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. 19 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 (including developments related to Ukraine and Russia), 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 $29.9 million in the first three months of fiscal 2022 as compared to $19.6 million in the first three 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. 20 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 three months ended March 26, 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: Three Months Ended March 26, 2022 March 27, 2021 Revenues 100.0 % 100.0 % Cost of revenues 52.2 58.9 Gross profit 47.8 41.1 Operating expenses: Research and development 13.8 12.9 Selling, general and administrative 16.7 16.1 Total operating expenses 30.5 29.0 Operating income 17.3 12.1 Interest income 0.1 0.1 Interest expense (0.1) (0.1) Other income, net 0.1 0.1 Income before income taxes 17.4 12.2 Provision for income taxes 2.2 1.7 Net income 15.2 % 10.5 % Revenues by Segment and Market Three Months Ended March 26, 2022 March 27, 2021 (In thousands) Probe Cards $ 159,983 $ 158,898 Systems 37,191 27,738 $ 197,174 $ 186,636 Three Months Ended March 26, 2022 % of Revenues March 27, 2021 % of Revenues $ Change % Change (Dollars in thousands) Probe Cards Markets: Foundry & Logic $ 114,121 57.8 % $ 113,410 60.7 % $ 711 0.6 % DRAM 34,437 17.5 33,898 18.2 539 1.6 Flash 11,425 5.8 11,590 6.2 (165) (1.4) Systems Market: Systems 37,191 18.9 27,738 14.9 9,453 34.1 Total revenues $ 197,174 100.0 % $ 186,636 100.0 % $ 10,538 5.6 % 21 Our Probe Cards markets for the three months ended March 26, 2022, improved slightly in total compared to the three months ended March 27, 2021, despite a decline within our top two customers in these periods. Our ability to maintain and grow our revenues, despite product mix changes between our top customers, is the result of our long-term customer and market diversification initiatives. The increase in Systems market revenue for the three months ended March 26, 2022, compared to the three months ended March 27, 2021, was driven by increased sales of metrology systems and our 200 and 300 millimeter probe stations. Revenues by Geographic Region Three Months Ended March 26, 2022 % of Revenue March 27, 2021 % of Revenue (Dollars in thousands) Taiwan $ 53,069 26.9 % $ 45,580 24.4 % China 38,399 19.5 42,625 22.8 South Korea 27,501 13.9 19,085 10.2 United States 25,647 13.0 29,486 15.8 Malaysia 22,199 11.3 19,930 10.7 Singapore 10,896 5.5 8,558 4.6 Japan 9,382 4.8 9,321 5.0 Europe 8,395 4.3 9,999 5.4 Rest of the world 1,686 0.8 2,052 1.1 Total revenues $ 197,174 100.0 % $ 186,636 100.0 % 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 26, 2022, compared to the three months ended March 27, 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. 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 26, 2022 March 27, 2021 $ Change % Change Gross profit $ 94,224 $ 76,706 $ 17,518 22.8 % Gross margin 47.8 % 41.1 % 22 Our gross profit and gross margin by segment were as follows (dollars in thousands): Three Months Ended March 26, 2022 March 27, 2021 Probe Cards Systems Corporate and Other Total Probe Cards Systems Corporate and Other Total Gross profit $ 77,202 $ 19,407 $ (2,385) $ 94,224 $ 70,315 $ 13,599 $ (7,208) $ 76,706 Gross margin 48.3 % 52.2 % 47.8 % 44.3 % 49.0 % 41.1 % Probe Cards For the three months ended March 26, 2022, gross margins increased compared to the three months ended March 27, 2021, primarily due to improved standard margins due to change in product mix, favorable absorption of costs on higher production volumes, and favorable capitalization, partially offset by higher manufacturing spending driven by higher material costs from fluctuations in commodity costs. Systems For the three months ended March 26, 2022, gross margins increased compared to the three months ended March 27, 2021, primarily as a result of favorable product mix, largely related to increased sales of metrology systems 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 months ended March 26, 2022 compared to the three months ended March 27, 2021 is primarily due to a reduction in the amortization of intangibles from significant intangibles becoming fully amortized. 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 26, 2022, compared to the three months ended March 27, 2021, gross profit and gross margins have increased on greater revenue levels, a favorable product mix, and less amortization of intangibles. Cost of revenues included stock-based compensation expense as follows (in thousands): Three Months Ended March 26, 2022 March 27, 2021 Stock-based compensation $ 1,078 $ 1,335 Research and Development Three Months Ended March 26, 2022 March 27, 2021 $ Change % Change (Dollars in thousands) Research and development $ 27,134 $ 24,046 $ 3,088 12.8 % % of revenues 13.8 % 12.9 % The increase in research and development expenses in the three months ended March 26, 2022 when compared to the corresponding period in the prior year was primarily driven by an increase in headcount to support current operating levels. Increased general operational costs, annual salary adjustments, project material costs, and stock-based compensation also contributed to the increase. 