Formfactor Inc: Form 10-Q for the period ended Jun 25, 2022

Cautionary Statement Regarding Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Securities Exchange Act of 1934 and the Securities Act of 1933, which are subject to risks and uncertainties. The forward-looking statements include statements concerning, among other things, our business strategy, financial and operating results, gross margins, liquidity and capital expenditure requirements and impact of accounting standards. In some cases, you can identify these statements by forward-looking words, such as “may,” “might,” “will,” “could,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “intend” and “continue,” the negative or plural of these words and other comparable terminology.

The forward-looking statements are only predictions based on our current expectations and our projections about future events. All forward-looking statements included in this Quarterly Report on Form 10-Q are based upon information available to us as of the filing date of this Quarterly Report on Form 10-Q. You should not place undue reliance on these forward-looking statements. We have no obligation to update any of these statements. These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to differ materially from those expressed or implied by these statements, including risks related to general market trends, the benefits of acquisitions and investments, our supply chain, uncertainties related to COVID-19 and the impact of our responses to it, the interpretation and impacts of changes in export controls and other trade barriers, military conflicts, political volatility and similar factors, our ability to execute our business strategy and other risks discussed in the section titled “Risk Factors” and elsewhere in our Annual Report on Form 10-K for the year ended December 25, 2021 and in this Quarterly Report on Form 10-Q. You should carefully consider the numerous risks and uncertainties described under these sections.

The following discussion and analysis should be read in conjunction with our condensed consolidated financial statements and the accompanying notes contained in this Quarterly Report on Form 10-Q. Unless expressly stated or the context otherwise requires, the terms “we,” “our,” “us” and “FormFactor” refer to FormFactor, Inc. and its subsidiaries.

Overview

FormFactor, Inc., headquartered in Livermore, California, is a leading provider of essential test and measurement technologies along the full semiconductor product lifecycle - from characterization, modeling, reliability, and design de-bug, to qualification and production test. We provide a broad range of high-performance probe cards, analytical probes, probe stations, metrology systems, thermal systems, and cryogenic systems to both semiconductor companies and scientific institutions. Our products provide electrical and physical information from a variety of semiconductor and electro-optical devices and integrated circuits from early research, through development, to high-volume production. Customers use our products and services to accelerate profitability by optimizing device performance and advancing yield knowledge.

We operate in two reportable segments consisting of the Probe Cards segment and the Systems segment. Sales of our probe cards and analytical probes are included in the Probe Cards segment, while sales of our probe stations, metrology systems, thermal systems and cryogenic systems are included in the Systems segment.

We generated net income of $60.1 million in the first six months of fiscal 2022 as compared to $37.5 million in the first six months of fiscal 2021. The increase in net income was primarily due to increased revenue with improved gross margins from a change in product mix and a reduction in the amortization of intangibles from significant intangibles becoming fully amortized, partially offset by higher operating expenses.

Impact of COVID-19

The COVID-19 pandemic continues to cause serious illness and death in many of the regions that we, our customers and our suppliers operate. The COVID-19 pandemic has resulted in significant governmental actions designed to control the spread of the virus, including the imposition of safety requirements and other orders in locations where we have manufacturing and other activities.

We continue to operate our manufacturing sites at production levels greater than those prior to the pandemic, albeit subject to certain safety and related constraints. Our other operations are continuing with substantial work-from-home activities.

If the provisions of governmental health orders or other safety requirements applicable to us or our customers or suppliers become more restrictive for an extended period of time, or if we have repeated occurrences of COVID-19 in any of our facilities, we may experience disruptions or delays in manufacturing, product design, product development, customer support, manufacturing and sales, and an overall loss of productivity and efficiency.

While the disruptions in our operations, supply chain and customer demand as a result of the COVID-19 pandemic have been somewhat limited, we continue to see impacts on elements in the supply chain and believe that the COVID-19 pandemic represents a sustained threat that may give rise to a variety of more significant adverse impacts on our business and financial results. The semiconductor industry is experiencing various supply constraints due to the pandemic. While we are working with our global supply chain partners to mitigate this risk, the duration and extent of the supply chain disruptions remain uncertain. For a further description of the uncertainties and business risks associated with the COVID-19 pandemic, see the risk factors discussed in our Annual Report on Form 10-K for the year ended December 25, 2021.

