Mike Slessor - Chief Executive Officer Mike Ludwig - Chief Financial Officer.

Edwin Mok - Needham & Company Tom Diffely - D.A. Davidson Patrick Ho - Stifel & Company Christopher Longiaru - Sidoti & Company.

Thank you and welcome everyone to FormFactor’s First Quarter 2015 Earnings Conference Call. On today’s call are Chief Executive Officer, Mike Slessor, and Chief Financial Officer, Mike Ludwig.

Before we begin, let me remind you that the company will be discussing GAAP P&L results and some key non-GAAP results to supplement understanding of the company’s financials. A schedule that provides GAAP to non-GAAP reconciliations is available in the press release issued today and also on the Investors section of FormFactor’s website.

Also a reminder for everyone, that today’s discussion contains forward-looking statements within the meaning of federal securities laws.

Such forward-looking statements include, but not limited to financial and business performance projections; statements regarding macroeconomic conditions and business momentum; statements regarding seasonal business trends; statements regarding the demand for our products and technologies; statements regarding our ability to design and develop, introduce and qualify new products and technologies with one or more customers and to realize revenue for those new products; and statements that contain words like expect, anticipates, believe, possibly, should, and the assumptions upon which such statements are based.

These forward-looking statements are based on current information and expectations that are inherently subject to change and involve a number of risks and uncertainties. FormFactor’s actual results could differ materially from those projected in our forward-looking statements.

The company assumes no obligation to update the information provided during today’s call to revise any forward-looking statements or to update the reasons actual results should differ materially from those anticipated in forward-looking statements.

For more information, please refer to the risk factor discussion in the company’s Form 10-K for the fiscal year 2014 as filed with the SEC in the press release issued today. As a reminder, this call will be recorded. With that, we will now turn the call over to CEO, Mike Slessor..

Good afternoon, everyone and thanks for joining us today. In the first quarter of 2015, FormFactor delivered a fourth consecutive quarter of cash generation and non-GAAP profitability. This year-long sequence represents our profitable navigation of the historically weak fourth and first quarter period.

Furthermore, we see strengthening demand consistent with if perhaps a bit more muted than historical mid-year seasonal robustness. A significant portion of that strengthening demand is for SoC probe cards and is resonant with some familiar themes.

First, several of the year’s major mobile application processor projects are beginning to ramp in volume and are now expected to contribute materially to our SoC revenues in 2015.

Second, the adoption of copper pillar packaging for 28-nanometer and below nodes is continuing with an increasing fraction of the high-end SoC devices being packaged with fine pitch pillars that demand Advanced MEMS Probe Card technologies.

Finally, microprocessor, automotive and industrial SoC markets continue to be healthy with more consistent and uniform demand profiles than the more peaky application processor release cadences. DRAM probe card demand continues to be driven by a high level of DDR4 and LPDDR4 activity paired with shrinks to the 20-nanometer node.

I recently had the opportunity to meet with customers in Asia. And one of our key DRAM customers provided an interesting insight that is worth sharing. In years past, their 20,000 wafer start per week fab would have had one or perhaps two DRAM designs running at any given time.

Today, that same fab is simultaneously running eight different designs across a mix of mobile, server and commodity parts with the wafer start mix being continually adjusted to match market demand.

Given that probe cards are a design-specific consumable item this increased diversity represents a positive trend for DRAM probe card demand and is reflected in our recent DRAM results. In flash, we continue building the installed base of Vector at the two customers that have quantified this new NAND Flash architecture.

And we are currently increasing capacity to meet customer demand. As is typical for a new architecture, we continue to compete for new production designs as well as fulfill reorder demand for the initial design wins.

Consistent with our previously described adoption plan, we expect Vector to deliver $2 million to $3 million in incremental quarterly revenue exiting 2015 as we begin to gain share in the $200 million growing market for advanced NAND Flash probe cards.

It’s illuminating our contrast our fourth and first quarter results since at comparable revenue levels, these periods provide a nearly volume independent measure of product and customer mix gross margin variability.

In the first quarter, we shipped a more favorable mix of products compared to the fourth quarter, which resulted in a quarter-to-quarter gross margin improvement of 2 points.

