FormFactor, Inc. (NASDAQ:FORM) Q4 2023 Earnings Call Transcript

FormFactor, Inc. (NASDAQ:FORM) Q4 2023 Earnings Call Transcript February 7, 2024

FormFactor, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Thank you. And welcome everyone to FormFactor’s Fourth 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 website. 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.

These statements are subject to known and unknown risks and uncertainties that 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 website at www.sec.gov and in our press release issued today. Forward-looking statements are made as of today February 7, 2024, 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 fourth quarter earnings call. FormFactor’s fourth quarter results were in line with the outlook we provided last November. Compared to that outlook, moderately higher revenue and gross margins were offset by a higher tax rate, producing non-GAAP EPS at the midpoint of the range. As we enter 2024, we continue to operate in an overall demand environment that remains similar to the levels we experienced during the past year, and we expect first quarter results to be similar to those achieved in recent quarters. The relatively stable aggregate demand across our combined served markets is a benefit of FormFactor’s diversification strategy and sets us apart from our direct competitors.

FormFactor has a broad lab-to-fab product portfolio across foundry and logic, DRAM and Flash probe cards, together with our system segment products. This unique portfolio enables us to compete for business across diverse demand pools at all major customers, producing relatively consistent top line results as we’ve demonstrated for the past four quarters and which we expect again in the current quarter. Customer investments in growing area is driven by generative AI, like high-bandwidth memory and co-packaged silicon photonics is helping offset the impact of areas that are presently at cyclically low levels, like mobile handsets and PCs and those entering cyclical downturns like automotive and industrial. The stability also enables FormFactor to keep investing in R&D for new product innovation and competitive differentiation, especially in our product road map for advanced packaging applications like chiplets and tiles, high-bandwidth memory and co-packaged optics.

It also enables us to invest in capacity and other strategic initiatives designed to produce market share gains and above industry revenue and profit growth when the industry returns to growth, which will enable FormFactor to achieve and then surpass the levels of our current target financial model. Because of the strength and stability of our balanced product portfolio, we can make these investments while maximizing quarterly profitability and protecting our strong balance sheet throughout prolonged periods of industry softness. Turning now to segment level details. DRAM probe cards are an area of current strength, and we expect first quarter DRAM revenue to approach the peak levels experienced in 2021. DRAM strength is being driven by two factors.

First, and perhaps surprisingly, we’re experiencing strong demand generated by new DDR5 DRAM designs as customers prepare for high-volume production when the eventual DRAM upturn arrives. This provides insight into the unique characteristics of probe card demand. Since probe cards are a device-specific consumable, customized to each individual chip design, early production activity for these new DDR5 designs is driving demand for new probe cards, albeit at lower overall levels and with somewhat greater short-term volatility than we might expect to see in a full-scale cyclical upturn. The second factor behind our strong DRAM outlook is the continuing acceleration in demand from multiple customers for probe cards to test high bandwidth memory or HBM.

Together with the headline grabbing GPUs, HBM is a key enabler for generative AI, and we are forecasting nearly 50% sequential growth in our HBM probe card business in the first quarter. HBM offers a great example of how advanced packaging is driving FormFactor’s results. As we mentioned in the past, advanced packaging applications like HBM produce both higher test intensity, which expands the number of probe cards required per good die out and higher test complexity, which raises the performance requirements for each probe card. 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 stacked 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 speeds 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 to foundry and logic probe cards, our largest business, we experienced the expected sequential reduction in the fourth quarter as key customers digested the significant third quarter shipments of probe cards for a major tile-based client PC design and two major high-performance compute designs in the foundry space.

We expect similar demand levels for foundry and logic probe cards in the current quarter as customers continue to closely manage their output now that inventories have stabilized at healthy levels in high unit volume end markets like client PC and mobile. Looking further ahead, the adoption of advanced packaging processes like chiplets and tiles by major foundry and logic customers continues to accelerate as they seek to advance their road maps in the face of a slowing Moore’s law. As in high-bandwidth memory, advanced packaging and foundry and logic applications again demands both higher test intensity and higher test complexity. The positive impact of this trend, together with the potential for increased compute power and PCs and handsets to support AI at the edge will drive significant growth in the foundry and logic probe card market.

