Document
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Form 10-Q
 
(Mark one)
 
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended June 25, 2016
 
Or
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from            to            
 
Commission file number: 000-50307
 
FormFactor, Inc.
(Exact name of registrant as specified in its charter)
 
Delaware
 
13-3711155
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
7005 Southfront Road, Livermore, California 94551
(Address of principal executive offices, including zip code)
 
(925) 290-4000
(Registrant’s telephone number, including area code)
 ______________________________________

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes ý  No o
 
Indicate by check mark whether the registrant submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of the Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes ý  No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large Accelerated filer o
 
Accelerated filer x
 
 
 
Non-accelerated filer o
 
Smaller reporting company o
(Do not check if a smaller reporting company)
 
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No ý
 
As of August 2, 2016, 70,565,320 shares of the registrant’s common stock, par value $0.001 per share, were outstanding.
 



FORMFACTOR, INC.
 
FORM 10-Q FOR THE QUARTERLY PERIOD ENDED JUNE 25, 2016

INDEX

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2



PART I. FINANCIAL INFORMATION
 
Item 1. Financial Statements (Unaudited)
 
FORMFACTOR, INC.
 
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
(Unaudited)
 
Three Months Ended
 
Six Months Ended
 
June 25,
2016
 
June 27,
2015
 
June 25,
2016
 
June 27,
2015
Revenues
$
83,083

 
$
73,885

 
$
136,694

 
$
144,714

Cost of revenues
57,656

 
50,582

 
101,475

 
98,621

Gross profit
25,427

 
23,303

 
35,219

 
46,093

Operating expenses:
 

 
 

 
 

 
 
Research and development
11,133

 
11,217

 
21,982

 
22,302

Selling, general and administrative
14,030

 
11,381

 
26,546

 
23,265

Restructuring charges, net
6,910

 

 
6,910

 
503

Impairment of long-lived assets

 
8

 

 
8

Total operating expenses
32,073

 
22,606

 
55,438

 
46,078

Operating income (loss)
(6,646
)
 
697

 
(20,219
)
 
15

Interest income, net
88

 
65

 
205

 
149

Other income (expense), net
(302
)
 
100

 
(616
)
 
1,602

Income (loss) before income taxes
(6,860
)
 
862

 
(20,630
)
 
1,766

Provision (benefit) for income taxes
(43,744
)
 
24

 
(43,714
)
 
145

Net income
$
36,884

 
$
838

 
$
23,084

 
$
1,621

Net income per share:
 

 
 

 
 
 
 
Basic
$
0.62

 
$
0.01

 
$
0.39

 
$
0.03

Diluted
$
0.61

 
$
0.01

 
$
0.39

 
$
0.03

Weighted-average number of shares used in per share calculations:
 

 
 

 
 
 
 
Basic
59,572

 
58,109

 
59,001

 
57,532

  Diluted
59,988

 
59,094

 
59,639

 
58,874

 
The accompanying notes are an integral part of these condensed consolidated financial statements.

3



FORMFACTOR, INC.
 
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
(Unaudited)
 
Three Months Ended
 
Six Months Ended
 
June 25,
2016
 
June 27,
2015
 
June 25,
2016
 
June 27,
2015
Net income
$
36,884

 
$
838

 
$
23,084

 
$
1,621

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Foreign currency translation adjustments
916

 
(302
)
 
1,519

 
(248
)
Unrealized gains on available-for-sale marketable securities
3

 
1

 
41

 
11

Other comprehensive income (loss), net of tax
919

 
(301
)
 
1,560

 
(237
)
Comprehensive income
$
37,803

 
$
537

 
$
24,644

 
$
1,384


The accompanying notes are an integral part of these condensed consolidated financial statements.


4



FORMFACTOR, INC.
 
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share amounts)
(Unaudited)
 
June 25,
2016
 
December 26,
2015
ASSETS
 

 
 

Current assets:
 

 
 

Cash and cash equivalents
$
100,225

 
$
146,264

Marketable securities
18,108

 
41,325

Accounts receivable, net
86,137

 
36,725

Inventories, net
68,357

 
27,223

Refundable income taxes
1,517

 

Prepaid expenses and other current assets
10,094

 
6,481

Total current assets
284,438

 
258,018

Restricted cash
438

 
435

Property, plant and equipment, net
43,791

 
23,853

Goodwill
188,517

 
30,731

Intangibles, net
172,146

 
25,552

Deferred tax assets
3,926

 
3,281

Other assets
2,000

 
853

Total assets
$
695,256

 
$
342,723

LIABILITIES AND STOCKHOLDERS’ EQUITY
 

 


Current liabilities:
 

 


Accounts payable
$
54,063

 
$
18,072

Accrued liabilities
51,088

 
21,507

Current portion of term loan
7,077

 

Income taxes payable
1,662

 
110

Deferred revenue
4,868

 
3,892

Total current liabilities
118,758

 
43,581

Long-term income taxes payable
1,240

 
1,069

Term loan, less current portion
141,417

 

Deferred tax liabilities
5,662

 

Deferred rent and other liabilities
4,595

 
3,392

Total liabilities
271,672

 
48,042

Commitments and contingencies (Note 18)


 


Stockholders’ equity:
 

 
 
Preferred stock, $0.001 par value:
 

 
 
10,000,000 shares authorized; no shares issued and outstanding at June 25, 2016 and December 26, 2015, respectively

 

Common stock, $0.001 par value:
 

 


250,000,000 shares authorized; 70,259,092 and 58,088,969 shares issued and outstanding at June 25, 2016 and December 26, 2015, respectively
70

 
58

Additional paid-in capital
823,152

 
718,904

Accumulated other comprehensive loss
(663
)
 
(2,222
)
Accumulated deficit
(398,975
)
 
(422,059
)
Total stockholders’ equity
423,584

 
294,681

Total liabilities and stockholders’ equity
$
695,256

 
$
342,723

 
The accompanying notes are an integral part of these condensed consolidated financial statements. 