Significant Accounting Policies and the Use of Estimates

Management’s Discussion and Analysis and Note 2, Summary of Significant Accounting Policies, to the Consolidated Financial Statements in our 2021 Annual Report on Form 10-K describe the significant accounting estimates and significant accounting policies used in preparation of the Consolidated Financial Statements. Actual results in these areas could differ from management’s estimates. During the six months ended June 25, 2022, there were no significant changes in our significant accounting policies or estimates from those reported in our Annual Report on Form 10-K for the year ended December 25, 2021, which was filed with the Securities and Exchange Commission on February 18, 2022.

Results of Operations

The following table sets forth our operating results as a percentage of revenues for the periods indicated:

Revenues by Segment and Market

(In thousands)

24

(Dollars in thousands)

The increase in Foundry & Logic product revenue for the three and six months ended June 25, 2022, compared to the three and six months ended June 26, 2021, was driven principally by the increased demand and increased unit sales to other large semiconductor foundries and integrated device manufacturers.

The decrease in DRAM product revenue for the three and six months ended June 25, 2022, compared to the three and six months ended June 26, 2021, was driven by decreased design wins and customer demand.

The increase in Flash product revenue for the three and six months ended June 25, 2022, compared to the three and six months ended June 26, 2021, was driven by increased customer demand.

The increase in Systems market revenue for the three and six months ended June 25, 2022, compared to the three and six months ended June 26, 2021, was driven by both increased sales of metrology systems and our 200 and 300 millimeter probe stations.

Revenues by Geographic Region

(Dollars in thousands)

Geographic revenue information is based on the location to which we ship the product. For example, if a certain South Korean customer purchases through their U.S. subsidiary and requests the products to be shipped to an address in South Korea, this sale will be reflected in the revenue for South Korea rather than the U.S.

Changes in revenue by geographic region for the three and six months ended June 25, 2022, compared to the three and six months ended June 26, 2021, were primarily attributable to changes in customer demand, shifts in customer regional manufacturing strategies, particularly with our large multinational customers, and product sales mix. More specifically, the increase in revenues for China and Malaysia were driven principally by a single large U.S.-based company with operations in China and Malaysia. Further increases in China were driven by increased demand from a large Chinese DRAM integrated device manufacturer.

Cost of Revenues and Gross Margins

Cost of revenues consists primarily of manufacturing materials, compensation and benefits, shipping and handling costs, manufacturing-related overhead and amortization of certain intangible assets. Our manufacturing operations rely on a limited number of suppliers to provide key components and materials for our products, some of which are a sole source. We order materials and supplies based on backlog and forecasted customer orders. Tooling and setup costs related to changing manufacturing lots at our suppliers are also included in the cost of revenues. We expense all warranty costs, inventory provisions and amortization of certain intangible assets as cost of revenues.

Our gross profit and gross margin were as follows (dollars in thousands):

26

Our gross profit and gross margin by segment were as follows (dollars in thousands):

Probe Cards

For the three and six months ended June 25, 2022, gross margins increased compared to the three and six months ended June 26, 2021, primarily due to higher revenues and improved standard margins related to favorable product mix, partially offset by higher net manufacturing spending driven by higher material and labor costs, and — for the three month periods — unfavorable absorption of costs despite higher production volumes.

Systems

For the three and six months ended June 25, 2022, gross margins increased compared to the three and six months ended June 26, 2021, primarily as a result of favorable product mix primarily driven by increased sales of metrology tools at favorable margins, and improved leverage on fixed costs at these higher volumes.

Corporate and Other

Corporate and Other includes unallocated expenses relating to share-based compensation and amortization of intangible assets, inventory and fixed asset fair value adjustments due to acquisitions, and restructuring which are not used in evaluating the results of, or in allocating resources to, our reportable segments. The reduction in Corporate and Other for the three and six months ended June 25, 2022 compared to the three and six months ended June 26, 2021 is primarily due to a reduction in the amortization of intangibles resulting from significant intangibles becoming fully amortized, partially offset by increased share-based compensation driven by increases in headcount to support our growth.