23 A detail of the changes is as follows (in thousands): Three Months Ended March 26, 2022 compared to Three Months Ended March 27, 2021 Employee compensation costs $ 1,606 Other general operations 967 Stock-based compensation 297 Project material costs 218 $ 3,088 Research and development included stock-based compensation expense as follows (in thousands): Three Months Ended March 26, 2022 March 27, 2021 Stock-based compensation $ 1,986 $ 1,689 Selling, General and Administrative Three Months Ended March 26, 2022 March 27, 2021 $ Change % Change (Dollars in thousands) Selling, general and administrative $ 32,906 $ 30,015 $ 2,891 9.6 % % of revenues 16.7 % 16.1 % The increase in selling, general and administrative expenses in the three months ended March 26, 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): Three Months Ended March 26, 2022 compared to Three Months Ended March 27, 2021 Employee compensation costs $ 1,385 General operating expenses 602 Travel related costs 656 Stock-based compensation 403 Amortization of intangibles (155) $ 2,891 Selling, general and administrative included stock-based compensation expense as follows (in thousands): Three Months Ended March 26, 2022 March 27, 2021 Stock-based compensation $ 4,456 $ 4,053 24 Interest Income and Interest Expense 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 26, 2022 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 interest expense for the three months ended March 26, 2022 compared to the same period of the prior year increased slightly primarily 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 Three Months Ended March 26, 2022 March 27, 2021 (In thousands, except percentages) Provision for income taxes $ 4,450 $ 3,206 Effective tax rate 13.0 % 14.0 % 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 31, 2022. The decrease in the effective tax rate in the three months ended March 26, 2022 when compared to the corresponding period in the prior year was primarily driven by an increased tax deduction from foreign derived intangible income, offset by a reduction in stock-based compensation tax benefits. 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 $401.5 million at March 26, 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 $296.4 million at March 26, 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 25 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, developments related to Ukraine and Russia, 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: Three Months Ended March 26, 2022 March 27, 2021 (In thousands) Net cash provided by operating activities $ 44,155 $ 32,356 Net cash used in investing activities $ (21,078) $ (39,922) Net cash used in financing activities $ (6,016) $ (3,768) Operating Activities Net cash provided by operating activities for the three months ended March 26, 2022 was primarily attributable to net income of $29.9 million and net non-cash expenses of $22.0 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 $7.7 million primarily related to cash paid for inventories of $17.1 million, partially offset by cash provided by an increase in accounts payable for $10.2 million. Investing Activities Net cash used in investing activities for the three months ended March 26, 2022 was primarily related to $15.6 million property, plant and equipment acquisitions and $5.5 million net cash used to purchase marketable securities. Financing Activities Net cash used in financing activities for the three months ended March 26, 2022 primarily related to $9.4 million used to purchase common stock under our stock repurchase program and $2.2 million of principal payments made towards the repayment of our term loans, partially offset by $5.7 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 26, 2022 was 1.20%. As of March 26, 2022, the balance outstanding pursuant to the FRT term loan was $5.8 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. 26 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 26, 2022 was 1.98%. As of March 26, 2022, the balance outstanding pursuant to the Building Term Loan was $16.3 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 converted a floating rate interest at one-month LIBOR plus 1.75% into a fixed rate interest at 2.75%. As of March 26, 2022, the notional amount of the loan that is subject to this interest rate swap is $16.3 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 26, 2022, we repurchased 240,548 shares of common stock for $9.4 million. During 2021, we repurchased and retired 622,400 shares of common stock for $24.0 million. As of March 26, 2022, $16.6 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 March 26, 2022: Payments Due In Fiscal Year Remainder 2022 2023 2024 2025 2026 Thereafter Total Operating leases $ 6,589 $ 7,680 $ 7,317 $ 7,270 $ 6,532 $ 9,195 $ 44,583 Term loans - principal payments 6,535 1,050 1,080 1,111 1,142 11,116 22,034 Term loans - interest payments (1) 276 302 282 258 236 996 2,350 Total $ 13,400 $ 9,032 $ 8,679 $ 8,639 $ 7,910 $ 21,307 $ 68,967 (1) Represents our minimum interest payment commitments at 1.98% per annum for the Building Term Loan and 1.20% 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 26, 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.