5



FORMFACTOR, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
Six Months Ended
 
June 25,
2016
 
June 27,
2015
Cash flows from operating activities:
 

 
 

Net income
$
23,084

 
$
1,621

Adjustments to reconcile net income to net cash used in operating activities:
 

 
 

Depreciation and amortization
10,410

 
11,908

Accretion of discount on investments
(28
)
 

Stock-based compensation expense
4,275

 
5,415

Deferred income tax (benefit) provision
(43,863
)
 
7

Recovery of doubtful accounts receivable
(34
)
 
(11
)
Provision for excess and obsolete inventories
2,800

 
2,964

Gain on sale of long-lived assets
(32
)
 

Impairment of long-lived assets

 
8

Non-cash restructuring
964

 
500

Foreign currency transaction (gains) losses
(1,753
)
 
681

Changes in assets and liabilities:
 

 
 

Accounts receivable
(21,657
)
 
1,077

Inventories
(7,978
)
 
(1,663
)
Prepaid expenses and other current assets
1,226

 
(817
)
Refundable income taxes

 
782

Other assets
(286
)
 
259

Accounts payable
21,177

 
1,051

Accrued liabilities
8,593

 
(1,640
)
Income tax payable
(1
)
 
(81
)
Deferred rent and other liabilities
115

 
148

Deferred revenues
(602
)
 
(539
)
Net cash (used in) provided by operating activities
(3,590
)
 
21,670

Cash flows from investing activities:
 

 
 

Acquisition of property, plant and equipment
(3,633
)
 
(4,245
)
Acquisition of Cascade Microtech, net of cash acquired
(215,216
)
 

Proceeds from sale of subsidiary
19

 
35

Proceeds from sale of property, plant and equipment
53

 

Purchases of marketable securities
(10,587
)
 
(23,761
)
Proceeds from maturities of marketable securities
33,900

 
32,000

Change in restricted cash
(3
)
 

Net cash (used in) provided by investing activities
(195,467
)
 
4,029

Cash flows from financing activities:
 

 
 

Proceeds from issuances of common stock
1,961

 
1,803

Purchase and retirement of common stock

 
(3,508
)
Proceeds from term loan debt
150,000

 

Payments of term loan debt issuance costs
(1,506
)
 

Net cash provided by (used in) financing activities
150,455

 
(1,705
)
Effect of exchange rate changes on cash and cash equivalents
2,563

 
(846
)
Net (decrease) increase in cash and cash equivalents
(46,039
)
 
23,148

Cash and cash equivalents, beginning of period
146,264

 
113,940

Cash and cash equivalents, end of period
$
100,225

 
$
137,088

 
 
 
 

6



FORMFACTOR, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
 
 
 
Non-cash investing and financing activities:
 

 
 

Fair value of stock issued in connection with the acquisition of Cascade Microtech
$
93,216

 
$

Fair value of stock options and restricted stock-based awards assumed in connection with acquisition of Cascade Microtech
$
7,776

 
$

Fair value of vested stock options and restricted stock-based awards paid in cash in the third quarter of fiscal 2016 in connection with acquisition of Cascade Microtech
$
12,815

 
$

Changes in accounts payable and accrued liabilities related to property, plant and equipment purchases
$
1,292

 
$
42

 
 
 
 
Supplemental disclosure of cash flow information:
 
 
 
Income and property taxes paid (refunded), net
$
217

 
$
(819
)
The accompanying notes are an integral part of these condensed consolidated financial statements.

7



FORMFACTOR, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) 

Note 1 — Basis of Presentation and Summary of Significant Accounting Policies
 
Basis of presentation. The accompanying unaudited condensed consolidated interim financial statements of FormFactor, Inc. and our subsidiaries have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and pursuant to the instructions to Form 10-Q and Article 10 of Regulation S-X of the U.S. Securities and Exchange Commission (the “SEC”). Our interim financial statements do not include all of the information and footnotes required by generally accepted accounting principles for annual financial statements. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) considered necessary to fairly present our financial position, results of operations and cash flows have been included. Operating results for the six months ended June 25, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016, or for any other period. The balance sheet at December 26, 2015 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by GAAP for complete financial statements. The condensed consolidated financial statements include our accounts as well as those of our wholly-owned subsidiaries after elimination of all inter-company balances and transactions.
 
The preparation of condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in our condensed consolidated financial statements and accompanying notes. Actual results could differ from those estimates, and may result in material effects on our consolidated operating results and financial position. 

These financial statements and notes should be read with the consolidated financial statements and notes for the year ended December 26, 2015 included in our Annual Report on Form 10-K filed with the SEC on March 4, 2016.
 
Fiscal year. We operate on a 52/53 week fiscal year, whereby the fiscal year ends on the last Saturday of December. Fiscal 2016 and 2015 each contain 53 weeks and 52 weeks, respectively and the six months ended June 25, 2016 and June 27, 2015 each contained 26 weeks. Fiscal 2016 will end on December 31, 2016.

Business Acquisition. On June 24, 2016, we completed the acquisition of Cascade Microtech Inc. ("Cascade Microtech"), headquartered in Beaverton, Oregon. Our consolidated financial statement as of June 25, 2016 included the condensed consolidated balance sheet of Cascade Microtech as of June 24, 2016 whereas our condensed consolidated statements of income for the three and six months ended June 25, 2016 excluded the financial results of Cascade Microtech for the second quarter of fiscal 2016 as the one-day stub period between the acquisition of Cascade Microtech and the end of our second quarter of fiscal 2016 was deemed immaterial. See Note 3 to the Condensed Consolidated Financial Statements - Acquisition, for further details. 

Critical Accounting Policies. Our critical accounting policies have not changed during the six months ended June 25, 2016 from those disclosed in our Annual Report on Form 10-K for the year ended December 26, 2015.


Note 2 — Concentration of Credit and Other Risks
 
Financial instruments that potentially subject us to concentrations of credit risk consist primarily of cash equivalents, marketable securities and trade receivables. Our cash equivalents and marketable securities are held in safekeeping by large, credit worthy financial institutions. We invest our excess cash primarily in U.S. banks, government and agency bonds, money market funds and corporate obligations. We have established guidelines relative to credit ratings, diversification and maturities that seek to maintain safety and liquidity. Deposits in these banks may exceed the amounts of insurance provided on such deposits. To date, we have not experienced any losses on our deposits of cash and cash equivalents.
We market and sell our products to a narrow base of customers and generally do not require collateral. The following customers accounted for more than 10% of our revenues for the periods indicated:

8



 
Three Months Ended
 
Six Months Ended
 
June 25, 2016
 
June 27, 2015
 
June 25, 2016
 
June 27, 2015
Intel
44.1
%
 
17.1
%
 
40.2
%
 
17.8
%
SK hynix
15.2

 
13.0

 
10.7

 
15.2

Samsung
*

 
13.1

 
*

 
13.4

Micron
*

 
17.8

 
*

 
14.3

 
59.3
%
 
61.0
%
 
50.9
%
 
60.7
%
* Less than 10% of revenues.
At June 25, 2016, one customer accounted for approximately 36% of gross accounts receivable. At December 26, 2015, one customer accounted for approximately 29% of gross accounts receivable. No other customers accounted for more than 10% of gross accounts receivable at either of these fiscal period ends. We operate in the competitive semiconductor industry, including the Dynamic Random Access Memory, or DRAM, Flash memory, and Foundry & Logic (formerly known as System-on-Chip, or SoC) markets, which have been characterized by price erosion, rapid technological change, short product life cycles and heightened foreign and domestic competition. Significant technological changes in the industry could adversely affect our operating results.
Certain components for our products that meet our requirements are available only from a limited number of suppliers. The rapid rate of technological change and the necessity of developing and manufacturing products with short life cycles may intensify our reliance on such suppliers. The inability to obtain components as required, or to develop alternative sources, if and as required in the future, could result in delays or reductions in product shipments, which in turn could have a material adverse effect on our business, financial condition, results of operations or cash flows.

