Selling Formfactor on valuation (FORM)

As I posted earlier today, the primary motivation behind my doing some wholesale selling today is to reduce my margin exposure in a time of unpleasantly high margin rates.

But I needed to also determine which of my many holdings to clear out for this purpose. I generally just took a short term viewpoint on all of them, which is somewhat alien for me, and selected the few companies that met most of these criteria:

• Smaller holding (and therefore, a company I'm less confident in or interested in)
• Stock I'm not interested in buying more of right now
• Stocks that don't have a near term positive catalyst that I'm confident about
• Shares that are either depressed and unlikely to recover quickly, or...
• Shares that have gotten more richly valued and no longer represent bargains

Formfactor is a company that I think is very solid -- they have recovered from a terrible manufacturing problem (contamination in their old plant, problems opening their new plant) about two years ago, to the point where their industry-leading technology can now be produced more efficiently.

And while they are levered to the very volatile semiconductor industry, they are not particularly levered to any one company or type of chip -- they can produce the best probe test equipment for any of the myriad varieties of semiconductors in demand in the world. You can read my optimistic postings when I purchased shares last year, and when their new fab went online and started helping them earlier this year.

But ... it's a fairly small position for me, because I wasn't smart enough to add more to it last year at $20, and it has more than doubled, so I can't complain about taking that kind of profit.

And, perhaps mosts importantly, this has become a much riskier position at $48 then it was at $22. When I bought shares back then, pessimism reined and the PE ratio was in bargain territory. Today, the PE is 43 and the forward PE a still high 37, so I think that the turnaround and recovery story, which is really what sparked my initial investment, is pretty much complete -- it may continue to do well, but even as we tack on another 5% in gains this morning I think the easy money has been made and I don't want to borrow money to hold these shares -- I sold my position today at $48 for about a 110% gain.

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One up for every one down (FORM, CKCM, AKAM, ISRG)

Many of my holdings have been moving in almost perfect mirror trajectories over the past couple of days, following earnings reports that either disappointed or encouraged investors.

Akamai (AKAM) did much better than I had expected -- and even though it showed accelerating growth, which is the holy grail for investors, I was shocked to see it climb back to within a hair of it's 52 week high. I thought the shares were already priced for some pretty dramatic outperformance, but clearly the wave of analyst upgrades following their earnings did their job as the shares zoomed higher by better than 20% yesterday. A nice surprise.

On the flip side, Intuitive Surgical (ISRG) shareholders reacted to strong growth and forecasts with much more anger -- we've gotten spoiled with ISRG, as with AKAM, and expect blowout growth every single quarter, so merely great growth isn't going to cut it if you're carrying a high multiple. Intuitive had very strong recurring revenue growth from their sales of instruments, which means procedure growth is very good. I think that's the most important thing to see, that surgeries using the da Vinci are continuing to grow, but clearly a lot of investors were looking for much more dramatic growth in system sales.

ISRG surprised everyone to the upside in the first quarter with 35 systems sold, many of them the newer, more expensive da Vinci S system, but even a 50% rise in systems sold year over year to 39 in this quarter was inadequate for many, even with a small-scale beat on earnings. I think folks expected a dramatic sequential climb in installations and didn't get it, but the growth there is still continuing and the second quarter can be pretty soft for big ticket purchases, so I'm not worried. I still think the key for ISRG will be procedure growth in Hysterectomies now that they have proven that they can build a dominant position in Prostatectomies, but it's early days still for the da Vinci in gynecological surgery.

And because my ISRG position is roughly twice as large as my AKAM position, they completely cancelled each other out yesterday.

The same thing happened today with two more volatile stocks -- Click Commerce (CKCM) disappointed due to a much higher tax rate and some slowing sales growth, and Formfactor (FORM) surprised with greater than expected growth in both earnings and sales.

I was a little disappointed with CKCM's performance, but not enough to sell my shares -- and frankly, given their low multiple, I think the shellacking the shares have taken this morning is quite overdone. Even if they were not growing very robustly, which they are even though taxes have taken a big bite out of earnings this quarter for the first time, they're being valued at a PE of about 9 on both forward and TTM earnings. That's just silly, and it implies an assumption that investors are assuming that their investments in R&D and in marketing will not allow them to build the business. They're priced for no growth now, but I expect good growth that will, within a couple quarters, come down to the bottom line. I am tempted to buy more but already have a large position, so I'll have to think about it a bit.