There are also secondary factors that impact our gross margin, some of which are favorable, like continuing improvement in our operational execution and some of which are potentially adverse like the presently strong U.S. dollar.

With the earnings leverage intrinsic to our operating model, we continue to focus on top line revenue growth, both from participating in growing markets as well as from share gains in these markets.

As you may have seen earlier this week, in its annual probe card survey, VLSIresearch validated both of these growth components along with FormFactor’s market leadership. The overall market grew a healthy 10% from 2013 to 2014 with FormFactor’s 16% growth outpacing the market in the same period indicative of share gains.

VLSIresearch also reported that the preponderance of growth occurred at the high-end of the market, characterized by differentiated products supported by significant R&D investments.

The good example are probe cards fabricating using MEMS technologies, which now represent both the majority of the probe card market as well as the fastest growing sector.

MEMS technology has been a longstanding area of investment for FormFactor and will continue to enable our product capability and cost roadmaps across the SoC, DRAM and Flash probe card markets.

Over the long-term, we expect these market trends and their fundamental drivers to continue, which will further benefit FormFactor’s market share, revenue, and gross margin results. Mike Ludwig will now review details of our first quarter and provide second quarter guidance.

Mike?.

Thank you, Mike and good afternoon. Overall, the financial performance of the company in Q1 was at the high-end relative to our Q1 guidance. Revenues were strong. The product mix was favorable resulting in higher non-GAAP gross margin than our communicated financial model. And we continued to demonstrate spending discipline.

As Mike mentioned, we generated our fourth consecutive quarter of positive non-GAAP earnings and positive cash flow and held by a one-time benefit we will discuss later, we generated GAAP fully diluted earnings per share of $0.01 in the quarter. Revenues for Q1 of $70.8 million decreased $0.5 million, or 1% compared to Q4.

While lower than Q4, the Q1 revenues were seasonally strong driven by our SoC and DRAM customers and increased by $14.8 million, or 26% compared to the first quarter of 2014. SoC revenues in Q1 of $33.4 million decreased $3.3 million, or 9% compared to the fourth quarter, but increased $3.6 million, or 12% compared to Q1 of 2014.

In the first quarter, we saw typical seasonal decreases in our PC-related revenues and decreases in our mobile application processor business as customers transitioned to new designs. Our automotive and industrial application revenues continued to be strong in the first quarter.

First quarter revenues for DRAM products were $34.6 million, an increase of $3.8 million, or 12% from the fourth quarter and an increase of $12.4 million, or 56% from Q1 of 2014.

Growth in the first quarter resulted from our customers continuing their shrinks to the 20-nanometer node and their continued ramp of DDR4 designs for both server and mobile applications. Flash revenues were $2.8 million for the first quarter, a decrease of $1 million from the fourth quarter and $1.2 million from the first quarter of 2014.

NOR Flash revenues were $0.6 million in the first quarter and NAND Flash revenues, including our new Vector probe card, were $2.2 million in the quarter. First quarter GAAP gross margin was $22.8 million or 32.2% of revenues compared to $20.9 million or 29.4% of revenues for the fourth quarter.

GAAP gross margin expenses in Q1 included $0.6 million for stock-based compensation and $2.6 million for the amortization of intangibles. On a non-GAAP basis, gross margin for the first quarter was $26 million or 36.7% of revenues compared to $24.5 million or 34.4% of revenues in the fourth quarter.

The increase in the first quarter non-GAAP gross margin resulted primarily from a stronger product mix, which Mike mentioned earlier. Our GAAP operating expenses were $23.5 million for the first quarter, a decrease of $0.8 million compared to Q4.

GAAP operating expenses in the first quarter included $2.3 million for stock-based compensation, $0.7 million for amortization of intangible assets and $0.5 million for restructuring expenses. Non-GAAP operating expenses for the first quarter were $20 million, $0.5 million higher than Q4, primarily from increased payroll taxes and benefit costs.

In the first quarter, the company realized the benefit of $1.5 million from business interruption insurance proceeds received due to lost business resulted from a fire at a customers’ plant in 2013. The non-recurring benefit was recorded as other income in our first quarter GAAP financial statement, but excluded from our non-GAAP results.

