FormFactor Inc (FORM) 2012 Q2 法說會逐字稿

Thank you and welcome, everyone, to FormFactor's second quarter 2012 earnings conference call. On to today's conference call are Chief Executive Officer, Tom St. Dennis and Chief Financial Officer, Mike Ludwig. As a reminder today's call will be recorded. 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's section of FormFactor's website.

Also as a reminder for everyone that 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 and macro economic conditions, demand for our products, and future growth. Statements about our development, introduction and/or qualification of next generation Matrix or new SoC products and statements that contain words like, expects, anticipates, believes, possibly, should, and the assumptions upon which such statements are based.

These forward-looking statements are based on the 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 the actual results could differ materially from those anticipated in forward-looking statements.

For more information, please refer to the risk factors discussions in the Company's form 10-K for the fiscal year 2011, as filed with the SEC, subsequent 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. During the second quarter, FormFactor experienced a strong recovery in orders and revenue relative to the first quarter of 2012. The increased demand was led by both our DRAM and Flash customers. We achieved record shipments of our Matrix product line and now have over 1,400 cards shipped. Gross margins as a percent of revenue were the highest since the fourth quarter of 2007, reflecting continued improvement in our manufacturing operations and supply chain organizations. Orders for the second quarter were also the highest since the fourth quarter of 2007, as we have continued to improve our market share with key customers. Lastly, our cash flows from operations were positive in the quarter. All of these were important milestones for the Company.

We continued our product development and customer evaluations of our next generation Matrix products in Q2 with three customers, and we expect to complete the evaluation phase with all three customers during Q3, with revenue beginning in Q4. Our vertical SoC product development is continuing with our focus now on customer-specific designs, versus engineering test vehicles. We expect to ship the first complete card for customer testing later this quarter. Similar to Q3 last year, we have reached -- we have recently seen a significant slowdown of orders for DRAM probe cards. The 10% decline of DRAM spot prices since May of this year, along with slower personal computer sales, appears to have reduced our customers' demand for DRAM probe cards. In the NAND Flash and NOR flash markets, price drops for NAND flash and overall volume decreases have reduced orders for probe cards in these segments. Our SoC customers have been forecasting improved performance in the second half of the year, but at this point it doesn't appear to be developing quickly. Several of our customers have had recent announcements indicating difficult market environments. As a result, our SoC sales are down slightly in Q2 from Q1, but don't appear to be improving for Q3.

This is normally a seasonally stronger time of the year for our customers and the probe card market in general, but the fact that the market is weakened abruptly, after a strong recovery in Q2, leads us to believe that a weak macro economy and the lack of a clear DRAM industry demand driver, will keep demand levels depressed in the near term. Multiple product platform transitions that are occurring now may also be contributing to erratic ordering. The upcoming transitions to next generation smartphones, tablets and Ultrabooks, cause the semiconductor industry supply chain to manage inventory very cautiously. As a result of this market environment, we are taking actions to control expenses this quarter, and additionally, we are revisiting our cost structures and break even levels with the intention of reducing them further during the second half of 2012.

I'll now turn the call over to Mike Ludwig to review our performance and Q3 guidance.

Thank you, Tom. Revenues for Q2 were $54.8 million, an increase of $20 million, or 57% versus Q1 2012. Compared to the first quarter, revenues increased in DRAM and Flash but declined in SoC. Second quarter revenues for DRAM products were $38 million, an increase of 74% from our first quarter. The positive momentum we experienced in the back half of the first quarter from DRAM device price stabilization continued through the second quarter. All of our full wafer contact DRAM customers increased their order and revenues in the second quarter compared to the first quarter. We experienced increased probe card revenues from customers that are transitioning to probe 4 gig devices and 3X-nanometer-nodes, while probe cards for mobile devices continue to be a strong revenue component.