Formfactor, on the other hand, continues to delight. As I wrote a few weeks ago, the competition and innovation in the semiconductor industry is mother's milk for FORM as it allows them to sell a greater variety of testing probe cards, in higher volume. I don't see a significant downside even with overall semi volatility, given the remarkable diversity of customers and end user semiconductor applications that they serve. They managed sequential sales growth of 14% and YOY growth of 77% ... no complaints there, even though the year ago quarter was a low point. And more impressively, they turned that 14% sales growth into better than 20% sequential earnings growth. Unlike CKCM, FORM is priced now for significant ongoing growth, but I still like their chances. FORM is actually a relatively small position for me because I was never wise enough to double down last summer when the price was very enticing -- if it was one of my larger holdings I'd be tempted to take a small portion of my profits off the table given their high multiple, but as the situation stands it makes more sense to just hold and watch.

Formfactor's industry colleague MEMC Electronic Materials (WFR), by the way, is clearly confusing investors on a very fundamental level. They soundly beat the earnings estimates AND significantly increased their guidance for this year's earnings, and the shares actually went down. They're poised to invest in capacity to serve the solar power industry, thanks to an agreement with Suntech Power, and they continue to supply scarce wafers to the semiconductor fabricators at very nice margins. Given the average market multiple and their dramatica decline already over the course of this year (from $48 to below $28), I can only imagine that the reason WFR is falling is that everyone is terrified of the Intel/AMD problems. That's close to irrelevant for WFR, in my opinion, as long as chips continue to be required to run everything from laptops to cell phones to cars.

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Intel and AMD sneeze, WFR and FORM carried out on gurneys

What an odd day. I wasn't watching the market this morning so didn't see how things played out at the open, but as I sit here now, near the end of the trading day, I am a little bit baffled about the wild movement in two strong semiconductor industry stocks that I own.

Both Formfactor (FORM) and MEMC Electronic Materials (WFR) are down dramatically today. FORM is down about 10%, WFR down about 13% as I type this. Neither company has issued earnings or guidance or, in fact, any news at all.

No, this is a reaction to AMD and Intel and various other semiconductor companies reporting disappointing results or lowered guidance.

And on the face of it, that's reasonable. But when you delve into the reasons for poor results at AMD and Intel, it makes less and less sense that those results should automatically hurt Formfactor or MEMC's businesses.

Formfactor is a semiconductor equipment company -- they sell testing products, specifically patented microspring test wafers that can be used to test semiconductor wafers during the manufacturing process.

They depend on several of the large foundries and manufacturers, including AMD and Intel, as large customers. But their profitability isn't related to the profitability of AMD or Intel, it's related to the number of testing devices and systems they sell.

Each different semiconductor chip design requires a different testing product, and testing is a source of a lot of waste and time lag in manufacturing. So when innovation is driving the industry and the companies are fighting to come up with the next revolutionary product or to speed up their production or improve the efficiency of their assembly processes, it stands to reason that they would require more testing wafers of the most advanced variety, not fewer.

Formfactor is the leading company in this space, and has, to the best of my knowledge, the leading product -- their patents have withstood court challenges, and they seem to have a technological edge on their competition.

On the flip side, everything I hear from AMD and Intel tells me that the problem is not that demand is drying up for their products, or that they're no longer innovating -- the problem is that they're having a price war, which is likely to bring prices down for the end product but, in the longer term, increase demand for those products. The more these two companies innovate and the more they fight to deliver more products faster and more efficiently to salvage their margins, the more they need products like those produced by Formfactor.

So I don't see why Formfactor is going down ... even if there is somewhat of a slowdown in the semiconductor space in general, as the market clearly fears with tough numbers from Broadcom and others, I expect FORM to be largely immune to anything but a dramatic crash in the industry -- as long as demand exists and companies are fighting for market share, Formfactor should be in the catbird's seat.

The situation with MEMC Electronic Materials is somewhat similar, but even simpler.

MEMC sells the raw material that becomes semiconductors -- the machined silicon wafers themselves. For the most part, they depend on overall demand in the industry, across all product lines (not just computer processors like AMD and Intel, but flash for Ipods or control chips for cell phones or any of the myriad of other chips out there).