As anticipated, we experienced a sequential reduction in Systems segment revenue in the fourth quarter, mainly due to the sale of our FRT metrology business. The Systems business continues to be driven by strong demand for our market-leading test and measurement products for early development of applications like co-packaged silicon photonics and quantum computing. More broadly, Systems is an important element of our diversification strategy as spending in this segment is primarily driven by customer innovation and R&D budgets and is not directly correlated with semiconductor production activity. Co-package optics enabled by silicon photonics remains an important and exciting driver for FormFactor’s current systems and future probe card businesses.

The transition of silicon photonics from early R&D to low-volume production continues, and we have now installed a CM300 silicon photonic system at the world’s leading foundry to support low-volume production, as well as serve as a platform for the co-development of the enhancements needed for high-volume electrical and optical test of co-package optics. As production volumes increased over the next several years, our product road map 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. Finally, earlier today, we announced an agreement to divest our subsidiaries in China to Grand Junction Semiconductor, together with a long-term exclusive distribution and partnership agreement.

This transaction is designed to adjust our operational strategy in the region in light of export controls that have caused our China revenues to decline over the past several quarters. In closing, we continue to operate efficiently and prudently in what we see as a relatively stable demand environment across our diversified product and technology portfolio. Longer term, we remain excited and confident in the growth prospects for FormFactor in the industry overall, driven by the fundamental trends of semiconductor content growth and exciting innovations like HBM, chiplets and co-packaged 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, Q4 revenues and non-GAAP gross margin were at the high end of our outlook range and non-GAAP EPS was at the midpoint of the range. Fourth quarter revenues were $168.2 million, a 2% sequential decrease from our third quarter revenues and a year-over-year increase of 1.3% from our Q4 2022 revenues. Probe card segment revenues were $126.8 million in the fourth quarter, a decrease of $1.5 million or 1.3% from the third quarter revenues and a year-over-year increase of 1.9%. The decrease from Q3 was driven by lower foundry and logic revenues, partially offset by an increase in DRAM and flash revenues. Systems segment revenues were $41.2 million in Q4, a $2 million decrease from third quarter record revenues and essentially flat year-over-year.

The decrease from the third quarter is mainly due to the sale of FRT, which closed on October 31. Systems segment revenues comprised 24.5% of total company revenues, slightly down from 25.2% in the third quarter. Within the probe card segment, Q4 foundry and logic revenues were $83.6 million, a 13.3% decrease from the third quarter revenues. Foundry and Logic revenues decreased to 49.8% of total company revenues compared to 56.2% in the third quarter. DRAM revenues were $35.9 million in Q4, $8.5 million or 31% higher than in the third quarter, an increase to 21.4% of total quarterly revenues as compared to 16% in the third quarter. Flash revenues of $7.3 million in Q4 were $2.8 million higher than in the third quarter and over 4.3% of total revenues in Q4 as compared to 2.6% in Q3.

Gross margin for the fourth – sorry, GAAP gross margin for the fourth quarter was 40.4%, same as in Q3. Cost of revenues included $2.8 million of GAAP to non-GAAP reconciling items, which we outlined in our press release issued today and in the reconciliation table available in the Investor Relations section of our website. On a non-GAAP basis, gross margin for the fourth quarter was 42.1%, 0.3 percentage points higher than the 41.8% non-GAAP gross margin in Q3 and 1.1 percentage points above the midpoint of our outlook range. The increase as compared to Q3 and the upside versus the midpoint of our outlook range were mostly a result of higher gross margin in the probe card segment, partially offset by lower system segment gross margin. Our probe card segment gross margin was 39.6% in the fourth quarter, an increase of 1.1 percentage points compared to 38.5% in Q3.

