FormFactor, Inc. (FORM) Q3 2010 Earnings Report, Transcript and Summary

Welcome, everyone to FormFactor’s third quarter fiscal 2010 earnings conference call. On today’s call are Carl Everett, Executive Chairman of the Board of Directors; Chief Executive Officer, Thomas St. Dennis; and Chief Financial Officer, Richard DeLateur. Before we begin, let me remind you that the company will be discussing GAAP P&L results and some key non-GAAP result supplement to understand the company’s financials. A schedule that provides GAAP to non-GAAP reconciliation 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 and that FormFactor’s actual result 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 factors discussed in the company’s form 10-K from 2009 fiscal year as filed to SEC, subsequent forms 10-Q, SEC filings and the press release issued today. With that, we will now turn the call over to the CEO, Thomas St. Dennis.

Thank you and good afternoon. My first six weeks at FormFactor had been focused on getting up to speed in our products, our organization and our customers. And I’d like to share with you some of the early impressions from this activity. I spend over a third of my time in the field with our customers and our field organization and it is clear to me from the conversations that I have had from our customers that they have a deed respect for the products and technologies the FormFactor has created over the past 17 years. They continue to see form factor as a leader in advanced probe card technology. They are counting on us to deliver the enabling test technologies that they will need to go to the 3x nanometer and the 2x nanometer technology nodes. We also see our field support organization as a benchmark in the industry. What we have fallen short is in our operational execution related to deliveries and lead time, which has been a continuous to be a focus area for FormFactor as we continue to turn the company’s performance around. Overall, I have been very impressed by the people and the products of FormFactor, and I am extremely encouraged by the commitment of our customers to a strong realationship – to a continued strong relationship with us. The key objective of my joining FormFactor was to ensure a seamless transition with Carl Everett to sustain the focus and momentum that the company has developed. I believe that we are meeting that objective and driving ahead on the key areas. Taking care of our core business is our first priority and that is where our initiatives are focused. Driving the critical product capabilities that our customers need, improving our operational executions, reducing our cost to produce and deliver our products and reducing our operating expenses defines our daily agenda. We have identified the programs that we must execute on and align the resources of the company to focus on driving those programs. I believe that we got the right people and the resources necessary to successfully deliver the required results. As we communicated on previous calls, the next two quarters will be challenging as we make the changes necessary to have a strong operational and financial foundation for FormFactor’s future. While there is significant work to do, there are several important indicators of recent progress. We recently completed the qualification of the Matrix platform at another major memory manufacturer and received a multiple unit order from them. We now have the Matrix platform, qualified at four out of the top five 5 MEM manufacturers with the fifth one well under way for qualification. Recently, delinquencies, hand-on-time delivery have both improved. Operating expenses and cash flow are both trending in the right direction. And while most of these have not reached their targets, their trends show that the actions we have taken are having a positive impact. We will remain focused on these until FormFactor regains its operational and financial health. With that I’ll turn the call over to Rich for details on the financials.