Note 3 — Acquisition

On June 24, 2016, we acquired Cascade Microtech pursuant to the Agreement and Plan of Merger dated as of February 3, 2016 (the “Merger Agreement”) by and among us, Cascade Microtech and Cardinal Merger Subsidiary, Inc., an Oregon corporation and our wholly owned subsidiary. Cascade Microtech is an Oregon corporation that designs, develops, manufactures and markets advanced wafer probing, thermal and reliability solutions for the electrical measurement and testing of high performance semiconductor devices. Design, development and manufacturing operations are located in Oregon, United States and Munich and Dresden, Germany, and sales, service and support operations in North America, Germany, Japan, Taiwan, China and Singapore. The acquisition of Cascade Microtech transforms our business into a broader test and measurement market leader with significant scale and increased diversification and demand for the combined company’s products and technologies.

In accordance with the terms of the Merger Agreement, each outstanding share of Cascade Microtech common stock was canceled and converted into the right to receive $16.00 in cash, without interest, and 0.6534 of a share of FormFactor common stock. At the effective time of the merger (the “Effective Time”), each in-the-money Cascade Microtech stock option which was outstanding and vested prior to the Effective Time (or that vested as a result of the consummation of the merger) was canceled and converted into the right to receive an amount in cash equal to the excess, if any, of $21.47 over the applicable per share exercise price of such option. Each out-of-the-money option to purchase shares of Cascade Microtech common stock was canceled without any cash payment. Also at the Effective Time, each Cascade Microtech restricted stock unit which was outstanding and vested immediately prior to the Effective Time (or that vested as a result of the consummation of the Merger) was canceled and converted into the right to receive an amount of cash (without interest) equal to $21.47 per share underlying such restricted stock unit.

Additionally, all of the equity awards originally granted by Cascade Microtech which were outstanding and unvested immediately prior to the consummation of the merger (and that did not vest as a result of the consummation of the merger) were assumed by us on substantially the same terms at the Effective Time, except that the number of shares of our common stock that underlie the assumed award and the exercise price of any assumed option were determined pursuant to a formula intended to preserve the intrinsic value of the original award, resulting in the assumption of stock options exercisable for an aggregate of 152,276 shares of our common stock and restricted stock units representing 777,444 shares of our common stock as of the acquisition date. The fair value of the stock options assumed was determined using a Black-Scholes valuation model with market-based assumptions. The fair value of the restricted stock units assumed was $8.92 per unit, based on the FormFactor closing stock price on June 24, 2016. The fair value of unvested equity awards relating to future services, and not

9



yet earned, will be recorded as operating expense over the remaining service periods. Option pricing models require the use of highly subjective market assumptions, including expected stock price volatility, which if changed can materially affect fair value estimates. See Note 14 to the Condensed Consolidated Financial Statements - Stockholder’s Equity, for further details.

The acquisition was accounted for using the acquisition method of accounting in accordance with the Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") Topic No. 805, Business Combinations, with FormFactor treated as the acquirer. The acquired assets and liabilities of Cascade Microtech were recorded at their respective fair values including an amount for goodwill representing the difference between the acquisition consideration and the fair value of the identifiable net assets. As a result of the acquisition, Cascade Microtech shares ceased to trade on the NASDAQ Global Market effective June 24, 2016.

The total acquisition consideration of $325.1 million, net of cash acquired of $40.7 million was determined based on the terms of the Merger Agreement which consisted of the a) payment of $255.9 million in cash to former shareholders of Cascade Microtech, b) issuance of 10,450,189 shares of FormFactor's common stock to former shareholders of Cascade Microtech which was valued at the closing market price of $8.92 per share on June 24, 2016 and amounted to $93.2 million in the aggregate, c) payment of $12.8 million at the commencement of the third quarter of fiscal 2016, in cash, to Cascade Microtech outstanding and vested equity award holders, and d) $3.9 million attributable to the fair value of the assumed unvested equity awards for services performed by Cascade Microtech employees for the period leading up to the effective date of the acquisition.

During the three and six months ended June 25, 2016, we incurred approximately $2.1 million and $3.8 million, respectively, in transaction costs related to the acquisition, which primarily consisted of investment banking, legal, accounting and valuation-related expenses. These expenses were recorded in selling, general and administrative expense in the accompanying Condensed Consolidated Statements of Operations.

Our consolidated financial statement as of June 25, 2016 included the condensed consolidated balance sheet of Cascade Microtech as of June 24, 2016 whereas our condensed consolidated statements of income for the three and six months ended June 25, 2016 excluded the financial results of Cascade Microtech for the second quarter of fiscal 2016 as the one-day stub period between the acquisition of Cascade Microtech and the end of our second quarter of fiscal 2016 was deemed immaterial.
To finance a portion of the acquisition consideration, we entered into a credit agreement with certain lenders to provide a senior secured term loan facility in an aggregate amount of $150 million. See Note 5 to the Condensed Consolidated Financial Statements - Debt, for further details.

The acquisition price was allocated to the tangible and identified intangible assets acquired and liabilities assumed as of the closing date of the acquisition based upon their respective fair values. Asset categories acquired included working capital, long-term assets and liabilities and identifiable intangible assets, including in-process research and development ("IPR&D"). The allocation of the acquisition price has been prepared on a preliminary basis and changes to that allocation may occur as additional information becomes available. The fair values assigned to assets acquired and liabilities assumed are based on management’s best estimates and assumptions as of the reporting date and are considered preliminary pending finalization of valuation analyses pertaining to intangible assets acquired, liabilities assumed and tax liabilities assumed including calculation of deferred tax assets and liabilities. Changes to amounts recorded as assets or liabilities may result in corresponding adjustments to goodwill, recognized deferred tax assets and liabilities including changes to release of valuation allowance during the measurement period (up to one year from the acquisition date). Any such revisions or changes may be material as we finalize the fair values of the tangible and intangible assets acquired and liabilities assumed.


10



The table below summarizes the assets acquired and liabilities assumed as follows (in thousands):
 
 
Amount
Cash and cash equivalents
 
$
40,681

Accounts receivable
 
27,112

Inventory
 
35,915

Prepaid expenses and other current assets
 
6,249

Property, plant and equipment
 
19,875

Other long-term assets
 
818

Deferred revenue
 
(1,829
)
Accounts payable and accrued liabilities
 
(22,901
)
Deferred tax liabilities
 
(43,344
)
Other long-term liabilities
 
(6,623
)
Total tangible assets acquired and liabilities assumed
 
55,953

Intangible assets
 
152,053

Goodwill
 
157,786

Total acquisition price
 
$
365,792


The intangible assets as of the closing date of the acquisition included (in thousands):
 
 
Amount
 
Weighted Average Useful Life (in years)
Developed technologies
 
$
91,100

 
5.3
Customer relationships
 
23,153

 
7.0
Order backlog
 
17,800

 
0.7
Trade names
 
7,600

 
3.7
In-process research and development
 
12,400

 

Total intangible assets
 
$
152,053

 
 

Indications of fair value of the intangible assets acquired in connection with the acquisition were determined using either the income, market or replacement cost methodologies. The intangible assets are being amortized over periods which reflect the pattern in which economic benefits of the assets are expected to be realized. Order backlog is expected to be fully amortized by the second quarter of fiscal 2017.