WFR does not care how much AMD and Intel are charging for their products -- when they look at the results today and see that AMD is reporting lower revenue because of this price war, they should look a little deeper and see that the volume of chips being sold is climbing, it's just AMD's margins that are suffering because they're cutting prices . They still need an increasing number of silicon wafers -- and since WFR is one of a limited number of suppliers in a business that is already charging premium prices because demand is so high, I would expect that they're not going to be very worried unless this price war reaches the point that AMD or Intel might suffer significantly and have to cut production. I don't think we're anywhere near that point right now.

And that's not even considering the other significant influence on MEMC's business -- their other major customers are the solar power companies, and from China to Germany to California demand for solar power is really ramping up, causing some real fights over the limited supply of polysilicon.

No, I don't think WFR or FORM needs to be that worried about an AMD/Intel price war just yet. Maybe there's more to this story today, and I've heard other say that options expiration is causing a lot of this dramatic volatility today. But business-wise, I don't we should worry about FORM and WFR's numbers, which haven't come out yet, not Intel's or AMD's.

When the giants throw rocks at each other there's always a danger that you'll get hit ... but there's also a nice profit to be made in selling rocks.

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A few week-ending thoughts

It has been a pretty interesting week for me in the market. A couple things I'm thinking about:

As I wrote last night, Jack Byrne potentially leaving as chairman of Overstock (OSTK) worries me. I'd like to see more than just this Wall Street Journal article that quotes him as saying he'll "think about it", however ... will see if I can hold on for long enough to get a more definitive answer, or if I decide that it's just not worth it to watch OSTK decline.

I'm thinking about giving Irobot (IRBT) a chance. I've been critical of them and their products since their IPO, don't remember if that criticism was in this space or not, but now I'm thinking that perhaps they have something worth investigating. I think the Scooba is doomed to failure as a floor cleaning robot, and I still am very skeptical of the Roomba even though it certainly has a huge cohort of fans, but maybe I'm thinking of this the wrong way. I listened to the CEO on the radio and found his arguments fairly compelling -- the company is focused on practicality and cost effectiveness in robotics, which certainly makes sense. After all, the stuff on the Jetsons is almost all available to us right now ... if we're billionaires. It's IRBT who has brought the first significant robotic tool for a humdrum daily task into our homes at a reasonable price, so perhaps I shouuld look into it with a less jaundiced eye. I also am convinced that their military robots might show some real promise. Hopefully I'll have a chance to read up on the company in the near future.

CV Therapeutics (CVTX) has had a rough week after earnings -- their lost a little more than expected, which is not a huge cause for concern since they're transitioning to building a sales force, but analysts are sounding warning bells that Ranexa's uptake in the market may be slower than folks are expecting. If it's just "slow", then I might see an opportunity to add to my shares this year before Merlin results hopefully allow for an expanded label ... if it's "slow" because there are actual concerns about the drug in the marketplace among cardiologists that could be a cause for actual concern. We'll see.

And I'm wondering why Formfactor (FORM), a company that has had a huge run, is filing for a secondary share offering that could pull in about $200 million at today's share price. They've got about $5 a share in cash already as far as I can tell and no debt, and they've already completed a large new facility ... I'd hate to see them diluting our shares just because they know they can get a good price for them today, but if they have plans in mind for expansion or acquisitions I'd be interested to hear them.

And finally, it looks like I jumped too soon in taking a flier on my Intel options ... I was guessing that the bad news was out and it wasn't likely to get much worse for this gigantic workhorse trading at a bargain valuation ... but now they've warned that revenues will likely be lighter than estimates and the shares are falling again. I'm still holding a small position in January LEAPs at $20 at a fair loss right now, but on the whole I still think Intel has a good chance to recover in the next several months as folks gear up for the replacement cycle with Vista. So far, Intel's warnings haven't impacted anyone else, and my other semi companies -- WFR and FORM -- have not caught the cold that semi companies typically catch when Intel sneezes, which is good news.

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Back in good Formfactor (FORM)

Wow! Great results from Formfactor (FORM -- click to register for free RT streaming quote) today ... they beat the high analyst's estimate for earnings and blew away the average by 20% or so and the stock is climbing dramatically in the after hours session thanks to these great earnings and dramatically improved margins.

I wrote in my Annual Checkup that I thought FORM's margins and sales should really hit their inflection point and start dramatically improving in the first quarter of 2006, and I was very pleased with progress following their third quarter conference call a few months ago, but it looks like I was too pessimistic. The margins and sales are already up thanks to even just the partial use of their new facility and a great environment for their test equipment.

