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FORM > SEC Filings for FORM > Form 10-K on 7-Mar-2014All Recent SEC Filings

Show all filings for FORMFACTOR INC

Form 10-K for FORMFACTOR INC


7-Mar-2014

Annual Report


Item 7: Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes included elsewhere in this Annual Report on Form 10-K. In addition to historical consolidated financial information, the following discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions as described under the "Note Regarding Forward-Looking Statements" that appears earlier in this Annual Report on Form 10-K. Our actual results could differ materially from those anticipated by these forward-looking statements as a result of many factors, including those discussed under "Item 1A: Risk Factors" and elsewhere in this Annual Report on Form 10-K.
Overview
We design, develop, manufacture, sell and support precision, high performance advanced semiconductor wafer probe card products and solutions. We are the largest probe card manufacturer, and semiconductor manufacturers use our wafer probe cards to perform wafer sort and test on semiconductor die, or chips, prior to wafer singulation. We work closely with our customers on product design, as each wafer probe card is a custom product that is specific to the chip and wafer designs of the customer. During wafer sort and test, a wafer probe card is mounted on a prober and electrically connected to a semiconductor tester. The wafer probe card is used as an interface to connect electrically with and test individual chips on a wafer. Our wafer probe cards are used by our customers in the front end of the semiconductor manufacturing process, as are our image sensor, parametric or in-line probe cards. We operate in a single industry segment and have derived substantially all of our revenues from the sale of wafer probe cards incorporating our proprietary technology, including our MicroSpring interconnect technology and our ATRE test technology.
During fiscal 2013, we saw revenues increase $53.0 million from $178.5 million in 2012 to $231.5 million in 2013. Revenue growth was driven by the SoC product market which was up $69.0 million when compared with 2012, driven by the impact of a full year of sales from our MicroProbe acquisition. DRAM revenues were down $9.9 million versus 2012 due to weaker personal computer demand and certain supply chain and manufacturing execution issues we experienced in connection with wafer probe cards for a Japan customer. Flash revenues were down $6.1 million due to lower unit volume in the flash memory markets.
During fiscal 2013, we continued the activities initiated in 2010 to restructure our operations to simplify our overall structure and better align our operations with the current business environment, streamline our manufacturing structure and reduce both manufacturing cost and cycle times. As part of this simplification, we reduced our workforce by 48 full-time employees, or 5%, during fiscal 2013, as compared to fiscal 2012. In January 2014, we implemented an organizational restructuring and cost reduction plan to improve our efficiency and effectiveness while better positioning the company for profitability. As part of this plan, we eliminated 51 full-time employees or approximately 5% as compared to the end of fiscal 2013. In addition, we reduced our temporary workforce by 9 positions.
In the latter part of the third fiscal quarter of 2013, we began to experience a significant decrease in customer orders for our products caused primarily by supply chain and manufacturing execution challenges that resulted in lost orders at one Japan customer and by a fire at a major customer's China facility that impacted probe card orders. This decrease in customer orders also carried-over into the fourth quarter of fiscal 2013. As a consequence, this decline resulted in lower than forecasted manufacturing utilization and coupled with lower margins on a specific high-volume DRAM design, increased warranty and service expenses and excess inventory charges, negatively affected our gross margin for the third quarter of fiscal 2013.

We incurred net losses of $57.7 million and $35.5 million in fiscal 2013 and fiscal 2012, respectively. The increase in net loss is primarily attributable to a one-time $25.5 million tax benefit from the release of valuation allowances on our deferred tax assets (DTAs) in connection with our MicroProbe Acquisition in the fourth quarter of fiscal 2012. Deferred tax liabilities (DTLs) were established on the acquired identifiable intangible assets. These DTLs exceeded the acquired DTAs by $25.5 million. The excess DTLs allowed us to realize a tax benefit by releasing the valuation allowances associated with our DTAs. Accordingly, the valuation allowances on a portion of our DTAs were released and resulted in a one-time income tax benefit of $25.5 million in the fourth quarter of fiscal 2012. In connection with the MicroProbe Acquisition, we also agreed to settle patent infringement, unfair competition, trade secret misappropriation and breach of confidence claims against Astria Semiconductor Holding, Inc., its subsidiary Micro-Probe Incorporated and a former FormFactor employee. The settlement in favor of FormFactor resulted in a one-time benefit of $3.3 million in the fourth quarter of fiscal 2012.
The increase in net loss for fiscal 2013 is also attributable to higher intangible amortization costs, integration expenses and a loss on the sale of a MicroProbe subsidiary in Reno, Nevada. These expenses relating to the MicroProbe Acquisition totaled $18.4 million and $12.1 million for fiscal 2013 and fiscal 2012, respectively, which includes amortization of the fixed


