Good day, ladies and gentlemen, and welcome to the FormFactor Inc. First Quarter Financial Results Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow given at that time. [Operator Instructions] As a reminder, today’s conference is being recorded. I would like to introduce your host for today’s conference Mr. Jason Cohen, Company’s General Counsel. Sir, please go ahead.

Thank you. Today, the company will be discussing GAAP P&L results and some important non-GAAP results intended to supplement your understanding of the Company’s financials. Reconciliations of GAAP to non-GAAP measures and other financial information are available in the press releases issued today by the company and on the Investor Relations section of our website. Today’s discussion contains forward-looking statements within the meaning of the Federal Securities Laws. Examples of such forward-looking statements include those with respect to the projections of financial and business performance, future macroeconomic conditions, foreign exchange rates, business momentum, business seasonality, the anticipated demand for products; customer requirements; our future ability to produce and sell products; the development of future products and technologies; and the assumptions upon which such statements are based. These statements are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from those expressed during this call. Information on risk factors and uncertainties is contained in our most recent filing on Form 10-K with the SEC for the fiscal year ended 2017 and our other SEC filings, which are available on the SEC’s website at www.sec.gov and in our press release issued today. Forward-looking statements are made as of today, May 2, 2018, and we assume no obligation to update them. With that, we will now turn the call over to FormFactor’s CEO, Mike Slessor.

Thanks, Jason, and thank you, everyone, for joining us today. The first quarter of 2018 demonstrated the benefits of FormFactor’s opportunity set as a diversified leader in electrical test and measurement. As anticipated, revenues from our largest customer were at their lowest levels since 2016, but we continued to capitalize on our line-of-sight opportunities in advanced packaging, mobile data and automotive applications, enabling us to deliver revenue and non-GAAP earnings per share at the top end of our outlook. Highlights were solid probe card demand in both Foundry and Logic and DRAM markets, driven by growth in advanced packaging applications and a robust memory investment environment. Momentum also continued in our engineering systems business, driven by multiple applications in regions in what is typically the seasonally weakest quarter of the year. These drivers are continuing in the second quarter, augmented by a forecasted sequential increase in demand from our largest customer. For 2018 overall, we continue to expect and plan for revenue growth as we progress through the year. Our revenue trajectory will depend on three key factors, namely: recovery and production probe card demand from our largest customer, further adoption of our technologies and advanced packaging applications at the world’s largest foundry and a continued strong investment environment in DRAM. Each of these is a major focus area for our worldwide team, and I’d like to provide more details on each of them here. As recently announced, yield challenges at the 10-nanometer node continue to be significant and has caused a further delay in the manufacturing ramp of this node to 2019 at our largest customer. However, they also announced that new products will continue to be released on the 14-nanometer node. As a reminder, the probe cards we provide are a device-specific consumable And these new 14-nanometer designs…

Thank you, Mike, and good afternoon. As Mike mentioned, I joined FormFactor in early March, and I’m very excited to be a part of the FormFactor family. The company has great potential for growth and value creation, given our leadership position in the electrical test and measurement space and the smart and passionate people that I’ve already met in the company. Having played a key leadership role in similar business situations in the semi and semi equipment industries, I’m confident that we can continue to execute our strategy to drive revenue growth and margin expansion. As you saw from our press release and from – and heard from Mike’s comments, our largest customer’s volume production delay in its 10-nanometer process resulted in an anticipated revenue decline in Q1 as compared to Q4. Despite the decline, we achieved first quarter results slightly above our expectations, with revenues above the midpoint and gross margin slightly above our outlook ranges. These results coupled with continued group operating cost control, allowed us to deliver non-GAAP EPS at the high end of our outlook range. FormFactor’s revenues for the first quarter of 2018 were $118.3 million, down 10.3% from the fourth quarter of 2017. Probe card segment revenues of $94.9 million decrease 11.5% compared to Q4, and system segment revenues of $23.4 million decreased by $1.3 million or 5.3% compared to Q4. The System segment’s revenue decrease is lower than the usual seasonal decline. Within the probe card segment, Foundry and Logic revenues of $58.4 million decreased 15% compared to fourth quarter. The decline was attributable to the anticipated lower revenue from our largest customer. On a more positive note, during the first quarter, we saw a significant sequential increase in shipments of a new design to the world’s largest foundry, which utilizes our technology…

Thank you. [Operator Instructions] Our first question comes from the line of Edwin Mok of Needham & Company. Your line is open. Please go ahead.

Hey guys, congrats on a great quarter and great guidance. First question I have, if you can let us know how many 10% customers you had in the first quarter and how many you expect in the second quarter? And how big was your largest customer in the first quarter?

