAP gross margin was $3.3 million or 8% of revenue compared to the negative $7.2 million or negative 50% revenue for the third quarter.

On a non-GAAP basis, gross margin for the fourth quarter was $4.2 million or 10% of revenue compared to a negative 13% in Q3. Improved product mix, a reduction in the charge for excess and obsolete inventory, reduced depreciation from the Q3 enterprise-wide impairments, and the absence of the Q3 prior period accounting adjustments of $4.1 million contributed to gross margin improvement. Lower absorption and fixed spending due to reduced revenue levels and continued excess inventory charges due to reduced demand continue to weigh negatively on gross margin.

Our GAAP operating expenses were $27.2 million for Q4 compared to $93 million for Q3. As you recall, Q3 included a number of extraordinary items, including an enterprise-wide impairment. Q4 operating expenses include $1.3 million of restructuring charges and additional charges for our cessation of manufacturing activities in Singapore.

Non-GAAP operating expenses in the quarter were $22.5 million, down $3.2 million from $25.7 million in Q3, demonstrating continued reductions in our operating expense. We continue to review all aspects of our spending, and we will continue to take the required actions to achieve our targeted structure by Q2 2011 with OpEx less than $20 million per quarter.

Cash, comprised of cash and short-term investments, ended the quarter at $348 million, approximately $24 million lower than the previous quarter, a lower cash burn than anticipated. This improvement was driven by higher than anticipated collections.

In Q4 we purchased 70,000 shares of our stock at a cost of $626,000. In addition, we purchased an additional 130,000 shares at a cost of $1,164,000 subsequent to our year-end. These purchases resulted in an average price of $8.95. Under our current program, we are authorized to purchase an additional $48.2 million worth of shares over the next nine months.

Here are some other financial details. Our depreciation and amortization in the fourth quarter was $3.4 million, a reduction of $4.4 million, primarily resulting from the enterprise-wide impairment recorded in Q3. Our capital additions are $5.2 million. We expect capital spending for all of 2011 to be approximately $12 million.

Before I discuss Q1, I want to reaffirm our position around breakeven. We have continued our efforts to restructure the Company to be cash flow breakeven at the $50 million revenue level by midyear. It should be noted due to the Q3 enterprisewide impairment, non-GAAP breakeven should occur with revenue in the mid to high 50s.

With respect to Q1, we expect Q1 revenue to be in the range of $35 million to $40 million. We expect continued improvement in the management of our excess inventory charges and reduced spending from the cessation of manufacturing activities in Singapore that will be partially offset by the negative impact of reduced overhead leverage from reduced revenue levels.

Consequently our non-GAAP gross margins should be similar to Q4 non-GAAP gross margin of 10% plus or minus a couple of points. We expect continued improvement in non-GAAP OpEx that should drop by approximately $1 million in Q1 2011. We expect Q1 cash burn to be 10% to 15% below Q4's cash burn level.

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

(Operator Instructions). C.J. Muse, Barclays Capital.

I guess the first question, you talked about on the SoC front your optimism there for the growth, and I was hoping you could elaborate on what you are seeing as the key drivers there, and in particular your positioning as the leader there and, I guess, your recapture or holding on to share there would be very helpful.

Well, the SoC market has been a large market that is pretty fragmented as there's so many different approaches, certainly different devices manufactured, different approaches to test and to probe in that space. What is happening, though, is that the pad pitch and the challenges for increasing parallelism in tests continue, and as that increases, it creates opportunities for us.

The TrueScale Matrix product that we have allows customers to go into significantly higher levels of parallelism while testing their more leading edge SoC products. So we are serving a portion of that market. As I said, it has grown for us over the last two years. It looks like it is positioned to grow again significantly for us this year. Last year it was -- it is a little bit over 10% of revenues in fiscal year 2010, and we would expect it to be a bigger percentage overall this year, and we will see, as we go through the year, how successful our TouchMatrix product is.

