FORMFACTOR INC 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 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, 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, 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 26, 2020 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 test and measurement technologies. 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 lower production costs, improve yields, and enable development of their complex next-generation products. 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, and thermal and cryogenic systems are included in the Systems segment. We generated net income of $19.6 million in the first three months of fiscal 2021 as compared to $15.9 million in the first three months of fiscal 2020. The increase in net income was primarily due to increased revenues, 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 have maintained social distancing, contact tracing, and various other measures to enable our manufacturing sites to continue efficient production. We believe that we operate in a critical infrastructure industry, as defined by the U.S. Department of Homeland Security. This reduces the current and anticipated impacts of the COVID-19 pandemic on our major customers and suppliers, and upon our operations, as compared to companies that are not part of the critical infrastructure. We currently continue to operate in all of our manufacturing sites at production levels comparable to those prior to the pandemic, albeit subject to certain safety and related constraints. Our other operations are similarly continuing with substantial work-from-home activities. 24 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 to date the disruptions in our operations, supply chain and customer demand as a result of the COVID-19 pandemic have been somewhat limited, we 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. 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 26, 2020. 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 2020 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 three months ended March 27, 2021, 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 26, 2020, which was filed with the Securities and Exchange Commission on February 22, 2021. Results of Operations The following table sets forth our operating results as a percentage of revenues for the periods indicated: Three Months Ended March 27, 2021 March 28, 2020 Revenues 100.0 % 100.0 % Cost of revenues 58.9 58.1 Gross profit 41.1 41.9 Operating expenses: Research and development 12.9 13.2 Selling, general and administrative 16.1 17.2 Total operating expenses 29.0 30.4 Operating income 12.1 11.5 Interest income 0.1 0.4 Interest expense (0.1) (0.2) Other income (expense), net 0.1 (0.1) Income before income taxes 12.2 11.6 Provision for income taxes 1.7 1.8 Net income 10.5 % 9.8 % Revenues by Segment and Market Three Months Ended March 27, 2021 March 28, 2020 (In thousands) Probe Cards $ 158,898 $ 134,715 Systems 27,738 26,038 $ 186,636 $ 160,753 25 Three Months Ended March 27, 2021 % of Revenues March 28, 2020 % of Revenues $ Change % Change (Dollars in thousands) Probe Cards Markets: Foundry & Logic $ 113,410 60.7 % $ 105,745 65.8 % $ 7,665 7.2 % DRAM 33,898 18.2 24,696 15.4 9,202 37.3 Flash 11,590 6.2 4,274 2.7 7,316 171.2 Systems Market: Systems 27,738 14.9 26,038 16.1 1,700 6.5 Total revenues $ 186,636 100.0 % $ 160,753 100.0 % $ 25,883 16.1 % The increase in Foundry & Logic product revenue for the three months ended March 27, 2021, compared to the three months ended March 28, 2020, was driven principally by increased unit sales to large semiconductor foundries and integrated device manufacturers, demonstrating success in diversifying across our strategic accounts. Additionally, sales have increased due to the demand for components and chipsets for 5G handsets, work and study from home infrastructure spending, and adoption of advanced packaging architectures like heterogeneous integration and high-bandwidth memory (“HBM”). The relative increase in DRAM product revenue for the three months ended March 27, 2021, compared to the three months ended March 28, 2020, was driven by a decreased customer demand for the three months ended March 28, 2020 as a result of the absorption of large purchases in fiscal 2019, that did not recur in the three months ended March 27, 2021. The increase in Flash product revenue for the three months ended March 27, 2021, compared to the three months ended March 28, 2020, was driven by increased sales as a result of increased customer demand for our legacy