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 other global, regional or national public health-related crises and the impact of our responses to them, 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 31, 2022 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 $1.3 million in the first three months of fiscal 2023 as compared to $29.9 million in the first three months of fiscal 2022. The decrease in net income was primarily due to a decline in revenues and the associated decline in gross margins. 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 2022 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 April 1, 2023, 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 31, 2022, which was filed with the Securities and Exchange Commission on February 24, 2023, except for: Government Assistance In January 2023, we received $18.0 million in cash from a California Competes Grant (the “Grant”) awarded from the California Governor’s Office of Business and Economic Development. The Grant requires FormFactor to create and maintain full-time jobs and make significant infrastructure investments within California over a 5-year term. If we do not meet the requirements of the Grant, we will be required to repay all or a portion of the Grant. The Grant is included in our Condensed Consolidated Balance Sheets within Deferred grant and we have elected to recognize when earned as an offset to Cost of revenues and Operating expenses within our Condensed Consolidated Statements of Income. We have elected to present the proceeds from the Grant as cash provided by operating activities within our Condensed Consolidated Statements of Cash Flows as the grant is to offset operations. 20 Results of Operations The following table sets forth our operating results as a percentage of revenues for the periods indicated: Three Months Ended April 1, 2023 March 26, 2022 Revenues 100.0 % 100.0 % Cost of revenues 63.5 52.2 Gross profit 36.5 47.8 Operating expenses: Research and development 16.9 13.8 Selling, general and administrative 19.5 16.7 Total operating expenses 36.4 30.5 Operating income 0.1 17.3 Interest income 0.8 0.1 Interest expense (0.1) (0.1) Other income, net — 0.1 Income before income taxes 0.8 17.4 Provision for income taxes — 2.2 Net income 0.8 % 15.2 % Revenues by Segment and Market Three Months Ended April 1, 2023 March 26, 2022 (In thousands) Probe Cards $ 127,328 $ 159,983 Systems 40,120 37,191 $ 167,448 $ 197,174 Three Months Ended April 1, 2023 % of Revenues March 26, 2022 % of Revenues $ Change % Change (Dollars in thousands) Probe Cards Markets: Foundry & Logic $ 101,562 60.6 % $ 114,121 57.8 % $ (12,559) (11.0) % DRAM 19,890 11.9 34,437 17.5 (14,547) (42.2) Flash 5,876 3.5 11,425 5.8 (5,549) (48.6) Systems Market: Systems 40,120 24.0 37,191 18.9 2,929 7.9 Total revenues $ 167,448 100.0 % $ 197,174 100.0 % $ (29,726) (15.1) % Foundry & Logic — The decrease in Foundry & Logic product revenue for the three months ended April 1, 2023, compared to the three months ended March 26, 2022, was driven by the weakening demand in the semiconductor industry that began in the third quarter of fiscal 2022 and continued into the three months ended April 1, 2023 and resulted in decreased unit sales across all major customers. DRAM — The decrease in DRAM product revenue for the three months ended April 1, 2023, compared to the three months ended March 26, 2022, was driven by lower customer demand, a result of the semiconductor industry's overall demand weakening and DRAM market weakness. 21 Flash — The decrease in Flash product revenue for the three months ended April 1, 2023, compared to the three months ended March 26, 2022, was driven by decreased customer demand from large multi-national customers, a result of the semiconductor industry's overall demand weakening and Flash market weakness. Systems — The increase in Systems market revenue for the three months ended April 1, 2023, compared to the three months ended March 26, 2022, was driven by increased sales of our 200 millimeter probe stations and cryogenic systems, partially offset by decreased sales of our metrology systems. Revenues by Geographic Region Three Months Ended April 1, 2023 % of Revenues March 26, 2022 % of Revenues (Dollars in thousands) Taiwan $ 40,329 24.1 % $ 53,069 26.9 % United States 37,731 22.5 25,647 13.0 China 27,099 16.2 38,399 19.5 South Korea 20,775 12.4 27,501 13.9 Malaysia 11,270 6.7 22,199 11.3 Japan 10,977 6.6 9,382 4.8 Europe 9,426 5.6 8,395 4.3 Singapore 5,340 3.2 10,896 5.5 Rest of the world 4,501 2.7 1,686 0.8 Total revenues $ 167,448 100.0 % $ 197,174 100.0 % 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 April 1, 2023, compared to the three months ended March 26, 2022, 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 the United States, and decreases in revenues for China and Malaysia were driven principally by a single large U.S.