As a quick follow-up, you talked about confidence that the March quarter would be a revenue trough for you guys. And I guess I was hoping to get a little bit of help around what is driving that expectation. I'm assuming it is on the DRAM front, so I would love to hear how you see the trajectory or improvement there beyond the March quarter?

Well, as we said, the challenges we have had have been going through some of the product qualifications. In the middle of that and through kind of Q4 and coming into Q1, a number of customers have shifted their production planning around out of commodity DRAM into mobile and consumer applications, which caused us to need to re-vector some of the qualifications at those applications.

Based on the data that we are seeing from the qualifications going on now, it looks promising that those will close out here in this quarter. Our view of the year is that it certainly will be a strong growth year for NAND Flash going into mobile products, if you will, whether it is smartphones or tablets or other consumer products, and that, as we get these mobile DRAM calls and such confirmed here in Q1, that is going to allow us to get opportunities for Q2 and the rest of the year and begin to focus more on design wins there as opposed to just qualifications.

Timothy Arcuri, Citigroup.

A couple of things. First of all, Rich, can you just sort of again go through what the P&L breakeven is? I know that cash flow breakeven is still $50 million, but it seems like P&L breakeven is sort of in the low 60s given where option expense is, but I just want to confirm that.

Yes. On a non-GAAP basis, like I said, the breakeven for the P&L should occur somewhere in the mid to high 50s, and GAAP breakeven should occur around the mid-60s, $65 million.

Okay. And are there any additional actions that have to happen to get there, or I mean is that done today, and you are just sort of -- it is volume that is going to get you there?

Yes, the bulk of the activities have been done, and volume is a very important part to restoring the gross margin that allows you to achieve that breakeven. We still have to identify a few areas, but it is in the 1% or 2% type error terms. The bulk of what we need to do has been done or is in process.

Okay. And then just on the NAND stuff, that has continued to be a big opportunity, but it really has not amounted to much yet. So given that there is a pretty significant amount of [front-end solution] shipping into the NAND market, you're going to see units grow there pretty significantly. What sort of competitive dynamic as they shrink more aggressively? Is there a switch that has to flip for that to really turn on for you? I know that the chips are sort of fundamentally not as complex as in DRAM, not as many PINs, but is that changing? And if so, what is going to be the switch that flips to make that market turn on?

So what I was trying to get across there in my comments on NAND was that the ongoing shrinks down in 2X and probably there's a couple of generations in the 2X decade there, if you will, what we see happening now is pad sizes are starting to shrink. And where they used to be kind of 90 microns by 90 microns, they are starting to come down into a range where DRAM was a couple of generations ago.

Also, the PIN count is going up as they are looking at expanding some of the test data that they want to collect. And those two things together make a MEMS-based solution like FormFactor's products substantially more competitive. When the pad sizes are larger, if it is -- you can use other technologies to pursue that. When PIN counts are exceptionally low, that is not a place where we are particularly cost-effective or a good value for them there.

What we see are these indications that things are shifting now towards a higher number of I/Os and PINs on each DUT and then the changing pad size. So it looks like it is coming our way. We have a couple of key examples of that that we are working on right now and are optimistic that they will be important wins for us in strengthening and building a stronger base in NAND.

Jim Covello, Goldman Sachs.

This is Kate Kotlarsky for Jim Covello. I wanted to ask a question about the TAM comments that you had made previously about expecting the advance probe card TAM to grow year over year this year. If we thought about that across applications looking at the DRAM portion versus the NAND portion versus the SoC portion of the market that you are serving, how are you thinking about those various segments? I would assume that DRAM is probably down year over year, and then the other segments are up. Is that the right way to think about it?

Well, the way I tried to profile it in my comments was that the highest growth segment that we see today is in the SoC market, which is really just a technology shift from many of the alternative technologies that are used towards some of the more advanced probe card solutions that fit better into FormFactor's product portfolio.