products and increased sales resulting from the acquisition of Baldwin Park. Our revenue in this market continues to be highly variable. The increase in Systems product revenue for the three months ended March 27, 2021, compared to the three months ended March 28, 2020, was driven by increased sales of cryogenic systems due to the acquisition of High Precision Devices, Inc. (“HPD”) and increased sales of thermal sub-systems, partially offset by lower 300mm station sales. Due to COVID-19, there were various impacts across our segments due to governmental mandates of social distancing. This resulted in a temporary factory shutdown for almost two weeks during our first fiscal quarter of 2020 in certain locations, limiting our manufacturing capacity. We believe these shutdowns negatively affected revenue and impacted our ability to maintain typical lead times, especially in our Probes segment. The plant shutdowns we experienced in the first fiscal quarter of 2020 did not recur in the first fiscal quarter of 2021, which presumably drove some of the increased sales in the first fiscal quarter of 2021 over the first fiscal quarter of 2020, particularly in the Probe Cards segment where the plant shutdowns in 2020 were longer in duration than the shutdowns for the Systems segment. 26 Revenues by Geographic Region Three Months Ended March 27, 2021 % of Revenue March 28, 2020 % of Revenue (Dollars in thousands) Taiwan $ 45,580 24.4 % $ 31,780 19.8 % China 42,625 22.8 % 43,642 27.1 % United States 29,486 15.8 % 31,916 19.9 % Asia-Pacific 1 28,958 15.5 % 7,863 4.9 % South Korea 19,085 10.2 % 14,088 8.8 % Europe 9,999 5.4 % 21,043 13.1 % Japan 9,321 5.0 % 8,370 5.2 % Rest of the world 1,582 0.9 % 2,051 1.2 % Total revenues $ 186,636 100.0 % $ 160,753 100.0 % 1 Asia-Pacific includes all countries in the region except China, Japan, South Korea and Taiwan, which are disclosed separately. 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 months ended March 27, 2021, compared to the three months ended March 28, 2020, were primarily attributable to changes in customer demand, shifts in customer regional manufacturing strategies, particularly with our large multinational customers, and product sales mix. 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): Three Months Ended March 27, 2021 March 28, 2020 $ Change % Change Gross profit $ 76,706 $ 67,390 $ 9,316 13.8 % Gross margin 41.1 % 41.9 % Our gross profit and gross margin by segment were as follows (dollars in thousands): Three Months Ended March 27, 2021 March 28, 2020 Probe Cards Systems Corporate and Other Total Probe Cards Systems Corporate and Other Total Gross profit $ 70,315 $ 13,599 $ (7,208) $ 76,706 $ 60,743 $ 13,334 $ (6,687) $ 67,390 Gross margin 44.3 % 49.0 % — % 41.1 % 45.1 % 51.2 % — % 41.9 % Probe Cards For the three months ended March 27, 2021, gross profit and gross margins decreased compared to the three months ended March 28, 2020, primarily due to less favorable absorption of costs from the mix of volumes through production sites and due 27 to product mix on a less favorable mix of higher gross margin Foundry & Logic probe card sales combined with higher sales of lower gross margin Flash probe cards. Systems For the three months ended March 27, 2021, gross margins decreased compared to the three months ended March 28, 2020, primarily as a result of less favorable product mix, largely related to lower sales of stations and related accessories at somewhat reduced gross margins on the lower volumes, partially offset by higher gross margins on higher sales of thermal sub-systems and additional contribution from HPD, which was acquired in the fourth fiscal quarter of 2020. 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 which are not used in evaluating the results of, or in allocating resources to, our reportable segments. Overall Gross profit and gross margins fluctuate with revenue levels, product mix, selling prices, factory loading and material costs. For the three months ended March 27, 2021, compared to the three months ended March 28, 2020, gross profit and gross margins have decreased, primarily on product mix. Cost of revenues included stock-based compensation expense as follows (in thousands): Three Months Ended March 27, 2021 March 28, 2020 Stock-based compensation $ 1,335 $ 937 Research and Development Three Months Ended March 27, 2021 March 28, 2020 $ Change % Change (Dollars in thousands) Research and development $ 24,046 $ 21,267 $ 2,779 13.1 % % of revenues 12.9 % 13.2 % The increase in research and development expenses in the three months