Identifiable intangible assets

Developed technology acquired primarily consist of Cascade Microtech’s existing technologies related to manufacturing wafer testing stations (150mm, 200mm, 300 mm), thermal chuck systems used in wafer testing stations for testing wafers at specific temperatures, engineering and production probes used in testing wafers as well as reliability test systems. A Multi-Period Excess Earnings (MPEE) Method was used to value the developed technologies. Along with the cash flow forecast associated with each developed technology, other key assumptions in MPEE method are remaining life of technology, technology migration pattern (or technology decay curve), level of R&D required to maintain the technology, discount rate and applicable tax rate. Using this approach, the estimated fair values were calculated using expected future cash flows from specific products discounted to their net present values at an appropriate risk-adjusted rate of return that resulted in a value of $91.1 million and will be amortized over their useful lives.

Customer relationships represent the fair value of future projected revenues that will be derived from the sale of products to existing customers of the acquired company. The fair value of the customer relationships is determined based on the With and Without Method and resulted in a value of $23.2 million which will be amortized over their useful lives. The With and Without Method is appropriate for valuing non-primary customer-related assets for which reasonable estimates can be made for both the time and resources required to recreate those assets, as well as the economic impact over the period of time in which

11



the assets are recreated. The Without scenario incorporates lost revenue and lost profits over the period necessary to retain the asset. Key assumptions in this valuation are attrition rate, time to recreate customer relationships, composition of costs into fixed versus variable costs, tax rates and discount rates.

Trade names and trademarks are considered a type of guarantee of a certain level of quality or performance represented by the brands owned including the Cascade Microtech brand. Trade names and trademarks were valued using the “relief-from-royalty income” approach. This method is based on the assumption that in lieu of ownership, a market participant would be willing to pay a royalty in order to exploit the related benefits of this asset. Key assumptions involved in valuation of trade names include royalty rate, expected utilization of the trade names, tax rates and discount rates. The value of the trade names acquired was determined to be $7.6 million and will be amortized over their useful lives.

IPR&D represents the estimated fair values of incomplete Cascade Microtech research and development projects that had not reached commercialization stage and meet the criteria for recognition as IPR&D as described in the American Institute of Certified Public Accountants IPR&D guide as of the date of the acquisition. In the future, the fair value of each project at the acquisition date will be either amortized or impaired depending on whether the projects are completed or abandoned. The fair value of IPR&D was determined using the MPEE method. For IPR&D, costs to complete the project and expected commercialization timeline are considered as key assumptions. This method reflects the present value of the projected cash flows that are expected to be generated by the IPR&D less charges representing the contribution of other assets to those cash flows. The value of the IPR&D was determined to be $12.4 million and the amortization will commence upon completion of the IPR&D projects.

Goodwill

The excess of purchase price over the fair value amounts assigned to the assets acquired and liabilities assumed represents the amount of goodwill resulting from the acquisition. We believe the factors that contributed to goodwill include synergies that are specific to our consolidated business such as cost savings and operational efficiencies and the acquisition of a talented workforce that expands our expertise in business development and commercializing semiconductor test products, none of which qualify for recognition as a separate intangible asset. We do not expect any portion of this goodwill to be deductible for tax purposes. The goodwill attributable to the acquisition has been recorded as a non-current asset and is not amortized, but is subject to an annual review for impairment.

The goodwill arising from the acquisition was preliminarily allocated to our reporting units based on the relative fair values of the expected incremental cash flows that the acquisition is expected to provide to each reporting unit within our reportable segments. The allocation of goodwill, which was prepared on a preliminary basis, may be subject to changes as additional information becomes available as the allocation was based on estimates and assumptions made by management at the time of acquisition. Goodwill is not expected to be deductible for tax purposes.

Operating and reporting segments, and reporting units

Upon acquisition of Cascade Microtech, we re-evaluated our operating and reportable segments as well as our reporting units for goodwill impairment consideration in accordance with Financial Accounting Standards Board's Accounting Standards Codification ("ASC") Topics Nos. 280, Segment Reporting and 350, Intangibles-Goodwill and Other. See Note 20 to the Condensed Consolidated Financial Statements - Operating Segments, for further details. 

Pro forma consolidated results of operations

The following unaudited pro forma results of operations for the three and six months ended June 25, 2016 and June 27, 2015 presents the combined results of operations of FormFactor and Cascade Microtech as if the acquisition had been completed at the beginning of fiscal 2015. The pro forma information includes adjustments to amortization and depreciation for intangible assets and property, plant and equipment, adjustments to stock-based compensation expense, interest expense for the incremental indebtedness incurred, and interest income for the cash paid in connection with the transaction. The pro forma results for the six months ended June 27, 2015 includes non-recurring adjustments related to deferred tax asset valuation allowance release of $43.9 million which increases pro-forma net income, and acquisition-related transaction costs of $13.8 million and restructuring charges of $6.9 million which decreases pro-forma net income.

The pro forma results also include utilization of the net increase in the cost basis of acquired inventory and acquisition related expenses. The pro forma data are for informational purposes only and are not necessarily indicative of the consolidated results of operations of the combined business had the acquisition actually occurred at the beginning of fiscal year 2015 and

12



2016 or of the results of future operations of the combined business. Consequently, actual results may differ from the unaudited pro forma information presented below (in thousands, except per share data):
 
 
Three Months Ended
 
Six Months Ended
 
 
June 25, 2016
 
June 27, 2015
 
June 25, 2016
 
June 27, 2015
Revenues
 
$
120,112

 
$
109,929

 
$
208,526

 
$
212,500

Net Income (loss)
 
3,596

 
(20,868
)
 
(10,112
)
 
14,386

Net Income (loss) per share - basic
 
$
0.05

 
$
(0.30
)
 
$
(0.15
)
 
$
0.21

Net Income (loss) per share - Diluted
 
$
0.05

 
$
(0.30
)
 
$
(0.14
)
 
$
0.21



Note 4 — Goodwill and Intangible Assets

Goodwill recorded from the acquisition of Cascade Microtech on June 24, 2016 was $157.8 million as of June 25, 2016. The Company determined the total consideration paid for its acquisition of Cascade Microtech as well as the fair value of the assets acquired and liabilities assumed as of the acquisition date. The fair values assigned to assets acquired and liabilities assumed are based on management’s best estimates and assumptions as of the reporting date and are considered preliminary pending finalization of valuation analyses pertaining to intangible assets acquired, liabilities assumed and tax liabilities assumed including calculation of deferred tax assets and liabilities. Changes to amounts recorded as assets or liabilities may result in corresponding adjustments to goodwill, recognized deferred tax assets and liabilities including changes to release of valuation allowance during the measurement period (up to one year from the acquisition date). Any such revisions or changes may be material as we finalize the fair values of the tangible and intangible assets acquired and liabilities assumed. See Note 3 to the Condensed Consolidated Financial Statements - Acquisition, for further details. 

