FormFactor, Inc. (NASDAQ:FORM) Q1 2024 Earnings Call Transcript May 1, 2024
FormFactor, Inc. beats earnings expectations. Reported EPS is $0.2775, expectations were $0.19. FORM 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 First Quarter 2024 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 crises 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 that could because actual results to differ materially from those expressed during this call. Information risk factors and uncertainties is contained in our most recent filing on Form 10-K with the SEC for the fiscal year ended December 31st, 2023, 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 May 1st, 2024, and we assume no obligations to update them. We will now turn the call over to FormFactor’s CEO, Mike Slessor.
Mike Slessor: Thanks, everyone for joining us for FormFactor’s first quarter earnings call. Although FormFactor’s first quarter revenue was near the top end of the outlook range we provided in February, non-GAAP EPS fell short of the midpoint due to lower-than-expected gross margins, primarily from a weaker product mix in both segments, along with higher warranty costs in the Probe Cards segment. In the current second quarter, we’re experiencing a significant sequential step-up in demand and expect a corresponding increase in gross margin and non-GAAP EPS. This is driven primarily by strength in both DRAM and foundry and logic probe cards, as industry adoption of advanced packaging accelerates. To ensure FormFactor fully leverages and benefits from our strong position in enabling advanced packaging, we recently completed an important series of coordinated organizational and talent changes.
First, we’ve realigned our organizational structure to consolidate the company’s global operations including manufacturing, quality, supply chain, environmental health and safety, and facilities in a central group. This operational consolidation provides the critical mass and scalability to create commonality and efficiency as we continue to grow. With our operations now consolidated, our business unit’s sole focus is on customer-facing innovation and competitive differentiation in FormFactor’s product roadmaps. Second, we deepened our bench recruiting and onboarding two experienced executives to lead our operations and commercial functions and realign responsibilities for other executives to ensure FormFactor has the required skills and experience in critical roles.
Finally, we added Kevin Brewer to our Board of Directors, who is the former Executive VP of Operations and CFO of Axcelis Technologies, brings significant operational experience and knowledge. Kevin replaces Lothar Maier, who’s retiring after nearly 18 years of service to FormFactor. On behalf of our shareholders, employees, and customers, I’d like to take this opportunity to thank Lothar for his many contributions. These coordinated changes are designed to position the company for our next phase of growth by enhancing our capability to develop and introduce highly differentiated products while advancing our ability to manufacture these products at world-class operational levels. This will allow us to capture the secular growth in our served markets, being driven by advanced packaging, and to gain market share, enabling us to outgrow these markets.
While the full benefit of these changes will be realized over a multi-year timeframe, we do expect short-term improvement in our gross margins. For example, by focusing on areas like quality to reduce unexpected costs. Turning now to market and segment-level details. DRAM probe card demand continues to be robust and as expected, first quarter DRAM revenue reached the peak levels last experienced in 2021, with strong growth in high bandwidth memory layered on top of steady DDR5 new design activity. In the first quarter, HBM was nearly half of FormFactor’s DRAM revenue and was double the quarterly levels, we delivered in the second half of 2023. We’d previously stated that we expected HBM revenue to reach these levels sometime in mid to late 2024.
Achieving these doubled quarterly run rate HBM revenue levels in the first quarter of the year is a good indicator of how quickly HBM capacity and output is accelerating across our customer base. We expect this trend to continue and are forecasting a similar incremental growth contribution from HBM in the second quarter. HBM chips, which are a stack of 8, 12, or even 16 individual DRAM die continue to offer a powerful example of how advanced packaging is driving our current results and foreshadows our long-term opportunity. As we mentioned in the past, advanced packaging applications like HBM produce both higher test intensity, which expands the number of probe cards required for good die-out, and higher test complexity, which raises the performance requirements for each probe card.
To ensure high yields of this stacked HBM DRAM chip, customers probe and test each component DRAM die prior to stacking and then 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 test are significantly more advanced than for standard unstacked DRAM products, involving higher test speeds and more challenging thermal scaling specifications. We believe our superior performance capabilities in meeting these requirements will drive both market share and profitability gains, as HBM continues to grow, driven by the accelerating adoption of generative AI. Even though HBM applications comprise a small portion of the total DRAM bits produced by our customers, because of the stack die architecture, HBM represents a much larger portion of the total silicon area and wafers produced, and because of the increased test intensity and test complexity, an even larger part of the overall test and probe guard spending by our customers.