-based company with operations in these regions. The decrease in China mentioned previously is also impacted by lowered demand from a large Chinese DRAM integrated device manufacturer and the impact from expanded export license requirements imposed by the United States government in the fourth quarter of fiscal 2022 for exporting advanced U.S. semiconductor technology sold in China. Cost of Revenues and Gross Margins Cost of revenues consists primarily of manufacturing materials, compensation and benefits, shipping and handling costs, manufacturing-related overhead (including equipment costs, related occupancy, and computer services), warranty adjustments, inventory adjustments (including write-downs for inventory obsolescence), 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 April 1, 2023 March 26, 2022 $ Change % Change Gross profit $ 61,078 $ 94,224 $ (33,146) (35.2) % Gross margin 36.5 % 47.8 % 22 Our gross profit and gross margin by segment were as follows (dollars in thousands): Three Months Ended April 1, 2023 March 26, 2022 Probe Cards Systems Corporate and Other Total Probe Cards Systems Corporate and Other Total Gross profit $ 43,623 $ 20,746 $ (3,291) $ 61,078 $ 77,202 $ 19,407 $ (2,385) $ 94,224 Gross margin 34.3 % 51.7 % 36.5 % 48.3 % 52.2 % 47.8 % Probe Cards — For the three months ended April 1, 2023, gross margins decreased compared to the three months ended March 26, 2022, primarily due to unfavorable absorption of costs on lower production volumes and greater inventory excess and obsolescence reserves. Systems — For the three months ended April 1, 2023, gross margins decreased compared to the three months ended March 26, 2022, primarily as a result of less favorable product mix. 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. Overall — Gross profit and gross margins fluctuate with revenue levels, product mix, selling prices, factory loading, labor costs, and material costs. For the three months ended April 1, 2023, compared to the three months ended March 26, 2022, gross profit and gross margins have decreased on lower revenue levels, unfavorable absorption of costs on lower production volumes, and greater inventory excess and obsolescence reserves. Cost of revenues included stock-based compensation expense as follows (in thousands): Three Months Ended April 1, 2023 March 26, 2022 Stock-based compensation $ 1,910 $ 1,078 Research and Development Three Months Ended April 1, 2023 March 26, 2022 $ Change % Change (Dollars in thousands) Research and development $ 28,245 $ 27,134 $ 1,111 4.1 % % of revenues 16.9 % 13.8 % Research and development expenses in the three months ended April 1, 2023 increased when compared to the corresponding period in the prior year primarily due to an increase in headcount, which is to support our continued investment in technology leadership. Increased general operational costs, annual salary adjustments, and stock-based compensation also contributed to the increase. These increases were partially offset by lower performance-based compensation and project material costs. A detail of the changes is as follows (in thousands): Three Months Ended April 1, 2023 compared to Three Months Ended March 26, 2022 Other general operational costs $ 490 Stock-based compensation 386 Depreciation 263 Project material costs (214) Employee compensation costs 186 $ 1,111 23 Research and development included stock-based compensation expense as follows (in thousands): Three Months Ended April 1, 2023 March 26, 2022 Stock-based compensation $ 2,372 $ 1,986 Selling, General and Administrative Three Months Ended April 1, 2023 March 26, 2022 $ Change % Change (Dollars in thousands) Selling, general and administrative $ 32,742 $ 32,906 $ (164) (0.5) % % of revenues 19.5 % 16.7 % Selling, general and administrative expenses decreased in the three months ended April 1, 2023 when compared to the corresponding period in the prior year, primarily driven by lower performance-based compensation, mostly offset by restructuring charges, higher stock-based compensation, and higher general operating expenses. A detail of the changes is as follows (in thousands): Three Months Ended April 1, 2023 compared to Three Months Ended March 26, 2022 Employee compensation (2,385) General operating expenses 843 Restructuring charges 826 Stock-based compensation 552 $ (164) Selling, general and administrative included stock-based compensation expense as follows (in thousands): Three Months Ended April 1, 2023 March 26, 2022 Stock-based compensation $ 5,008 $ 4,456 Interest Income (Expense), Net Interest income is earned on our cash, cash equivalents, restricted cash and marketable securities. The increase in interest income for the three months ended April 1, 2023 compared with the corresponding period of the prior year was attributable to an increase in investment yields due to the higher interest rate environment. Interest expense primarily includes interest on our term loan, interest rate swap derivative contracts, and term loan issuance costs amortization charges. The interest expense for the three months ended April 1, 2023 compared to the same period of the prior year decreased due to lower outstanding debt. Other Income, Net Other income, net, primarily includes the effects of foreign currency impact and various other gains and losses. We partially mitigate our risks from currency movements by hedging certain balance sheet exposures, which minimizes the impacts during periods of foreign exchange volatility. 