FormFactor, Inc. (NASDAQ:FORM) Q3 2023 Earnings Call Transcript

FormFactor, Inc. (NASDAQ:FORM) Q3 2023 Earnings Call Transcript November 1, 2023

Operator: Thank you. And welcome everyone to FormFactor’s Third Quarter 2023 Earnings Conference Call. On today’s call are Chief Executive Officer, Mike Slessor; and Chief Financial Officer, Shai Shahar. Before we begin, Stan Finkelstein, the company’s VP of Investor Relations, will remind you of some important information.

Stan Finkelstein: Thank you. Today, the company will be discussing GAAP P&L results and some important non-GAAP results intended to supplement your understanding of the company’s financials. Reconciliations of GAAP to non-GAAP measures and other financial information are available in the press release issued today by the company and on the Investor Relations section of our Web site. Today’s discussion contains forward-looking statements within the meaning of the Federal Securities Laws. Examples of such forward-looking statements include those with respect to projections of financial and business performance, future macroeconomic and geopolitical conditions; the benefits of acquisitions and investments in capacity and in new technologies; the impact of global, regional, and national health crisis including the COVID-19 pandemic; anticipated industry trends; potential disruptions in our supply chain; the impact of regulatory changes including the recent US-China trade restrictions; the anticipated demand for products; our ability to develop, produce, and sell products and the assumptions upon which such statements are based.

A technician looking at a circuit board of analog semiconductor products.

These statements are subject to known and unknown risks and uncertainties and could cause actual results to differ materially from those expressed during this call. Information on risk factors and uncertainties is contained in our most recent filing on Form 10-K with the SEC for the fiscal year ended December 31, 2022 and in our other SEC filings, which are available on the SEC’s Web site at www.sec.gov and in our press release issued today. Forward-looking statements are made as of today November 1, 2023, and we assume no obligations to update them. With that, we will now turn the call over to FormFactor’s CEO, Mike Slessor.

Mike Slessor: Thanks everyone for joining us for FormFactor's third quarter earnings call. Stronger than anticipated demand for Foundry and Logic probe cards, coupled with record revenue in our systems business, produced third quarter revenue near the high end of our outlook range. This, together with higher than expected gross margin and leverage on our operating expenses, produce non-GAAP earnings per share above the top end of our outlook range. We continue to operate in an overall demand environment that remains relatively stable at the levels we've experienced throughout 2023. The moderate sequential decrease in our fourth quarter revenue outlook range is due to the reduction in system segment revenue from the sale of FRT to Camtek, which we completed today and weaker foundry and logic probe card demand due to a short term reduction in customer spending, partially offset by stronger DRAM probe card demand.

While we continue to operate in a cyclical downturn and see no near term acceleration of demand, we're encouraged by broader signs of bottoming in our most important high unit volume end markets like client PC and mobile. In this environment, we continue to carefully balance short term results and long term investments with disciplined cost control that prioritizes quarterly profitability and sustains our strong balance sheet. We're maintaining our investment in R&D for new product innovation and competitive differentiation, especially in our product roadmap for advanced packaging applications like chiplets and tiles, high bandwidth memory and co- packaged optics. As you'll hear from Shai, we've completed the majority of the long lead time facilities and equipment capacity increases required to reach our target financial model and have slowed our CapEx to ensure a better balance between our capacity and anticipated long term demand.

Turning now to segment level details. Foundry and logic probe cards, our largest business, delivered higher than expected sequential growth in the third quarter as key customers ramped several major designs more aggressively than originally forecast. This inter-quarter acceleration provides insight into FormFactor's demand profile. Because probe cards are a device specific consumable customized for each individual chip design, increased wafer starts for a specific chip design can drive incremental demand for the corresponding probe cards. Since our lead times are less than a quarter and demand is correlated to the specific mix of customers dynamic wafer start plans for their new chip designs, we can experience inter-quarter changes in demand as we did in the third quarter.

In the foundry space, we experienced strong third quarter demand for probe cards testing two major high performance compute designs. In these HPC applications, FormFactor’s differentiated vertical MIMS probe card products meet demanding power and speed requirements with best in class, test sell, uptime and productivity, delivering significant value to our customers. We do expect a smaller contribution from foundry probe cards in the current quarter as our strong third quarter shipments are utilized to ramp fourth quarter foundry wafer production volume. In the microprocessor space, we delivered on higher demand for probe cards testing a major tile based client PC design. Like the high performance compute foundry example I just shared, probe card demand for this design accelerated within the third quarter as our customer expanded their wafer start plans to meet increased end customer demand.

This client PC microprocessor is assembled from multiple tiles or chiplets into a single die using leading edge advanced packaging processes. This is a great example of how advanced packaging is driving FormFactor’s business. As we've noted in the past, advanced packaging integration schemes drive both higher test intensity, which expands the number of probe cards required per good die out and higher test complexity, which raises the performance for each probe card. Probe card architectures like FormFactor’s MEMS technology are essential to meeting these challenging performance requirements on short lead times at a compelling cost of ownership. In memory as expected, we experienced stable overall demand for DRAM probe cards while flash remained weak.