Yes. Thanks, Edwin. it’s Mike Slessor. So we had two 10% customers in the first quarter. The Q will come out next week, and you’ll see the details of that. But obviously, our perennial 10% customer, our largest customer was significantly stepped down in the first quarter. And because of the heavy activity and demand in DRAM, we added one of our DRAM customers as a 10% customer. As we move here through the second quarter, I think there’s a reasonable chance that some of our other memory customers will end up in the disclosable 10% customer line. But we’ll have to wait and see sort of how that plays out as we finish up the quarter.

Okay, great. And then I guess focus on a large customer as you mentioned, there is a push out or they pushed out the 10-nanometer ramp. But it sounds like our growing demand for 14-nanometer as they cover all new products is still supporting demand for probe card and that’s why you’ve guided a highest during thesecond quarter. How do you kind of see that progressing into the second half? I think, historically, you guys talked about couple then records second half, obviously, that predicated 10-nanometer’s not happening. So maybe you can give some color on how you kind of think about the demand dynamics into the second quarter and then second half, relative to what you’ve done in the first quarter?

Yes. I think directionally, we continue to see our largest customers demand building throughout the year. As you noted, the addition of some new 14-nanometer design that drive probe card demand is a helpful trend that’s going to directionally move in that way. But as you also noted, the expectation that we’ll have record demand and record revenue from this customer is probably not a realistic one given the push out of the 10-nanometer node. And I think people over the last few weeks have seen various data points that would confirmed that. We still do see 10-nanometer activity and the existence and appearance of 14-nanometer designs in probe cards activity is certainly a helpful trend that will allow us to continue to execute on growth throughout the year with this customer. But obviously, not at the levels that would take us to record levels in Q3 and Q4.

Okay, great. Two more questions. One is on the largest foundry, it sounds like you guys have done very well in the first quarter and expect level to see in that consumer level lease in the second quarter. As you go in second half, I know, historically, you guys have very concentrated on one particular design with that customer. How has that changed this year and I think that kind of lead as kind of think about how we think about optioning that customer look beyond this year and how do you think that [indiscernible] progress in terms of 90.

Well, I think, it’s a very important point in our opportunity set. Our opportunity, both last year and for the first part of this year at the largest foundry, really has been focused on a single design that’s driving the most advanced node and the integrated fan-out packaging. As we move through the back half of this year, we’re seeing some opportunities beyond that single design. They’re still very much associated with the advanced node and the integrated fan-out packaging, where FormFactor’s MEMS technology really enables these customers to do an effective job of wafer test. So we’re seeing the initial activity on broadening this business beyond the single design. We think that’ll result in some probe card revenues in the second half of the year. But more importantly, as we move forward into 2019 and beyond, as more of that foundries wafer mix shifts to the advanced nodes and employs advanced packaging, things like integrated fan-out, we think that as a real opportunity for FormFactor to grow our business much more significantly. So the opportunity will shift towards us as their mix shift more towards the advanced nodes and integrated fan-out packaging, where really FormFactor’s MEMS technology is a key enabler.

Okay, great. Thank you. Last question is on the systems side, I think you mentioned in the call that 1Q was better than seasonal, right? And I think you came out very strong fourth quarter and last year I think grew 15% last year. Historically, we don’t expect much growth on the systems business, how do you kind of think about that business this year? And seasonably, typically, grow through the year, used to expect similar trends this year?

We are planning on growth for the systems business again this year. The double-digit growth we delivered in 2017, to be honest, surprised us a little. I think it’s a result of a couple of different things, but one of them is the broader customer engagement we have as part of the worldwide FormFactor team with the leading customers in the world in serving a whole vast plethora of applications, things like MicroLED, things like silicon photonics, that continue to broaden the opportunity set for the systems business beyond its sort of classical niche of CMOS characterization. So we are planning for a growth year. I don’t think we’ll be able to match the double-digits we put up last year. But the opportunities continue to present themselves to diversify our business and work closely with customers on these emerging applications in development. And we’re pretty confident that’s going to result in some interesting opportunities when these applications get to production.

Okay, great. That’s all I have. Thank you.

Appreciate it. Thanks, Edwin.

Thank you. And our next question comes from the line of Craig Ellis with B. Riley FBR. Your line is open Please go ahead.

Thanks for taking my question. Mike, good job executing in dynamic demand environment, and Shai, welcome aboard. Mike, I wanted to start with questions on Intel, just to understand some of the points you’re making there a little bit better. When you talk about 14-nanometer volume ramping through the year, is the point there that there is more happening from a new product standpoint? Or that with volume growth, they’re going to need more probe cards deal with that volume or something different?