Flash revenues were $9.7 million for the second quarter, an increase of 91% from the first quarter. Our NAND Flash revenues for Q2 increased close to 100% to $5.3 million, resulting from improved lead time execution and increased complexity at our customers. Our NOR flash revenues increased $2 million compared to Q1 to $4.4 million. SoC revenues were $7.1 million, a decrease of $0.7 million, or 9% from Q1. We saw several of our SoC customers' businesses experience reduced demand in the quarter, negatively impacting our business in the quarter as well.

Second quarter GAAP gross margins were $16.2 million, or 29% of revenues, compared to $4.2 million, or 12% of revenues for the first quarter of 2012. On a non-GAAP basis gross margin for the second quarter was $16.9 million, or 31% of revenues compared to $4.7 million, or 13% of revenues for the first quarter. Non-GAAP gross margin for the second quarter was favorably impacted by approximately $12.9 million from fixed spending leverage on incremental revenues and a favorable product mix.

Our GAAP operating expenses were $22.5 million for Q2, an increase of $0.5 million compared to Q1. Non-GAAP operating expenses for the second quarter were $19.7 million, an increase of $0.2 million compared to the first quarter. The increase in non-GAAP operating expenses in the second quarter was due to increased charges for evaluation and test vehicles for our next generation Matrix product and an increase in quarterly sales incentive compensation from the increased booking level in the quarter. The increases were partially offset by reduced professional fees incurred in the quarter. In the second quarter, the Company recorded a tax benefit of $1.6 million compared to a provision of approximately $100,000 the first quarter. The benefit in the second quarter was derived primarily from the expiration of the federal statute of limitations around specific uncertain tax positions. We do not expect this level of tax benefits to be recorded in the foreseeable future.

Cash, comprised of cash, short-term investments, and restricted cash, ended the second quarter at $278 million, $2.6 million lower than Q1. The Company generated over $100,000 of cash from operations in the quarter, including a cash usage of $3.5 million from increases in current asset investments as a result of the increase in orders and revenues from the second quarter. This is the first quarter since Q4 of 2007, that the Company has generated positive cash flow from operations. The Company did not repurchase any of its common stock in the first half of 2012. Here are some other financial details. Our depreciation and amortization in the second quarter was $2.6 million. Our capital additions in Q2 were $2.1 million compared to $1.8 million in Q1. Our stock-based compensation for the second quarter was $3.5 million compared to $3 million in the first quarter.

With respect to Q3, we are experiencing a demand contraction across all market segments similar to that experienced by some of our customers, as a result of market uncertainty created by the global macroeconomic conditions, and the lack of a new demand driver for DRAM devices. As such, we expect third quarter revenues to be in the range of $38 million to $42 million. With respect to gross margin, the decreased revenues and unfavorable product mix will have a negative impact on fixed spending leverage and factory utilization, therefore, we expect our non-GAAP gross margin to be in the range of 11% to 17% for the third quarter. We expect Q3 non-GAAP operating expenses to be approximately $18.5 million to $19 million, a decrease from our Q2 expense of $1.7 million. With the reduced revenues and demand, we expect to recapture the net current asset investment made in Q2. Therefore, Q3 cash earned will be $5 million to $7 million, not including any stock repurchase activity.

Given the significance of the order decline in Q3 and the protracted nature of the macroeconomic environment, we believe it is prudent to reduce our current cash flow break even level. We expect our actions to reduce our break even level to $50 million by the end of the fourth quarter, compared to our current level of $54 million to $56 million, while preserving our ability to complete development and to commercialize new Matrix and SoC vertical technologies.

With that, lets open the call for Q&A. Operator?

Thank you.

(Operator Instructions)

Vernon Essi, of Needham and Company.

Yes. Thank you for taking my question. I say congratulations on what you can control and I am sorry to hear that you are having a tough guide here going into the third quarter. If you could just elaborate a little bit, Mike, about taking some cost reductions, and what areas you are targeting. It looks like you are also reducing your break even about $5 million on a cash basis, maybe a little bit more. What specific areas do you think you will be tackling? More on the cost side or OpEx?