As in the second quarter, DRAM was driven by DDR 5 as well as third generation high bandwidth memory designs, which are enabling the rapid growth in generative artificial intelligence and we expect a similar HBM rich DRAM revenue profile in the current fourth quarter. The positive impact of high bandwidth memory is evident in the product mix profile at one of our largest DRAM customers where probe cards for testing HBM comprise more than half our revenue to that customer in the third quarter. As in the tile based microprocessor example I discussed earlier, the need for sophisticated probe cards to test HBM illustrates how advanced packaging is driving FormFactor’s results. As a reminder, each HBM chip is a stack of 8, 12, or even 16 individual DRAM die assembled with advanced packaging processes, such as through silicon vias and hybrid bonding.

To ensure high yields of the stack DRAM chip, customers probe and test each component DRAM die prior to stacking and probe and test the multi die DRAM stack at various points during the assembly process, leading to a substantial increase in the overall probe card intensity for good die out. In addition, the technical requirements for HBM tests are significantly more advanced than for standard unstacked DRAM products, involving higher test feeds and more challenging thermal scaling specifications. FormFactor's MEMS based SmartMatrix probe card architecture meets these advanced requirements, providing significant value to our customers and differentiation for FormFactor. We believe our superior performance capabilities will drive both market share and profitability gains as HBM continues to grow, driven by the accelerating adoption of generative AI.

Shifting now to systems. As anticipated, our systems business delivered record revenue in the third quarter as we shipped systems that were pushed out of the second quarter. This business continues to be driven by strong demand for our market leading test and measurement products for early development of applications like copackaged silicon photonics, quantum computing, and advanced packaging metrology. Copackaged optics enabled by silicon photonics remains an important and exciting driver for FormFactor's current and future business. We're engaged with major customers in the transition of silicon photonics from early R&D to low volume production. And in the fourth quarter, we plan to ship a CM300 silicon photonics system to a leading foundry to support low volume production.

As silicon photonics production volumes increase over the next several years, our product roadmap delivers both systems and consumable probe cards to test these electro optical devices and improve yields, enabling our customers to seamlessly transition from the lab to the fab. Moving forward, we do expect a short and medium term reduction in system segment revenues from the third quarter's record levels due to the sale of our FRT metrology business. We grew FRT substantially following our 2019 acquisition of the business, and I want to thank all of the FormFactor team worldwide for the contributions to this growth and value creation. Operationally, the transaction enables the FRT team to leverage Camtek's established scale and expertise in inspection in metrology to deliver the next stage of growth.

Financially, the transaction maximizes FormFactor shareholder value by realizing a robust return on our investment, while also allowing us to focus our resources on strategic initiatives and businesses where we have market leadership and significant scale in enabling advanced packaging like the tile based microprocessor and copackaged optics examples I shared earlier. Shai will update you with more details later, but our capital allocation priorities of focused reinvestment in R&D and capacity together with M&A and share repurchases to offset dilution are unchanged. M&A remains one of the primary pillars of FormFactor's growth, and we continue to evaluate a broad funnel of targets that add complementary technologies and expand our served addressable markets.

In closing, we continue to operate efficiently in what we see as a relatively stable near term demand environment across our diversified product and technology portfolio. Longer term, we remain excited and confident in the growth prospects for FormFactor and the industry overall, driven by the fundamental trends of semiconductor content growth and exciting innovations like chiplets, high bandwidth memory and copackaged silicon photonics. These are trends where FormFactor is well positioned as an industry and technology leader, and we're confident that our investments in R&D and capacity position FormFactor to emerge from the current cyclical downturn a stronger and leaner competitor, enabling us to achieve our target model that delivers $2 of non-GAAP earnings per share on $850 million of revenue.

Shai, over to you.

Shai Shahar: Thank you, Mike, and good afternoon. As you saw in our press release and as Mike mentioned, Q3 revenues were near the high end of our outlook range and non-GAAP gross margin and non-GAAP EPS were above the high end of the range. Third quarter revenues were $171.6 million, a 10% sequential increase and a year-over-year decrease of 5.1%. Q3 revenues were $0.4 million below the high end of our outlook range and benefited from strong revenues in both probe cards and system segment revenue. Probe card segment revenues were $128.3 million in the third quarter, an increase of $13 million or 11.3% from Q2. The increase was driven by higher foundry and logic and flash revenues, partially offset by a decrease in DRAM revenues.

System segment revenues were a record $43.2 million in Q3, a $2.6 million increase from the second quarter and comprised 25.2% of total company revenues, down slightly from 26% in Q2. Within the probe card segment, Q3 foundry and logic revenues were $96.4 million, a 17.7% increase from Q2. Foundry and logic revenues increased to 56.2% of total company revenues compared to 52.5% in the second quarter. DRAM revenues were $27.4 million in Q3, a $3.1 million decrease or 10.2% lower than in the second quarter and decreased to 16% of total quarterly revenues as compared to 19.6% in the second quarter. Flash revenues of $4.5 million in Q3 were $1.6 million higher than in the second quarter and were 2.6% of total revenues in Q3 as compared to 1.9% in Q2.