In the first quarter, the company recorded a tax provision of $0.1 million compared to a tax benefit of $1.3 million in the fourth quarter. The tax benefit in the fourth quarter related to the completion of prior year tax audits in certain jurisdictions.

Basic and fully diluted GAAP earnings per share were $0.01 in Q1 compared to a basic loss per share of $0.03 in Q4. Fully diluted non-GAAP earnings per share were $0.10 in Q1 compared to $0.11 in Q4. Cash comprised of cash, short-term investments and restricted cash ended the first quarter at $172.1 million, $7.8 million higher than Q4.

For the past four quarters, the company has generated $27.6 million of positive cash flow. With our current cash and short-term investment balance plus the capital available from our universal shelf registration, we have sufficient means to fund our organic and inorganic growth initiatives.

As a result of our continual review of our capital structure, on April 16, we announced a 12-month $25 million share repurchase program. Here are some other financial details for the first quarter.

Our depreciation and amortization in the first quarter was $5.9 million including $2.7 million for depreciation and $3.2 million for amortization of intangible assets. Our capital expenditures in Q1 were $1.4 million, $0.3 million higher than the fourth quarter expenditures.

Our stock-based compensation expense for the first quarter was $2.9 million, $0.4 million lower than the fourth quarter. With respect to the second quarter, we see continued strength in all of our markets. We expect second quarter revenues to be in the range of $71 million to $76 million. Our product mix is forecasted to be less favorable than Q1.

Therefore we expect the non-GAAP gross margin to be the range of 34% to 37%. Non-GAAP operating expenses will be in the $20 million to $21 million range. We expect cash flow will be positive $7 million to $9 million. With that, let’s open the call to questions.

Operator?.

Thank you. [Operator Instructions] And our first question comes from Harry [indiscernible] Summit. Your line is open..

Hi, this is Srini from Hambrecht Summit. Thank you for taking the question.

Just wanted to know in your identified incremental $65 million of potential revenue increase over the next 2 years, how much of that has been achieved and how much of that is remaining?.

Yes, Srini, it’s Michael Slessor. So, to levels that everyone, back in the early part of 2014, we had articulated growth initiatives that increased our revenue from the 2013 levels by $65 million to $75 million and these were around three market based opportunities. The first in SoC associated with the adoption in copper pillar by our key customers.

We have – as we described in the last conference call, we essentially achieved the growth associated with that first initiative. On the other hand, we see a much larger opportunity as we continue to move forward in copper pillar.

So we achieved the $20 million, $25 million in SoC growth that we talked about as part of the $65 million to $75 million in the past year. However, we see that trajectory continuing and further opportunity there.

In DRAM, really, the initiatives in DRAM were around us becoming quantified at all of the major DRAM manufacturers and completing for business. As we exited 2014 and where we currently sit now, I would say we are two-thirds to three quarters through executing that initiative.

And there is probably a little bit of opportunity left there, but not to the extent there is in SoC. DRAM is more about continuing to execute now that you got broad based market exposure and coverage. On NAND Flash, NAND Flash is really about us gaining market share through our new Vector architecture.

And as we described on the call earlier today, we believe that we are still in the very early stages of that. Exiting 2015, if we look at Q4 run rate, we believe we can generate $2 million to $3 million incremental revenue opportunity associated with Vector and NAND Flash.

But again, that’s going to have significant legs beyond the $2 million to $3 million a quarter opportunity as we continue to gain share in the $200 million in growing NAND Flash probe card market.

So to summarize all of that, I think in SoC we achieved the elements of the $65 million to $75 million increment, but we see further opportunity beyond that in a fairly significant way. DRAM, we are sort of in the middle to late innings in achieving the incremental opportunity and it’s about continuing to execute.

And NAND Flash, we are very, very early on in that. So much of that opportunity, in fact the majority of that opportunity, remains in front of us..

And just as a quick follow-up, what fraction of DRAM that your probe card currently probe are DDR4 versus DDR3 and when do you expect the crossover?.

So the date is a little bit convoluted, but from a revenue basis, it’s getting pretty close to the crossover point right now. As we said, a lot of the activity being driven right now is heavily biased towards DDR4 and LPDDR4. So I would hazard to guess, but it’s really close to the crossover point..