This compounding power of advanced packaging is clear in our first-quarter results and our second-quarter outlook for HBM. Shifting to foundry and logic probe cards. As expected, we delivered first-quarter revenue comparable to the fourth quarter as we shipped probe cards for a variety of PC, server, and mobile designs. As a reminder, since probe cards are a device-specific consumable that’s customized to each individual customer chip design, production ramps of new chip designs generate demand for new probe cards even when these new designs are produced on the same technology node. This provides a more diverse and stable set of demand drivers than for capital equipment. We expect second-quarter growth in our foundry and logic probe card business, primarily driven by the mid-year ramp of new mobile application processor designs and stronger probe card demand for client PC and server microprocessor designs.
As in DRAM with HBM, an increasing number of these foundry and logic designs are architected using advanced packaging processes like Foveros and 3D Fabric. Similar to the die stacking in HBM, these processes drive both higher test intensity and higher test complexity. This is driving increased customer spending on FormFactor’s products, to both improve yields and reduce costly scrap. In the Systems segment, the sale of FRT in the fourth quarter produced the anticipated sequential reduction in revenue in the first quarter. However, product mix was weaker than expected with fewer high-complexity thermal systems shipped. We believe this mix of lower complexity configurations is a short-term dynamic and not a structural change in this market. Our customers continue to engage us to solve the most complex challenges in test and measurement, utilizing our engineering provers, cryostats and other system segment products to test, measure, and characterize new technologies like co-packaged silicon photonics, infrared detectors, and quantum computers that are at the forefront of industry innovation.
System segment products are also an of our lab-to-fab diversification strategy. Our uniquely broad portfolio enables us to compete for business across diverse demand pools at all major customers, providing a measure of stability and downturns and inherent exposure to fast-growing areas of the industry like high bandwidth memory. Finally, I want to share an important customer highlight from the first quarter. FormFactor was one of 27 suppliers to receive the exclusive Intel EPIC Program Distinguished Supplier Award for 2024. This award marks the third consecutive year we’ve been recognized as a top performer in the Intel supply chain. I’m extremely proud of the global FormFactor team for the dedication and performance that resulted in this recognition from Intel and I’d like to take this opportunity to thank and congratulate our team.
In closing, we’re excited about both the strength of our second-quarter outlook and the accelerating adoption of advanced packaging underpinning that strength. Longer-term, we’re confident in the growth prospects for FormFactor in the industry overall, driven by the fundamental trends of semiconductor content growth and advanced packaging 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 along with the organization and talent changes we’ve made recently position FormFactor as a stronger and leaner competitor. This will enable us to achieve and then surpass 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, Q1 revenues were $3.7 million above the midpoint of our outlook range. Non-GAAP gross margin was 0.8 percentage points below the bottom end of the range and non-GAAP EPS was $0.01 below the midpoint of the range. First quarter revenues were $168.7 million, a 0.3% sequential increase from our fourth quarter revenues and a year-over-year increase of 0.8% from our Q1 ’23 revenues. The increase is due to stronger revenues in our Probe Card segment. Probe Card segment revenues were $136.7 million in the first quarter, an increase of $9.7 million or 7.6% from Q4. The increase was driven by a small increase in foundry and logic revenues and a significant increase in DRAM revenues, partially offset by a decrease in flash revenues.
The Systems segment revenues were $32 million in Q1, a $9.2 million decrease from the fourth quarter and comprised 19% of total company revenues, down from 24.5% in Q4. The main reason for the decrease is the set of FRT in Q4 ’23. Within the Probe Card segment, Q1 foundry and logic revenues were $86.8 million a 3.6% increase from Q4. Foundry and Logic revenues increased to 51.5% of total company revenues, compared to 49.8% in the fourth quarter. DRAM revenues were a record $45.9 million in Q1, $10 million or 27.9% higher than in the fourth quarter and increased to 27.2% of total quarterly revenues as compared to 21.3% in the fourth quarter. Flash revenues of $4 million in Q1 were $3.3 million lower than in the fourth quarter and were 2.4% of total revenues in Q1, as compared to 4.3% in Q4.
GAAP gross margin for the first quarter was 37.2% as compared to 40.4% in Q4. Cost of revenues included $2.6 million of GAAP to non-GAAP reconciling, which we outlined in our press release issued today and in the reconciling table available in the Investor Relations section of our website. On a non-GAAP basis, gross margin for the first quarter was 38.7%, 3.4 percentage points lower than the 42.1% non-GAAP gross margin in Q4 and 0.8 percentage points below the low end of our outlook range. The decrease compared to Q4 and to the midpoint of our outlook range was a result of lower gross margins in both the Probe Card segment and the Systems segment. Our Probe Card segment gross margin was 37.2% in the first quarter, a decrease of 2.4 percentage points, compared to 39.6% in Q4.
