Mike Slessor - CEO Mike Ludwig - CFO.

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

Thank you and welcome everyone to the FormFactor's Second 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 understandings 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 the Federal Securities Laws.

Such forward-looking statements include, but are 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 from 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 could differ materially from those anticipated in forward-looking statements.

For more information, please refer to the risk factor discussions in the company's Form 10-K for the fiscal year of 2014 as filed with the SEC, subsequent SEC filings and in the press release issued today. With that, we now turn the call over to CEO, Mike Slessor..

Good afternoon, everyone and thanks for joining us today. In the second quarter of 2015, FormFactor again delivered strong operational and financial results as we continue to build on our leadership position in the Advanced Probe Card space.

We executed well against our financial model generating profit and cash for the fifth consecutive quarter and we used a portion of that cash to buy back shares for the first time since 2011. Here in the third quarter, FormFactor along with the rest of the industry and supply chain is experiencing weakness in PC related demand.

However, because of our improved market and customer diversification compared to previous cycles, the present weakness is now being partially offset by solid demand from Mobile SoC and Mobile DRAM Probe Card.

In this very dynamic environment, we are keeping a tight rein on costs and a strong focus on operational execution to ensure short term financial performance while at the same time investing in our long term growth opportunities.

The Advanced Probe Card market is a structurally attractive area of the semiconductor supply chain, especially in light of the recently well publicized slowing of more slot.

An interesting example of this is currently evident in our SoC business where we are preparing for the probe card refresh cycle associated with the third major 40-nanometer microprocessor platform recently announced by one of our largest customers.

As with each of the previous 240-nanometer platforms, a device specific fleet of probe cards is required to test these processors. And so even though the transition from 40-nanometer to 10-nanometer is delayed, there is an equivalent device change replacement cycle for probe cards that FormFactor is well positioned to capitalize on.

In our SoC probe card business, the softness associated with PC applications is being partially offset by robust volume supporting a significant mobile application processor ramp.

As we look forward to the later part of the year and into 2016, production ramps are planned for multiple microprocessor and application processor devices on advanced silicon notes with each of these devices using fine pitch copper pillar packaging.

This produces high interconnect density and extreme performance requirements, these devices require probe cards that rely on MEMS technology.

This technology is a cornerstone of FormFactor's leadership in the Advanced Probe Card market, and as customers migrate more devices to these fine pitch copper pillar packages, we expect significant continued growth of our SoC business.

With FormFactor's DRAM probe card demand now driven by all three major DRAM manufacturers, we have significantly improved the marketing customer exposure of this business over the past year.

At present, much of the market demand for DRAM probe cards is concentrated in mobile DRAM devices on advanced nodes such as 20-nanometer, and our improved position is enabling us to capitalize on this demand.

With our primary competitor in this market being a Japanese company, we have experienced some exchange rate related pricing pressure on a few opportunities at a specific customer. We've used a historically high Yen to Dollar exchange rate as a temporary situation and are committed to staying disciplined as we compete at all three DRAM manufacturers.

With the qualification of our new Vector NAND Flash product at two major customers, we've invested in both initial production capacity, as well as quality and yield improvement initiatives.

These initiatives will ensure that we can successfully make and meet aggressive lead time and delivery commitments in volume production while also meeting our internal cost and gross margin targets. Initial indications are that Vector is well positioned to serve the fast growing demand associated with 3D NAND.

In these early stages, it appears 3D NAND is requiring longer test times driving increased demand for overall test and improved card capacity for this new memory technology. Our initial target of $2 million to $3 million of quarterly incremental Vector revenue remains intact, and we expect to achieve this run rate later this year or early next year.

Finally, on the capital allocation front, we continue to both buyback shares and pursue M&A opportunities. In assessing our M&A opportunities, we have defined a scope that includes market adjacencies and analytical instrumentation, failure analysis and yield enhancement.

These are all areas where we can leverage our significant R&D and channel investments, as well as create long term product and technology synergies.

As more slot advances become more challenging and our customers seek multiple solutions to advance their product roadmaps, the technology enabling these advance has become critical, and FormFactor plans to continue to expand our presence in the strategic area of semiconductor manufacturing.

Mike Ludwig will now review details of our second quarter results and provide our third quarter guidance.

Mike?.

Thank you, Mike and good afternoon. Overall, the financial performance of the company in Q2 was better than midpoint of our Q2 guidance and inline with our communicated financial model for the revenue level achieved.