Okay. Thank you very much for taking my questions..

Our next question comes from Edwin Mok from Needham & Company. Your line is open..

Hey. Thanks for taking my question. So first question just to clarify your guidance, based on your guidance, you expect growth in all three segments.

I just wanted to clarify that commentary?.

We didn’t comment on that. The answer is I think we are slightly – at the midpoint, we are certainly up. And probably I would say up slightly in all the segments..

Okay, that’s great. Just wanted to clarify that. And then I think in the beginning, you guys talked about you expect policies if your seasonal strength as implied in your guidance, right, but maybe a little bit less than, a little bit more muted than historical seasonal trends.

And we have heard so many customers talk about channel inventory being built on that chip side, right, is that with you guys and referring to maybe there is some – that has some impact on your business.

And regarding the three segments, DRAM has been very strong over the last two quarters, is that one area that you might have seen a bigger impact?.

Well, I think the comment we made at the top was certainly as we have come through the fourth quarter of 2014 and the first quarter of 2015, which have historically been weak to very weak periods of the calendar year. Obviously, if you look at our results, we have navigated through that with much less ups and downs than we have in the past.

So, certainly, that element of seasonality has been muted. I think as we move here into the second quarter and look towards further down the road in 2015 the increase in demand in revenue again seems a little more muted.

So, the – if you like the amplitude of the seasonality demand variations seem to be a little bit more muted, at least at this point – at least at this point in the cycle.

Now some of that, no question, is due to our more diversified exposure across all of the markets and all of the customers that we can point to several instances, where that’s helped damp typical seasonality, but it does feel like the kick-up we typically get in the middle of the year is a little more muted than it has been in past years..

Great. That’s good color and very helpful. And also actually I want to touch on the SoC you gave some color on the different end-markets, right, auto industry being strong. PC market you see some – one of your customer always pre-announced, but I want to touch on mobile application and adoption of copper pillar.

Are we still seeing the copper pillar mostly at the very leading edge high-end mobile processors? Are we starting to see that actually re-branch out to almost like all these different mobile processors? Maybe this is more a longer term trend question..

Yes. So, I think in the very short-term, we are still seeing a pretty diverse mix of mobile processors, whether they would be full-fledged combos or full-fledged combo application processors or pure-based MEMS and modems. We are still seeing a pretty good mix between copper pillar and the classic [indiscernible] techniques.

If we look at our new design pipeline, there is definitely a bias and a push towards the copper pillar packaging across many of the mobile application processor new designs.

So, I think as a – if you like a secular trend or something pointing towards future volume and mix, we definitely see movement towards adoption of copper pillar packaging technology in the mobile space..

Okay, that’s a good color there. And then last question I guess on the gross margin, I think you guys mentioned favorable mix for the last quarter, but less favorable this quarter.

I think my understanding historically DRAM market tend to have maybe have carry a little low gross margin, but DRAM mix increased this quarter where your gross margin actually increased.

Maybe you can give some color in terms of when you say favorable product mix, what does that mean? And then can you give also some color about where you are in terms of your factory utilization right now? And as volume increase which you guided for in the June quarter, does that also help you in gross margin? Thank you..

Yes, Edwin. So, this is Mike. So, on the margin side in the mix, we tend just to again say that SoC has higher margins than DRAM, which is higher margins than Flash. And that’s true, but you have to look at the mix even within product mix, even within those areas. And so it’s a little bit more nuance than just at that high level.

And so, yes, DRAM was a higher percentage, but we also had even within DRAM we had better mix this quarter than last quarter. And even though SoC was down slightly, we had better standard margins because of some mix opportunities there as well. So, it’s a little more nuance than that. So, again, it gets to be products, customers.

It’s definitely little more complex. And then with respect to factory utilizations, we have three factories here they are all running at a little bit different utilizations that I would say in general we are running probably high 70s to low 80s with respect to utilization.

So, they are running pretty hard, but we still have a little bit of room and yes, to the extent that we have additional capacity going through there it definitely helps our margin..

Great, that’s all I have. Thank you..

