FormFactor Inc (FORM) 2011 Q3 法說會逐字稿

Thank you, and welcome, everyone, to FormFactor's third quarter 2011 earnings conference call. On today's call are Chief Executive Officer Tom St. Dennis and Chief Financial Officer Michael 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 in the press release issued today, and also on the investor section of FormFactor's website.

Also, a reminder for everyone that today's discussion contains forward-looking statements within the meaning of the federal securities laws. Such forward-looking statements include, but are not limited to, projections, including statements regarding business momentum, demand for our products and future growth, statements that contain words like "expects," "anticipates," "believes," "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 the forward-looking statements.

For more information, please refer to the risk factor discussions in the Company's Form 10-K for fiscal year 2010 as filed with the SEC, subsequent SEC filings, and the press release issued today. With that, we will now turn the call over to CEO, Tom St. Dennis.

Thank you. Good afternoon. The probe card market in the third quarter had two very different phases to it. The first phase was a continuation of strong DRAM probe card demand from the second quarter, which challenged our capacity for several weeks in July and August. The second phase was an abrupt drop off to demand for DRAM probe cards beginning in September. This is continuing into Q4, consistent with DRAM industry trends. The market for DRAM probe cards can be very volatile when prices drop below the cash cost to manufacture a DRAM chip and that is a situation that many of our customers have found themselves in during the past few months.

Until DRAM prices stabilize at levels somewhere above the variable cost to manufacture, we expect probe card demand from this segment of the market to remain weak. The technical drivers within the DRAM probe card market continue in spite of the current market swings. Today, there's a strong push by DRAM manufacturers in two key areas. One area is related to shrinking the bond pad size. As lithographic shrinks are pushed out due to delays in EUV technology, DRAM manufacturers are looking fir all possible ways to increase the number of die per wafer. By reducing the area necessary for bond pads, DRAM manufacturers can see meaningful increases in the number of die per wafer.

FormFactor's current and next generation of 3D MEM Spring technology will enable these [shrinks] in ways that are highly differentiated as compared to the 2D springs from our competitors. The secondary investment for DRAM manufacturers is in high parallelism wafer test. Next year, we expect to see the market for probe cards migrating to designs that test 1,200 to 1,400 devices simultaneously as compared to the 600 to 800 devices that are tested simultaneously today.

To meet this market demand, we've been investing in the next generation of the Matrix architecture beyond the SmartMatrix 100 and the SmartMatrix 100XP. Earlier this year, we shipped engineering prototypes to customers and this quarter we'll ship our first production evaluating cards to two customers followed by a third customer in Q1 of next year. This new Matrix product is capable of meeting customer demands for high parallelism testing and will incorporate the latest components of our ATRE technology. We expect this new product to contribute to revenues in the second half of 2012.

As I mentioned last quarter, we've increased our investments in vertical probe card technology for the SoC market. We made great progress through the third quarter on this innovative technology and have demonstrated a prototype card at our development customer's facility. We plan to deliver more cards to our customer this quarter to support this fast-paced development. The market for advanced SoC probe cards is larger than the market for DRAM probe cards and is an important part of the strategy to diversify and grow FormFactor. We expect this new product will contribute to revenue in the second half of 2012.

We continue to make progress in Q3 on an operational basis. We reduced lead times for the Matrix product by approximately 10% while increasing our weekly capacity. Operating expenses were further reduced in spite of increased R&D spending on the next generation Matrix product and the new SoC product. Cash used in operations was reduced to $3.1 million from $8 million in Q2. We believe that the abrupt and significant drop in DRAM probe card demand is a reaction related to global market uncertainties that have affected many parts of the semiconductor industry.

These uncertainties plus the seasonal slow down in the overall probe card market in Q4 combine to make a challenging quarter ahead for us. While the market drivers for DRAM growth appear to be slowing, the opportunities for FormFactor to enable our customers to significantly reduce their cost of test and increase the number of die per wafer are in fact growing. At the DRAM market bottoms, we expect to see the DRAM probe card market return to levels that will support FormFactor's continued growth in revenue and profitability.

Our continued progress and the strong interest in our new products reinforce to me that we're making the right investments for FormFactor's future.

Now, Mike will review our third quarter financial performance and our fourth quarter guidance.

Thank you, Tom. The results for our third quarter are as follows. Revenues for Q3 were $52.1 million, an increase of 12% from Q2 2011 and 10% from Q3 2010 respectively. The revenue growth compared to the second quarter came from all sectors of the business.