No, Craig, I think it’s more of the latter. In that – I’m sorry, the former, in that, there to fill the hole associated with the continued delays of 10-nanometer on the product roadmap, this customer’s chosen to release some new designs and rather then rely on the node transition from 14 to 10 to get them increased performance, they’re continuing to innovate on the architectural side. While doing that means new designs, new products and to remind everyone again, new designs require a new set of probe cards. And so really if this design innovation on 14-nanometer that’s going to provide some level of increased demand for us compared to a base case of just pushing 10-nanometer out. Now I will temper enthusiasm a little bit, because 14-nanometer is a relatively mature node and so yields are high and test times are relatively shorter than they would be for, say, 10-nanometer. But this isn’t a straight trade of 14-nanometer volume for 10-nanometer volume as far as FormFactor’s concerned. But it is a helpful trend and it is one of the aspects of this business that lends a consumables like flavor to it.

That’s helpful. It leads to my next question, which is the probe card intensity of 10-nanometer versus 14-nanometer and understanding that Intel is in a completely different point of their ramp with those two technologies for immature 14-nanometer plus-plus, 10-nanometer just coming up the curve. But as 10-nanometer gets to volume sometimes next year or whenever it does, would probe card intensity for10-nanometer be similar to 14-nanometer? Or would it be, for whatever reason, higher than 14-nanometer?

I think we’ve seen in pretty much every node transition and this is true, certainly at all of our customers and Foundry and Logics, and as I think about it is probably true in DRAM as well. When a node first comes out, obviously the yields are lower and customers are working aggressively on yield enhancements and yield improvements activities and that drives up test times and test intensity. And therefore, there’s a higher probe card intensity associated with the first part of the node. Over time, we’ve typically seen that then moderate or normalize to kind of historical levels, right? Nodes tend to get to entitlement yield levels, customers dial back test times as they solve their problems. And we tend to see a pretty normalized view of the probe card intensity per wafer start, if you will. I think the thing that’s maybe different this time and this, again, is true across Foundry and Logic and DRAM across the industry. I think the Moore’s Law shrinks, the node shrinks are getting so difficult and so contemplate and so drawn out that we’re seeing that normalization process take longer and longer. With the DRAM, for example, even with the capacity additions that each of the customers are going through, I think the view as DRAM growth rates for the year as still something only like 20%. That’s indicative of how hard it is to shrink and how hard it is to add capacity. So it’s true, not just in our Foundry and Logic’s business, but I think it’s true across the industry.

That’s very helpful. And just picking up on the DRAM point. The business has been tracking very well right at $30 million per quarter. I think a couple of DRAM manufacturers recently talked about moving more towards volume 1x nanometer output as they go through 2018. So as you look at the year, can you just frame for us some of the puts and takes from what has been a nicely consistent DRAM performance over the last four to five quarters?

Yes. As we said in the prepared remarks, DRAM remains one of the exciting opportunities here for us in 2018 to continue to grow the business. Now it fits into the larger FormFactor diversified profile of businesses, and we still believe that DRAM is cyclical. But right now, we’re in a cyclical investment period. As you know, different customers are talking about and planning for different node shrinks and different design releases as we move through the year. They continue to be on, as we’ve described before, slightly different cadences on these different activities, which is nice for us trying to balance our DRAM capacity. But the sum total of it is that we view DRAM continuing to be a pretty healthy business throughout the balance of the year. It will depend a lot on the in demand scenarios and our customers continued discipline on not over adding capacity. But for right now and for the balance of 2018, we see DRAM probe card spend continuing at these levels, and we’re executing pretty well on helping our customers migrate through those node transitions and design releases.

Last question for me, Mike, and I appreciate all the color. It has been two years since the Cascade deal and our view has been for a long time that, that was just a very strategically robust deal, and I think the post-integration performance of the business shows that. But can you just update us on how you’re thinking about inorganic growth and where the company is in it’s process of moving from integration with Cascade onto potentially other opportunities. Thank you.

Sure, sure. So to reiterate, we’ve talked about our strategy having two components: the first, continued share in efficiency gains in the markets we serve. And I think the VLSI report that I highlighted in my prepared remarks shows that we continue to execute well on that front. But the other piece is important for us is to continue to increase our addressable markets through M&A. We said we want to be a buyer of leaders like we were with the Cascade acquisition. And leaders in attractive markets, like we were with the Cascade acquisition and RF and the Engineering Systems business. We’ve refocused ourselves in 2018 in taking a fairly broad view inside the electrical test and measurement space. And that – we continue to go through that process. But I’m very pleased with the progress our team has made on identifying opportunities that will increase our addressable market that are probably resonant with some of the other teams in our business like advanced packaging and will continue to allow us to grow the overall FormFactor business along these two components. So M&A is part of our future. We’re continuing to focus on where we want to execute that. And as you all know, deals take a while to come together. But I’m pleased with the progress we’ve made on the analysis and defining our funnel and direction as we move forward.