asset fair value step-up. Excluding these non-recurring MicroProbe Acquisition related benefits and costs, our gross margins and operating margins improved as a result of our ongoing initiatives to reduce manufacturing overhead costs, lower production material costs and reduce operating expenses. The net loss for fiscal 2013 includes the entire fiscal year's operational activity of MicroProbe, which was acquired in October 2012. In addition, the net loss includes restructuring charges of $4.7 million, impairment charges of $0.8 million, loss on the sale of a subsidiary of $0.3 million and $1.3 million in acquisition and integration costs.
The net loss for fiscal 2012 includes MicroProbe operating activity from the acquisition date on October 16, 2012 to fiscal 2012 year-end of $19.8 million in revenue and $6.4 million of net loss, which includes $8.2 million of intangible amortization and other expenses. In addition, the net loss includes restructuring charges of $2.9 million, impairment charges of $0.4 million, and $3.0 million in acquisition and integration costs, offset by a benefit of $25.5 million from the release of the U.S jurisdiction deferred tax asset valuation allowance resulting from the deferred tax liability recorded in connection with the $77.6 million of intangible assets acquired in the business combination. The net loss also included a gain of $3.3 million from our litigation settlement.

Our cash, cash equivalents and marketable securities and restricted cash totaled $151.5 million as of December 28, 2013, as compared to $166.1 million at December 29, 2012. The decrease in our cash, cash equivalents and marketable securities and restricted cash was primarily due to the use of cash for operating activities in 2013. We believe that we will be able to satisfy our working capital requirements for at least the next twelve months with the liquidity provided by our existing cash, cash equivalents and marketable securities. If we are unsuccessful in increasing our revenues, improving our operating efficiency, reducing our cash outlays or increasing our available cash through financing, our cash, cash equivalents and marketable securities will decline in future fiscal years.

We believe the following information is important to understanding our business, our financial statements as well as the remainder of this discussion and analysis of our financial condition and results of operations:
Fiscal Year. Fiscal years ended December 28, 2013 and December 29, 2012 had 52 weeks each and fiscal year ended December 31, 2011 had 53 weeks. Our fiscal year ends on the last Saturday in December.
MicroProbe Acquisition. On October 16, 2012, pursuant to an Agreement and Plan of Merger and Reorganization dated as of August 31, 2012, a wholly-owned subsidiary of FormFactor merged with and into Astria Semiconductor Holding, Inc., including its subsidiary, Micro-Probe Incorporated (together "MicroProbe"), with MicroProbe continuing as the surviving corporation and as a wholly-owned subsidiary of FormFactor.
MicroProbe was a semiconductor equipment company that designs, develops, manufactures, sells and services high performance, custom designed advanced SoC wafer probe cards and analytical test equipment used in the semiconductor industry. MicroProbe was a global company with operations in the U.S. and Asia, including China, South Korea, Singapore and Taiwan. The acquisition of MicroProbe enabled us to leverage the combination of two advanced wafer probe card manufacturers and expand our SoC product portfolio to meaningfully diversify our business.
Revenues. We derive substantially all of our revenues from product sales of wafer probe cards. Revenues from our customers are subject to fluctuations due to factors including, but not limited to, design cycles, technology adoption rates, competitive pressure to reduce prices, cyclicality of the different end markets into which our customers' products are sold and market conditions in the semiconductor industry. Historically, increases in revenues have resulted from increased demand for our existing products, the introduction of new, more complex products and the penetration of new markets. We expect that revenues from the sale of wafer probe cards will continue to account for substantially all of our revenues for the foreseeable future.
Cost of Revenues. Cost of revenues consists primarily of manufacturing materials, payroll, shipping and handling costs, manufacturing-related overhead and amortization of certain intangible assets. Our manufacturing operations rely upon a limited number of suppliers to provide key components and materials for our products, some of which are a sole-source. We order materials and supplies based on backlog and forecasted customer orders. Tooling and setup costs related to changing manufacturing lots at our suppliers are also included in the cost of revenues. We expense all warranty costs and inventory provisions as cost of revenues.
We design, manufacture and sell custom advanced wafer probe cards into the semiconductor test market, which is subject to significant variability and demand fluctuations. Our wafer probe cards are complex products that are custom to a specific chip design of a customer and must be delivered on relatively short lead-times as compared to our overall manufacturing process. As our advanced wafer probe cards are manufactured in low volumes and must be delivered on relatively short lead-times, it is not uncommon for us to acquire production materials and start certain production activities based on estimated production yields and forecasted demand prior to or in excess of actual demand for our wafer probe cards.