Our next question comes from Tom Diffely from D.A. Davidson. Your line is open..

Yes, good afternoon. First, a question on FX and the fact that your main competitor on the SoC side is Italian and on the other side it’s Japanese and obviously they have some cost advantages at this point on a relative basis.

Are you seeing any kind of reaction from them to take advantage of that at this point?.

So, I think a little more color on the FX or currency exchange elements of it. I think we are seeing people behave differently in different areas even to the extent of behaving differently in different deals.

I think the place probably to focus the discussion for now is on things that revolve around Japan and it’s an interesting case for us, because we have key suppliers in Japan as you allude to in DRAM, our primary competitor is Japanese. And we have some pretty significant customers or customer in Japan for DRAM.

So, it provides kind of an interesting case study. I think for DRAM and the Japanese competitor, we have seen the leading indications of them for a couple of deals taking advantage of some of the cost advantage they have, because of the – well, the hopefully, temporary FX advantage, but I don’t think it’s anything too drastic at this point.

We obviously on the other side of that as we said gained some COGS advantages, because a significant part of our bought materials are sourced in Japan at least in DRAM..

Okay, but you are not seeing much on the Italian side, so to speak?.

Yes. I think most of if you like these leading indicators revolve around Japan..

Okay, alright.

And then you mentioned earlier in your prepared remarks that one of the DRAM customers you are talking to has gone from one to two designs to eight in their fab, I am curious, if it’s one or two designs proliferated across all of their equipment or eight designs proliferated off the equipment? Does it matter to you, which of those two scenarios it is if you are supplying the same number of masks?.

Same number of probe card?.

Probe card, sorry, yes. So, you have essentially a bunch of copies of one versus unique designs on the other case..

So, that’s a great question. And as we have started to try and understand how that affects our business and impacts our business, it’s one of the key consideration. If the fab runs with the same eight designs and they are all loaded the same, then you are right, it’s [indiscernible] the other.

Where the interesting part comes in for us is when the relative wafer starts associated with each of those eight designs starts to move up and down, because the probe card fleet has to be there and ready to accommodate those wafer starts when they get to the end of the line.

So, the interesting part for us is the fluctuations and the need for the customer to be flexible in allocating wafer starts, oftentimes, as frequently as any given week, they are changing things up and to have the tooling in place to be able to sort those wafers at the end of the line..

Okay.

I mean, along those lines, do you make more on your first probe that goes to the customer assuming you have to do some engineering work that the second and third probes does include?.

So, yes, the first article always involves a bunch more design engineering work. Again, sort of maybe to bounce back to Edwin’s question a little bit, one of the important things to understand about our business is probe cards are a design-specific consumable.

And so for each first article, there is a lot of engineering design work in as the operating income line, that means the first article is not going to be as profitable as some of the maybe card two, three or even four. By the time we get through that though, the ASPs are largely dominated or have taken care of the NRE.

And in some cases, some certain segments, certain customers, we get directly compensated for that engineering work..

Okay, that’s helpful.

And then I guess for the other, Mike, when you look at the drop-through of the three segments now, DRAM, SoC and NAND, is it all kind of in that 50% to 60% range?.

I would say again the drop through in general is the corporate level is 60%. So, SoC is again above that. DRAM is probably at that level. And Flash, at this point in time, is still below that 60%. Obviously, as we transition to Vector, we expect to move that up to be more – to be closer to the corporate norm..

Okay.

And then the flash business you had during the quarter, was that a combination of the old stuff still as well as the new Vector?.

Yes, it was. A lot of the NAND business there was using our legacy product in high end applications..

Okay.

That’s fit into the mix issue then?.

Correct..

Okay, alright. Thank you..

And our next question comes from Patrick Ho from Stifel & Company. Your line is open..

Thank you very much.

Mike, maybe first off, in terms of the copper pillar adoption in the marketplace, as you start seeing it broaden to say, even legacy, but not legacy, but 28-nanometer type of devices, have you seen the competition, I guess enter or have more competitive products out there or do you believe that you are still kind of the only player in town and you will be able to kind of take the bulk of the share of new devices that are coming out?.