I think we will be looking at several different areas. I think we'll be looking at manufacturing footprint. We'll be looking at our cost structure in general. We'd certainly be looking at payback on certain of our programs that we have out there, whether they are R&D programs, or marketing programs, or any other types of programs. Lastly, I think what we will also have to look at, is how we are compensated for the level of services that we're providing our customers as well. So, I think the actions will be pretty comprehensive across several, several areas.

Okay. And then, Tom, getting back to some comments you'd made out of SEMICON West about lead times. It sounds as though those were helpful and beneficial to your gross margin, as well as gaining some additional, perhaps, market share in the second quarter. Can you discuss the landscape of that, and how that's playing out relative to your competitors, and what your customers are saying or thinking about your ability to deliver on time? Thanks.

Well, I think that when we started on this 15, 16 months ago, we were at a competitive disadvantage with what our lead times were for first articles and for reorders. And as we've talked about over the last four or five quarters or so, we have been able to make steady progress in reducing those lead times. As you go through that, you eliminate, really, waste throughout your process in your supply chain and your own factory. That has contributed to the improvements in gross margin and overall product profitability that we've seen. And in a quarter like Q2, we came off essentially a $35 million revenue run rate coming out of Q1, and we did essentially $55 million in Q2. And that improvement in cycle time, it added some capacity, as you shrink your total cycle time through the factory, and it allowed us to respond to the opportunities that showed up in the quarter. What's striking is how abruptly things have changed in the last 6 weeks or 8 weeks here -- 6 weeks, I guess, that things have slowed down so rapidly, and now we'll have the challenge of also slowing rapidly.

Just as a sidebar, this is my last question, but your lead times have come down, and obviously the tone is not upbeat, if you will, in the overall semi industry. I'm just curious if your looking glass, if you will, is now more narrow, and your visibility is certainly shorter because of this? Your customers perhaps responding to that as well? Or do you feel very comfortable that if you went back, say, a year ago and the lead times were longer, you would be getting pretty much the same message from your customers?

I think if you went back a year, we would have been getting the same kind of messages. When we didn't have sufficient -- when our lead times were not sufficiently short, we just missed opportunities because we couldn't match up competitively on that, and I think at this point in time, we have a competitive set of lead times. I think that the entire electronics food chain has made great progress in reducing lead times. The uncertainty today is that there are product transitions going on, people talk about the fourth quarter being better for DRAM and for some of the new products coming out.

There is a number of product transitions going on with timing around new iPhones and other things, and I think that people are extremely cautious with the inventory positions they take, and distributors and IDMs alike are being really very careful about how they spend and invest. And then you listen and you see, Toshiba cuts back 30% of their production in Flash. There's information out that Elpida and Rexchip have been taking down their capacity. We have heard of other DRAM suppliers taking down their wafer starts. So, it's hard to say which way it's going to go with some of the things hit there in the fourth quarter, I think you could see demand snap back on it, but at this point in time we kind of see six weeks ahead.

Okay. Thank you very much.

James Cavello, of Goldman Sachs.

Hi. It's Mark Delaney calling for Jim Covello. Thanks very much for taking the question. I guess I was hoping you could talk a little bit longer term about the DDR4 revenue opportunity. When do you expect that transition to occur? What could it mean for sales? And what do you need do from an R&D perspective to prepare for that?

We've been supplying engineering cards for LPDDR3 as well as DDR4 now in 2012, and have -- we have customer designs in for both of those that would -- that support early production on that. Really, in terms of positioning the product and having the technologies in place for it, was an activity back in the 2011 time frame. So we are in good shape and in good position to support manufacturing on both of those technologies.

Okay. That's helpful. Thank you. And then as a follow-up question, I was wondering if you could talk about any impact you have seen, in terms of market share, from some of the reorganization that's going on in some of the larger DRAM customers, that has been publicly announced. Is it an opportunity for you to either increase share? Or do you see risk of share loss?

As we talked about, we think -- I'd say it's relatively neutral with the actions that are going on between Micron and Elpida there. I think if we look at Q2 compared to our competitors, we had pretty strong growth against the forecast and contraction on their part. Some of that comes from market share growth, some of it comes from customer mix also. So, hard to say on that. But the consolidation or integration that is expected to go on between Elpida and Micron, we believe, will -- should be good for FormFactor. We support both customers and have good working relationships with both of them, so we would expect to continue that.