Third quarter revenues for DRAM products were $36.5 million, an increase of 8% from our second quarter, and an increase of 21% versus the third quarter a year ago. The increase in DRAM revenues versus the second quarter resulted from a 34% increase in our SmartMatrix business in the quarter to $26.2 million, a continued positive outcome from the qualifications of the Matrix platform at customers in the first half of 2011.

Flash revenues were $7.3 million for the third quarter, an increase of 40% from the second quarter, and a decline of 19% compared to the third quarter a year ago. Our NAND flash revenues for Q3 were $4.5 million, an increase of $3.1 million, or a 211% increase compared to Q2. The increase resulted primarily from high pin count opportunities at one customer. SoC revenues were $8.3 million in the quarter, an increase of 12% from Q2 and flat versus the third quarter of last year.

Revenues from our SmartMatrix and TouchMatrix architecture were $31.1 million for the third quarter, which accounted for essentially all of our full wafer contact business and is a 40% increase compared to Q2 2011. Third-quarter GAAP gross margin was $12 million or 23% of revenue, compared to $9.9 million or 21% of revenue for the second quarter.

On a non-GAAP basis, gross margin for the third quarter was $12.7 million, or 24% of revenue, compared to 23% in the second quarter. The fall through percentage was 36% on increased revenues. The fixed spending leverage on incremental revenues was negatively impacted during the quarter by several factors, including a higher mix of lower margin TouchMatrix products for Flash, high non-recurring engineering costs associated with new DRAM designs where we had not yet received follow-on orders, election challenges from an isolated customer, and warranty repair costs for a specific probe card design. Charges for excess and obsolete inventory remain consistent with second quarter levels.

Our GAAP operating expenses were $22 million for Q3, an increase of $1.1 million compared to Q2. Q2 operating expenses included $1.1 million of restructuring benefit primarily from the termination of a lease obligation in Singapore.

Non-GAAP operating expenses for the quarter were $19 million, down $1.4 million from $20.4 million in Q2. Q2 non-GAAP operating expenses included a charge of approximately $1 million for an indirect tax audit underway in a foreign jurisdiction. While we continue to reduce our operating expense structure, we will continue to make the necessary investments in our next generation Matrix product for the DRAM market and in vertical probe card technology for the SoC market.

In the third quarter, the company recorded a tax provision of approximately $200,000 compared to a benefit of $2.4 million in Q2. The tax benefit recorded in Q2 was a one-time benefit derived primarily from evaluation allowance release of $2.5 million associated with the deferred tax assets for past operating losses incurred in Singapore. Going forward, we do not expect additional releases of significant valuation allowances.

Cash, comprised of cash, short-term investments, and restricted cash, ended the quarter at $316.3 million, $8.6 million lower than the previous quarter. The cash burn included $5.5 million for the repurchase of common stock during the third quarter compared to $1 million of stock repurchases for Q2. Excluding the repurchases of common stock, the cash usage for Q3 was $3.1 million compared to $8 million for Q2. The improvement in cash usage compared to Q2 was driven by good collection efforts. Though not the break event we envisioned, it does mark dramatic progress in restructuring the Company.

Our stock repurchases for the third quarter were just under 700,000 shares at an average price of $7.95 per share compared to slightly more than 117,000 shares at an average price of $8.85 per share in the second quarter. Since inception of the program, we have repurchased just over 1,145,000 shares for $9.5 million, an average price of $8.31 per share. As discussed in our press release, the Board of Directors authorized the extension of our stock repurchase program for an additional 12 months. We are authorized to purchase an additional $40.5 million worth of shares over the respective period.

Here are some other financial details. Our depreciation and amortization in the third quarter was $2.8 million. Our capital additions were $2.2 million. We expect capital spending for all of 2011 to be at or below $8 million. Our stock-based compensation for the third quarter was $3.3 million, consistent with our ongoing expense expectations communicated last quarter. The Company reduced its manufacturing and OpEx cost structure significantly over the past five quarters in an effort to achieve our objective of cash flow break even at $50 million in revenue.

We continued our progress in the third quarter by continuing to reduce our OpEx structure. However, we continue to be a few million dollars of actions short of our goal. Our current focus will be to balance future reductions while we work to develop and deliver the new Matrix and SSE technology to exploit the market opportunity mentioned in Tom's comments. Therefore, we will continue to be a few million dollars of actions short of our break-even goal at $50 million of revenue as we exit 2011 and into the first half of 2012. Consequently, our revenue break-even level will be $54 million to $56 million exiting 2011.

