Business Context and Reporting Period
FormFactor, Inc. provides semiconductor test and measurement solutions, including probe cards, analytical probes, probe stations, metrology systems, and thermal and cryogenic subsystems. Operations are reported in two segments: Probe Cards and Systems. This unaudited Form 10-Q covers the 13 weeks ended September 26, 2020 and the nine months ended September 26, 2020, compared with the corresponding periods ended September 28, 2019.
Key Financial Metrics
| Metric | Q3 2020 | Q3 2019 | 9M 2020 | 9M 2019 |
|---|---|---|---|---|
| Revenue | $178.0 million | $140.6 million | $496.6 million | $410.8 million |
| Gross profit | $76.7 million | $55.3 million | $210.3 million | $163.2 million |
| Gross margin | 43.1% | 39.3% | 42.4% | 39.7% |
| Operating income | $22.0 million | $9.3 million | $63.0 million | $25.9 million |
| Operating margin | 12.4% | 6.6% | 12.7% | 6.3% |
| Net income | $22.9 million | $8.3 million | $59.3 million | $20.7 million |
| Diluted EPS | $0.29 | $0.11 | $0.75 | $0.27 |
| Net margin | 12.9% | 5.9% | 11.9% | 5.0% |
Q3 revenue increased 26.6% year over year, while nine-month revenue increased 20.9%. Probe Cards revenue was $150.8 million in Q3 and $419.3 million for the nine months; Systems revenue was $27.2 million and $77.3 million, respectively.
Foundry and Logic revenue increased 58.4% in Q3 and 51.6% for the nine months. DRAM revenue declined 20.4% in Q3 and 28.0% for the nine months. Flash revenue increased 27.8% in Q3 and 1.3% for the nine months. Management attributed growth primarily to higher foundry and logic demand, including demand related to 5G and work-from-home infrastructure, while DRAM was affected by the absorption of large prior-year purchases.
Cash Flow, Balance Sheet, Debt, and Liquidity
- Cash provided by operating activities was $124.2 million for the first nine months of 2020, compared with $83.4 million in the prior-year period.
- Capital expenditures were $41.9 million, including $24.0 million for a building adjacent to the Livermore facilities.
- Investing cash outflows were $56.2 million, including the $35.0 million Baldwin Park acquisition and net marketable-security purchases and sales.
- Financing cash outflows were $29.0 million, primarily from $41.1 million of term-loan repayments and $15.4 million of tax withholdings on equity awards, partly offset by $18.0 million of new building-loan proceeds.
- Cash, cash equivalents, and restricted cash totaled $188.2 million at September 26, 2020. Cash, cash equivalents, and marketable securities totaled approximately $241.5 million, compared with $220.9 million at December 28, 2019.
- Working capital was $319.9 million, compared with $282.5 million at year-end 2019. Inventories increased to $94.6 million from $83.3 million.
- Term loans totaled $36.0 million net of issuance costs, compared with $58.5 million at year-end 2019. The CMI Term Loan was fully repaid on June 30, 2020. Remaining debt consisted primarily of the FRT Term Loan and the Building Term Loan.
- Management stated that existing liquidity and operating cash flow should satisfy working-capital needs and scheduled debt repayments for at least the next twelve months.
Material Changes Versus the Prior Comparable Period
- Higher revenue, improved product mix, and greater factory utilization increased gross margin by 3.8 percentage points in Q3 and 2.7 percentage points for the nine months.
- Operating expenses increased in absolute dollars but declined as a percentage of revenue. Nine-month R&D expense rose 8.6%, while SG&A rose 6.4%.
- Lower debt balances reduced interest expense, while lower market interest rates reduced interest income.
- The nine-month effective tax rate declined to 7.0% from 22.2%. Q3 recorded a $0.5 million tax benefit and a negative 2.2% effective tax rate, driven by discrete benefits related to finalized GILTI regulations and stock-based compensation.
- FormFactor acquired the Baldwin Park probe-card assets of Advantest for $35.0 million on July 30, 2020. Purchase accounting remained provisional, with $19.5 million initially recorded as goodwill; some amount may later be allocated to amortizing intangible assets.
- Goodwill increased to $220.8 million from $199.2 million at year-end 2019. No goodwill impairments were recorded.
- On October 19, 2020, after the reporting date, the company acquired High Precision Devices for $17.0 million in cash. The acquisition was not expected to be material, and purchase accounting was incomplete at filing.
Outlook, Commentary, Risks, and Unusual Items
FormFactor stated that its manufacturing sites continued operating at production levels comparable to those before the pandemic, subject to safety constraints, while many other employees worked remotely. A temporary factory shutdown of nearly two weeks in the first fiscal quarter limited manufacturing capacity and affected lead times. Management warned that further COVID-19 restrictions, supply-chain disruptions, customer-site access limitations, economic weakness, or facility outbreaks could materially affect demand, production, productivity, liquidity, and results.
The filing does not provide a clear quantitative revenue or earnings forecast. Management noted that uncertainty surrounding COVID-19 could lead it to limit or refrain from providing financial guidance.
- Customer concentration remained significant. Intel represented 25.6% of Q3 revenue and 32.4% of nine-month revenue. The four largest disclosed Q3 customers represented 56.9% of revenue.
- The company relies on a limited number of suppliers, including some sole-source suppliers, creating potential component availability and quality risks.
- Increasing U.S. export controls, tariffs, and other trade barriers affecting China could reduce sales or delay shipments. China represented 24.4% of nine-month revenue.
- In June 2020, the company identified a malware-related data breach involving unauthorized access to information technology systems. Management did not believe it had significantly affected production or ordinary-course operations, but cybersecurity and remediation risks remain.
- The company has a $50.0 million stock-repurchase authorization, approved in October 2020, intended to offset dilution from equity compensation.
- Remaining performance obligations were $3.8 million at September 26, 2020, primarily deferred service and extended-warranty contracts.
- The company reported no material legal proceedings and no off-balance-sheet arrangements.
Important Facts for Investors to Verify
- Whether foundry and logic demand remains strong and offsets continued DRAM cyclicality and variable Flash demand.
- The final purchase-price allocation for Baldwin Park and any resulting amortization, goodwill changes, or integration costs.
- The financial contribution and purchase accounting for the post-period High Precision Devices acquisition.
- COVID-19 effects on manufacturing capacity, lead times, supply availability, customer demand, and access to customer sites.
- The effect of export-control changes and China-related trade restrictions on revenue and customer relationships.
- Customer concentration, particularly exposure to Intel and other major semiconductor customers.
- Inventory growth, potential excess or obsolete inventory charges, and the effect of product mix and factory utilization on gross margins.
- The sustainability of the unusually low 2020 effective tax rate, including discrete tax benefits from regulatory changes and stock-based compensation.
- Compliance with debt covenants, scheduled repayments, and the impact of the building loan and related interest-rate swap.