Goodwill recorded from the acquisition of MicroProbe Inc. on October 16, 2012 was $30.7 million as of June 25, 2016 and remained unchanged from the amounts recorded as of December 26, 2015.

The Company has not recorded any historical goodwill impairments as of June 25, 2016.

The changes in intangible assets during the six months ended June 25, 2016 and the net book value of intangible assets as of June 25, 2016 and December 26, 2015 were as follows (in thousands):
 
 
Intangible Assets, Gross Amount
 
Accumulated Amortization
 
Intangible Assets, Net
 
Weighted Average Useful Life
Other Intangible Assets (1)
 
December 26, 2015
 
Additions/Disposals
 
June 25, 2016
 
December 26, 2015
 
Expense, net
 
June 25, 2016
 
December 26, 2015
 
June 25, 2016
 
June 25, 2016
Existing developed technologies 
 
$
52,200

 
$
91,100

 
$
143,300

 
$
39,581

 
$
4,158

 
$
43,739

 
$
12,619

 
$
99,561

 
5.1
Trade name
 
4,388

 
7,600

 
11,988

 
1,409

 
219

 
1,628

 
2,979

 
10,360

 
4.4
Customer relationships
 
17,000

 
23,153

 
40,153

 
7,046

 
1,082

 
8,128

 
9,954

 
32,025

 
6.3
Backlog
 

 
17,800

 
17,800

 

 

 

 

 
17,800

 
0.7
Total finite-lived intangible assets
 
73,588

 
139,653

 
213,241

 
48,036

 
5,459

 
53,495

 
25,552

 
159,746

 
 
In-process research and development
 

 
12,400

 
12,400

 

 

 

 

 
12,400

 
 
Total intangible assets
 
$
73,588

 
$
152,053

 
$
225,641

 
$
48,036

 
$
5,459

 
$
53,495

 
$
25,552

 
$
172,146

 
 
(1
)
Excludes fully amortized intangible assets

Intangible asset additions during the six months ended June 25, 2016 related to Cascade Microtech acquisition-see Note 3 to the Condensed Consolidated Financial Statements - Acquisition, for further details. 


13



The IPR&D intangible assets are classified as indefinite lived assets that are not currently subject to amortization but are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. The IPR&D assets will be subject to amortization upon completion of their respective research projects and when commercialization begins. The fair value assigned to IPR&D assets was determined using the MPEE approach based on estimates and judgments regarding risks inherent in the development process, including the likelihood of achieving technological success and market acceptance. If an IPR&D project is abandoned, the acquired technology attributable to the project will be written-off.
For the three months ended June 25, 2016, amortization expense of $2.1 million and $0.6 million were included in cost of revenues and selling, general and administrative expenses, respectively. For the six months ended June 25, 2016, amortization expense of $4.2 million and $1.3 million were included in cost of revenues and selling, general and administrative expenses, respectively.
For the three months ended June 27, 2015, amortization expense of $2.6 million and $0.7 million were included in cost of revenues and selling, general and administrative expenses, respectively. For the six months ended June 27, 2015, amortization expense of $5.2 million and $1.3 million were included in cost of revenues and selling, general and administrative expenses, respectively.
Based on the carrying values of the intangible assets recorded as of June 25, 2016 and assuming no subsequent additions to or impairment of the underlying assets, the remaining estimated annual amortization expense is expected to be as follows (in thousands):
Fiscal Year
 
Amount
2016
 
$
22,023

2017
 
32,913

2018
 
30,243

2019
 
27,675

2020
 
24,129

and thereafter
 
22,763

Total
 
$
159,746


As of the Effective Date of the acquisition of Cascade Microtech, we began operating under new reportable segments consisting of Probes and Systems segments. See Note 20 to the Condensed Consolidated Financial Statements - Operating Segments, for further details. The following table summarizes the changes in the carrying amount of goodwill, by reportable segments, for the six months ended June 25, 2016, applying the segment changes as of June 24, 2016, which was the date when we acquired Cascade Microtech.

 
Probes
 
Systems
 
Total
 
 
(in thousands)
Goodwill, gross, as of December 26, 2015
 
$
30,731

 
$

 
$
30,731

Additions-Cascade Microtech
 
141,496

 
16,290

 
157,786

Balance as of June 25, 2016
 
$
172,227

 
$
16,290

 
$
188,517


Note 5 — Debt

Senior Secured Term Loan Facility

Long-term debt as of June 25, 2016 consisted of the following (in thousands):
 
June 25, 2016
Principal amount
$
150,000

Less debt issuance costs
(1,506
)
Long-term debt less debt issuance costs
$
148,494


On June 24, 2016, we entered into a Credit Agreement (the “Credit Agreement”) with HSBC Bank USA, National Association, as administrative agent, co-lead arranger, sole bookrunner and syndication agent, other lenders that may from

14



time-to-time be a party to the Credit Agreement, and certain guarantors. Pursuant to the Credit Agreement, the lenders have provided us with a senior secured term loan facility of $150 million (the “Term Loan”). The proceeds of the Term Loan were used to finance a portion of the purchase price paid in connection with the Cascade Microtech acquisition and to pay related bank fees and expenses.

The Term Loan bears interest at a rate equal to, at our option, (i) the applicable London Interbank Offered Rate ("LIBOR") rate plus 2.00% per annum or (ii) Base Rate (as defined in the Credit Agreement) plus 1.00% per annum. We have initially elected to pay interest at 2.00% over LIBOR. Interest payments are payable in quarterly installments over a five-year period. The Term Loan will amortize in equal quarterly installments, beginning June 30, 2016, in an annual amount equal to 5% for year one, 10% for year two, 20% for year three, 30% for year four and 35% for year five. On July 25, 2016, we entered into a interest-rate swap agreement with HSBC to hedge the interest payments on our Term Loan entered into on June 24, 2016. See Note 22 to the Condensed Consolidated Financial Statements - Subsequent Events, for further details. 

The obligations under the Term Loan are and will be fully and unconditionally guaranteed by certain of our existing and subsequently acquired or organized direct and indirect domestic subsidiaries and are secured by a perfected first priority security interest in substantially all of our assets and the assets of those guarantors, subject to certain customary exceptions. See Note 18 to the Condensed Consolidated Financial Statements - Commitments and Contingencies, for a schedule of our principal and interest payment commitments under the Term Loan.