Our Q1 System segment gross margin was 45.3%, a decrease of 4.3 percentage points from the 49.6% gross margin in the fourth quarter. The decrease in consolidated non-GAAP gross margins from the midpoint of our outlook range is due to the net effect of three main factors. First, a less favorable product mix in both segments, which contributed to a 1.9 percentage point decrease. Second, higher-than-expected warranty expense in Q1 contributed to a 0.4 percentage points decrease. Partially offsetting these two factors was 0.5 percentage points related to higher-than-expected revenues. First-quarter GAAP operating expenses were $61.7 million compared to $59.6 million in the fourth quarter. The two main reasons for the increase were higher stock-based compensation of $1.2 million related to the benefit from core features in the previous quarter that did not recur in Q1 and transaction cost of $0.6 million related to the sale of our China operations.
During the quarter, we entered into a definitive agreement to sell our China operations for $25 million subject to customary working capital adjustments. The transaction closed on February 26, and Q1 includes results from our China operations for the first two months of the year. Net proceeds from the transaction after adjustments and expenses were approximately $21.1 million. Non-GAAP operating expenses for the first quarter were $52.3 million or 31% of revenues, as compared with $51.6 million or 30.7% of revenues in Q4. The $0.7 million increase relates mainly to the typical annual benefits reset, partially offset by lower performance-based compensation and the reduction in costs related to the sale of FRT and our China operations. Company non-cash expenses for the first quarter included $10.4 million for stock-based compensation, $1.1 million higher than in the fourth quarter, as well as amortization of intangibles of $0.6 million and depreciation of $7.2 million both slightly lower than in the fourth quarter.
GAAP operating income was $21.3 million for Q1, compared with $81.3 million in Q4, which included a $73 million gain from the sale of FRT. Q1 included $20 million gain from the sale of our China operations. Non-GAAP operating income for the first quarter was $13 million compared with $19.1 million in the fourth quarter, a decrease of $6.2 million or 32%, mostly due to the decrease in gross margins. GAAP net income for the first quarter was $21.8 million or $0.28 per fully diluted share, compared with GAAP net income of $75.8 million or $0.97 per fully diluted share in the previous quarter. As discussed, the prior quarter included the gain from the sale of FRT. The non-GAAP effective tax rate for the first quarter was 13.7%, seven percentage points lower than the 21.2% in the fourth quarter.
We continue to expect our annual non-GAAP effective tax rate to be between 14% and 18%. First quarter net, sorry, first quarter non-GAAP net income was $14.3 million or $0.18 per fully diluted share compared to $15.7 million or $0.20 per fully diluted share in Q4. Q1 EPS was $0.02 lower sequentially due to lower gross margins and higher OpEx on flat revenue, partially offset by higher other income and lower effective tax rate. Moving to the balance sheet and cash flows. We generated free cash flow of $19.7 million in the first quarter, compared to negative $0.3 million in Q4. The increase in free cash flows of $20 million is mainly due to higher operating cash flows, primarily driven by more efficient working capital of $19.4 million, partially offset by an increase of $3.5 million in capital expenditures.
We invested $13.4 million in capital expenditures during the first quarter compared to $9.9 million in Q4. There is no change in our previously communicated 2024 expected CapEx range of $35 million to $45 million. At quarter end, total cash and investments were $357.2 million, an increase of $25 million from Q4. The increase relates to cash provided by operating activities and net cash received from the sale of our China operations, partially offset by CapEx and stock repurchases. At the end of the first quarter, we had one term loan remaining with the balance totaling $14 million. Regarding stock buyback, during the first quarter, we purchased $17.4 million worth of shares under our $75 million two-year buyback program that was approved in Q4 2023.
As of quarter end, $56.4 million remains available under that authorization. As a reminder, the main purpose of this share repurchase program is to offset dilution from stock-based compensation. Turning to the second quarter non-GAAP outlook. We expect Q2 revenue of $195 million plus or minus $5 million. At the midpoint of our outlook range, Q2 revenue is expected to be approximately $25 million higher than in Q1. We expect DRAM revenues in Q2 to be approximately $10 million higher than in Q1 and foundry and logic revenues to be approximately $15 million higher than in the first quarter. Second quarter non-GAAP gross margin is expected to be 45%, plus or minus 150 basis points. The expected increase in non-GAAP gross margins in the second quarter is related to higher volumes and a more favorable mix.
At the midpoint of these outlook ranges, we expect Q2 operating expenses to be $60 million plus or minus $2 million. The expected increase is mainly due to higher performance-based compensation related to higher profitability. Non-GAAP earnings per fully diluted share for Q2 is expected to be $0.31 plus or minus $0.04. Reconciliation of our GAAP to non-GAAP Q2 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?
Operator: Our first question comes from the line of Brian Chin from Stifel. Your question, please.
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