As Mike mentioned, with continued focus on execution and spending discipline, we generated our fifth consecutive quarter of positive non-GAAP earnings and positive cash flow, and we generated GAAP fully diluted earnings per share of $0.01 in the quarter with the assistance of one-time items.

Revenues for Q1 of $73.9 million increased $3.1 million, or 4% compared to a strong first quarter, and increased $6.5 million or 10% compared to Q2 of 2014. Increased Q2 revenues compared to the first quarter were driven by modest increases in each of our product markets.

SoC revenues in Q2 of $34.6 million increased $1.2 million, or 3% compared to our first quarter. Towards the later part of the second quarter, we felt the beginning of a weakening PC market. But this weakening was more than offset by stronger mobile processor revenues driven by specific new designs.

Our automotive and industrial application revenues continued to be healthy in the second quarter. Second quarter revenues for DRAM products were $35.3 million, an increase of $0.7 million, or 2% from the first quarter. Growth in the second quarter resulted from our customers continuing their shrinks to the 2X nanometer node.

Flash revenues were $4.1 million for the second quarter, an increase of $1.2 million from the first quarter. NOR Flash revenues were $2 million in the second quarter and NAND Flash revenues, including our new Vector probe card, were $2.1 million in the quarter.

Second quarter GAAP gross margin was $23.3 million or 31.5% of revenues compared to $22.8 million or 32.2% of revenues for the first quarter. GAAP gross margin expenses in Q2 included $0.6 million for stock-based compensation and $2.8 million for the amortization of intangibles.

On a non-GAAP basis, gross margin for the second quarter was $26.7 million or 36.1% of revenues compared to $26 million or 36.7% of revenues for the first quarter.

The increase in the second quarter non-GAAP gross margin dollars resulted from higher revenue, rather lower margin percentage resulted from slightly less favorable manufacturing absorption and manufacturing variances compared to the first quarter.

As I mentioned earlier, the 36.1% non-GAAP gross margin is consistent with our financial model for the level achievement in the second quarter. Our GAAP operating expenses were $22.6 million for the second quarter, a decrease of $0.9 million compared to Q1.

GAAP operating expenses for the second quarter include $1.9 million for stock-based compensation, and $0.7 million for amortization of intangible assets. Non-GAAP operating expenses for the second quarter were $20 million, the same as first quarter.

The tax provision in the second quarter was $24,000 compared to a tax provision of $0.1 million in the first quarter. GAAP net income was $0.8 million in the second quarter, fully diluted GAAP earnings per share were $0.01 in Q2, consistent with earnings per share in Q1.

Non-GAAP earnings were $6.7 million or $0.11 per fully diluted share in Q2 compared to $0.10 in Q1. Cash comprised of cash, short term investments, and restricted cash ended the second quarter $179.2 million, $7.1 million higher than Q1. Excluding cash used for stock buyback, the company generated $10.6 million of cash in the quarter.

The company used $3.5 million to repurchase 400,000 in the second quarter. At the end of the second quarter we had $21 million to $25 million remaining on our authorized $25 million stock repurchase program which extends through April 2016. He are some other financial details for the second quarter.

Our depreciation and amortization to the second quarter was $6 million including $2.7 million for depreciation and $3.3 million for amortization of intangible assets. Our capital expenditures in Q2 were $2.8 million which brings our first half expenditures to $4.3 million, well within our planned annual CapEx of $8 million to $10 million.

Our stock-based compensation expense for the second quarter was $2.5 million, $0.04 million lower than the first quarter. With respect to the third quarter, we see a weakening PC environment partially offset by a strong mobile design cycle consisting with Mike's statements.

We expect third quarter revenues to be in the range of $63 million to $68 million. With lower quarter-over-quarter revenues, we are tightly managing our factory in infrastructure cost but our factories will experience lower utilization and hence lower cost absorption. Therefore we expect non-GAAP gross margin to be in the range of 31% to 34%.

Non-GAAP fully diluted earnings per share will be $0.01 to $0.05 per share. We expect cash flow to be positive, $5 million to $7 million before the impact of stock repurchases. With that, let's open the call to questions.

Operator?.

[Operator Instructions] And our first question comes from Patrick Ho with Stifel Nicolas. Your line is open..

Thank you very much.

Of course maybe Mike in terms of the DRAM market, the mix shift that you're seeing from PC to mobile, can you give a little bit of color how that shook out in June and how it looks like going into September in terms of the mix of your DRAM business?.

If we look at the quarter just in, the second quarter where we reported results, PC was certainly lower than mobile and lower than the historical sort of 50-50 split we've seen between PC and mobile. I think that trend certainly is continuing as we move forward into the third quarter of the year.