With respect to Q4, the quarter will be a 14-week quarter for the Company, ending on Saturday, December 31st. We expect fourth quarter revenues to be in the range of $30 million to $34 million with significant reductions forecasted to be in our DRAM revenues. With respect to gross margin, the reduced revenues will put pressure on our margins. Consequently, our non-GAAP gross margins should be in the range of 3% to 8%. We expect Q4 non-GAAP operating expenses to be roughly equal to Q3 at $19 million. Employees are required to take time off during the fourth quarter to mitigate additional expenses resulting from the 14-week quarter. The significant reduction in revenues will have a negative impact on cash usage for the fourth quarter. We expect Q4 cash burn to be less than or equal to $10 million not including any stock repurchase activity.

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

(Operator Instructions) Our first question comes from Patrick Ho from Stifel Nicolaus.

Thanks a lot. Tom, can you give a little bit of color in terms of the SmartMatrix qualification of your next generation products? What are some of the, I guess, technical hurdles that customers are trying to qualify now and what's kind of the timeline of these type of qualification process?

Well, the cards targeted at high parallelism testing, as I was mentioning and what we're seeing now is customers going at simultaneous testing of 1,000 to 1,400 devices simultaneously. So the purpose of the target, the purpose of the cards in this new architecture is to enable us to do that with high signal fidelity and with all of the continued benefits of the high precision of our MEMS probe technology, but enabling them to make a dramatic reduction in their total cost to test. The evaluations and all will get cards there by the end of this quarter to two customers, as I said. I would expect that we'll get our first feedback from them middle to end of Q1 and depending on that then we'd start to look at further production designs for them moving into Q2 and the second half of 2012.

Right, and is it fair for me to characterize that these are four the 2X nanometer DRAM for the 2X nanometer node?

Yes, I think they'll be used both at 3X and at 2X. What's happened in the DRAM industry it seems is that increasing bits per device has slowed. People seem to be focused mostly now on two gigabit and four gigabit type devices. But what is happening as they continue to make progress on shrinks, the number of die per wafers has gone to 2,000, and up to 3,000 die per wafer. So they're looking for ways to test that many die more cost effectively. But it's in the 2X and 3X range.

Great. Question for you, Mike. In terms of the leverage in the model, you guys have done a good job of maintaining OpEx in a pretty narrow range. In terms of the cost of goods side, do you have any levers that you can maneuver at least as you navigate through this part of the cycle? Or have those actions been spent?

I think the majority of those actions have taken place, Patrick. I think we still have execution opportunities where we can gain additional leverage, but in terms of the structure itself I think most of those have taken place at this point in time. We'll continue to look and be prudent about it, but we think at this point in time most have taken place from the COGS side.

Great. Final question from me in terms of the products itself. With a lot more talk about vertical name device structures, what do you see the potential opportunity for FormFactor as the industry moves towards that?

I think that what that's going to allow is the continued cost reduction, obviously, for [bit], for NAND devices. At this point in time, what we know of and we would expect that the probe requirements would be similar to what's there today. The opportunity in Flash is that as the demand for Flash cards grows, obviously the demand for wafer [starts] and probe will grow. We are still targeting in that market really just about 10% of the market. It's the higher end of the market, but it will grow with the overall market. So we should be able to continue to see growth in our Flash business, albeit we're only really going after that higher end of the market.

Great. Thank you very much.

Thank you. Our next question comes from C.J. Muse from Barclays Capital.

Hi, this is (inaudible) calling in for C.J. Thanks for taking my question. I was wondering, granted the visibility remains pretty well, but if we assume that DRAM remains in a similar sluggish pace into the first half of 2012 how do you view your other (inaudible)? Is there room for SoC to expand much more significantly or what would have to happen to drive Flash or SoC much higher off of current levels?

Well, the SoC market continues to be an area for us that has growth opportunities in there and it has been growing for us through 2011. I think all of the semiconductor industry has been impacted recently by macroeconomic effects and all. So both SoC and Flash I think have even slowed. Nothing like DRAM, but going forward the SoC business is an opportunity for growth with our current products. The really exciting part of it is in the -- it's in the vertical card space where we're making investments now that look very promising, albeit for the second half of 2012.

Got it. And then, you mentioned that part of the growth margin drag that you're seeing in the December quarter has to do with collections from a customer. Is that something that we -- is there room for that to remain a headwind going forward and do you see risk to other customers as well? Just more color in terms of where this is coming from?

No, we actually see this as an isolated customer that we had a challenge on, but we're actually not seeing any other challenge in our customer base. So we do not expect it to be headwinds going forward.