Thanks, Mike.

Thank you. [Operator Instructions] Our next question comes from the line of Edgar Roesch with Sidoti & Company. Your line is open. Please go ahead.

Just wanted to ask another question about your largest customer. So if there hadn’t been the planned node migration right out of the gates, kind of early January. Would you expect their business to have fallen off as much in Q1? Or would they have spread out more of this 14-nanometer probe cards for their architectural changes? And have some of those orders fallen to Q1 more so than what occurred?

I’m not sure I really understanding the question, Ed, but let me talk about some of the puts and takes that can hopefully provide some insight there. Obviously, the fundamental principle here is that this is a very dynamic situation. And the mix between continued 14-nanometer innovation and ramping 10-nanometer is obviously one of the bigger dynamic pieces. I think with all of our customers, they’re continuing to innovate, whether it’s moving to advance packages on the 7-nanometer node at the world’s largest foundry or using what’s a mature node like 14-nanometer to continue to release new designs. Those are choices that our customers are making in a pretty active and real time way. And so baselines, to be honest, are pretty tough to establish here. I think the – what we’ve learned recently is that the 14-nanometer innovation and design releases are going to be helpful in us continuing to grow off of the Q1 lows. There will be a lower intensity, a lower demand of probe cards than if it were pure 11-nanometer, as we discussed a little bit earlier. But I think it points to the drivers of FormFactor’s business in this device-specific consumables arena, where if a customer decides to innovate with a Moore’s Law shrink, that’s very good for us, but if they decide to innovate by releasing a new design on the more mature node, that’s good for us as well.

Okay. And then on the DRAM side, it seems like trailing 12-month revenues settled in at about $120 million, which is very healthy pace. I was a little surprised that you – it appears to have been a 10% customer show up in that segment and still tend to be at that $120 million. So do you think that this is sort of a peak 12-month trailing revenue level for DRAM for this cycle or would you expect to maybe build on that pace?

Well, I think a couple of comments on DRAM probe card spending overall. We do see it continuing at that kind of run rate level. There is probably some relative strength right now as we indicated in our guidance comments. We’re going to have a pretty memory-rich product mix and that’s indicative of, for sure, a component of strong DRAM demand. But I think from an overall intensity standpoint, I would not expect DRAM probe card spending and revenues to go up too much from the run rate we’ve talked about. We’ll probably see quarters that are a little bit stronger and maybe quarters that are a little bit weaker. That was part of the comment around DRAM probe card revenues, I think, from Q4 to Q1 went down by a little bit. But that’s not indicative of anything other than a short-term fluctuation and some customer delivery request timing. We see the DRAM probe card investments and spending to continue to be right at above that level.

Got it. Okay, thank you for the clarity there and congrats on managing in a very dynamic situation.

Thanks, Ed.

Thank you. And our next question comes from the line of Tom Diffely with D.A. Davidson. Your line is open, please go ahead.

Yes, good afternoon. So maybe another question on the Foundry business. I know a year ago in the second quarter, you had some really nice margins based on the type of products you were producing for them. Is that still the case as to a high-margin business and it’s just getting – the margin profile is getting overshadowed by more of a high-end memory concentration?

So Tom, Mike Slessor again. So if I back up to Q2 of 2017, that was an usually unfavorable product mix on our full budget fronts. So there were some very high-end DRAM cards in there as we talked about at the time. And I think the Q1 gross margins probably more closer to normal from a product mix standpoint. Although, as Shai noted, we executed pretty well and so the gross margins for the revenue levers were higher than you might have otherwise expected. With our business, with the 7-nanometer fan-out package part, as we commented on in the last call, we’re a little bit earlier in the cycle this time. Obviously, our 10-nanometer experience last year, we were in there late, and we were kind of under probation with a key supplier, if you will. This year, we were involved much more early in the process. And obviously, it was a contributor to some of our Q1 revenues, where it was not in 2017, but as I said in the prepared remarks, continues into Q2. I still would expect this to be pretty lumpy but I think the timing shift was a little bit earlier than it was in 2017.

Okay. But from a margin point of view, it seems like the Foundry business, the 7- nanometer business or 10 last year, was a pretty nice added to margins and kind of latter. And I was surprised that you didn’t get more of a margin kick in the first and then the second quarter of this year from that business?