Thank you Tom, I will begin with a summary of our third quarter results. Total revenue was $47.3 million, down 18% sequentially and up 8% on a year-over-year basis. Total revenue included 1.6 million from a decrease in deferred revenue. Revenue decline came primarily from the DRAM sector of the business. The details as follows: Third quarter revenue for DRAM products was $30.1 million, down 29% from our second quarter and down 17% versus the third quarter a year ago. Flash revenue was $9 million, up 7% from Q2 and (330%) versus the third quarter a year ago. NAND growth was considerably stronger with NOR revenue declining, NAND revenue was $6 million. SoC revenue was 8.3 million in the third quarter, up 21% sequentially and 57% versus the third quarter a year ago. Revenue from our new product architecture, SmartMatrix and TouchMatrix was $12.7 million. Our matrix products grew as a percentage of revenue from 21% in the second quarter to 27% in the third quarter. We did however fall short of our goal to grow Matrix units 30% quarter over quarter. All unit shipments did grow 20%. There was s large shift from SmartMatrix for DRAM towards the TouchMatrix for Flash, which results in lower (inaudible) versus the second quarter, explaining the muted revenue growth. This large mix change form DRAM into Flash had a negative impact on gross margins as well. Without regard to mix change, the unit prices rose on almost all product lines. Moving down the income statement, second quarter GAAP gross margin was a negative $7.2 million or a minus 15% of revenue. On a non-GAAP basis, gross margin from third quarter was negative 6.3 million. This non-GAAP gross margin of negative 13% compared to a previously reported non-GAAP margin of 7% in Q2 resulting in 20 point or 10.2 million of margin decline. Adverse mix changes and the lower absorption of fixed spending due to reduced revenue levels should result in near zero margins. An additional 13 point decline as a result of our prior period account adjustments of $4.1 million and increase inventory reserves. The prior period account adjustment resulted from incorrect calculations regarding the capitalization of manufacturing branches to be inventoried for 2009 and the first half of 2010. Other than mixed (inaudible) and inventory adjustments, fixed spending was slightly down from Q2 and material spending declined consistent with lower revenue. Our GAAP operating expenses was 93 million, includes $52 million write-down of long lead assets resulting from an enterprise wide impairment. I will not go into the details on the (inaudible) at this time but I am confident that this will be a one-time events and has no impact on the cash generating capabilities of the company or our turn-around program Going forward this impairment will result in the reduction of depreciation of slightly under $4 million per quarter. 2.5 million of this reduction will impact across the (goods sold). In addition to the enterprise wide impairment we had 8.5 million of restructuring charges associated with changing factory roadmap and (8.4) million of the impairments unrelated to the change in factory strategy. Non-GAAP operating expenses were $25.7 million down 6.1 million from 31.8 million in Q2. This is 1 million better than I anticipated, $5 million decline from standard reduction programs. We also consolidating our Livermore operations into four buildings and to continue to review all aspects of our operation’s spending. You should expect some further restructuring charges in the future but not at Q3 level. Cash, comprised of cash on short term investments and recorded at 372 million approximately 26 million lower than the previous quarter a lowered cash (inaudible) was driven by higher collections on lower capital spending. Though 26 million is better than our expectation, it was still an unacceptable large number and our goal remains to get into the single digit cash run as soon as possible. Here are some other financial details. Our depreciation and amortization in the second quarter was $7.8 million. Our capital spending was $6.3 million and our tax rate was 0.2% for the third quarter. Before I get into Q4, I want to address some commentaries around breakeven. We are still structuring the company to be non-debt break-even at the 65 million revenue level about midyear 2011. Not counting any benefit from in the depreciation of the enterprise loan impairment (inaudible) were not forecast the 65 million revenue for Q2 which is to set a benchmark for filing purposes. In addition to this call, we are committed to achieving cash flow breakeven up the 50 million revenue level by midyear. For Q4, there are a number of trends that I can speak to. We expect Q4 revenues within the range of $40 to $45 million. Margin degradation caused by high Flash product mix of Q3 should reverse. The improved mix should result in margin of 5 to 10% depending on revenue levels. Six margin points should be added to these numbers so the impact of the reduced depreciation from the enterprise wide impairment. To be clear, reported non-GAAP gross margin will in 11 to 16% range. With regards to our change of factory strategy, the impact will not improve margin in Q4 as personnel and equipment will be transitioned out of Singapore throughout Q4. Longer terms, we expect to realize the 2 to 2.5 million per quarter in savings. We expect to continued improvement with non-GAAP operating expenses. It should drop about 10% each quarter to totally achieve our under $20 million goal for Q2 2011. Q4 cash trend will be at or below Q3. One final note, as described in our earnings release, we are authorized repurchase of up to $50 million of common stock over the next 12 months. Please note that I will not commenting on how much or when the purchase may or may not take place. We will report any action retrospectally at the end of each quarter. With that let us have some calls for questions and answers. Operator.

Thank you. (Operator Instructions) Our first question comes from Gary Hsueh, Oppenheimer. Gary, your line is open. I am muting your phone. And our next question comes from the line of Jim Covello with Goldman Sachs.

Hi, this is Kate Kotlarsky for Jim Covello, thank you for taking the question. I’m clipping – to ask Tom a big picture question and just ask how – when you think about all of these initiatives that the company has over the next twelve to 18 months how to you rate all of these things that you are hoping to accomplish?