The increase from Q3 is mainly due to improved factory utilization and lower excess and obsolete inventory expense, partially offset by a less favorable mix and lower volume. Our Q4 systems segment gross margin was 49.6%, 220 basis points lower than the 51.8% gross margin in the third quarter. The decrease relates mainly to the sale of FRT during the quarter, which resulted in a less favorable mix and inventory adjustments related to the transaction close. Our GAAP operating expenses were $59.6 million for the fourth quarter as compared to $66.6 million in the third quarter. The main reason for the decrease versus Q3 were nonrecurring M&A expenses in the third quarter and only one month of FRT OpEx in the fourth quarter, partially offset by higher performance-based compensation in Q4.

Non-GAAP operating expenses for the fourth quarter were $51.6 million or 30.7% of revenues as compared with $54.5 million or 31.8% of revenues in Q3. The decrease relates to similar reasons I mentioned regarding GAAP operating expenses. Company noncash expenses for the fourth quarter included $9.3 million for stock-based compensation, $1.6 million lower than in the third quarter due to timing of grants. $0.8 million for the amortization of acquisition-related intangibles, $0.5 million lower than in Q3 and depreciation of $7.7 million, similar to the third quarter. GAAP operating income was $81.3 million for Q4 and includes a $73 million gain from the sale of FRT compared with GAAP operating income of $2.7 million in Q3. The gain from the sale of FRT has been excluded from our fourth quarter non-GAAP results.

Non-GAAP operating income for the fourth quarter was $19.1 million compared with $17.3 million in the third quarter, an increase of $1.9 million or 10.8%. GAAP net income for the fourth quarter was $75.8 million or $0.97 per fully diluted share compared with a GAAP net income of $4.4 million or $0.06 per fully diluted share in the previous quarter. The main reason for the increase is the gain on the sale of FRT. The non-GAAP effective tax rate for the fourth quarter was 21.2% as compared with 12.2% in the third quarter, mainly due to usual year-end adjustments and changes in mix of foreign versus domestic taxable income. For the full fiscal 2023, the non-GAAP effective tax rate was 15.6%, within the range of 13% to 17% previously communicated and similar to the 15.4% in 2022.

We estimate that our annual non-GAAP effective tax rate for 2024 will be between 14% and 18%. Fourth quarter non-GAAP net income was $15.7 million or $0.20 per fully diluted share compared to $17.3 million or $0.22 per fully diluted share in Q3. Moving to the balance sheet and cash flows. We used $0.3 million in free cash flow in the fourth quarter compared to generating $16.9 million in Q3. The main reasons for the change were timing of shipments to and collections from customers during the fourth quarter and higher capital expenditures. We invested $9.9 million in capital expenditures during the fourth quarter compared to $5.9 million in Q3. This brings our 2023 annual capital expenditures to $56 million, within the range previously communicated.

The decrease in CapEx in the second half of 2023 as compared to the first half and as compared with the $65.3 million invested in 2022 is due to completing the majority of the long lead time facilities and equipment investments required to reach our target financial model. Accordingly, we expect CapEx in 2024 to be between $35 million and $45 million. At quarter end, total cash and investments were $332 million, an increase of $84 million from Q3. The increase was mainly a result of approximately $104 million received from the sale of FRT, partially offset by the $9.9 million of capital expenditure, as I just described and by stock buyback in the amount of $20 million. As of the end of the fourth quarter, we had one term loan remaining with a balance totaling $14 million.

Regarding the stock buyback, as I mentioned, during the fourth quarter, we purchased $20 million worth of shares to fully utilize our $75 million 2-year buyback program that was approved in May 2022 and started utilizing the new $75 million 2-year plan that was approved in October 2023. As of Q4 quarter end, $73.8 million remain available for future repurchases under this plan. As a reminder, the main purpose of the share repurchase program is to offset dilution from stock-based compensation. Turning to the first quarter non-GAAP outlook. We expect Q1 revenues of $165 million, plus or minus $5 million. At the midpoint of our outlook range, Q1 revenues is expected to be approximately $3 million lower than in Q4. The expected decrease relates to lower systems segment revenues, mainly due to the sale of FRT in Q4.