All right. Great. Thanks very much.

C.J. Muse of Barclays.

This is Olga, calling in for C.J. Thanks for taking my question. Just wondering if you could provide us a bit more granularity for the revenue guide, regarding how the DRAM, Flash and SoC revenues will break out?

Yes. We think that DRAM certainly is going to be down relative to Q2, that's probably the biggest decline. No surprise given that 65% or 70% of our revenues is there. Flash probably will be somewhat lower, but as a percentage, will probably make up a higher mix with respect to Q2 revenues versus Q1 revenues. And then SoC, I believe, will be -- it may be flat, maybe slightly down, but generally it will be flat, to maybe slightly down. That's how we see the mix coming in Q2.

Got you. And I then guess on the SoC side, previously you had talked about a vision to some level of growth in the second half of the year. You had also discussed potential for market share gains with the vertical probe card. I am just wondering how much of that is, of the current, that is lower than anticipated ramp there, is driven by just caution at your customers versus longer than expected time to actually get the design wins? How should we think about that?

I'd say actually we've been pretty successful with our -- the current product line, which we think we have room to grow share in and grow the business in. We've had good luck in terms positioning those products, getting through some key qualifications, getting engaged in some key projects on it. The unfortunate part of it is, is that companies like TI and Renasas, Infineon, Freescale, others are really being very cautious. Many of them had talked about upcoming market and business improvements for the second half of the year, and I think that in most cases the second half of the year doesn't even appear flat with the first half or Q2, that in many cases they have guided down on revenue on it. So it's frustrating because we feel like we have gotten ourselves in a good position. But we have just run into a headwind there of conservative capacity planning, spending, et cetera. So we continue on with those. I think as those businesses recover we've got a much improved position there for the SoC business with our existing product line.

On the vertical probe card, that part of the market is certainly hotter, as it's serving a lot of the mobile application processors. So whether it's Apple processors, or Samsung processors, or Qualcomm processors, that part of the market, I think, is quite active today, still, and that is where we have our vertical technology targeted. And, as I said, we'll work to build the fully functional card, product-type card, for a customer this quarter to get their test and feedback on it. But as we've said all along, the incremental revenue that would come from it would be in Q4, and it would be relatively small for us, but important for positioning going into 2013 and 2014.

Thank you, and for a final sort of housekeeping question. What are you assuming for stock comp and the tax expense or benefit in the third quarter?

Stock compensation, I think you should think of it -- stock based compensation, pretty much what we saw in Q2, around $3.5 million. And the tax provision should be somewhere between $100,000 and $200,000 of expense, which is what we would typically run.

Thank you.

Patrick Ho, of Stifel Nicolaus.

Thank you. Tom, you mentioned some of the cut-backs on the DRAM side in terms of wafer starts. Can you provide a little bit of color, whether you are seeing any slowdowns in the conversion to both the 3X- and the 2X-node, or are some of the cuts that you are seeing, on the, I guess, the existing capacity? And I guess how is your competitive positioning in terms of those really leading edge nodes, the 3X and 2X?

We've got designs on 2X and on 3X. Customers have cards in, and are using them in a pilot manufacturing way. So I think our position on that is pretty strong. With regards to what the timing is around that, to some degree, I would say we saw some of this -- some similar behavior in the fourth quarter of last year. If you look at the fact that it certainly appears that at least two of the four major suppliers on DRAM today have made cutbacks. Most recently, some of the articles that came out around Elpida and Rexchip. When they're doing that, the existing technology nodes are the most mature. The yields on them are the highest and the most conservative thing to do is to continue to run that, versus trying to ramp a new technology node, where yields are often substantially lower and yet wafer start requirements go high. Additionally, there is a great deal of spending to put in place all of the infrastructure to test the new nodes, which of course includes probe cards.