So again, the Q2 2017 had a whole bunch of favorable factors. One was the heavy Foundry and Logic mix, but there was a lot of other DRAM mix in that Q2 2017 that really helped us out. So I think viewing it at in isolation probably maybe a little too simplistic of a view. But the business this year, although it’s still Foundry and Logic, which is our highest – there is our highest margins, is spread out a little bit more between Q1 and Q2.

Okay. And then I noticed that when you talked about the Flash business, you said 50% or so was NAND. So I guess that means the other 50% are NOR Flash. And kind of curious with that more or looks like, is it more or like Flash or is it more or like a DRAM, from a probe card point of view.

Well, in general, as we’ve talked about our Flash strategy is to be relatively of opportunistic. Most of wafer testing in Flash is a pretty simple endeavor for our customers and so they don’t need FormFactor’s technology. It’s almost the inverse situation of some of the high-end Foundry and Logic or DRAM HBM opportunities I talked about, they really need a MEMS technology to effectively test. Flash is a much simpler proposition. And so therefore, the pricing and the margins are not nearly what we need to support our overall business model. Having said that, at the high end of flash, whether it be NOR or NAND, there are opportunities with individual designs, which do look a lot like DRAM. They’re high density, small die sizes, relatively demanding electrical requirements that play more towards our strengths. And as we’ve commented, probably for the last couple of years, our strategy is to be opportunistic about competing for those, but not really participate in the mainstream commodity flash market. So for our business, the Flash, whether it be NOR or NAND, looks pretty similar and it looks relatively similar to a low-end DRAM configuration, where we are being compensated for the technology and value that we provide.

Okay. Great. And finally, I noted that you had a nice uptick in business in Japan. I’m curious what segment that comes from? And how it is that you compete against kind of the homegrown competitor there?

Well, I think, with all of our customers – well, not all of them, but most of them have a pretty global footprint now. And it’s hard to think of any reason, whether it be Japan or U.S., as associated with individual customers. I mean, I can give you example, obviously DRAM tends to be still pretty localized in Korea but there are elements in China. And the U.S. DRAM manufacturers footprint spreads all over the place, because the acquisitions for that. I think we’re doing relatively well from a market share standpoint against our major competitors. Again, if you dig into the VLSI report that I mentioned, I think it pretty clearly shows that, for the first time in a long time, we had higher market share in DRAM than our Japanese competitor. And we continue to try and execute to really win opportunities and execute on them profitably so that we can continue to build our share position and the overall gross margin and operating profit characteristics associated with the businesses as we currently own.

Okay. Thank you for your time.

Thanks, Tom.

Thank you. [Operator Instructions] Our next question comes from the line of Gus Richard with Northland. Your line is open, please go ahead.

Yes, thanks for taking my question. Mike, on the fan-out opportunity, is the probe intensity for that kind of packaging more sufficient or is the probe card itself more expensive?

I think there’s two elements to it, Gus. And so the simple answer to your question is both. When 10-nanometer in integrated fan-out first ramped a year ago, the ATE provider commented that there was much higher test intensity. And you go back and look at their commentary around the test intensity being much higher, partially because the yields were lower, but partially because there’s a whole bunch of new failures nodes to take care of. The other piece to this is because they are in more complex, higher density, higher performance probe card, those tend to bear higher ASPs as well. So we’ve got both things working for us. As customers migrate to these advanced packages, higher density, higher node, more content, tougher electrical test content, that does raise the value of what we’re doing, primarily through the MEMS technology. And we get compensated for that value. It was a tougher test problem until people are willing to pay for it to enable things like integrated fan-out.

Got it. And then a very similar question for high-memory bandwidth. Is that, again, a more difficult test, longer test times, more probe cards? And then are the ASP is higher because the I/O speeds higher?

HBM is an interesting one, and that’s why we chose to comment on it in the prepared remarks. You can imagine the final HBN configuration is this stack of die. And it turns out that each of those die need to be tested pretty rigorously to make sure that they’re all going to end up being good in the stack and not kill their neighbors. Several people have referred to this over the years as known good die. I think our customers continue to come short of that standard, but for sure, the test intensity’s going up. And in certain cases, you’re right, the speeds are higher and so the electrical performance associated with the card tends to be quite a bit higher. And those are more complicated configurations but they’re higher ASPs.

Got it. Okay, that was it for me. Thank you.

Thank you.

Thank you. And I’m showing no further questions at this time, and I would like to turn the conference back to Mike Slessor for closing remarks.

All right. Well, thank you all for joining us today. We’ll talk to you in another quarter.

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