And in the probe card segment, we expect flat Foundry and Logic and lower Flash revenues in the first quarter, partially offset by the increase in DRAM revenues. The sale of our Chinese subsidiaries that we announced today is expected to close in the first half of 2024, and it is not expected to have a significant impact on our financial results. First quarter non-GAAP gross margin is expected to be 41%, plus or minus 150 basis points. The expected decrease at the midpoint of this range as compared to Q4 ’23 gross margin is a result of a less favorable product mix, mainly the expected decrease in Systems segment revenues and the increase in DRAM revenues. Although we expect HBM revenues to grow in the first quarter, non-HBM DRAM revenues, which has a lower gross margin profile is also expected to grow.

At the midpoint of these outlook ranges, we expect Q1 operating expenses to be $53 million, plus or minus $1 million. The increase as compared to Q4 is mainly as a result of the annual benefits reset. Non-GAAP earnings per fully diluted share for Q1 is expected to be $0.19 plus or minus $0.04. A reconciliation of our GAAP to non-GAAP Q1 outlook is available on the Investor Relations section of our website and in our press release issued today. With that, let’s open the call for questions. Operator?

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Q&A Session

Operator: Certainly. [Operator Instructions] Our first question comes from the line of Brian Chin from Stifel. Your question, please.

Brian Chin: Hi, there. Good afternoon. Thanks for letting us ask a few questions. Maybe first, and I know Shai, you just said that – I think you said that upon closure in first half with the China divestiture s[ph] kind of has no impact. But I imagine there are some financial implications either in terms of cost and margins, some expectations as it relates to revenue, even maybe some cash on the balance sheet. Can you maybe break that down a little bit more? And also whatever regulatory hurdles or other hurdles need to be cleared to consummate the transaction?

Shai Shahar: Sure. So as I said, we don’t expect it to have a significant impact on our financial results. When it comes to the balance sheet, once the deal closes, we will make the appropriate disclosure with more details. But since the details of the transaction were not disclosed, you can imagine that we concluded it’s immaterial. When it comes to the P&L, again, not a material impact since we maintain – we continue to maintain the direct relationship with the multinational customers in the region. And with respect to the local China customers, we have the new distribution agreement. And we expect and hope that this will continue to grow our China business as we move forward. And that’s the conclusion we don’t expect it to have a material impact. And Mike, do you want to refer to the regulatory…

Mike Slessor: Yes. Brian, this has been structured in a way where we don’t believe there are significant regulatory approvals required. Basically, what we’re doing is divesting what’s in China already. And so there’s no technology transfer, no significant technology licensing. It really is a focus and a shift to our operational and customer channel strategy in the region, given some of the challenges we’ve had with the export control. You’ve seen our domestic China revenue contract over the past several quarters, and this is a response to that. We are hopeful that Grand Junction can bring some more resources and focus to those business and through the distribution channel, help grow our domestic China business for us.

Brian Chin: Okay. That’s helpful. And for maybe for my follow-up, can you quantify – I guess it’s been operating maybe around $10 million a quarter, but what the HBM contribution was to the $36 million DRAM in Q4? And then also kind of more broadly, do you see wafer probe card test intensity continuing to increase alongside your customers’ road maps based on more die stack and hybrid bonding, et cetera? Or do you see test intensity leveling off at some point as customers yield and manufacturing efficiency improves?

Mike Slessor: Yes, I think it’s a question of timing on the second one. I think for the medium term, certainly through 2024 and into 2025 with HBM, customers are still riding up a pretty significant yield learning curve. And so the increase in test intensity that we’ve talked about associated with die-stacking and advanced packaging of 20% to 30%. I think we’re pretty confident is going to hold here as we go through the early part of the HBM3 and into the HBM4 ramp. Over time, as with anything, we see this in new nodes as well. Customers accomplished the yield learning using products like ours, reducing the overall test intensity, improving their yields. And so we would expect it to go down over time. But I think we’re pretty confident in increased test intensity as all the different yield reduction modes associated with die stacking or work through in HBM and in the logic space as well.

On the numbers, HBM in the fourth quarter was approximately $10 million, as you said, maybe a little bit more of the $36 million of DRAM revenue. And as we said in the prepared remarks, we expect that to increase around 50% sequentially. So up into the, call it, mid-teens in the Q1 outlook.