I think consistent with comments some of our customers have made about them shifting their wafer start mixes away from PC into mobile, I think we're continuing to see that movement towards more demand on mobile DRAM, less demand on PC DRAM.

Certainly in response – our customers responding to the prices they are getting in the markets and the end demand for DRAM, we're seeing that reflected – not quite one for one but certainly from a qualitative basis in our demand as well..

Great, that's helpful. And maybe moving to the NAND Flash side, the traction you're getting with Vector. You've talked about the two customers wins you've had today and the traction for 3D NAND that's beginning today and carrying into 2016.

Do you see those two customers being your key drivers into next year or you're working to get some of the other players that are out there remaining as customers as well?.

I think it's certainly a question of timing Patrick, we didn't introduce a NAND Flash product to only address two of the four major NAND Flash manufacturers but we also want to make sure that we have done all of the required preparations and this goes back to my comments about investing in internal yield, internal quality improvements, as we take the initial phase of the production ramp on.

I would like to make sure that we're able to execute to make aggressive delivery commitment, to meet those aggressive delivery commitments and hit our cost targets as Vector grow share. So, a year and a half from now, 18 months from now, I expect us to be qualified at all four NAND Flash manufacturers.

In the very short term we're focused on pilot production and moving forward with the two qualifications we have but we're definitely going to pursue qualification of all four NAND Flash manufacturers as we move forward in the future..

Great, thank you very much..

Thank you. Our next question comes from Sundar Arjun [ph] from Summit Research. Your line is open..

Hi, thanks for taking my question. If you look at Q2 and Q3, who are the 10% customers in each of those quarters, perhaps on Q3 you may not be able to tell but if you can enlighten me on who are the 10% customers in both the quarter that would – I'd appreciate it..

So our 10-Q I believe is filed later today where they will be disclosed. So, for the second quarter I'll tell you things haven't changed much from what we reported in the first quarter in terms of 10% customers.

Obviously for Q3, given the turns element of this business, and for lead times that we have that allow us to be competitive in the market, we don't really know how that's going to shake out from an absolute quantitative perspective but I will say that qualitatively I wouldn't expect much change in the names that appear there..

Okay.

And when do you see a DDR3 versus DDR4 crossover for you guys? Have we already seen it?.

I think we've already seen it. A lot of the stuff we did in the second quarter and I believe we made comments in the first quarter as well, we felt like we were qualitatively close.

There can be some uncertainty on whether the design is a DDR3 or a DDR4 design but I would say within those air bars, it's my judgment that we probably gone through that crossover from a probe card perspective..

Okay, thank you very much, that's all..

Thank you. [Operator Instructions] Our next question comes from Christopher Longiaru with Sidoti & Company. Your line is open..

Hi, thanks for taking my question. Can you just comment a little bit on the competitive environment, I know advanced test is talking about probe card product that they are qualifying with customers.

Can you give us kind of an idea into if there is any changes in your competitive environment by market over the course of last couple of quarters?.

Yes, I think as you probably know the advanced probe card market breaks down into essentially three segments or three submarkets. The one I think you're referring too with advance test is DRAM, and I think I'd point back to advance test is certainly add an active DRAM probe card program for many, many years.

It's an area where we feel like the technology investments that both us and our Japanese competitor who is not Advantest have made over the years, have created a relatively high barrier to entry and I think you see that by the way market share breaks down in DRAM.

So certainly we don’t take entry especially by a company as formidable as Advantest lightly, however it's a tougher business than it looks on the face of it.

We need to continue to compete to advance our technology, to lower our cost and improve our quality but again I think in DRAM structurally I don’t think we see significant changes in the overall competitive dynamic..

That’s really helping and just what kind of steps can you take if this yen weakness continues.

Is there anything you can actively do or that you’re considering doing?.

Obviously, even though as we said in the prepared remarks we view it as a temporary situation. We’re doing everything we can offset that situation. And I think the actions fall into two large scale buckets. In the short term we continue to be very focused on incremental improvements on our existing product architecture for DRAM.

So improving yields, investing in improvements in our overall cost structure making sure we become more and more efficient at making that product. I would say longer term and we have talked about this before in several forums.

Our overall strategy is to take our fundamental investments in things like MEMS technology, and essentially leverage them across all three markets.

SoC probe cards, DRAM probe cards and NAND Flash probe cards and so we have begun to look at and investigate how we fundamentally changed the cost structure of our DRAM architecture as we look towards leveraging our R&D investments and manufacturing investments across all of our different product lines.

