It is a well-known fact among analysts and investors that the semiconductor industry is highly cyclical. Expansion and contraction ebbs and flows, capital spending rises and falls, and companies invest in new technologies almost as regularly as the changing seasons. (And thank goodness winter is finally behind us!) It's the rare company that can rise above -- and stay ahead of -- those shifting fortunes.
California-based FormFactor (NASDAQ:FORM), the leading manufacturer of advanced wafer test probe cards for semiconductor chips, has turned out to be one of those anomalies. Regardless of the times, irrespective of economic conditions, no matter where we might be in the industry cycle, FormFactor's products are in demand. It simply dominates the advanced probe card market with 80% market share, which it reports is growing as chip manufacturers adopt its latest-generation test probe cards. In just two "touchdowns," they can test an entire wafer from which individual chips are cut. But more on that in a minute.
After a contamination quirk at its old manufacturing facility caused FormFactor to report revenue growth of only 46% for the quarter, there was a collective gasp by the investment community, since the company had been nearly doubling revenues in each of the preceding quarters of the fiscal year. The contamination caused orders to be delayed, shipments to fall behind, and revenues for the last month of the fiscal year took a hit. So did the stock price, tumbling 28% from its 52-week high. It was a great time for savvy investors to swoop in and scoop up shares, which many of us at the Motley Fool Hidden Gems small-cap investing service did. We saw it as a one-time problem that was quickly righting itself and would not impede the company's performance for very long.
When FormFactor reported its quarterly earnings last week, it was just the sort of performance I was expecting when I recommended the stock for Hidden Gems last year. In the face of a tough semiconductor slump, the probe card manufacturer reported a 10.5% sequential increase in revenues and a 37% increase year-over-year to $51 million, exceeding the company's guidance of $47 million-$48.5 million, while non-GAAP earnings increased to $0.19 per share from $0.13 last year. It still has no debt, and it has $189 million in cash and marketable securities on hand.
The reason the company was able to get back on track so quickly was because demand for its wafer test probe cards has continued unabated. Even when FormFactor had contamination issues, customers chose to wait until the company was back to peak production rather than switch to competitors. FormFactor boasts some of the biggest names in the industry as customers, too: Intel (NASDAQ:INTC), InfineonTechnologies (NYSE:IFX), Samsung, Spirox, and ElpidaMemory. It's hard for companies to earn such loyalty, but in the world of semiconductor chip production, a product that significantly reduces costs will generate such devotion.
FormFactor has been the industry leader from the moment it went public two years ago because its advanced test probe cards, using its proprietary MicroSpring design, can test a wafer in just a handful of tests. Testing is one of the most expensive parts of chip production, and FormFactor's probe cards are becoming more essential to manufacturers who want and need to keep those costs in line. Its newest product tests the entire wafer in just two touchdowns and will soon be able to do so in just one. By coming into contact with the wafer just one or two times, companies will be able to move on to the next process that much quicker, and that will lower costs. No other probe card manufacturer offers anywhere near that level of efficiency.
Yet how is FormFactor able to stay above industry cycles? When chip manufacturers are in boom times, they need to be able to test as many wafers as possible to meet demand. When the cycle turns, manufacturers invest in new designs and most maintain costs. Each new design change means a whole new probe card is needed to test the wafer. And the industry is in the midst of a confluence of transitions: wafer sizes are growing from 200 millimeters to 300 millimeters; chip sizes are falling below 110 nanometers; and new chip architectures (the migration to DDR2 memory chips from DDR1, for example), are all in full swing and create a powerful set of growth drivers for FormFactor.
The company is reporting relatively flat growth in revenues and only moderate growth in earnings, sequentially for next quarter, but 22% to 23% growth year-over-year. Considering the uncertain times chip manufacturers have been experiencing, and the down year analysts are forecasting for the industry, FormFactor is performing true to form.
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Fool contributor Rich Duprey and Tom Engle recommended FormFactor for Hidden Gems. Rich owns shares in FormFactor but does not own any of the other stocks mentioned in the article. The Motley Fool has a disclosure policy.