We record an adjustment to our inventory valuation for estimated obsolete and non-sellable inventories based on assumptions about future demand, past usage, changes to manufacturing processes and overall market conditions. Research and Development. Research and development expenses include expenses related to product development, engineering and material costs. Research and development costs are expensed as incurred. We plan to continue to invest in research and development activities to improve and enhance existing product technologies and to develop new technologies for current and new products and for new applications.
Selling, General and Administrative. Selling, general and administrative expenses include expenses related to sales, marketing, and administrative personnel, internal and outside sales representatives' commissions, market research and consulting, and other sales, marketing, administrative activities, amortization of certain intangible assets, and provision for doubtful accounts. These expenses also include costs for protecting and enforcing our intellectual property rights and regulatory compliance costs.
Restructuring Charges. Restructuring charges include costs related to employee termination benefits, cost of long-lived assets abandoned or impaired, as well as contract termination costs.
Impairment of Long-Lived Assets. Asset impairment charges include charges associated with the write-down of assets that have no future expected benefit or assets for which circumstances indicate that the carrying amount of these assets may not be recoverable, as well as adjustments to the carrying amount of our assets held for sale.
Use of Estimates. The preparation of consolidated financial statements in conformity with generally accepted accounting principles in the United States of America ("GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Estimates may change as new information is obtained. We believe that the estimates, assumptions and judgments involved in revenue recognition, fair value of marketable securities, allowance for doubtful accounts, reserves for product warranty, valuation of obsolete and slow moving inventory, assets acquired and liabilities assumed in business combinations, legal contingencies, realizability of goodwill, the assessment of recoverability of long-lived assets, valuation and recognition of stock-based compensation, provision for income taxes and related deferred tax assets, valuation and tax liabilities and accruals for other liabilities have the greatest potential impact on our consolidated financial statements. Actual results could differ from those estimates. Critical Accounting Policies and Estimates Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements require us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of net revenue and expenses in the reporting period. Our accounting policies are fundamental to understanding our financial condition and results of operations reported in our financial statements and related disclosures. We have identified the following accounting policies as being critical because they require our management to make particularly difficult, subjective and/or complex judgments about the effect of matters that are inherently uncertain. We evaluate our estimates and assumptions on an ongoing basis and we base these estimates and assumptions on current facts, historical experiences and various other factors and assumptions that are believed to be reasonable under the circumstances. Actual results may differ materially and adversely from our estimates. Our management has discussed the development, selection, application and disclosure of these critical accounting policies with the Audit Committee of our Board of Directors.
Revenue Recognition: We recognize revenue when persuasive evidence of an arrangement exists, title and risk of loss has transferred to the customer, the selling price is fixed or determinable and collection of the related receivable is reasonably assured. In instances where final acceptance of the deliverable is specified by the customer, revenue is deferred until all acceptance criteria have been met. Revenues from the licensing of our design and manufacturing technology, which have not been material to date, are recognized over the term of the license agreement or when the significant contractual obligations have been fulfilled.
Goodwill: Goodwill represents the excess of the purchase price over the fair value of identifiable assets acquired and liabilities assumed. We have determined that we operate in one reportable segment consisting of two operating segments relating to our FormFactor and MicroProbe product groups. We further have determined that for the purposes of our goodwill impairment analysis, we have two reporting units relating to our FormFactor and MicroProbe product groups and which are