I think that our execution really on an operational side of things is a first priority for us, next step are to continue down our product and technology road map. I think it is quite strong and is well targeted in market needs but we need to execute well on that. I think those 2 things will have a huge impact on the overall performance for FormFactor.

Okay and just also I wanted to follow up and ask you. One of the issues the company has had in the past is that trying to do some of this restructuring initiative but also making sure that the R&D spending continues on track and that you guys continue to innovate and meet customer requirements given the specialized nature of the product. How do you sort of balance that going forward and ensure that you are you know cutting cost on one hand but not on the same time making sure that the product does not suffer and your qualification do not suffer?

One of the things that we focused on is identifying the core technologies that we need to ensure that our competitiveness and market decision – those were well-identified throughout the summer and our – the programs that we are driving ahead. With regards to managing down the OpEx maybe Rich can comment.

So our goal to get operating expenses below – 20 million. We think that is achievable, by no means is it easy but when we are at that level, fully half of that budget will be dedicated to R&D. And that R&D is highly focused. So I think you can do your own calculations, see that is a pretty robust R&D program and in no way endangers the company’s future.

How can you think – Just one final question, the qualification of Matrix that you have mentioned half in this quarter of the major memory customer, How should we thing about revenues from that? When should we start to see that?

As I said, there is top five memory customers, getting your qualifications dominate each one of them is obviously vital. I don’t know if it is quite – one step than each one but they are all very important. With that qualification done we can to bid now on new designs and ramp our way back up into their volume supplier there. But it is a transition over the next couple of quarters until we can get all of our designs laid down on it.

Okay, thank you so much.

Thank you.

Our next question comes from Tim Arcuri with Citigroup.

Hi, this is (inaudible) for Tim Arcuri. A couple of questions. First of all, if I put your monthly share outside and just look at your general demand for year-end market. Based on your recent discussion with customers what is the (Inaudible) demand in line of DRAM price decrease in a (inaudible)?

Well, we certainly did a lot of reading about changes in the year end market and it is clear that their prices are declining. Speaking of customers, they are really adjusting and aligning their production to take advantage of the market that are still strong, so we see movement between commodity DRAM, mobile DRAM and other applications that way. I think there are concerned but people are still watching to really see how everything is going to unfold.

Specifically for FormFactor you have not paid off that demand.

We have seen – I think some realignment to specific application need – as I said between mobile and commodity DRAM and those changes are a little bit more rapid than they have been in the past but we are still watching closely to kind of see how this all unfolds.

Okay, the product. In terms of major product – I think last quarter the biggest problem for (inaudible) is the qualification time last longer than you expected in outrunning for product is longer – what progress have you made in this quarter in terms of qualification and detail?

As I mentioned we made a – we completed the qualification at another – one of the top five memory manufacturers and we did see multiple unit orders following that. That it is another important milestone for us to strengthen the product offering out there with regards to lead time we keep – we are focused on that. We have been making incremental improvements on lead time – on time delivery has improved over the last month and we are focused at creating a competitive advantage out of all of this, but again it is going to take us couple quarter to get that until we work out.

Okay. When I looked at your revenue distribution prior to your graphical region is – is the revenue for Japan is very well quite apparently in Q3. Is this more of a timing issue for your customer or it is (inaudible) market share?

Some of it is timing and some of that is market share. Particularly in Japan there was probably a bigger impact in Q3 from market share than timing but it is a mix of both.

Okay. Last question based on your guidance 40 to 45 million next quarter. What do you expect your cash bank for the quarter? You said you will try to achieve single digit cash run. Can you achieve that for the next quarter?

We could not achieve a single digit cash run with revenue level in the 40 to $45 million range. So I would expect to be 25 million high-low – but not maturely lower.

Okay.

Our next question comes from the line of C.J. Muse with Barclays Capital

Hi this is (Sweeney) calling for C.J. Muse. I just wanted to – probably this particular question. Just wanted to go the cash burn profile and the total cash bond that you are play for calendar year 2011?