So, what we have seen in the last couple of weeks is customers defer ramping some of the new technology, citing yield issues and whatever, and committing to continue with the existing, more mature products, where they've got all of the infrastructure in place, including probe cards, to run their production. I would say that the first article designs for the new technology nodes and such, those continue, but those are one card versus 10, 20, or 30 cards. I'd say the profile is to kind of pull back, be conservative, run the manufacturing that you know well, and continue to do technology development, but not be aggressive about ramping the new nodes.

Great, that's really helpful. With the improved lead times that you are seeing now and then your competitive -- I guess you're being more competitive now versus MJC, have you seen any response from them in terms of pricing and what that potential impact could be on gross margins?

Well, I'll tell you, MJC had an announcement of some substantial organizational cutbacks and substantial restructuring back in the June time frame. And if you look at it, I mean, obviously we've had our challenges and difficulties and we've made some progress. I think both FormFactor and MJC realize that we've got to focus on overall profitability. We have to make sure we're making investments in the right product areas, and we have got to make sure we've got business models, P&Ls, and everything that are healthy and profitable going forward.

So, as a result, I think that they're looking at the business more critically, perhaps more than just kind of all out market share, if you will. And so at this point in time we don't see any significant price collapse or anything like that. I think we've already gone through that. At this point in time we need to make sure that we're getting full value from our cards from customers, and I think they're trying to work through those things also.

And a final question, maybe for Mike, in terms of the working capital management. You have done a really good job with the inventory situation, particularly given how both orders and revenues have ramped. What can we look at, like inventories, maybe over the next quarter or so, given that you had strength in orders and how quickly you can turn that inventory into product?

We can turn it into product relatively quickly, so I'm not concerned about that. And I think in inventory management, it looks to me like it won't be really any different in the third quarter versus the second quarter. The one thing we are trying to manage is the fact that with the decline in orders that we don't get ourselves caught into a large E&O position. However, the nature of the business is we do have minimum order quantities and whatnot, so we will be somewhat susceptible. But certainly, Patrick, we are very much sensitive to that, and trying to keep incremental or unnecessary materials out of the Company. Therefore, we have a strong management program on that, but, once again, the decline in orders, we will be challenged in the third quarter.

All right. Thanks a lot, guys.

Terence Whalen, of Citigroup.

Yes. Thanks for taking the question. This one is on, sort of, the progression over the next couple of quarters to get to break even. What are some of the milestones there and the timing that we can expect as you break even? $5 million? And I believe you may have said this earlier, but I didn't catch it. What component of that will be through COGS reduction as it is to OpEx? Thanks.

Yes. So we haven't given any specific breakout between what will be COGS versus what will be OpEx. We are still working through what we think are the appropriate actions, and we're getting into that. And at this stage, I think you could probably see, -- so we're trying to reduce our cash flow break even by $5 million to $6 million, right? From $54 million to $56 million down to $50 million, so I would expect you would be able to see maybe a third to a half of that in the third quarter, and probably then, the remainder of that taking place in the fourth quarter, so that at the end of the fourth quarter we get to cash flow break even -- have the ability to get to cash flow break even at $50 million. So, that's sort of the progression, and at this stage we haven't worked out the specific targets for COGS versus OpEx.

Okay, terrific. And then, in terms of market share position, it sounds like you have two ongoing bake-offs. Were expectations that those were to close in the second quarter? Or the timing of those qualifications proceeding as you expected? In other words, are they being influenced one way or the other by the pullback in orders? Thanks.

Yes. On the next generation Matrix card there were chances in the second quarter in the June time frame to finish some of the work. But actually one of the cards was damaged, and the evaluation cards or qualification cards was damaged. It had to be rebuilt and shipped last month. And so there were some things that held us up there. On the vertical product side of it, I think we are pretty much going against the schedule that we talked about. If we get through some product level qualifications this quarter, that will transition us into really going after new designs and things like that in the follow-on quarter. So, we'll continue to drive on that.

Thanks. And then another follow-up question I had was, I understand it's not a major component of the business, but have you seen any change in behavior on the part of your NAND customers recently, based on improving NAND spots? Thanks.