Overall

Gross profit and gross margins fluctuate with revenue levels, product mix, selling prices, factory loading and material costs. For the three and six months ended June 25, 2022, compared to the three and six months ended June 26, 2021, gross profit and gross margins have increased on higher revenue levels, favorable product mix, and less amortization of intangibles.

Cost of revenues included stock-based compensation expense as follows (in thousands):

27

Research and Development

(Dollars in thousands)

The increase in research and development expenses in the three and six months ended June 25, 2022 when compared to the corresponding period in the prior year was primarily driven by an increase in headcount to support our continued investment in technology leadership. Increased general operational costs, annual salary adjustments, project material costs, and stock-based compensation also contributed to the increase.

A detail of the changes is as follows (in thousands):

Research and development included stock-based compensation expense as follows (in thousands):

Selling, General and Administrative

(Dollars in thousands)

28

The increase in selling, general and administrative expenses in the three and six months ended June 25, 2022 when compared to the corresponding period in the prior year was primarily driven by increased headcount, annual salary adjustments, increased travel related costs as restrictions related to COVID-19 relaxed, and higher stock-based compensation. We expect travel costs to continue to return to previous levels assuming travel restrictions continue to ease. These increases were partially offset by lower amortization of intangibles.

A detail of the changes is as follows (in thousands):

Selling, general and administrative included stock-based compensation expense as follows (in thousands):

Interest Income and Interest Expense

Interest income is earned on our cash, cash equivalents, restricted cash and marketable securities. The increase in interest income for the three and six months ended June 25, 2022 compared with the corresponding period of the prior year was attributable to a slight increase in investment yields due to the higher interest rate environment on higher invested balances.

Interest expense primarily includes interest on our term loans, interest rate swap derivative contracts, and term loan issuance costs amortization charges. The interest expense for the three and six months ended June 25, 2022 compared to the same period of the prior year remained consistent despite a lower outstanding debt due to increased average interest rates on the outstanding debt.

Other Income (Expense), Net

Other income (expense), net, primarily includes the effects of foreign currency impact and various other gains and losses.

Provision for Income Taxes

(In thousands, except percentages)

Provision for income taxes reflects the tax provision on our operations in foreign and U.S. jurisdictions, offset by tax benefits from tax credits and the foreign-derived intangible income (“FDII”) deduction. Our effective tax rate may vary from period to period based on changes in estimated taxable income or loss by jurisdiction, changes to the valuation allowance, changes to U.S. federal, state or foreign tax laws, changes in ASC 718 stock-based compensation expense/benefit, future expansion into areas with varying country, state, and local income tax rates, and deductibility of certain costs and expenses by jurisdiction.

We have utilized our previous net operating loss carryforwards, and expect the FDII deduction and corresponding benefit to be available, resulting in a decrease from the U.S. statutory rate for the year ending December 31, 2022.

The decrease in the effective tax rate in the three months ended June 25, 2022 when compared to the corresponding period in the prior year was primarily driven by an increased tax deduction from FDII.

As of January 1, 2022, the Tax Cuts and Jobs Act of 2017 eliminates the option to deduct research and experimental expenditures immediately in the year incurred and requires taxpayers to amortize such expenditures over five years in the U.S. and fifteen years in foreign jurisdictions. While it is possible that Congress may defer, modify, or repeal this provision, potentially with retroactive effect, we have no assurance that this provision will be deferred, modified, or repealed. If this provision is not deferred, modified, or repealed with retroactive effect to January 1, 2022, we expect our cash taxes to slowly increase over the next few years until we have fully utilized our Federal research and development credits to offset our Federal tax liability to the extent allowed by law.

Liquidity and Capital Resources

Capital Resources

Our working capital was $377.5 million at June 25, 2022, compared to $375.3 million at December 25, 2021.