Hi this is (Sweeney) calling for C.J. Muse. I just wanted to – probably this particular question. Just wanted to go the cash burn profile and the total cash bond that you are play for calendar year 2011?

You actually wanted the total cash burn for 2011?

Yes.

Yes.

So we have not done a forecast. Our goal is to achieve that single digit or zero cash burn by Q2 2011 midyear and then we expect to have zero cash burn at a positive cash creation from then on. You can pretty much draw a straight line from the 25 million in Q4 to zero or single digit number in Q2 to figure out how however we get there.

Okay. For the next question –

Okay. For the next question –

My goal is to keep the 2011 cash burn to under $50 million but it is highly dependent on revenue.

Great. The next question is: By this quarter do you think 90% of what is going out of the Matrix?

Great. The next question is: By this quarter do you think 90% of what is going out of the Matrix?

Say it again.

By this quarter would 90% of the product that are going out would be Matrix or Harmony or any of the little situation?

By this quarter would 90% of the product that are going out would be Matrix or Harmony or any of the little situation?

I do want to clarify that – FormFactor still does quite of bit of a business making investor happy with the business and what is called traditional (inaudible) business. Would never have Matrix imagine (inaudible). That is a good business and we are trying to maintain as long as possible.

Thank you.

Thank you.

Our next question comes from Patrick Ho with Stifel Nicolaus.

Thanks a lot and good luck Tom on road going forward.

Thanks Patrick

First of all in terms of the pricing scheme and what are you trying to get from customers and your relationships there – Tom you have been in the industry a long time. These are familiar customers for you. How do you extract the value from Matrix from these customers given that a lot of them have experience the way and way and lead time issues in the past? How do you get the full value back from them over the next several quarters?

It is a combination of things really. First is our well execution getting lead times down and stable is a key factor. As I mentioned we have strong product in technology road map that is rolling out and I think each of these bring real value and differentiation for FormFactor, real value to our customers and real productivity games and all that. I think that there is going to be opportunity for us to get paid for the value that we bring while we are delivering to them a lower total cost of test. I think that the roadmap is going to allow us to bring substantial value forward of the next 4-5 quarters.

Okay. Great maybe related to that and which maybe you could give a little bit color on this: As your ramping up matrix and as that volume and percentage increases over time. How much is over the next few quarters on a little bit of mix of ramping down of some of your older products and ramping up Matrix where we would not see the revenue grow up for couple of quarter? How much of it is I guess the leverage moving?

All product Harmony did turn down a little bit in Q3, but not enough to help the margin out and we will shift about the same amount in Q4. So even though we are in the blight with Harmony and ramping Matrix as fast as possible you should accept that substantial tail on the Harmony product. The customer need product, we are going pull over it, right?

Great. Final question for me – in terms some of the operational improvements that you guys have discussed. What are some of the – I guess specific initiatives and what are those specific gains that you would make in terms of improving delivery times to customer? What are the exact – I guess tangible things that we can go out and tell investors?

There is number of elements to delivery that start all the way from the design phase through manufacturing and including our supply chain contributions to that and as well as our assembly in depth and we broken down that to a very granular over-all process and we have been working to eliminate delays and gaps if you will and in that process. But we had also been working with suppliers to find ways to help them recycle time and collapse things there. It is going to take time for us to continue to work our way through that but already we have seen improvements on supplier lead times that are – have come down. They are also on time – delivery or delinquencies have improved. Some of that is come for us putting people at the suppliers and working with them directly also working with them to clarify processes and things that make it simple for them. It is a very detailed and focused plan about how we can impact overall lead time and performance there. Similarly on the cost side I think it has been mentioned in prior calls. One of the things that Carl kicked off early on was a really in depth analysis around the total cost side of the equation for us on the matrix product line. We are few months into that now and still working diligently on that and finding opportunity to continue to improve not just cost but quality and often with impact on improved lead time so this is just the nut and bolts of execution and as you work your way down through it you really build momentum on it and I think that is the kind of phase where am I right now.

Great. Thank you

Ladies and gentlemen this concludes the FormFactor Quarter conference call. Thank you for your participation. You may now disconnect.