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.

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News from the FORM

I've been holding my Formfactor shares for a while now, and hope to be able to hold them for the very long term. I was very interested to see what they would say this quarter, and see what kind of update we would get on their new facility.

Well, I'm sitting here waiting for the conference call to begin, and I see that Formfactor (FORM -- get free real time quote from ADVFN) is trading down a bit after hours today. That's probably a "sell on the news" reaction to the quick runup before earnings, which I was a little surprised by after Intel's numbers yesterday. Logical or no, I figured that the market's ambivalence toward Intel would percolate down through the rest of the industry.

But the numbers look good to me at first blush. FORM has a pretty big stable of analysts on board now, and if you ignore their one time 8-cent tax windfall this quarter they hit the high analysts's earnings number -- not bad, and technically a "beat" of the street!

Their margins look solid ... forward bookings look great ... expenses were pretty high this quarter due to the new facility.

But what about that new facility? Not much of a real update in their press release, so I'll come back and flesh this post out with more info after the call. Their forward statements about the new facility and their new bookings are the key for the stock price's performance in the remainder of this year.

Even with some inroads made by their competition, FORM is still leading this part of the industry -- I expect growth will remain very good, though margins might be hampered if their competitors really succeed, which is always an open question. One nice thing is their patent win in Korea, which certainly helps -- we will see how that plays out long term and, especially, how it plays in the Japanese patent courts ... but I'm encouraged.

So what do you have to say, FORM -- how's that new factory coming?

Call has just started -- will update with more once I've listened and pondered.

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Rayonier falls -- Timberrrr! (RYN)

Just kidding.

Though you couldn't blame a soft-headed guy for looking at Rayonier's stock price today and wondering why on earth it fell more than 30%. After all, this is a great stock with an excellent dividend and this company owns mills and thousands and thousands of acres of forest -- that stuff is getting more valuable, not less.

In case you didn't notice, the key thing to note is that Rayonier (RYN -- get free real time quote from ADVFN) split today.

Which brings me to the meat of my Rayonier rant:

Before I get too far, let me reiterate: I really like this business (just as much as when I did my initial writeup here -- or even more, now that they've settled their New Zealand property deal), and I'm not selling. I just think the split is silly.

Why on earth did Rayonier put the energy and money into splitting their stock? It was trading at about $53, and today it's down around $35. What corporate or other purpose could that possibly serve? I know, it's not a big deal -- but this transaction is not free, either ... I'd rather see my company focus on business than micromanage the stock price like this.

And at the same time, Deutsche Securities coincidentally decides to initiate coverage with a buy?

How on earth does doing a confusing and pointless 3-for-2 exchange make a company more valuable to the extent that you want to begin covering it?

Prez and CEO Lee Nutter's quote was that "The stock split recognizes the appreciation in value of Rayonier's common shares since our last split in June 2003 and should further improve liquidity and trading volume." (AP story here). Since when do you have to "recognize" an increased share price by bumping the price back down to where it began?

And I wasn't aware that Rayonier had any liquidity or trading volume problems. This isn't a stock that it's difficult to trade -- if you place a reasonable order, you'll get it filled pronto. 250,000 shares change hands every day, which is plenty for this $2 billion company that's in a not-particularly-volatile business (if a tree takes at least 20 years to grow, do you really think it'll help you to trade in and out of this company three times a day?).

Is a slight increase in daily trading volume -- let me go out on a limb here and suggest that the increase in volume will exactly track with the decrease in share price -- going to help anyone?

No.

If anything, for those few people who remain mired in brokerage accounts which require you to pay per number of shares, this will hurt -- you'll be trading more shares for the same position in the company, so you might pay a little more. Helps the brokerage a bit, I suppose, but why should management care?

I assume that this is just one of the tried-and-true ways to boost the share price. There are still plenty of traders who believe that the price of a stock really matters -- haven't you been paying attention? Berkshire Hathaway and Google, among many others, should have disabused any long-term investor of the value of a stock split. As long as you're not treading water below $5 or in the stratosphere at several hundred dollars or more, why would it make a difference?