Cash and cash equivalents primarily consist of deposits held at banks, money market funds, U.S. treasuries and commercial paper. Marketable securities primarily consist of U.S. treasuries, corporate bonds, and commercial paper. We typically invest in highly-rated securities with low probabilities of default. Our investment policy requires investments to be rated single A or better, and limits the types of acceptable investments, issuer concentration and duration of the investment.

Our cash, cash equivalents and marketable securities totaled approximately $266.3 million at June 25, 2022, compared to $276.1 million at December 25, 2021. Based on our historical results of operations, we expect that our cash, cash equivalents, and marketable securities on hand, and the cash we expect to generate from operations, will be sufficient to fund our short-term and long-term liquidity requirements primarily arising from: research and development, capital expenditures, working capital, outstanding commitments, and other liquidity requirements associated with existing operations. However, we cannot be certain that our cash, cash equivalents, and marketable securities on hand, and cash generated from operations, will be available in the future to fund all of our capital and operating requirements. In addition, any future strategic investments and significant acquisitions may require additional cash and capital resources. To the extent necessary, we may consider entering into short and long-term debt obligations, raising cash through a stock issuance, or obtaining new financing facilities, which may not be available on terms favorable to us. If we are unable to obtain sufficient cash or capital to meet our needs on a timely basis and on favorable terms, our business and operations could be materially and adversely affected.

If we are unsuccessful in maintaining or growing our revenues, maintaining or reducing our cost structure (in response to a potential reduction in demand due to an industry downturn, COVID-19, or other event), or increasing our available cash through debt or equity financings, our cash, cash equivalents and marketable securities may decline.

We utilize a variety of tax planning and financing strategies to manage our worldwide cash and deploy funds to locations where needed. As part of these strategies, we indefinitely reinvest a portion of our foreign earnings. Should we require additional capital in the United States, we may elect to repatriate indefinitely-reinvested foreign funds or raise capital in the United States.

Cash Flows

The following table sets forth our net cash flows from operating, investing and financing activities:

(In thousands)

Operating Activities

Net cash provided by operating activities for the six months ended June 25, 2022 was primarily attributable to net income of $60.1 million and net non-cash expenses of $42.0 million, which includes depreciation, amortization, stock-based compensation, and the provision for excess and obsolete inventories. These inflows were partially offset by net changes in working capital of $15.3 million, primarily related to cash paid for inventories of $32.3 million, partially offset by cash provided by an increase in accounts payable of $7.5 million, an increase in accrued liabilities for $4.1 million, and a reduction in accounts receivable of $5.5 million.

Investing Activities

Net cash used in investing activities for the six months ended June 25, 2022 was primarily related to $30.1 million property, plant and equipment purchases, $6.9 million net cash used to purchase marketable securities, and $3.1 million for acquisition of a business.

Financing Activities

Net cash used in financing activities for the six months ended June 25, 2022 primarily related to $54.3 million used to purchase common stock under our stock repurchase programs, $4.4 million of principal payments made towards the repayment of our term loans, and $4.2 million related to tax withholdings associated with the net share settlements of our equity awards, partially offset by $5.7 million of proceeds received from issuances of common stock under our employee stock purchase plan.

Debt

FRT Term Loan

On October 25, 2019, we entered into a $23.4 million three-year credit facility loan agreement (the “FRT Term Loan”), to fund the acquisition of FRT GmbH, which we acquired on October 9, 2019.

The FRT Term Loan bears interest at a rate equal to the Euro Interbank Offered Rate (“EURIBOR”) plus 1.75% per annum and will be repaid in quarterly installments of approximately $1.8 million plus interest. The interest rate at June 25, 2022 was 1.29%. As of June 25, 2022, the balance outstanding pursuant to the FRT term loan was $3.7 million. The FRT Term Loan is expected to be fully paid as of October 25, 2022.

Building Term Loan

On June 22, 2020, we entered into an $18.0 million 15-year credit facility loan agreement (the “Building Term Loan”). The proceeds of the Building Term Loan were used to finance the purchase of a building adjacent to our leased facilities in Livermore, California.