ended March 27, 2021 when compared to the corresponding period in the prior year was primarily driven by increased headcount, increased facilities costs in other general operations, higher project material costs, higher stock-based compensation and higher depreciation expense. These increases are primarily related to our recent acquisitions of Baldwin Park and HPD. A detail of the changes is as follows (in thousands): Three Months Ended March 27, 2021 compared to Three Months Ended March 27, 2020 Employee compensation costs $ 1,436 Project material costs 304 Stock-based compensation 250 Depreciation 114 Other general operations 675 $ 2,779 28 Research and development included stock-based compensation expense as follows (in thousands): Three Months Ended March 27, 2021 March 28, 2020 Stock-based compensation $ 1,689 $ 1,439 Selling, General and Administrative Three Months Ended March 27, 2021 March 28, 2020 $ Change % Change (Dollars in thousands) Selling, general and administrative $ 30,015 $ 27,693 $ 2,322 8.4 % % of revenues 16.1 % 17.2 % The increase in selling, general and administrative in the three months ended March 27, 2021 when compared to the corresponding period in the prior year was primarily due to an increase in headcount, higher stock-based compensation, and increase in amortization of intangibles. These increases are primarily related to the acquisitions of Baldwin Park and HPD, partially offset by decreased travel due to travel restrictions. A detail of the changes is as follows (in thousands): Three Months Ended March 27, 2021 compared to Three Months Ended March 27, 2020 Employee compensation $ 2,072 Stock-based compensation 806 Amortization of intangibles 202 Travel related costs (598) Consulting fees (178) General operating expenses 18 $ 2,322 Selling, general and administrative included stock-based compensation expense as follows (in thousands): Three Months Ended March 27, 2021 March 28, 2020 Stock-based compensation $ 4,053 $ 3,247 Interest Income and Interest Expense Three Months Ended March 27, 2021 March 28, 2020 (Dollars in thousands) Interest Income $ 194 $ 685 Weighted average balance of cash and investments $ 266,209 $ 210,791 Weighted average yield on cash and investments 0.38 % 1.68 % Interest Expense $ 180 $ 318 Average debt outstanding $ 32,263 $ 42,854 Weighted average interest rate on debt 1.62 % 2.50 % 29 Interest income is earned on our cash, cash equivalents, restricted cash and marketable securities. The decrease in interest income for the three months ended March 27, 2021 compared with the corresponding period of the prior year was attributable to lower investment yields due to the low interest rate environment despite 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 decrease in interest expense for the three months ended March 27, 2021 compared to the same period of the prior year was primarily due to lower outstanding debt balances due to the pay-off of the CMI Term Loan on June 30, 2020, partially offset by the Building Term Loan that originated in the second quarter of 2020. Interest expense was also lower due to lower 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 Three Months Ended March 27, 2021 March 28, 2020 (In thousands, except percentages) Provision for income taxes $ 3,206 $ 2,816 Effective tax rate 14.0 % 15.1 % 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 and included in our worldwide effective tax rate for the year ending December 25, 2021. Liquidity and Capital Resources Capital Resources Our working capital was $351.5 million at March 27, 2021, compared to $332.5 million at December 26, 2020. Cash and cash equivalents primarily consist of deposits held at banks and money market funds. Marketable securities primarily consist of U.S. treasuries and corporate bonds. 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 $267.7 million at March 27, 2021, compared to $255.0 million at December 26, 2020. We believe that we will be able to satisfy our working capital requirements and scheduled term loan repayments for at least the next twelve months with the liquidity provided by our existing cash, cash equivalents, marketable securities and cash provided by operations. 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. Our future capital requirements may vary materially from those now planned. The COVID-19 pandemic has negatively impacted the global economy, disrupted global supply chains and created significant volatility and disruption of financial markets. An extended period of global supply chain and economic disruption could materially affect our business, results of operations, access to sources of liquidity and financial condition. 