Now that's a much longer term effort and we certainly are hopeful and optimistic that the currency headwinds don’t last that long. But those are the two elements of actions that we’re actively taking..

And just in the past you kind of talked about where cash flow breakeven is still the same kind of expectation for cash flow breakeven?.

Yes, we communicated that it's 61 to 63 and at that we would have gross margins at 30% to 33% and so we have not changed that, as a matter of fact we’re very committed to that model and you can see even if you look at sort of the mid-points of the guide that we gave we’re still in-line with that model and again that’s important for us and we are very committed to that..

[Operator Instructions]. And we have a question from Tom Diffely with D.A. Davidson. Your line is open. .

Couple of questions here, first we have all talked about the PC weakness for a while but did I hear you say early on that you’re now getting the third generation of MPU on 40 nanometer and so that business might pick up for you?.

Well I think there is a distinction in our micro-processor business between pure PC and some of the server stuff as well Tom, that’s important to recognize.

Obviously from a units perspective and legitimately from a dollar perspective our micro-processor business is dominated by the client side and that's part of the reason why you see revenues reduce in quarter over quarter.

But yes we were trying to give you some flavor of the distinction between our design specific consumables or tooling business compared to perhaps a pure capital equipment business and so obviously our big micro-processor customer has announced a third device on the 40 nanometer silicon generation.

That’s an areas that will require, that’s a set of products that will require a complete refresh of probe cards and so as we move forward here the timing is a bit uncertain whether it's the [indiscernible] late of this year or early next year.

But there is certainly the demand profile there to allow us to continue to capitalize on the refresh cycle associated with new designs even in the absence of a fewer node shrink.

And then on the DRAM side, you know is it really the softness of the PC market that’s causing the trouble or is it more of the fact that couple of your customers are really working to move from the higher nodes down to the 20 nanometer node and that transition obviously you’re not going to do a lot of design work while the transitions went on, but once that’s transition is done then it opens up kind of the flood gates again for more design activity.

I think certainly as a couple of the customers get to 20 nanometer being yielding in a way where they are confident to ramp production in a significant way. I certainly think that drives demand and opens back up the flood gates in [indiscernible] to some demand there as well.

So somewhat of a question of timing but certainly as we look at our mix and overall DRAM results, there is weakness in the PC side, as we look forward to the back half of the year certainly we’re excited about the prospect of 20 nanometer ramps at two of the customers as they get their yields up and start to really quit significant design and capacity on those leading edge nodes..

Okay and you talked a little bit about FX pricing pressure based in Japan, what about your Italian competitor, are you seeing much kind of Euro based pricing pressure at all?.

Yes, and just so everybody is on the same page. In SoC one of our chief competitors is an Italian based company and obviously there is some of the same strong U.S. dollar effects whether it be yen to dollar or dollar to euro.

Given where we are in the advance SoC market and the need for MEMS technology to probe some of these advanced micro-processor and application processor devices we haven't seen our European competitor take significant steps in really competing on price.

They have been fairly disciplined in competing in the market and I think in the early stages, copper pillar adoption, we still feel is in the early innings and so they and us are really still building capacity and probably around a different set of constraints early in the life cycle of building probe cards for that.

So pricing has held up pretty well there..

And then in your prepared comments you talked a little bit about the uses of cash and acquisition, and you mentioned that there are synergies between what you do and things like failure analysis and I guess it's just not as clear to me, what those synergies would be? Is it the take home synergies or is it really just the more of the scale synergies?.

I think there is a couple of different elements of it and it comes in different stages in time.

I think right out of the gate you can certainly look to both scale and channel synergies obviously the customers for anything in the areas we defined are the same customers we currently interact and currently sell to and with FormFactor having significantly broadened and diversified it's market coverage and aligned itself pretty well with the Top 20 semi-conductor manufactures, we have now got a channel and support structure built up that we feel like is a pretty good asset to bring other technologies and products through.

So that’s probably a short term aspect to the synergies. I think scale certainly in this industry right now, and going forward is a good thing. Our customers are consolidating like crazy.

There has been more limited consolidation in the supply chain and I think that for a company of our scale and several people around us of similar scales it's going to make sense for us to generate more scale and more efficiency. I think the more exciting opportunities in the longer term.

As you know the pure Moore's Law of shrinks in the front end get harder and harder. You’re seeing integration schemes 3D NAND certainly being one of the examples right in front of us right now.