24 Provision for Income Taxes Three Months Ended April 1, 2023 March 26, 2022 (In thousands, except percentages) Provision for income taxes $ 48 $ 4,450 Effective tax rate 3.5 % 13.0 % 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 allowing us to benefit more from the available FDII deduction, which, combined with higher research and development tax credits, results in a lower worldwide effective tax rate for the three months ended April 1, 2023 when compared to the corresponding period in the prior year. The Creating Helpful Incentives to Produce Semiconductors and Science Act of 2022 (“CHIPS Act”) was signed into law on August 9, 2022. The CHIPS Act provides for various incentives and tax credits among other items including the Advanced Manufacturing Investment Credit (“AMIC”) which equals 25% of qualified investments in an advanced manufacturing facility that is placed in service after December 31, 2022. At least a portion of our future capital expenditures and research and development costs will qualify for this credit, which benefits us by allowing us to net the credit received against our costs. The AMIC credit is accounted for outside of ASC 740 as a reduction to the depreciable basis of the assets used in operations and will not have an impact on our effective tax rate. Beginning in 2022, the U.S. Tax Cuts and Jobs Act of 2017 (“TCJA”) eliminated the existing option to deduct research and development expenditures and requires taxpayers to amortize such expenditures attributable to domestic and foreign research over five and fifteen years, respectively, pursuant to IRC Section 174. While the capitalization requirement has a negative impact on our cash flows, there are offsetting benefits from the enactment of this provision that we have included in our estimated annual effective tax rate. 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. Changes in our tax provisions or an increase in our tax liabilities, whether due to changes in applicable laws and regulations, the interpretation or application thereof, or a final determination of tax audits or litigation or agreements, could have a material adverse effect on our financial position, results of operations and/or cash flows. Liquidity and Capital Resources Capital Resources Our working capital was $352.8 million at April 1, 2023, compared to $324.9 million at December 31, 2022. Cash and cash equivalents primarily consist of deposits held at banks, money market funds, and commercial paper. Marketable securities primarily consist of U.S. treasuries, U.S. agency securities, 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 $236.3 million at April 1, 2023, compared to $238.1 million at December 31, 2022. 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. 25 If we are unsuccessful in maintaining or growing our revenues, maintaining or reducing our cost structure, 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 April 1, 2023 March 26, 2022 (In thousands) Net cash provided by operating activities $ 12,309 $ 44,155 Net cash used in investing activities $ (13,539) $ (21,078) Net cash provided by (used) in financing activities $ 4,378 $ (6,016) Operating Activities Net cash provided by operating activities for the three months ended April 1, 2023 was attributable to net income of $1.3 million and net non-cash expenses of $26.0 million, which includes depreciation, amortization, stock-based compensation, and the provision for excess and obsolete inventories, partially offset by an increase in net working capital of $15.1 million. The increase in net working capital related to an increase in accounts receivable of $15.9 million and decreases in accrued liabilities and deferred revenues of $10.2 million and $6.0 million, respectively, partially offset by an increase in deferred grant of $18.0 million. Investing Activities Net cash used in investing activities for the three months ended April 1, 2023 primarily related to $19.7 million in property, plant and equipment purchases, partially offset by $6.2 million net cash received from the maturities and sales of marketable securities. Financing Activities Net cash provided by financing activities for the three months ended April 1, 2023 primarily related to $5.0 million received from issuances of common stock under our employee stock purchase plan, partially offset by $0.3 million principal payments made towards the repayment of our term loan and $0.4 million related to tax withholdings associated with the net share settlements of our equity awards. Debt 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 April 1, 2023 was 4.66%. As of April 1, 2023, the balance outstanding pursuant to the Building Term Loan was $15.2 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 April 1, 2023, the notional amount of the loan that is subject to this interest rate swap is $15.2 million. 26 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 the three months ended March 26, 2022, we repurchased 240,548 shares of common stock for $9.4 million. We utilized the remaining funds available for repurchase under this program during fiscal 2022. 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 April 1, 2023, we did not repurchase any shares of common stock. As of April 1, 2023, $18.6 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 April 1, 2023: Payments Due In Fiscal Year Remainder 2023 2024 2025 2026 2027 Thereafter Total Operating leases $ 6,190 $ 8,106 $ 8,018 $ 6,641 $ 5,756 $ 3,431 $ 38,142 Term loans - principal payments 791 1,080 1,111 1,142 1,175 9,940 15,239 Term loans - interest payments (1) 729 912 834 763 688 2,538 6,464 Total $ 7,710 $ 10,098 $ 9,963 $ 8,546 $ 7,619 $ 15,909 $ 59,845 (1) Represents our minimum interest payment commitments at 4.66% per annum for the Building Term Loan. This 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 April 1, 2023, we were not involved in any such off-balance sheet arrangements. Recent Accounting Standards For a description of a recent change in accounting standards, including the expected dates of adoption and estimated effects, if any, in our condensed consolidated financial statements, see Note 1, Basis of Presentation and Significant Accounting Policies, in Part I, Item 1 of this Form 10-Q.