The Credit Agreement contains negative covenants customary for financing of this type, including covenants that place limitations on the incurrence of additional indebtedness, the creation of liens, the payment of dividends; dispositions; fundamental changes, including mergers and acquisitions; loans and investments; sale leasebacks; negative pledges; transactions with affiliates; changes in fiscal year; sanctions and anti-bribery laws and regulations, and modifications to charter documents in a manner materially adverse to the Lenders. The Credit Agreement also contains affirmative covenants and representations and warranties customary for financing of this type.

In addition, the Credit Agreement contains financial maintenance covenants requiring, at the end of, and for, each period of four consecutive fiscal quarters, beginning as of June 30, 2016, (a) a ratio of total debt to earnings before interest, taxes, depreciation and amortization ("EBITDA") not in excess of 2.75 to 1:00, stepping down to 2.50 to 1.00 at the end of the fiscal quarter ending June 30, 2017; and (b) a fixed charge coverage ratio of not less than 1.50 to 1.00, stepping down to 1.30 to 1.00 on the fiscal quarter ending June 30, 2018 and to 1.20 to 1.00 at the end of the fiscal quarter ending June 30, 2019. As of June 25, 2016, the Company was in compliance with all of the financial covenants under the senior secured term loan facility.

The Credit Agreement contains customary events of default, including (subject to certain materiality thresholds and grace periods) payment default, failure to comply with covenants, material inaccuracy of representation or warranty, bankruptcy or insolvency proceedings, change of control, certain material Employee Retirement Security Act ("ERISA") events and cross event of default and cross-acceleration in respect of other material debt.

The foregoing description of the Credit Agreement does not purport to be complete and is subject to and qualified in its entirety by reference to the full text of the Credit Agreement, which is filed as Exhibit 10.1 to our Current Report on Form 8-K filed on June 28, 2016.


Note 6 — Restructuring Charges
 
Restructuring charges are comprised of costs related to employee termination benefits. During the three months ended June 25, 2016, we recorded approximately $0.5 million of severance charges and $0.3 million of stock-based compensation expense relating to the modification of certain equity-based awards of a full-time employee as a result of the consolidation of our sales operations. In addition, we also recorded approximately $5.4 million of severance charges and $0.7 million of stock-based compensation expense relating to the acceleration of certain equity-based awards of certain executives of Cascade Microtech who were terminated upon our acquisition of Cascade Microtech and in accordance with their contractual change of control agreements. The cash payments associated with the restructuring activities are expected to be paid by the end of the third quarter of fiscal 2016. See Note 3 to the Condensed Consolidated Financial Statements - Acquisition, for further details. 

There were no restructuring charges during the three months ended March 26, 2016. During the six months ended June 27, 2015, we recorded stock-based compensation expense of approximately $0.5 million relating to the modification of an equity-based award.


15



The activities in the restructuring accrual for the six months ended June 25, 2016 were as follows (in thousands):
 
Employee Severance and Benefits
 
Stock-based Compensation
 
Total
Accrual at December 26, 2015
$
2

 
$

 
$
2

Restructuring charges
5,946

 
964

 
6,910

Cash payments
(2
)
 

 
(2
)
Non-cash settlement

 
(964
)
 
(964
)
Accrual at June 25, 2016
$
5,946

 
$

 
$
5,946


The activities in the restructuring accrual for the six months ended June 27, 2015 were as follows (in thousands):
 
Employee Severance and Benefits
 
Stock-based Compensation
 
Total
Accrual at December 27, 2014
$
584

 
$

 
$
584

Restructuring charges

 
500

 
500

Cash payments
(569
)
 

 
(569
)
Adjustment to restructuring charges
3

 

 
3

Non-cash settlement

 
(500
)
 
(500
)
Accrual at June 27, 2015
$
18

 
$

 
$
18



Note 7 — Fair Value
Assets Measured at Fair Value on a Recurring Basis
 
We measure and report certain assets and liabilities at fair value on a recurring basis, including money market funds, U.S. Treasury securities, agency securities and foreign currency derivatives (see Note 19 to the Condensed Consolidated Financial Statements - Derivative Financial Instruments, for a discussion of fair value of foreign currency derivatives).

Assets measured at fair value on a recurring basis as of June 25, 2016 were as follows (in thousands): 
 
Level 1
 
Level 2
 
Total
Assets:
 
 
 
 
 
Cash equivalents
 
 
 
 
 
Money market funds
$
18,694

 
$

 
$
18,694

Marketable securities
 
 
 
 
 
U.S. Treasuries

 
7,507

 
7,507

Agency securities (Federal)

 
10,601

 
10,601

Foreign exchange derivative contracts

 
317

 
317

Total
$
18,694

 
$
18,425

 
$
37,119



16



Assets measured at fair value on a recurring basis as of December 26, 2015 was as follows (in thousands):

 
 
Level 1
 
Level 2
 
Total
Assets:
 
 
 
 
 
Cash equivalents
 
 
 
 
 
Money market funds
$
82,935

 
$

 
$
82,935

Marketable securities
 
 
 
 
 
U.S. Treasuries

 
18,853

 
18,853

Agency securities (Federal)

 
22,472

 
22,472

Total
$
82,935

 
$
41,325

 
$
124,260

 
The Level 1 assets consist of our money market fund deposits. The Level 2 assets consist of our available-for-sale investment portfolio, which are valued utilizing a market approach. Our investments are priced by pricing vendors who provided observable inputs for their pricing without applying significant judgment. Broker pricing is used mainly when a quoted price is not available, the investment is not priced by our pricing vendors or when a broker price is more reflective of fair values in the market in which the investment trades. Our broker-priced investments are labeled as Level 2 investments because fair values of these investments are based on similar assets without applying significant judgments. In addition, all of our investments have a sufficient level of trading volume to demonstrate that the fair values used are appropriate for these investments.
We did not have any transfers of assets measured at fair value on a recurring basis to or from Level 1 and Level 2 during the six months ended June 25, 2016 and June 27, 2015.
Assets Measured at Fair Value on a Non-Recurring Basis

We measure and report goodwill and intangible assets at fair value on a non-recurring basis if we determine these assets to be impaired or when we make a business acquisition. Refer to Note 4 to the Condensed Consolidated Financial Statements-Goodwill and Intangible Assets, for further details. The only assets that were measured at fair value on a nonrecurring basis during the three and six months ended June 25, 2016 related to the Cascade Acquisition. See Note 3 to the Condensed Consolidated Financial Statements - Acquisition, for further details. There were no assets measured at fair value on a nonrecurring basis during the three and six months ended June 27, 2015.


