FormFactor, Inc. — Q2 2016 Form 10-Q Summary
Reporting period: Fiscal quarter and six months ended June 25, 2016, compared with June 27, 2015. FormFactor designs and manufactures semiconductor probe cards and, following the June 24, 2016 acquisition of Cascade Microtech, provides wafer probing, thermal, reliability, and measurement solutions. Cascade’s results were not included in revenue or earnings because only one day remained in the quarter, but its balance sheet was consolidated.
Financial performance
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Revenue | $83.1 million | $73.9 million | $136.7 million | $144.7 million |
| Gross profit | $25.4 million | $23.3 million | $35.2 million | $46.1 million |
| Gross margin | 30.6% | 31.5% | 25.8% | 31.9% |
| Operating income (loss) | $(6.6) million | $0.7 million | $(20.2) million | $0.0 million |
| Net income | $36.9 million | $0.8 million | $23.1 million | $1.6 million |
| Diluted EPS | $0.61 | $0.01 | $0.39 | $0.03 |
- Q2 revenue increased 12.4%, driven by a 67.4% increase in Foundry & Logic revenue to $57.9 million. DRAM revenue declined 31.3% to $24.2 million, and Flash revenue declined 76.0% to $1.0 million.
- Six-month revenue declined 5.5%, primarily because of a slower-than-planned Foundry & Logic capacity ramp in the first quarter and weaker DRAM and Flash demand.
- Operating results were affected by $6.9 million of restructuring charges in Q2, including severance and accelerated equity awards related largely to the Cascade acquisition, and $3.8 million of acquisition-related costs during the first six months.
- Net income was significantly overstated relative to operating performance by a $43.7 million income-tax benefit, primarily from releasing a valuation allowance after Cascade acquisition-related deferred tax liabilities created additional sources of taxable income.
Cash flow, balance sheet, debt, and liquidity
- Six-month operating cash flow was $(3.6) million versus $21.7 million of operating cash flow in the prior-year period. Working-capital uses included $21.7 million of higher accounts receivable and $8.0 million of inventory investment.
- Investing cash flow was $(195.5) million, including $215.2 million paid for Cascade Microtech net of cash acquired and $3.6 million of capital expenditures.
- Financing cash flow was $150.5 million, primarily reflecting proceeds from a new $150.0 million senior secured term loan.
- Cash and cash equivalents were $100.2 million and marketable securities were $18.1 million at June 25, 2016. Including restricted cash, reported liquidity was approximately $118.8 million. This compares with approximately $187.6 million of cash and marketable securities at December 26, 2015.
- Term loan debt had a $150.0 million principal balance and $148.5 million carrying value after debt issuance costs. The loan bears interest at LIBOR plus 2.0% or the applicable base rate plus 1.0%, matures in 2021, and amortizes over five years.
- Management stated that existing cash, cash equivalents, and marketable securities should satisfy working-capital requirements for at least the next twelve months, subject to revenue, cost, industry, and financing conditions.
Material changes and unusual items
- FormFactor completed the Cascade Microtech acquisition for total consideration of approximately $365.8 million, including $255.9 million of cash consideration, $93.2 million of FormFactor stock, and assumed or paid equity awards. Net consideration after cash acquired was approximately $325.1 million.
- The acquisition added $157.8 million of preliminary goodwill and $152.1 million of identifiable intangible assets. The purchase-price allocation remained preliminary and could change materially during the measurement period.
- The combined company now reports Probes and Systems segments. Cascade is expected to broaden product offerings and diversification, but its operating results will affect future periods rather than Q2 2016 reported revenue.
- Q2 operating margin was negative 8.0%, compared with positive 0.9% in the prior-year quarter. Six-month operating margin was negative 14.8%, compared with approximately breakeven previously.
- Customer concentration remained significant: Intel represented 44.1% of Q2 revenue and 40.2% of six-month revenue; the three largest disclosed customers represented 59.3% and 50.9%, respectively.
Outlook, risks, contingencies, and management commentary
- The filing provides no specific numerical revenue, margin, or earnings guidance. Management expects future revenue to include Cascade product lines such as probe stations, thermal subsystems, and reliability test systems.
- Key operating risks include semiconductor-market cyclicality, price erosion, rapid technological change, customer concentration, limited-source suppliers, inventory obsolescence, factory utilization, and demand weakness in DRAM and Flash markets.
- Integration risks include failure to achieve anticipated synergies, employee attrition, customer or supplier disruption, unexpected costs, technology and systems integration challenges, and the possibility that the acquisition becomes dilutive.
- The term loan includes leverage and fixed-charge coverage covenants, restrictions on additional debt, liens, dividends, investments, asset dispositions, and other activities. The company reported compliance with the financial covenants at June 25, 2016.
- A July 25, 2016 interest-rate swap was entered into to hedge the term loan’s LIBOR exposure.
- Pending legal matters include a Cascade shareholder merger-related action for which the parties contemplated a settlement subject to court approval, and a California wage-and-hour class action. The company believed any wage-and-hour settlement would be immaterial but could incur material defense costs.
- Management reported effective disclosure controls and procedures. Internal-control integration work related to Cascade was ongoing.
Investor verification checklist
- Verify the final purchase-price allocation, goodwill, intangible-asset values, deferred taxes, and subsequent impairment or amortization effects from the Cascade acquisition.
- Assess whether Cascade generated the expected revenue, margins, synergies, and cash flow after being included in subsequent quarters.
- Monitor operating cash flow, receivables, inventory levels, customer concentration, and liquidity after the acquisition.
- Review compliance with term-loan leverage and fixed-charge coverage covenants and the effect of interest-rate changes despite the swap.
- Separate recurring operating performance from the $43.7 million tax benefit, $6.9 million restructuring charge, acquisition costs, and other unusual items.
- Track the outcome and potential costs of the Cascade merger litigation and California wage-and-hour litigation.