both associated with the design, development, manufacture, sale and support of precision, high performance advanced semiconductor wafer probe cards. In September 2011, the FASB amended its guidance to simplify testing goodwill for impairment, allowing an entity to first assess qualitative factors to determine whether it is necessary to perform a two-step quantitative goodwill impairment test. If an entity determines as a result of the qualitative assessment that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then the quantitative impairment test is required. Otherwise, no further testing is required.
The performance of the quantitative impairment test involves a two-step process. The first step of the impairment test involves comparing the fair values of the applicable reporting units with their aggregate carrying values, including goodwill. We generally determine the fair values of our reporting units using a combination of the income approach (that includes the use of the discounted cash flow method) and the market approach (guideline company approach) valuation methodologies. If the carrying amount of a reporting unit exceeds the fair value of that reporting unit, we perform the second step of the quantitative impairment test to determine the amount of impairment loss. The second step of the goodwill impairment test involves comparing the implied fair value of the affected reporting unit's goodwill with the carrying value of that goodwill. We acquired MicroProbe and performed a fair value assessment as of the acquisition date, October 16, 2012, resulting in our current goodwill balance.
As we entered the fourth quarter of fiscal 2013, we faced increasing operational and financial challenges, including manufacturing overcapacity and weak operating performance which led to a deterioration in market conditions. As a result, during the fourth quarter of fiscal 2013, in conjunction with our annual goodwill impairment test, we performed the first step of the two-step goodwill impairment test relating to our two reporting units to ascertain if the carrying values of the net assets exceeded fair values. The results of the first step of the impairment test indicated that the goodwill of the FormFactor and MicroProbe reporting units were not impaired, as the estimated fair values in excess of carrying values were approximately $32 million and $41 million, respectively, or 16% and 39%, over the carrying value of the reporting units, respectively. As a result, we did not record any impairment to our goodwill as of December 28, 2013. The evaluation of goodwill and intangible assets for impairment requires the exercise of significant judgment. In the event of future changes in business conditions, we will be required to reassess and update our forecasts and estimates used in future impairment analyses. If the results of these analyses are lower than current estimates, a material impairment charge may result at that time. See note 9 to Notes to Consolidated Financial Statements - Goodwill and Intangible Assets, for further details.
Impairment of Long-Lived Assets: We test long-lived assets or asset groups such as property, plant and equipment and intangibles for recoverability when events or changes in circumstances indicate that their carrying amounts may not be recoverable. Circumstances that could trigger a review include, but are not limited to: significant decreases in the market price of the asset; significant adverse changes in the business climate or legal factors; accumulation of costs significantly in excess of the amount originally expected for the acquisition or construction of the asset; current period cash flow or operating losses combined with a history of losses or a forecast of continuing losses associated with the use of the asset; and current expectation that the asset will more likely than not be sold or disposed of significantly before the end of its estimated useful life.
Recoverability is assessed based on the carrying amounts of the asset or asset group and the sum of the undiscounted cash flows expected to result from the use and the eventual disposal of the asset. An impairment loss is recognized when the carrying amount is not recoverable and exceeds fair value.
Significant judgments and assumptions are required in the forecast of future operating results used in the preparation of the estimated future cash flows, including profit margins, long-term forecasts of the amounts and timing of overall market growth and our percentage of that market, groupings of assets, discount rates and terminal growth rates. In addition, significant estimates and assumptions are required in the determination of the fair value of our intangible assets and tangible long-lived assets, including replacement cost, economic obsolescence, and the value that could be realized in an orderly liquidation. Changes in these estimates could have a material adverse effect on the assessment of our long-lived assets, thereby requiring us to write down the assets.
As we entered the fourth quarter of fiscal 2013, we faced increasing operational and financial challenges, including manufacturing overcapacity and weak operating performance which led to a deterioration in market conditions. As a result, during the fourth quarter of fiscal 2013, we reviewed the recoverability of our long-lived asset groups and we concluded that our business was able to fully recover the carrying amounts of our assets.
Business Acquisitions: Our consolidated financial statements include the operations of an acquired business after the completion of the Microprobe Acquisition in October 2012. We account for acquired businesses using the acquisition method of accounting. The acquisition method of accounting for acquired businesses requires, among other things, that assets acquired and liabilities assumed be recognized at their estimated fair values as of the acquisition date, and that the fair value of acquired intangible assets including in-process research and development, or IPR&D, be recorded on the balance sheet. Also, transaction