Note 8 — Marketable Securities
 
We classify our marketable securities as available-for-sale. All marketable securities represent the investment of funds available for current operations, notwithstanding their contractual maturities. Such marketable securities are recorded at fair value and unrealized gains and losses are recorded in accumulated other comprehensive income until realized.
 
Marketable securities at June 25, 2016 consisted of the following (in thousands):
 
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
U.S. Treasuries
$
7,498

 
$
9

 
$

 
$
7,507

Agency securities (Federal)
10,602

 

 
(1
)
 
10,601

 
$
18,100

 
$
9

 
$
(1
)
 
$
18,108

 

Marketable securities at December 26, 2015 consisted of the following (in thousands):
 
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
U.S. Treasuries
$
18,896

 
$
1

 
$
(44
)
 
$
18,853

Agency securities (Federal)
22,484

 

 
(12
)
 
22,472

 
$
41,380

 
$
1

 
$
(56
)
 
$
41,325


17



 
The marketable securities with gross unrealized losses have been in a loss position for less than twelve months as of June 25, 2016 and December 26, 2015, respectively.
 
When evaluating the investments for other-than-temporary impairment, we review factors such as the length of time and extent to which fair value has been below the amortized cost basis, current market liquidity, interest rate risk, financial condition of the issuer, and credit rating downgrades. We believe that the unrealized losses are not other-than-temporary and anticipate recovering the full cost of the securities either as market conditions improve or as the securities mature.
 
Contractual maturities of marketable securities as of June 25, 2016 were as follows (in thousands):
 
 
Amortized Cost
 
Fair Value
Due in one year or less
$
10,602

 
$
10,601

Due after one year to five years
7,498

 
7,507

 
$
18,100

 
$
18,108

 
There were no realized gains and losses on sales and maturities of marketable securities during the three and six months ended June 25, 2016 and June 27, 2015, respectively.


Note 9 — Allowance for Doubtful Accounts

A reconciliation of the changes in our allowance for doubtful accounts receivable for the six months ended June 25, 2016 and June 27, 2015, respectively, is as follows (in thousands):

 
 
June 25,
2016
 
June 27,
2015
Balance at beginning of period
$
284

 
$
266

Reductions
(34
)
 
(11
)
Balance at end of period
$
250

 
$
255


Note 10 — Inventories
 
Inventories consisted of the following (in thousands):
 
June 25,
2016
 
December 26,
2015
Raw materials
$
27,580

 
$
12,996

Work-in-progress
24,522

 
12,492

Finished goods
16,255

 
1,735

 
$
68,357

 
$
27,223
















18



Note 11 — Warranty

A reconciliation of the changes in our warranty liability for the six months ended June 25, 2016 and June 27, 2015, respectively, is as follows (in thousands):
 
June 25,
2016
 
June 27,
2015
FormFactor Inc:
 
 
 
Balance at beginning of period
$
1,116

 
$
1,592

   Accruals
2,054

 
828

   Settlements
(1,693
)
 
(1,338
)
Balance at the end of period
$
1,477

 
$
1,082

Add warranty reserve from acquisition-Cascade Microtech
795

 

Balance at the end of the period
$
2,272

 
$
1,082



Note 12 — Long-lived Assets
 
Long-lived Assets
 
Property, plant and equipment consisted of the following (in thousands):
 
 
June 25,
2016
 
December 26,
2015
Machinery and equipment
$
164,310

 
$
150,983

Computer equipment and software
29,923

 
27,951

Furniture and fixtures
5,980

 
5,380

Leasehold improvements
73,032

 
67,121

Sub total
273,245

 
251,435

Less: accumulated depreciation and amortization
(236,665
)
 
(232,005
)
Net long-lived assets
36,580

 
19,430

Construction-in-progress
7,211

 
4,423

Total
$
43,791

 
$
23,853


During the six months ended June 25, 2016 and June 27, 2015, we ceased using fully depreciated assets with an acquired cost of $1.1 million and $0.4 million, respectively.

Refer to Note 4 to the Condensed Consolidated Financial Statements - Goodwill and Intangible Assets for further details relating to our intangible long-lived assets.


Note 13 — Accumulated Other Comprehensive Loss
 
Accumulated other comprehensive loss includes foreign currency translation adjustments and unrealized losses on available-for-sale securities, net of tax, the impact of which has been excluded from earnings and reflected as components of stockholders' equity as shown below (in thousands):
 
 
June 25,
2016
 
December 26,
2015
Unrealized loss on marketable securities, net of tax of $405 at June 25, 2016 and $428 at December 26, 2015, respectively
$
(443
)
 
$
(483
)
Cumulative translation adjustments
(220
)
 
(1,739
)
Accumulated other comprehensive loss
$
(663
)
 
$
(2,222
)


19



Note 14 — Stockholders’ Equity
 
Common Stock Repurchase Program

On April 16, 2015, our Board of Directors authorized a program to repurchase up to $25.0 million of outstanding common stock. Under the authorized stock repurchase program, we may repurchase shares from time-to-time on the open market. The pace of repurchase activity will depend on levels of cash generation, current stock price and other factors. The stock repurchase program was announced on April 16, 2015 and expired on April 15, 2016. During the six months ended June 25, 2016, we did not repurchase any shares under this program.

Restricted Stock Units
 
Restricted stock unit (RSU) activity under our equity incentive plan during the six months ended June 25, 2016 is set forth below:
 
 
Units
 
Weighted Average Grant Date Fair Value
Restricted stock units at December 26, 2015
2,578,138

 
$
7.63

Awards granted
920,044

 
4.53

Awards vested
(1,416,349
)
 
7.03

Awards canceled
(97,500
)
 
5.51

Restricted stock units at June 25, 2016
1,984,333

 
$
6.72


On June 24, 2016, pursuant to the Agreement and Plan of Merger with Cascade Microtech, we granted 777,444 RSUs with a total grant date fair value of approximately $6.9 million, of which approximately $3.6 million was attributable to the fair value of the assumed unvested RSUs for services performed by Cascade Microtech employees for the period leading up to the effective date of the acquisition and which was included as part of the purchase price consideration. See Note 3 to the Condensed Consolidated Financial Statements - Acquisition, for further details. 

On May 2, 2016, we issued 40,000 RSUs to our Chief Executive Officer which will vest based on certain market performance criteria. The performance criteria are based on a metric called our Total Shareholder Return (TSR) for the period from April 1, 2016 to March 31, 2019 relative to the TSR of the companies identified as being part of the S&P Semiconductor Select Industry Index (FormFactor peer companies), as of April 1, 2016. The total stock-based compensation cost of approximately $0.3 million will be recognized ratably over the requisite service period.

On May 28, 2015, we issued 195,000 RSUs to seven senior executives of our company that will vest based on certain market performance criteria. The performance criteria are based on a metric called our Total Shareholder Return (TSR) for the period from April 1, 2015 to March 31, 2017 relative to the TSR of the companies identified as being part of the S&P Semiconductor Select Industry Index (FormFactor peer companies), as of April 1, 2015. The total stock-based compensation cost of approximately $1.5 million will be recognized ratably over the requisite service period.

