One Guy's Investments: FORM post-call update

OK, so I wrote up my initial reaction to the FORM earnings press release as a little pessimism was setting in and driving away the gains of earlier in the day ... then it turns out that the initial after-hours pessimism turned around pretty quick once the conference call really got going. Lots of optimism out of management, which is nothing new for Formfactor, but we finally seem to have some good production out of the new facility that's helping to drive margins and volumes higher and get their capacity up closer to demand ... which is great.

There may be some confusion about whether or not they hit the number -- according to FORM's analysis, they hit 17 cents a share because they backed out one-time facility costs as well as the tax benefit. Seems relatively fair to me, since the facility costs going forward for the new factory are going to be part of operating margins, not just start-up costs. The consensus for Yahoo Finance was 14 cents, and for Reuters 16 cents ... my initial reaction, not factoring out their two cents of one-time costs, was 15 cents. In the sea of confusion, there was also a significant one-time cost for severance and stock-based compensation that was not included in analyst estimates, so the waves continue to lap at my brain. And to add to that, Reuters just clarified that FORM did indeed beat by two cents.

So it's safe to say, I'm pleased with those earnings ... and I'm not the only one.

And I think it's pretty clear, as we sit here at 11am up about 20%, that the market is pretty happy about the progress of the new facility and their ongoing business prospects. As I wrote a few months ago, that new facility and what it means for margin expansion and their competitiveness is absolutely key for Formactor.

These guys talk like they are ready to take over the world in their segment and no one else can even come close to their capabilities in the MEMS probe sector. I'm not an engineer, but I accept a lot of their argument -- I don't see other strong competitors who are able to do everything that FORM can do, and if it's true that they are now producing a good quantity from the new factory as they say and that they expect to be capable of $320 million in revenue annuall, I'll keep drinking the Kool Aid. That, and they believe their addressable market within a few years will be $1.5 Billion. With a B. That gives a lot of room for potential growth.

The strongest themes that I took away from the call were that this is the beginning of the real turnaround in their margins and capacity with the new factory and new products -- and that they are going to have what seems to be their most critical new product, the 300MM one-touchdown wafer probe card, in production within a year, following their 200MM version of the same product and a slightly less advanced 300MM probe that are now in testing and, in the case of the 200MM one-touch, already on the floor in their customers' plants.

So their capacity is going to increase pretty dramatically, they will continue to be able to produce the lowest cost, best performing probe test system with high performance and reliable delivery, and they appear to be capable of defending the intellectual property and R&D edge that they have over the competition -- including their 600-plus patents and their 12-14% R&D spending as well as their now state-of-the art facility that is unmatched (and somewhat snakebitten until now, but apparently that's over).

There are a few sector trends that are really working on Formfactor's favor as well. Smaller architecture (now moving through 80nanometer down to 70nm), larger wafers (300MM now makes up the major portion of FORM's growth), and more diverse offerings of diferent kinds of chips requires more and better probe cards. That coexistence of multiple architectures is a strength for Formfactor -- more need for more of their products, and as groundbreaking advances are made by FORM's customers in chip architecture they will require the most advanced testing equipment available -- FORM is the logical supplier for much of that.

Some quotes from the CEO (some of these might be slightly paraphrased, sorry)

"We made substantial progress during the quarter in bringing up the facility, which enabled us to exceed our revenue targets and take on additional demand."

"[new facility is] Now operating 24/7. 75% of the workforce certified. Exit old facility by the end of the first quarter."

"Now that we have additional capacity, we are focused on capturing a higher portion of the flash market."

"Competition is fragmented, most companies rely on older technology. Several companies are trying to get into this segment, but we believe most of these companies don't have the capability or resources to address all the technologies or customers FORM can reliably address."

The guidance FORM's CFO supplied was very encouraging, and has obviously moved the market -- annualized revenue growth rates can exceed 25% in coming years, margin improvement is expected to continue (from current mid to high 40% range to 53-55%), factory startup costs have already begun to decline ... and most costs going forward are already incorporated into operating earnings as the factory is running.

The new facility is well enough underway that they will complete the transfer of the wafer line and exit the old factory by end of Q1 2006.

Hallelujah.

So I'm still looking forward to a nice future for FORM after this up and down year, I think we're just at the beginning of their long term climb -- valuation is pretty high right now, but I'm expecting very solid sales growth and, just as importantly, significant margin improvement as they begin to rely fully on the new, more efficient factory. The one fear for me, and the one reason for some caution, is the possibility for competition ... but as far as I can tell, the competition remains significantly behind FORM in quality, capability, customer service, and reliability.

Labels: FORM