GAAP gross margin for the third quarter was 40.4% as compared to 38.7% in Q2. Cost of revenues included $2.5 million of GAAP to non-GAAP reconciling items, which we outlined in our press release issue today and in a reconciliation table available in the investor relations section of our Web site. On a non-GAAP basis, gross margin for the third quarter was 41.8%, 1.2 percentage points higher than the 40.6% of non-GAAP gross margin in Q2 and 0.3 percentage points above the high end of our outlook range. The increase as compared to Q2 and the upside versus our outlook range were a result of higher probe card segment gross margin. Our probe card segment gross margin was 38.5% in the third quarter, an increase of 2 percentage points compared to 36.5% in Q2.

The increase from Q2 is due to the net effect of three main factors. First, higher revenues contributed at 2.1 percentage points increase. Second, improved factory utilization at higher production levels contributed to a 0.3 percentage points increase. Partially offsetting these two positive factors was 0.3 percentage points related to a slightly less favorable product mix. Our Q3 system segment gross margin was 51.8%, basically flat with a 52% gross margin in the second quarter. Our GAAP operating expenses were $66.6 million for the third quarter as compared to $61.6 million in the second quarter. The two main reasons for the increase were $1.8 million higher stock based compensation related to timing of grants and a higher grant date share value and transaction expenses of $2.1 million related to the sale of the FRT business.

As previously disclosed, we entered into a definitive agreement during the quarter to sell FRT to Camtek for $100 million in cash, subject to customer repurchase price adjustments. The transaction closed today and the outlook and the results of operations for Q4 will include FRT for the month of October. Net proceeds from the transaction after adjustments, expenses and taxes, are expected to be approximately $95 million. Non-GAAP operating expenses for the third quarter were $54.5 million as compared with $52.1 million in Q2, declining to 31.8% of revenues from 33.4% in the prior quarter. The $2.4 million increase relates mainly to higher performance based compensation. Company noncash expenses for the third quarter included $10.8 million for stock based compensation, $1.6 million higher than in the second quarter, as I said earlier, $1.3 million for the amortization of acquisition related intangibles, which was $1.1 million lower than in Q2 due to certain intangible assets reaching full amortization, and depreciation of $7.8 million similar to the second quarter.

GAAP operating income was $2.7 million for Q3 compared with GAAP operating loss of $1.3 million in Q2. Non-GAAP operating income for the third quarter was $17.3 million compared with $11.2 million in the second quarter, an increase of $6.1 million or 55%. GAAP net income for the third quarter was $4.4 million or $0.06 per fully diluted share compared with a GAAP net income of $0.8 million or $0.01 per fully diluted share in the previous quarter. The non-GAAP effective tax rate for the third quarter was 12.2%, 200 basis points lower than the 14.2% in the second quarter, mainly due to discrete items arising from normal differences between estimated and actual US taxes. We continue to expect our annual non-GAAP effective tax rate to be between 13% and 17%.

Third quarter non-GAAP net income was $17.3 million or $0.22 per fully diluted share compared to $11.2 million or $0.14 per fully diluted share in Q2. Moving to the balance sheet and cash flows. We generated free cash flow of $16.9 million in the third quarter compared to $2.1 million in Q2. The main reason for the increase in free cash flow was a decrease of $14.6 million in capital expenditures. We invested $5.9 million in capital expenditures during the third quarter compared to $20.5 million in Q2. The decrease in CapEx in Q3 is partially due to timing of payments but it is also aligned with our intent to slow down capacity expansions to ensure capacity does not significantly outpace demand as we have completed the majority of the long lead time facilities and equipment investments required to reach our target financial model.

There's no change in our previously communicated expected CapEx range for 2023 of $55 million to $65 million. Overall, at quarter end, total cash and investments were $249.4 million, an increase of $9 million from Q2. As of the end of the third quarter, we had one term loan outstanding with a balance of $15 million. Regarding stock buyback during the third quarter, we did not purchase shares under our $75 million two year buyback program approved in Q2 2022. On October 30, our Board of Directors approved a new two year $75 million share repurchase program, which is in addition to the $18.6 million that remains available under the existing authorization. As a reminder, the main purpose of these share repurchase programs is to offset dilution from stock based compensation.

Turning to the fourth quarter non-GAAP outlook. We expect Q4 revenues of $165 million plus or minus $5 million. At the midpoint of this outlook range, Q4 revenues is expected to be approximately $7 million lower than in Q3 with half of the decrease related to the sale of FRT metrology business at the end of October. We also expect lower foundry and logic revenues in the fourth quarter, partially offset by an increase in DRAM revenues. Fourth quarter non-GAAP gross margin is expected to be 41% plus or minus 150 basis points. At the midpoint of these outlook ranges, we expect Q4 operating expenses to be $51 million plus or minus $1 million. Non-GAAP earnings per fully diluted share for Q4 is expected to be $0.20 plus or minus $0.04. A reconciliation of our GAAP to non-GAAP Q4 outlook is available on the investor relations section of our Web site and in our press release issued today.

With that, let's open the call for questions. Operator?

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