Sorry. Say again. Our NAND customers on improving what?

Based on improving NAND prices recently.

Oh, no, haven't seen that. I haven't seen a signal, if you will. I mean, it fluctuates up and down. There have been a few orders recently that came through, but I can't correlate it to a flattening or improvement in NAND prices in the last few weeks.

Okay. Great. And then my final one is, what would your expectation be, in terms of mobile DRAM as the portion of mix of overall DRAM, in the third quarter?

I would expect it to be not terribly different than what we saw in the second quarter, and that's somewhere in the high 30%, with respect to overall percentage of DRAM.

Terrific. Thank you.

Tom Diffely, of D.A. Davidson.

Yes, good afternoon. First, Tom, I was hoping you could talk a little bit about the DRAM market. I'm kind of curious. When you see a little bit of a slowdown, how do you know if it's just lumpiness at few customers versus some seasonality or really kind of a secular slowdown or a typical slowdown, if you will?

Well, I don't know how much specific visibility we get. There is not too many customers in the market that are as large as Apple. And when Apple has taken some capacity from people, it gets reported in the industry trade news and things like that, and we can kind of line that up and say, boy, there was a big order there, and geez, we can see the impact to demand for us. And I think some of that was certainly what unfolded in Q2 and surprised us on the upside by the strength, if you will.

The rest of it, we're following -- you know, following along through the market. When the prices drop, the further they drop the more conservative the customers get. If prices continue to fall and they go below the cash manufacturing levels, then we could see things slow even further. But I'm afraid we're watching the bulk of the DRAM market as it responds to electronic manufacturing and overall DRAM, I'm afraid. Don't have much more than that.

So this business is becoming less seasonal and more based on pure product cycles?

Well, certainly that's the indicator right now with, I think, some of the Apple products. It is much more -- it is much more influenced by the big products coming out. You know, things like Samsung Galaxy, Apple products, be it iPad or iPhone. These obviously put a significant demand on the overall supply chain. You look at what happened with Cirrus Logic recently, and their orders and demand have gone up dramatically, I think is a function of basically, one product. I would say it's product cycles more than -- dominated more now by product cycles than just the seasonality.

Okay. Not, just to move away from the PC centric world to the mobile consumer world?

That's certainly had a big impact, and it has shifted around demand for mobile DRAM and mobile compatible circuits and support for that versus some of the more standard or commodity parts. And that causes some challenges for the customers also.

Yes. Okay. And then, Mike, you talked about OpEx going down $18 million to $19 million. It sounds like from your comments, that you expect it to come down further then in the fourth quarter as you get the other half of your cost reduction program?

That's correct. That's correct.

And do you give out the order numbers any more? Or do you provide quarter number guidance?

No, we have never -- we haven't provided guidance on orders in a long time. I don't know when we did.

Okay. So your comment was that it just -- you saw orders slow down in the first part of the third quarter then?

Sorry. Say again.

You had a comment earlier about orders slowing down over the last six to eight weeks then?

Sorry. Yes, yes. Just -- we had good strong flow as we went through the second quarter, and the last week or so, maybe the second quarter, things slowed down, and then it's just continued to slow down since we have gone through July.

And then a final question. On the SoC side, you talked about it being kind of soft in the quarter, soft in the third quarter as well. What do you expect to drive that going forward?

I think if you see some strength come back into the businesses at the bigger -- the bigger microcontroller companies like, Freescale or Renasas, TI, Infineon, those are areas where we focused on some of our products. They fit very well with their needs, and we've had success with regards to design wins and qualifications and things like that, but currently they are fighting some headwinds in their business, and expectations for the second half seem to have come down. In many cases, guiding down, and certainly guiding below what people thought they were going to do. So, business, it carries on, but it doesn't have all the strength in it that it could have, I think, if they were in a little bit more normal environment.

Okay. Great. Thank you.

Ladies and gentlemen, this does conclude the FormFactor second quarter conference call. Thank you for your participation.