Formfactor's Losses Continue

Formfactor Inc. ( FORM - Analyst Report ) reported third quarter loss that exceeded the Zacks Consensus estimate by 7 cents, or 12.5%.

Revenue

Formfactor’s revenue of $47.3 million was down 17.9% sequentially, up 8.2% from a year ago, but well below management’s original expectations of a flattish quarter. However, revenue was within the revised guidance range of $46−$48 million provided on August 31. Slower-than-expected qualification of the Matrix family at major customers (Matrix units were up 20% versus expectations of 30% increase), avoidance of lower-margin business and operational hitches, such as stretching lead times impacted Formfactor’s revenue in the last quarter.

Revenue by End User

DRAM, flash and logic customers generated 64%, 19% and 17%, respectively, of third quarter revenue. Demand from DRAM customers weakened considerably, although both flash and logic held up quite well.

The DRAM business was down 29.0% sequentially and 17.4% year over year. The decline was attributed to a big shift from SmartMatrix DRAM to TouchMatrix flash products. Unit prices were up.

The Flash business has strengthened considerably, posting triple digit year-over-year growth in each of the last 3 quarters. The business was up 6.7% sequentially and 329.4% from last year. The segment has benefited from ongoing strength in NAND, something which should continue into next year.

The Logic business (SoCs) was up 20.3% sequentially and 56.3% year over year. This business is being driven by rapid changes in semiconductor manufacturing from 45nm to 32nm to 22nm. Therefore, probe card demand for this segment should hold steady for a few quarters.

Revenue by Region

All regions declined on a sequential basis, although North America and Asia (including Taiwan but excluding Japan) grew from a year ago. Japan generated 16% of quarterly revenue (down 37.6% sequentially and 66.4% year over year), North America accounted for another 17% (down 31.0% sequentially, but up 12.1% year over year) Other Asia 64% (down 3.5% sequentially, up 164.9% year over year and Europe 3% (down 41.6% sequentially and 38.3% year over year).

Margins

The gross margin dropped to 2,028 bps sequentially to -15.2%. Lower volumes, unfavorable mix and initial high ramp-up costs on some products were responsible for the increase.

Operating expenses of $29.0 million were down 16.4% from the previous quarter’s $34.7 million and in-line with guidance. The operating margin was -76.5%, down 2,138 bps from -55.2% recorded in the previous quarter. The lower gross margin was responsible for the decline, since R&D declined as a percentage of sales and SG&A increased only slightly.

Net Income

The pro forma net loss was $31.9 million, or 67.3% of sales, compared to loss of $31.4 million, or 54.4% in the previous quarter and loss of $23.9 million, or 54.6% of sales in the year-ago quarter. Our pro forma estimate in the last quarter takes into account restructuring and asset impairment charges, but does not exclude stock compensation expenses. Our pro forma calculations could differ from Formfactor’s presentation due to the inclusion/exclusion of some items that were not considered by management.

Including the special items, the GAAP net loss was $95.8 million ($1.90 per share), compared to loss of $33.9 million (68 cents per share) in the June 2009 quarter and loss of $23.9 million (48 cents per share) in the September quarter of 2009.

Balance Sheet

Inventories were down 18.8% in the last quarter, taking the inventory turns from 6.1x to 7.5x. Days sales outstanding (DSOs) improved slightly from 70 to 69. The company ended with cash and short-term investments of $371.5 million, down $26.3 million during the quarter. Formfactor has no debt and long-term liabilities totaled $14.4 million at quarter-end. PP&E was reduced to less than half during the quarter.

Guidance

For the fourth quarter, Formfactor expects revenue of $40−$45 million (down 5.0% to 15.5% sequentially. The gross margin is expected to improve in the next quarter, as the high mix of lower-margin NAND in September is not expected to repeat in the December quarter. As a result, the non GAAP gross margin will be 11%−16%. Formfactor expects that the benefits of closing down the Singapore facility will not be apparent next quarter, as transition costs will continue. Opex is expected to decline 10%. The cash burn in the fourth quarter is expected to be less than in the third.

Formfactor also provided some longer-term targets. The company expects to reach $65 million in revenue by the second quarter of 2011. It also expects to reduce opex by 10% each quarter until the second quarter of 2011, when it will be under $20 million (target). The cash break-even point is expected to be achieved at revenue levels of $50 million.

Our Take

The company missed our expectations on both the top and bottom lines. It also continues to post significant losses and burn cash. We therefore do not see much sense in investing in the shares and encourage investors to avoid them in the near term. The Zacks #4 Rank (short-term "Sell") indicates that there could be downward pressure on Formfactor's share prices. However, we remain positive about Formfactor's technology and the key position of its probe cards in semiconductor manufacturing. Therefore, our longer-term (3−6 month) recommendation remains Neutral.