What matters is the value of the company, and what percentage of the company you're buying (and how much you're willing to invest in the company). For that, it shouldnt' matter at all what the share price is. It doesn't matter if I'm buying 2 shares of BRK.B or 20 shares of GOOG or 200 shares of SUNW -- it's the same amount of money (okay, roughly ... I didn't do the math).

Now, I do see some point to this when you get to BRK and GOOG land -- it's true that small investors might have trouble buying a single share of BRK, even the $3,000 B shares. And for those enrolled in plans like Sharebuilder where you add just a hundred dollars a month or some such thing, it's hard to include GOOG and it's $300 price.

But do you really think Rayonier's CEO particularly cares about those people? I don't.

And even if you accept the argument of the market that you need to do a split now and then to keep your share price in line with what people prefer to pay for stocks, there is certainly no point in splitting your shares when they have just barely squeaked above $50. And splitting 3 for 2? Why make this confusing for everyone? If you need to split, wait until you're well above $100 and split in half.

OK, rant over.

What mostly bothers me is that this announcement of a split overshadowed Rayonier's much more significant announcement made on the same day -- they have increased their dividend by almost 14%. That is big news, and, to be fair, I expect that news was the prime driver behind the stocks 4% tick up back in mid-September.

Now, RYN is down again a bit from those heady days when they announced their stock split and increased dividend last month -- not a big deal. Keep an eye out for the property sales they're making along the SE Georgia/NE Florida coast -- that's where people want to live, and Rayonier owns the land and is willing to sell at the right price. And watch that dividend -- trees take a long time to grow, and tree products are as valuable and irreplaceable as ever, I expect this little income producer will continue to kick out nice dividends, even though I don't expect many more years like this of 20% capital gains like this on top of that.

So buy up some more Rayonier ... I might, one of these days. But not because it's at $35 instead of $53 -- that matters not a whit.

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What's up with WFR?

MEMC Electronic Materials (WFR -- get free real time quote from ADVFN) has been a hard stock to figure out for the past couple months.

Is it the stock that wowed everyone during the last few months after riding the wave of increasing silicon wafer demand from the semiconductor manufacturers, or the stock that has now been downgraded twice by brokers?

Is it the stock that is benefitting from the same trends that have led one of WFR's major competitors, SUMCO, to go public next month, or the company who just won a significant patent suit against that same company?

I'm not sure which of these news items should carry the most weight, but I'm still quit confident in MEMC's long-term success. You can read my earlier article on them here. My argument remains the same:

WFR is the biggest US and one of the biggest international manufacturers of silicon wafers. Not only do they have defensible patents, as we have just seen from their win in a European patent court, but they have another advantage in that they produce their own polysilicon, the raw material for silicon wafers. That has some significance in that there is currently a very tight market for polysilicon due to both increased semiconductor demand and increased demand from the newly-hot solar power industry, so having your own cost-controlled supply of the raw material should be an advantage -- but be careful, as no such imbalance is likely to exist for long. Competitors will open new plants to increase supply ... but still, I believe having their own supply will remain an advantage for MEMC.

The market seems completely complacent about the patent win, so we can assume that the win was already factored into the price -- and I imagine a win in US courts is predicted as well.

No one blinked an eye when MEMC reported that their facilities in Texas were unscathed after the hurricanes.

The competition from the other big three wafer companies remains the same, even though one of them is now going public in Japan -- though I'm balancing in my head the fact that this IPO means the market is hot for this sector right now, versus the point that now one of WFR's major competitors is going to get a big cash infusion.

But really, for those of us who are planning to hold WFR long term, the question is simple:

Will semiconductor demand continue to rise over the next (insert your holding period here)?

Intel, the behemoth of the industry and a major MEMC customer, reports tonight ... stay tuned, their conference call and projections for future growth are likely to impact WFR just as much as, if not more than, WFR's own earnings and estimates.

(Oh, and by the way -- my other holding in the semiconductor industry, FormFactor (previous FORM writeup here), reports earnings tomorrow evening as well ... and they'll also likely move based on Intel's assessment of industry demand as well as on the latest information on their soap-operatic struggle to get their new facility up and running. I'll be paying close attention to that call, too.)

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