Now, of course, I regret not picking up some more FORM just before earnings today -- it looks like $30 was an awfully nice bargain price now that they're hitting their stride ... but as one who has been burned for several quarters by FORM's troubles with bringing their new fab online and correcting contamination problems at their older facility, I can't blame myself for a bit of caution.

Still, I am a big fan of this company's prospects -- now that they have industry-leading flexibility and dramatically increased capacity, as well as much-improved margins on their products coming out of the new facility, they should be able to do a much better job of leveraging their superior product to really boost sales and earnings.

To some extent, Formfactor is subject to the same cycle as the rest of the semiconductor companies have been, but their ability to help companies cut costs and increase production is important in both the expansion and the cost reduction swings in the cycle ... and I'm becoming convinced in part that the semi industry is not going to follow quite the same cycles as in the past -- chips are in so many more products now than just computers, and there are so many different markets for chips, that I expect the cycle to moderate somewhat ... that'll be good for those companies who, like Formfactor at times and like MEMC Electronic materials, are being discounted because all of us fear their eventual dramatic fall. I could certainly be wrong on that.

Can't wait to hear what they say on the call about their great margins and utilization rates in the new facility -- and if this stock market jubilations tempers a bit and the price dips from these ridiculous after hours highs (I saw $37 pass by a few minutes ago, which is more than a 20% boost after hours), I might be tempted to increase my position now that FORM seems to have proven themselves capable of taking the steps forward that we patient shareholders have been awaiting for the past year.

Congratulations, Formfactor.

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Annual Checkup -- FORM

There hasn't been much to say about Formfactor (FORM -- free RT quote) in the last couple of months since their earnings release and conference call. The price hasn't changed much since then, either, except for a little blip when Jim Cramer featured Formfactor on Mad Money as a play on Korea. (Which I still don't get, by the way -- their key new manufacturing plant and headquarters are both in California, though some of their customers are Korean. If you want Korea, buy EWY, Samsung, Hyundai, Kookmin Bank or Posco, as far as I'm concerned). I don't plan on buying or selling any additional FORM shares early this year, but I will be watching their next couple of months quite closely -- the first quarter is when they're supposed to have their new facility fully online, and that will be the key to increasing margins (new faciity is more efficient) as well as bringing an end to this year or two of capped sales as they have been constrained from increasing production. After their last call, I was very optimistic about the progress in bringing the new fab online, but as we have seen with this company over the past year there's always potential for bad things to happen to this snakebit transition to the new factory. FORM should continue to prosper and hit new levels of growth in the coming year as more and more semiconductor manufacturers produce broader product lines on tighter schedules and at lower prices, all of which demand the highest quality in-line semi test equipment available. No one has better technology than Formfactor, and no one else can supply this type of testing equipment for virtually all types of semiconductors as FORM can. Barring huge problems with their new plant, or unexpected patent problems, FORM should be able to leverage the huge upswing in semiconductor manufacturing and continue to increase earnings.

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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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Fantastic Formfactor?

Formfactor (FORM)



Bought January 20, 2005 at $22.59
and April 28, 2005 at $23.02

I think semiconductors are amazing, and I am astounded at the array of things that now rely on tiny silicon brains in order to operate. This is not unlike the transistor, or the battery in its influence on so many facets of our lives (and before I go any further, thanks, Jack Kilby, for making it all possible). Formfactor is one company that will benefit from the long term success of the semiconductor industry -- here's my one sentence assessment:

Formfactor is a relatively new and fast-growing company, public for only two years, that should ride the wave of semiconductor demand by providing the best and most efficient testing devices for semiconductor manufacturing.

The semiconductor business seems to be in great shape these days, recovering from an inventory glut and lower demand to reach quite strong levels of performance. Texas Instruments, Jack Kilby's old home, just released analyst-beating numbers. You probably saw Intel's news that they're investing in a three BILLION dollar fab plant in Arizona, which is another good indication that they see business remaining strong for many years (the plant won't be online until late 2007).

And Taiwan Semiconductor (TSMC) just released their latest earnings, with some good indicators of the continuing strength of the business and demand for their products -- according to them, wafer shipments are increasing by a "mid-teen percentage point sequentially", and utilization rates should exceed 90% going forward.