NAND Flash is clearly on a extremely strong growth curve at this point in time, if for no other reason than just the huge amount of capacity in terms of wafers per month that will be coming out. So we expect it to grow kind of consistent with the way that the capital investments are growing for NAND Flash with the addition of the comments I made just a minute ago about the fact that the testing requirements are getting more physically challenging with some smaller pad size, as well as the test complexities going up with some more PINs per DUT.

DRAM is I would say is uncertain at this point in time. The ASP decreases that happened in the fourth quarter I think you can see that reflected in customer spending investment decisions going on throughout the industry. I do think that the second tier companies are more strongly impacted by that than the first tier companies. But of the three segments of those three market segments in 2011, I would have the lowest expectations for DRAM followed by greater expectations for Flash with the highest expectations for -- (technical difficulty).

Okay. That is very helpful. And then maybe one other question on a different topic. I wanted to ask you about your thoughts around M&A. As you guys look out into the market, are there any combinations do you feel like make sense in companies out there that are highly complementary to your business or you think you might be open to a combination?

Yes, we think the right time for M&A both as an acquirer or being acquired is when you are a healthy company that has a positive cash flow. So it's still not a focus of ours.

But is it something that you would be open to once you got to a point where you are cash flow positive?

Yes, absolutely. The fact that combinations can provide operating leverage is pretty obvious, and we would be open-minded.

(Operator Instructions). Patrick Ho, Stifel Nicolaus.

First, can you guys discuss, I guess, some of the concrete measures that have helped you improve on-time delivery with customers? Tom, I know that this was a problem before you got there. Can you just say qualitatively what you have done or what you guys have implemented to improve that on-time delivery now and on a going forward basis?

Well, it has been a number of things. It really starts with our supply chain and getting the supply chain -- understanding what was impacting the supply chain and causing delays in the past. In early 2010 I think the industry at large was suffering with component availability and all. But we have three of the major suppliers to FormFactor were performing below 50% on-time delivery. And so there were a number of different initiatives that went through to understand what was impacting them and working through that with our engineering teams and with our supply chain team to clear that up.

In some cases, they had to add capacity. In some cases, they had to add capability in order to move through that. And, in other cases, there were some significant quality issues that were impacting yields on probe cards -- sorry, on PC boards and such that the suppliers had to work through. Those started to come back in a substantially better way in late Q3 and then moving into Q4. So Q4, as I said, on-time delivery improved substantially and I would say largely impacted by improvements in our supply chain.

What we have been doing further in-house is working through our complete order fulfillment process and really understanding where there are intrinsic delays or gaps within our own processes, handoffs in different areas, or delays in transmission of information orders or what have you. And so we have been able to flush out significant amount of that that allowed us to reduce lead times while maintaining significantly improved on-time delivery performance. As I said, we expect to continue that going into this quarter, and we would expect to see another 10% improvement in leadtime without degrading any of our on-time delivery.

The second phase of on-time delivery with our suppliers now is working with them to decrease their own cycle times and understanding what has been impacting them there. And it just improves execution throughout the whole supply chain. I would say today we understand the causes significantly better than we did six months ago, and now we're at the point of working through the opportunities that exist to improve leadtime without having any degradation on on-time delivery.

Great. And a follow-up question to some of the items you just mentioned. I think on the prepared remarks, you said something about getting better design to manufacturing that process improved. Can you just give a little color what efforts you are making on that front to get better results once you go from design to the actual production?

Well, on the upfront design process, when we get our first article product in certainly is complex. These are not simple technologies, if you will. But we have had a number of initiatives to understand both the sources of error and the areas that impact overall cycle time and have packaged that much better in terms of what a release package is to our -- to the complete manufacturing cycle, that part that goes to our suppliers, as well as those components internally. That has had a significant impact in our overall performance, and we continue to make improvements on that.

So one is getting the basic process well defined and kind of cleaning up the gaps that allowed for some delays there. And then what we are working on now is in that area, of course, is further reduction in overall cycle times. So that is helped by some design tools, and it is helped by some process approach and kind of scheduling approaches that we have changed.

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