costs are expensed as incurred. Any excess of the purchase price over the assigned fair values of the net assets acquired is recorded as goodwill. Cash, Cash Equivalents and Marketable Securities: Cash and cash equivalents consist of deposits and financial instruments which are readily convertible into cash and have original maturities of 90 days or less at the time of acquisition. Marketable securities consist primarily of highly liquid investments with maturities of greater than 90 days when purchased. We generally classify our marketable securities at the date of acquisition as available-for-sale. These securities are reported at fair value with the related unrealized gains and losses included in "Accumulated other comprehensive income (loss)", a component of stockholder's equity, net of tax. Any unrealized losses which are considered to be other-than-temporary impairments are recorded in "Other income, net" in the Consolidated Statements of Operations. Realized gains (losses) on the sale of marketable securities are determined using the specific-identification method and recorded in "Other income, net" in the Consolidated Statements of Operations. We measure our cash equivalents and marketable securities at fair value.
All of our available-for-sale investments are subject to a periodic impairment review. We record a charge to earnings when a decline in fair value is significantly below cost basis and judged to be other-than-temporary, or have other indicators of impairments. If the fair value of an available-for-sale investment is less than its amortized cost basis, an other-than-temporary impairment is triggered in circumstances where (1) we intend to sell the instrument, (2) it is more likely than not that we will be required to sell the instrument before recovery of its amortized cost basis, or (3) a credit loss exists where we do not expect to recover the entire amortized cost basis of the instrument. If we intend to sell or it is more likely than not that we will be required to sell the available-for-sale investment before recovery of its amortized cost basis, we recognize an other-than-temporary impairment charge equal to the entire difference between the investment's amortized cost basis and its fair value.
Restructuring Charges: Restructuring charges include costs related to employee termination benefits, long-lived assets impaired or abandoned, and contract termination costs. The determination of when we accrue for employee termination benefits and which standard applies depends on whether the termination benefits are provided under a one-time benefit arrangement or under an on-going benefit arrangement. For restructuring charges recorded as an on-going benefit arrangement, a liability for post-employment benefits is recorded when payment is probable, the amount is reasonably estimable, and the obligation relates to rights that have vested or accumulated. For restructuring charges recorded as a one-time benefit arrangement, we recognize a liability for employee termination benefits when a plan of termination, approved by management and establishing the terms of the benefit arrangement, has been communicated to employees. The timing of the recognition of one-time employee termination benefits is dependent upon the period of time the employees are required to render service after communication. If employees are not required to render service in order to receive the termination benefits or if employees will not be retained to render service beyond the minimum legal notification period, a liability for the termination benefits is recognized at the communication date. In instances where employees will be retained to render service beyond the minimum legal notification period, the liability for employee termination benefits is measured initially at the communication date based on the fair value of the liability as of the termination date and is recognized ratably over the future service period. We continually evaluate the adequacy of the remaining liabilities under our restructuring initiatives.
We record charges related to long-lived assets to be abandoned when the assets cease to be used. When we cease using a building or other asset with remaining non-cancelable lease payments continuing beyond our use period, we record a liability for remaining payments under lease arrangements, as well as for contract termination costs, that will continue to be incurred under a contract for its remaining term without economic benefit to us at the cease-use date. Given the significance of, and the timing of the execution of such activities, this process is complex and involves periodic reassessments of estimates made at the time the original decisions were made, including evaluating real estate market conditions for expected vacancy periods and sub-lease rents. Although we believe that these estimates accurately reflect the costs of our restructuring plans, actual results may differ, thereby requiring us to record additional provisions or reverse a portion of such provisions.
Warranty Obligations: We offer warranties on certain products and record a liability for the estimated future costs associated with warranty claims at the time revenue is recognized. The warranty liability is based upon historical experience and our estimate of the level of future costs. While we engage in extensive product quality programs and processes, our warranty obligation is affected by product failure rates, material usage and service delivery costs . . .

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