So Patrick, I think we have had competition in this space for a while. There is a variety of probe card manufacturers that do have viable offerings for fine-pitch copper pillar. As I think you know, we have held a pretty strong share position in copper pillar for a while.

But I think at the high end, we are certainly with this next generation of designs that we alluded to in the prepared remarks. We are not in a sole source position, there is a competitive position, as I think there needs to be in any healthy element of the semiconductor supply chain. So yes, there is competition.

I think there will continue to be competition, but there has also been competition in the past..

Great.

Maybe moving to the DRAM side of things, I know in the past you have talked about how there is obviously, a greater mix of mobile server for you guys as well, have you seen that mix change in over the last couple of quarters because the DRAM business continues to gain momentum despite a lot of the moving pieces there, have you seen any changes in the mix or is it still being driven by the real strong growth on the mobile DRAM side, have you seen anything on the server side that gives you confidence for the core additional growth?.

Yes, I think if you look at the mix between mobile and what we have historically called commodity, but commodity probably is server plus PC through commodity DRAM. There has been a lot of recent activity around regular DDR4 as contrasted by low power or mobile DDR4.

But I still think along the swim lanes that we have talked about of our DRAM business breaking down roughly 50-50 in any given period between mobile and server and PC, it was right about there in Q1, and I don’t see that mix fundamentally changing. There is a lot of activity around DDR4 both server and low-power..

Great, thank you very much..

[Operator Instructions] And our next question comes from Christopher Longiaru from Sidoti & Company. Your line is open..

Hey, guys.

How are you?.

Good..

Good..

So, you mentioned some share gains, I wonder if you could give us a little color on exactly where those are coming from and how you see those kind of progressing, does it open up new opportunities for you? Can you give us a little color there?.

Yes. So the share gains we referred to and you can – VLSIresearch has put out a pretty nice report that cuts the probe card market in any number of dimensions and segments, the detailed thing is pretty – with pretty fine resolution.

I think if you look at our results from a segment perspective, along the lines of SoC, DRAM and Flash that we typically describe our market in, I think in 2014 we gained share in both SoC and DRAM where we have been focused.

I think with the transition out of supplying at least the bulk of our Flash opportunities with our legacy products and moving over to Vector, I think we probably lost share there as we navigate through this transition.

I think the other way to cut the market is when you look at some of the technologies required and one of the interesting things that we see both in the VLSI report in the past year, but longer-term is the requirements to serve the probe card market continue to migrate the higher and higher complexity.

They detailed MEMS probe cards or probe cards built using MEMS technology as being not only the largest segment, but the fastest growing segment.

And so I think that plays a little bit to the market based share gains in SoC and DRAM we talked about, because the requirements are just moving towards the kind of things that suppliers like FormFactor are able to do and maybe some of the smaller players aren’t able to invest the R&D in the capital in solving these problems..

That’s really helpful. Thanks.

And this one really has to do with the operating cost structure, you guys keep lowering it which is great, but how does this kind of shake out? I mean, at this point, it’s just kind of a run-rate we should expect the model going forward long-term or aside from maybe some occasional mask cost and things like that?.

Yes, Chris. So, actually, the cost structure actually increased slightly in Q1 relative to Q4, but again, due to some cost….

[indiscernible]..

Yes, but I would say just to get back to your, I guess, fundamental question though is the cost structure probably is where we think it’s going to be on a go-forward basis. Again, we think we are set up for very good leverage. So, we think we can grow revenues at pretty good clip and keep the same cost structure in place.

On the gross margin side, again, we are not planning anything big, but I think we want to leverage the investments that we have made in our technology across all three product lines to reduce our product cost. But I think that’s going to be a multiyear opportunity for us.

So, overall, I would say we are pretty comfortable with our cost structure where it is and expect that we can leverage it from here..

Great. Thank you for that. I will jump out..

And I have no further questions. And I like to turn the conference back to management for any closing comments..

Thanks again for joining us today and for your interest in FormFactor and our performance. We will be continuing to update our opportunities and results as we participate in several investor conferences and events in the coming months.

We look forward to seeing you in person at these events and encourage your attendance at our Annual Shareholder Meeting on May 1. Thanks again..

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude today’s program. Everyone, have a great day..