Semiconductor testing company FormFactor (NASDAQ:FORM) reported results ahead of analysts' expectations in Q1 CY2024, with revenue flat year on year at $168.7 million. Guidance for next quarter's revenue was also optimistic at $195 million at the midpoint, 14.5% above analysts' estimates. It made a non-GAAP profit of $0.18 per share, improving from its profit of $0.16 per share in the same quarter last year.
FormFactor (FORM) Q1 CY2024 Highlights:
- Revenue: $168.7 million vs analyst estimates of $165.8 million (1.7% beat)
- EPS (non-GAAP): $0.18 vs analyst expectations of $0.19 (5.3% miss)
- Revenue Guidance for Q2 CY2024 is $195 million at the midpoint, above analyst estimates of $170.3 million
- Gross Margin (GAAP): 37.2%, up from 36.5% in the same quarter last year
- Inventory Days Outstanding: 93, down from 102 in the previous quarter
- Free Cash Flow of $19.72 million is up from -$683,000 in the previous quarter
- Market Capitalization: $3.46 billion
With customers across the foundry and fabless markets, FormFactor (NASDAQ:FORM) is a US-based provider of test and measurement technologies for semiconductors.
FormFactor was founded in 1993 by former IBM researcher, Igor Khandros. The initial products served three semiconductor applications: sockets, packaging, and probe cards. FormFactor went public in June of 2003.
Designing semiconductors involves modeling, reliability testing, and design de-bug followed by qualification and production assessments. Along the way, testing and measurement occurs to ensure compliance with industry standards and to ensure accuracy. Since semiconductor manufacturing is a complex and resource-intensive process, detecting flaws early in the process means saving money and time. As such, testing and measurement impact yields, time-to-market, and overall quality.
FormFactor’s products – often customized to meet customers’ unique wafer and chip designs – address these testing and measurement needs through products such as probe cards, probe stations, thermal systems, and cryogenic systems. Probe cards, for example, ensure that a customer’s composite contact elements used in manufacturing are precise to length scales of a few microns and reliable across various compression levels. Thermal systems ensure precise temperature management during certain steps in semiconductor manufacturing.
Competitors in the market for probe cards, FormFactor’s largest product category, include Advanced Micro Silicon Technology, Chungwa Precision Test Technology, Feinmetall, and Japan Electronic Materials Corporation (TYO:6855).Sales Growth
FormFactor's revenue has been declining over the last three years, dropping by 1.8% on average per year. As you can see below, this was a weaker quarter for the company, with revenue growing from $167.4 million in the same quarter last year to $168.7 million. Semiconductors are a cyclical industry, and long-term investors should be prepared for periods of high growth followed by periods of revenue contractions (which can sometimes offer opportune times to buy).
While FormFactor beat analysts' revenue estimates, this was a sluggish quarter for the company as its revenue only grew 0.8% year on year. Despite these results, we believe FormFactor is still in the early days of an upcycle, as this was just the second consecutive quarter of growth and a typical upcycle tends to last 8-10 quarters.
FormFactor's management team believes its revenue growth will accelerate, guiding to 25.1% year-on-year growth next quarter. Wall Street expects the company to grow its revenue by 10.7% over the next 12 months.
Product Demand & Outstanding Inventory
Days Inventory Outstanding (DIO) is an important metric for chipmakers, as it reflects a business' capital intensity and the cyclical nature of semiconductor supply and demand. In a tight supply environment, inventories tend to be stable, allowing chipmakers to exert pricing power. Steadily increasing DIO can be a warning sign that demand is weak, and if inventories continue to rise, the company may have to downsize production.
This quarter, FormFactor's DIO came in at 93, which is 1 days below its five-year average. At the moment, these numbers show no indication of an excessive inventory buildup.
Pricing Power
In the semiconductor industry, a company's gross profit margin is a critical metric to track because it sheds light on its pricing power, complexity of products, and ability to procure raw materials, equipment, and labor. FormFactor's gross profit margin, which shows how much money the company gets to keep after paying key materials, input, and manufacturing costs, came in at 37.2% in Q1, up 0.7 percentage points year on year.
FormFactor's gross margins have been trending up over the last 12 months, averaging 39.3%. This is a welcome development, as FormFactor's margins are below the industry average, and rising margins could suggest improved demand and pricing power.
Profitability
FormFactor reported an operating margin of 7.7% in Q1, down 0.2 percentage points year on year. Operating margins are one of the best measures of profitability because they tell us how much money a company takes home after manufacturing its products, marketing and selling them, and, importantly, keeping them relevant through research and development.
FormFactor's operating margins have been trending up over the last year, averaging 9.1%. This is a welcome development for FormFactor, whose cost structure isn't as efficient as it could be, as indicated by its slightly below-average margins.
Earnings, Cash & Competitive Moat
Analysts covering FormFactor expect earnings per share to grow 61.9% over the next 12 months, although estimates will likely change after earnings.
Although earnings are important, we believe cash is king because you can't use accounting profits to pay the bills. FormFactor's free cash flow came in at $19.72 million in Q1, up 367% year on year.
FormFactor has generated $35.69 million in free cash flow over the last 12 months, or 5.4% of revenue. This FCF margin enables it to reinvest in its business without depending on the capital markets.
Return on Invested Capital (ROIC)
EPS and free cash flow tell us whether a company was profitable while growing revenue. But was it capital-efficient? Enter ROIC, a metric showing how much operating profit a company generates relative to how much money the business raised (debt and equity).
FormFactor's five-year average ROIC was 11.7%, somewhat low compared to the best semiconductor companies that consistently pump out 35%+. Its returns suggest it historically did a subpar job investing in profitable business initiatives.
The trend in its ROIC, however, is often what surprises the market and drives the stock price. Unfortunately, FormFactor's ROIC averaged 3.6 percentage point decreases over the last few years. Paired with its already low returns, these declines suggest the company's profitable business opportunities are few and far between.
Key Takeaways from FormFactor's Q1 Results
It was unfortunate to see FormFactor miss analysts' expectations for EPS. On the bright side, its inventory levels shrank and its free cash flow increased from the last quarter. Looking ahead, it shared strong revenue guidance for the next quarter, which blew past analysts' expectations. Overall, we think it was a solid quarter. The stock is up 6% after reporting and currently trades at $46.50 per share.
Is Now The Time?
When considering an investment in FormFactor, investors should take into account its valuation and business qualities as well as what's happened in the latest quarter.
We cheer for everyone who's making the lives of others easier through technology, but in the case of FormFactor, we'll be cheering from the sidelines. Its revenue has declined over the last three years, and analysts expect growth to deteriorate from here. On top of that, its operating margins reveal subpar cost controls compared to other semiconductor businesses, and its low free cash flow margins give it little breathing room.
FormFactor's price-to-earnings ratio based on the next 12 months is 36.6x. While we've no doubt one can find things to like about FormFactor, we think there are better opportunities elsewhere in the market. We don't see many reasons to get involved at the moment.
Wall Street analysts covering the company had a one-year price target of $44.79 per share right before these results (compared to the current share price of $46.74), implying they didn't see much short-term potential in the FormFactor.
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