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. 30 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: Three Months Ended March 27, 2021 March 28, 2020 (In thousands) Net cash provided by operating activities $ 32,356 $ 39,339 Net cash used in investing activities (39,922) (5,442) Net cash used in financing activities $ (3,768) $ (9,071) Operating Activities Net cash provided by operating activities for the three months ended March 27, 2021 was primarily attributable to net income of $19.6 million and net non-cash expenses of $27.4 million, further impacted by changes in operating assets and liabilities, as explained below. Accounts receivable, net, decreased $4.1 million to $103.5 million at March 27, 2021, compared to $107.6 million at December 26, 2020, as a result of lower revenue for the three months ended March 27, 2021, compared to the revenue for the three months ended December 26, 2020. Inventories, net, increased $5.5 million to $104.7 million at March 27, 2021, compared to $99.2 million at December 26, 2020, as a result of anticipated projected customer demand. Accounts payable increased $5.7 million to $67.7 million at March 27, 2021, compared to $62.0 million at December 26, 2020, as a result of timing of payments to vendors. Accrued liabilities decreased $11.8 million to $43.5 million at March 27, 2021, compared to $55.3 million at December 26, 2020, as a result of timing of payments for accrued taxes payable, a decrease in accrued variable compensation, decrease in employee compensation accrual, and decrease in employee stock purchase plan accrual from the issuance of common stock to employees under our employee stock purchase plan. Investing Activities Net cash used in investing activities for the three months ended March 27, 2021 was primarily related to $13.5 million of acquisition of property, plant and equipment and $26.5 million of net cash used to purchase marketable securities. Financing Activities Net cash used in financing activities for the three months ended March 27, 2021 primarily related to $2.4 million of principal payments made towards the repayment of our term loans, $1.1 million related to tax withholding associated with the net share settlements of our equity awards, and $5.7 million used to purchase common stock under our stock repurchase program, partially offset by $5.5 million of proceeds received from issuances of common stock under our employee stock purchase plan and stock option plans. 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 $2.0 million plus interest. The interest rate at March 27, 2021 was 1.21%. As of March 27, 2021, the balance outstanding pursuant to the FRT term loan was $14.4 million. 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 a building adjacent to our leased facilities in Livermore, California. 31 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 March 27, 2021 was 1.87%. As of March 27, 2021, the balance outstanding pursuant to the Building Term Loan was $17.3 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 convert a floating rate interest at one-month LIBOR plus 1.75% into a fixed rate interest at 2.75%. The interest rate swap also includes a 0% floor that is effective for one year from the date of the swap. As of March 27, 2021, the notional amount of the loan that is subject to this interest rate swap is $17.3 million. Stock Repurchase Program In October 2020, our Board of Directors authorized a program to repurchase up to $50.0 million of outstanding common stock to offset potential dilution from issuances of common stock under our stock-based compensation plans. The share repurchase program will expire on October 28, 2022. During the three months ended March 27, 2021, we repurchased 136,402 shares of common stock for $5.7 million and, as of March 27, 2021, $44.3 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 March 27, 2021: Payments Due In Fiscal Year Remainder 2020 2021 2022 2023 2024 Thereafter Total Operating leases $ 6,747 $ 8,040 $ 6,710 $ 6,297 $ 7,814 $ 14,416 $ 50,024 Term loans - principal payments 6,949 9,276 1,050 1,080 1,111 12,258 31,724 Term loans - interest payments (1) 360 373 290 271 248 1,185 2,727 Total $ 14,056 $ 17,689 $ 8,050 $ 7,648 $ 9,173 $ 27,859 $ 84,475 (1) Represents our minimum interest payment commitments at 1.87% per annum for the Building Term Loan and 1.21% 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 March 27, 2021, 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.