They create new yields learning opportunities, new failure analysis opportunities, that we feel like in the long term our resonance can couple with what we do on the production wafer test floor.

So that’s certainly a longer term view but building a scope and a platform around helping customers measure and improve their wafer test electrical yields, it's certainly a theme that we’re excited about in the long term..

And finally how is the tax event, de minimis for a bit here.

Can you just remind us what the current levels of NOLs are and how long will it be before you expect to pay full taxes again?.

It will be a long time, Tom. The gross NOLs are somewhere close to $300 million. So the deferred tax asset around that is by about 0.35 when you get that, so around $200 million but the fact is it will be a while before we run through that..

All joking side, I think that’s one of the interesting aspects in an M&A strategy, clearly it has to solve for some of the strategic product and technical rationale that we talked about but it also needs to be financially attractive the fact that we have these NOLs we believe is a -- an interesting asset in bringing other technologies and other business under the FormFactor umbrella..

Thank you. And our next question comes from Kimberly Donovan with Needham & Company. And your line is open..

So two question I guess I’ve, first is on the guidance right? Is it safe to say that sequentially all the decline came from DRAM side or how do you think about, SoC -- see your business sequentially?.

Yes, I would say, Edwin, that when you look at the guidance the drop is in memory obviously most from DRAM and we would expect not to see any real sequential drop from the SoC business..

And then related to your gross margin number, on the gross margin guidance, so I obviously understand more revenue has an effect on your utilization rate.

However you also talk about FX as an impact right? If you can talk -- quantify how much of the sequential decline of gross margin always -- any way you’re not going to quantify the change in gross margin, rest those two factors?.

Could you ask that again?.

Yes basically just relative to FX impact on your gross margin, FX as a result of low price versus low utilization, how did those impact your gross margin in any way--.

So the impact is primarily from just the lower revenue and lower cost absorption. The FX for the most part really isn't hurting the margin that much as much it's probably taking away the opportunity for revenues on the top side.

So again the FX impact on our margin per se is more an opportunity cost with the fact that we’re just not getting revenue opportunities for it, not so much that it's impacting us on a gross margin standpoint..

And then just talk a little bit longer term.

I think Mike you talked about copper pillars adoption that needs to be happened ahead of us right? Is that where you can think about maybe the opportunities there, what kind of penetration rate should we expect for copper pillars as we go to '16 - '17 and even longer term that you’re looking at in terms of how market adopted [ph] are you?.

I'm going to have to take that as a bit of homework in terms of real penetration rates. We’re looking at it right now because it's obviously an important question for us. I think if I were to be qualitative about it, I certainly think that of the designs we see and as the market share leader in SoC probe cards I think we got pretty good coverage.

Still looks like something well less than half of the design starts and wafer starts worldwide are on copper pillar packages. What we’re seeing is some of the more advanced 40 nanometer [indiscernible], standard micro-processor and mobile application processor parts.

We’re seeing more adoption certainly of copper pillar packaging but there is even still a few major parts that are not yet on copper pillar packaging even at the 40 nanometer, 60 nanometer nodes. So if you made me give you an answer I would say less than 50% penetration rate now.

It's certainly the more customers you talk to about it, the cost benefits certainly appear to starting to be realized and the performance benefits I think have been obvious to the industry for a while..

So interestingly so you said that some of the leading edge 40, 60 nanometers products still not adopting copper pillar.

Why is that the case, maybe at the leading edge it makes a lot of more sense for them to start using it? Is it just cost or copper pillar is still relatively too high compared to other packaging solutions?.

I think part of it's cost and part of it's the fundamental die size and then number of inputs and outputs and power supply as you got to get out. There are some shifts on leading edge nodes that essentially if you’re going to use soccer ball packaging technology you’re die size is limited.

Your packaging technology is going to drive your die size which is obviously a very unattractive proposition for a semi-conductor manufacturer.

There are some die even at the leading edge that have so much content packed on the silicon that they are still able to package them at using soccer balls however at very aggressive [indiscernible] for soccer balls and pretty much the pitches that we have seen most of the industry transition to copper pillar is right on the cusp of those..

We have no further questions. I would like to turn the conference back to Mr. Mike Slessor for any closing remarks..

Thanks again for joining us today. As we navigate through a dynamic time in the industry in our business, we remain optimistic about the long term secular trends benefiting FormFactor.

Accordingly we will continue to invest in our key growth initiatives but are also committed to our execution, our stated financial model and our profitability as we continue to position FormFactor to deliver both short and long term results. Thanks again..

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone have a great day..