And is that a DRAM customer?

Yes.

Got it. Thank you.

Thank you. (Operator Instructions) Our next question comes from Wayne Nguyen from Citigroup.

Hi. Thank you for taking my question. The (inaudible) clearly is pretty low in terms of revenues. Besides the DRAM cost issue, is there any other reason that the DRAM customers continue to slow down their probe card purchase?

No, I think that the current cost pressure on them ahs caused them to react pretty aggressively in reducing costs and including reducing output for some of the manufacturers. As Mike mentioned, we had a number of first article design wins and these are designs that are targeted at 3X and 2X technology that occurred in the Q3 timeframe. Those technologies need to ramp for us to see the follow through and the volume follow through on that, and would appear at this point that customers are staying with current generations of technology in many instances, not all, either because of the cost to ramp it or the fact that yields are not yet at the levels that they need to ramp it further.

But given that there's a -- seems to be a weakness in demand and more than enough supply, many of these new technologies right now represent further shrinks, which would essentially expand capacity and drive the [over] supply further ahead. So I think some customers are comfortable staying with the existing technology, running their fabs on that until they see the opportunity to get better prices and then move to the shrinks.

So one of the up side for your DRAM business is to get into the door of the biggest DRAM maker. What's the progress there so far?

Well, as we said, we sent first designs to them last quarter for the Matrix product and they're very interested in our follow on technology product. So both of those will be -- are in evaluation or will be in evaluating through the quarter here. And we'll see how that goes. That would be a significant opportunity for us.

So it's safe to say you haven't seen meaningful revenue contribution from that customer yet?

Not yet.

Okay. So you talked about the new product, which can do 1,200 to 1,400 chips versus 600 to 800. Could you update us on is this a unique capability from FormFactor? What's the capability of your competitor at this point versus your new product?

I think all of the suppliers in the market realize at this point that the high parallelism test will become a reality in the course of 2012. So everyone is working hard to bring products to market for that. At this point in time where the uniqueness of our 3D MEMS technology in terms of being able to place, now this is upwards of 60,000, 70,000 springs on these cards going potentially up to even 100,000 where I think that our product architecture and the mechanical characteristics as well as the precise location of our springs gives us a substantial advantage. No one has proven that they can do it yet at the extremely high levels, but I think we'll know by the end of Q2 next year just how everyone performs. At this point, we're -- frankly, I'm really welcoming this as I think it's a real opportunity for FormFactor to differentiate in this space.

That's helpful. One last question regarding the (inaudible) level, so you mentioned about it being (inaudible) cash [$65] million revenue for quite a while and now the break even both in terms of numbers and also the timeline has shifted. What's the explanation here and could you just reiterate your cash as well as revenue break-even and the timeframe to achieve that?

Yes, I think for us, I think we've been fairly prudent about our investment and where we're going. And we certainly have looked, I think, done a very good job over the last five quarters and we believe that we will continue to look at opoprutnities. But we believe that what we really want to do is take advantage of the opoprutnities to drive our technology leadership and continue our market leadership.

And we think if we cut much more than that, we're going to put that in jeopardy. So the answer is at this point in time we will continue to look for opportunities but we think we've done the bulk of the work there. And so I think at this point in time people should look at our cash flow break even at the $54 million to $56 million of revenue that we discussed. And I don't think there is a timeline at this point time to say that we will get it to the $50 million level.

Wayne, it's really about us having the opportunity to be the clear leader in the probe card industry and in all three market segments. And right now, the best thing we can do for the Company and for our shareholders is to drive the investment on these new products, get them to market, and continue to focus on gaining our share in those different accounts. I think we will continue to look for opportunities to improve on our overall operational efficiency, but we are not focused solely on that now. Now, we see the opportunity to really go out and increase our position.

That's helpful. So along that line, you look at those three product lines. It's clear that DRAM is not growing as fast as NAND and SoC. It's probably to be the similar case in the next several years. So is the Company thinking about strategically shifting your product direction more towards the growth areas in SoC and instead of continuing to expand the DRAM sector?

Well, as we mentioned, as I said a quarter ago, we've been on a product development for SoC now for about almost a year and as we have been able to validate the technology, which is very innovative, we accelerated that investment beginning in Q2. And that's all about moving into a market segment that is larger than the current DRAM probe card market area. So I think that should be a clear indication of the fact that we see an opportunity to bring what we do well to that market segment and accelerate revenue and profitability there. So that's our current focus.

Great. Thank you.

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