Brian Chin: Okay, great. Thank you.

Mike Slessor: Thanks, Brian.

Operator: Thank you. One moment for our next question. And our next question comes from the line of David Duley from Steelhead. Your question, please. David Duley, you might have your phone on mute.

David Duley: Yes, you’re right. Thanks. I noticed the Foundry & Logic revenue was down, it’s similar decline that we saw in the revenue out of the geographic region of Taiwan. I was just wondering if you could make some a lot more elaborate comments about that? That’s my first question. And my second question is, could you remind us what percentage of the overall DRAM market uses MEMS-based probe cards? And I think you mentioned that all the high-bandwidth memory stuff is going to be on MEMS…

Mike Slessor: Yeah.

David Duley: Does the growth in high-bandwidth memory really kind of benefits you guys since you’re a MEMS-based provider?

Mike Slessor: Yes. I’ll take the second one first. The DRAM wafer probe market is almost entirely MEMS-based. Us and our primary Japanese competitor in high-end DRAM, really the only way to build these probe cards, which test the entire wafer once and have approximately 100,000, 150,000 individual contacts on them. The only way to do that in a cost-effective and high-quality way and deliver the speed performance, the high power performance is with the MEMS technology. And so I don’t view HBM in and of itself as a headwind or a tailwind for MEMS adoption considering we’re already largely adopted with MEMS and DRAM. But the requirements, as we talked about in the prepared remarks are more stringent. And so it increases one, the value to our customers.

It also increases our competitive differentiation on things like speed – high-speed performance and thermal scaling. And so it’s not purely a MEMS adoption story, but really a raising of the bar of the existing MEMS probe card for HBM, which as Shai commented helps our gross margins in the segment a little bit. On the Foundry & Logic observation, if you recall back on our previous call, we had a very strong third quarter with some of our major Foundry & Logic customers. And in particular, in the foundry space, delivered high volumes of two high-performance – pro cards for high-performance compute projects. And those are in the digestion mode right now. So the inference you’ve drawn is correct. It also ties to the expectations we said on the previous call about some digestion in the foundry space as we go through Q4 and now Q1.

David Duley: And just as my follow-on, you talked about in your prepared comments, I think some place about you saw unusually strong demand in just in DDR5. Is that associated with the specific end market? Or could you just maybe just elaborate further on that particular comment. Thank you.

Mike Slessor: Sure. The overall DRAM guidance, as we said, our outlook is that we’re going to approach the levels that we approached in the middle part of 2021. So somewhere in the low $40 million of quarterly DRAM revenue. And that’s composed. You can do the math from the previous question-and-answer session. You can do the math on how much of that is HBM, which leaves you with some pretty solid growth associated with non-HBM memory. We’re seeing DDR5 for both mobile and server PC applications be pretty strong in the first quarter. I want to be clear that we’re not calling a DRAM upturn at this point. It’s pretty concentrated on a couple of designs and mostly at one customer, but it is an interesting indication of our customers beginning to invest in new designs because we know DRAM is cyclical, and we know it’s going to turn at some point. So this represents some investments in them getting ready for the ramp when it does turn.

David Duley: Thank you.

Operator: Thank you. [Operator Instructions] And our next question comes from the line of Krish Sankar from TD Cowen. Your question, please.

Krish Sankar: Yeah, hi. Thanks for taking my question. I have two of them. First one, if I look at your guidance, I’m just kind of curious, Mike or Shai, you said foundry logic revenue is flat, HBM growth, 50% and overall DRAM revenue is approaching peak levels in Q2 of ’21, which is $42 million, and DDR5 is growing too. But if we do the math, it looks like HBM as a percentage of DRAM revenue is going to be higher in March versus in the December quarter. So why is gross margin still lower? Shouldn’t gross margin be better than December then?

Shai Shahar: Well, let’s not forget the system segment, right? We did – I did talk about the call that Systems segment is expected to go down in Q4. And as you recall, our system segment gross margin historically is higher. So we’re going to have less favorable mix between systems and probes, and that’s another driver that pushes gross margin a little lower than Q4.