The Building Term Loan bears interest at a rate equal to the applicable LIBOR rate plus 1.75% per annum. Interest payments are payable in monthly installments over a fifteen-year period. The interest rate at June 25, 2022 was 2.81%. As of June 25, 2022, the balance outstanding pursuant to the Building Term Loan was $16.0 million.

On March 17, 2020, we entered into a forward starting interest rate swap agreement to hedge the interest payments on the Building Term Loan for the notional amount of $18.0 million, and an amortization period that matches the debt. As future levels of LIBOR over the life of the loan are uncertain, we entered into this interest-rate swap agreement to hedge the exposure in interest rate risks associated with movement in LIBOR rates. By entering into the agreement, we converted a floating interest rate of one-month LIBOR plus 1.75% into a fixed interest rate of 2.75%. As of June 25, 2022, the notional amount of the loan that is subject to this interest rate swap is $16.0 million.

Stock Repurchase Programs

On October 26, 2020, our Board of Directors authorized a two-year program to repurchase up to $50 million of outstanding common stock to offset potential dilution from issuances of common stock under our stock-based compensation programs. During fiscal 2021 we repurchased and retired 622,400 shares of common stock for $24.0 million. During the six months ended June 25, 2022, we repurchased and retired 676,408 shares of common stock for $26.0 million, utilizing the remaining funds available for repurchase.

On May 20, 2022, our Board of Directors authorized an additional program to repurchase up to $75 million of outstanding common stock, also with the primary purpose to offset potential dilution from issuances of common stock under our stock-based compensation programs. The share repurchase program will expire on May 20, 2024. During the three months ended June 25, 2022, we repurchased and retired 767,083 shares of common stock for $28.4 million under this program. As of June 25, 2022, $46.6 million remained available for future repurchases.

Contractual Obligations and Commitments

The following table summarizes our significant contractual commitments to make future payments in cash under contractual obligations as of June 25, 2022:

(1) Represents our minimum interest payment commitments at 2.81% per annum for the Building Term Loan and 1.29% per annum for the FRT Term Loan. This also excludes any amounts related to our interest rate swap.

Off-Balance Sheet Arrangements

Historically, we have not participated in transactions that have generated relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As of June 25, 2022, we were not involved in any such off-balance sheet arrangements.

Recent Accounting Pronouncements

See Note 1, Basis of Presentation and New Accounting Pronouncements, of Notes to Condensed Consolidated Financial Statements.

For financial market risks related to changes in interest rates and foreign currency exchange rates, reference is made to Item 7A “Quantitative and Qualitative Disclosures about Market Risk” contained in Part II of our Annual Report on Form 10-K for the fiscal year ended December 25, 2021. Our exposure to market risk has not changed materially since December 25, 2021.

Evaluation of Disclosure Controls and Procedures

Based on our management’s evaluation (with the participation of our principal executive officer and principal financial officer), as of the end of the period covered by this report, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”)) are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms and is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

There have been no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the period covered by this Quarterly Report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Limitations on the Effectiveness of Controls

Control systems, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control systems’ objectives are being met. Further, the design of any control systems must reflect the fact that there are resource constraints, and the benefits of all controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected. These inherent limitations include the realities that judgments in decision making can be faulty and that breakdowns can occur because of a simple error or mistake. Control systems can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based, in part, on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.

CEO and CFO Certifications

We have attached as exhibits to this Quarterly Report on Form 10-Q the certifications of our Chief Executive Officer and Chief Financial Officer, which are required in accordance with the Exchange Act. We recommend that this Item 4 be read in conjunction with the certifications for a more complete understanding of the subject matter presented.

There have been no material changes during the six months ended June 25, 2022 to the risk factors discussed in our Annual Report on Form 10-K for the year ended December 25, 2021. If any of the identified risks actually occur, our business, financial condition and results of operations could suffer. The trading price of our common stock could decline and you may lose all or part of your investment in our common stock. The risks and uncertainties described in our Annual Report on Form 10-K for the year ended December 25, 2021 are not the only ones we face. Additional risks that we currently do not know about or that we currently believe to be immaterial may also impair our business operations.