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I expect the worldwide reliance on chips will continue to increase, and that all these businesses -- whether handheld devices and cell phones with TI chips, or new computers to run Microsoft's Longhorn OS with Intel chips -- will do pretty well and benefit from increased demand. We are in the beginning of the sweet spot here, with the next couple of years promising significant inventory replacement cycles for both cell phones and computers in addition to the general pace of change and technological obsolescence (not to mention the equipment-replacement and redesign cycle for the chips themselves, which are moving to tighter architectures on larger wafers).

But I don't want to own a chip maker these days -- much as I respect these very strong businesses, and appreciate the innovation brought to the marketplace by all the large and specialized chip manufacturers, it seems like an awfully tough business with sometimes very tight margins and strong competition. Like the electronics business in a microcosm, chips are becoming in higher demand because they can be made more cheaply and incorporated into more devices, and the drive is to continue building cheaper products with ever better capabilities. That's a bear on margins, even though margins are pretty good these days during the demand recovery cycle.

No, I want to be in businesses that do well simply due to the expanded demand for chips, and that will benefit from the need of the chip foundries to get more productive and to implement new product lines.

One of those I've talked about before -- MEMC Electronic Materials (WFR) is one of the biggest wafer manufactureres around. Competition is tight for them, too, but they supply only the the raw materials so any of the manufacturers can buy their stuff, and most do, and they've got some competitive advantages besides (without being sued for exercising monopoly power).

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And the other one that's in my portfolio today is Formfactor -- I like them because they make semiconductor manufacturing more effective by offering one of the best testing products in the world, and one that is patented and very differentiated from its competitors. Their MicroSpring technology is used in an integrated testing card that tests each wafer as it's fabricated, checking the functionality of each individual chip on the wafer. (If you're curious about the manufacturing process, there's a clear tutorial available here.)

Why buy FORM?

With competition and high demand for chips expected going forward, the company that can supply test cards that allow you to more effectively and efficiently test the product is in a good position. FORM's own claim is that their newest test solution reduces costs by as much as 60% for manufacturers and, just as importantly, increases yield. They have a good corporate presentation on their website, linked here.

And this cycle of increased semiconductor demand is only one reason to like Formfactor's prospects -- there's also the parallel cycle of semiconductor advancement, which is moving in two directions right now. First, the move to 300MM wafers is well underway and will mean that all new test equipment is needed to test these larger wafers. And second, the move to smaller and smaller architectures places an increasingly high demand on the testing devices and requires more and more sophisticated tools like those designed and manufactured by FORM.

So what's the bad news, and why has the stock taken a beating following their last earnings release? That's almost all because they've been having a bear of a time getting their new facility opened, so the market has pushed their price back down to near my entry points. It might be time to buy again, if you think (as I do) that this is a temporary problem.

You see, Formfactor has been on a bit of a roller coaster, even more than many of its competitors. They have been building and rolling out a new fab plant for their test cards, but the process has been a bit challenging, to say the least, and while they struggle along with their old plant and try to get fully online with the new one by the end of the year they are temporarily capacity-constrained and may not be able to grow the business or accept new orders in the very short term. This facility is nearly as complex as the actual semiconductor fabs, since building their test probes demands the same kind of specifications, but by all accounts when it is finally on line they will have one of the most advanced facilities in the industry.

Why or when would I sell?

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Demand is there -- will they be able to supply? I think so, but there are certainly risks. The first sellable product came out of the new plant about eight weeks ago, and they claim to be on line for full rollout, but they are still having trouble with capacity and recovering from contamination in their old plant so any slowing of this progress will have a material impact on their results. Income dropped year over year as the new plant lagged and the old one had difficulties, but they are a profitable company with a strong balance sheet, and sales and orders are booming.

I might sell if FormFactor loses its lead in the test probe market, but I don't see that happening in the near future. They sell the best product, and they are well ahead of the competition in developing capacity to serve the demands of the industry, even if their capacity is not yet quite there. I am prepared to hold and buy more if Formfactor remains on pace to have its new facility open at full capacity by early next year, even if there are additional hiccups that present buying opportunities, but if they are not yet running the new fab at 100% a year from now they will be in big trouble -- it would very likely be time to sell then, though odds are it would be at quite a loss. Just to reiterate: That's only the doomsday scenario for Formfactor, and I expect a rosy future.

Good Motley Fool article on Formfactor followed the earnings release, here, and an older one here.

technorati tags: Formfactor, FORM, semiconductor, semi, chip

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