On May 5, 2014, we issued 350,000 RSUs to seven senior executives of our company that will vest based on certain market performance criteria. The performance criteria are based on our TSR for the period from April 1, 2014 to March 31, 2016 relative to the TSR of the companies identified as being part of the S&P Semiconductor Select Industry Index (FormFactor peer companies), as of April 1, 2014. Upon the review of the market performance criteria on April 4, 2016, our Compensation Committee certified a total earn out of 328,600 RSUs which immediately vested as of that date.

The total fair value of RSUs vested during the three and six months ended June 25, 2016 and June 27, 2015 was $6.4 million and $10.4 million, and $10.0 million and $17.5 million, respectively.

Stock Options
 
On June 24, 2016, pursuant to the Agreement and Plan of Merger with Cascade Microtech, we granted 152,276 stock options with a total grant date fair value of approximately $0.8 million, of which approximately $0.3 million was attributable to the fair value of the assumed unvested options for services performed by Cascade Microtech employees for the period leading

20



up to the effective date of the acquisition and which was included as part of the purchase price consideration. See Note 3 to the Condensed Consolidated Financial Statements - Acquisition, for further details. 

During the six months ended June 27, 2015, we granted 450,000 stock options to our Chief Executive Officer with a grant-date fair value of approximately $1.7 million which will be recognized as stock-based compensation expense ratably over the service period. The following weighted average assumptions were used in the estimated grant-date fair value calculations using the Black-Scholes option pricing model:
Stock Options:
 
Dividend yield
%
Expected volatility
47.5
%
Risk-free interest rate
1.57
%
Expected term (in years)
5.52


Note 15 — Stock-Based Compensation
 
We account for all stock-based compensation to employees and directors, including grants of RSUs and stock options, as stock-based compensation costs based on the fair value measured as of the date of grant. These costs are recognized as an expense in the Condensed Consolidated Statements of Income over the requisite service period.

The table below shows stock-based compensation charges included in the Condensed Consolidated Statements of Income (in thousands):
 
 
Three Months Ended
 
Six Months Ended
 
June 25,
2016
 
June 27,
2015
 
June 25,
2016
 
June 27,
2015
Stock-based compensation included in:
 

 
 

 
 
 
 
Cost of revenues
$
405

 
$
602

 
$
1,038

 
$
1,185

Research and development
542

 
726

 
1,338

 
1,571

Selling, general and administrative
594

 
1,178

 
1,899

 
2,659

Total stock-based compensation
1,541

 
2,506

 
4,275

 
5,415

Tax effect of stock-based compensation

 

 

 

Total stock-based compensation, net of tax
$
1,541

 
$
2,506

 
$
4,275

 
$
5,415

 

During the six months ended June 25, 2016, we recorded approximately $0.3 million of stock-based compensation expense relating to the modification of certain equity-based awards of a full-time employee as a result of the consolidation of our sales operations. In addition, we also recorded approximately $0.7 million of stock-based compensation expense relating to the acceleration of certain equity-based awards of an executive of Cascade Microtech who was terminated upon our acquisition of Cascade Microtech and in accordance with his contractual change of control agreement with Cascade Microtech. During the six months ended June 27, 2015, we recorded stock-based compensation expense of approximately $0.5 million relating to the modification of an equity-based award. We therefore classified these stock-based compensation expenses as restructuring-related expenses. Refer to Note 6 to the Condensed Consolidated Financial Statements - Restructuring Charges for further details.

Employee Stock Purchase Plan
 
Under our 2012 Employee Stock Purchase Plan ("ESPP"), the offering periods are 12 months commencing on February 1 of each calendar year and ending on January 31 of the subsequent calendar year, and a six-month fixed offering period commencing on August 1 of each calendar year and ending on January 31 of the subsequent calendar year. The 12 month offering period consists of two six month purchase periods and the six-month offering period consists of one six-month purchase period. The price of the common stock purchased is 85% of the lesser of the fair market value of the common stock on the first day of the applicable offering period or the last day of each purchase period.

During the three months ended June 25, 2016 and June 27, 2015, we did not issue any ESPP shares. During the six months ended June 25, 2016 and June 27, 2015, we issued 303,585 and 302,705 ESPP shares, respectively.


21



The following weighted-average assumptions were used in estimating the fair value of employees' purchase rights under our approved employee stock purchase plans:
 
Six Months Ended
 
June 25,
2016
 
June 27,
2015
ESPP:
 
 
 
Dividend yield
%
 
%
Expected volatility
45.3
%
 
51.7
%
Risk-free interest rate
0.40
%
 
0.08
%
Expected term (in years)
0.50

 
1.00

 

Unrecognized Compensation Costs
 
At June 25, 2016, the unrecognized stock-based compensation, adjusted for estimated forfeitures, was as follows (in thousands): 
 
Unrecognized Expense
 
Average Expected Recognition Period in years
Stock options
$
1,430

 
2.51
Restricted stock units
10,994

 
2.78
Employee stock purchase plan
84

 
0.10
Total unrecognized stock-based compensation expense
$
12,508

 
 


Note 16 — Net Income per Share
 
Basic net income per share for the three and six months ended June 25, 2016 and June 27, 2015 was computed by dividing net income by the weighted-average number of common shares outstanding for the period. Diluted net income per share for the three and six months ended June 25, 2016 and June 27, 2015 was computed by dividing net income by the diluted weighted-average number of shares outstanding during that period.

A reconciliation of the numerator and denominator used in the calculation of basic and diluted net income per share is as follows (in thousands):
 
 
Three Months Ended
 
Six Months Ended
 
June 25,
2016
 
June 27,
2015
 
June 25,
2016
 
June 27,
2015
Numerator:
 

 
 

 
 
 
 
Net income used in computing basic and diluted net income per share
$
36,884

 
$
838

 
$
23,084

 
$
1,621

Denominator:
 
 
 
 
 
 
 
Weighted-average shares used in computing basic net income per share
59,572

 
58,109

 
59,001

 
57,532

Add potentially dilutive securities
416

 
985

 
638

 
1,342

Weighted-average shares used in computing basic and diluted net income per share
59,988

 
59,094

 
59,639

 
58,874


22



The following securities were excluded from the calculation of diluted net income per share because their effect would have been anti-dilutive for the periods presented (in thousands):
 
 
Three Months Ended
 
Six Months Ended
 
June 25,
2016
 
June 27,
2015
 
June 25,
2016
 
June 27,
2015
Options to purchase common stock
2,255

 
1,948

 
1,809

 
2,059

Restricted stock units
4

 

 

 
197

Total potentially dilutive securities
2,259

 
1,948

 
1,809

 
2,256



Note 17 — Income Taxes
 
We recorded an income tax benefit of $43.7 million for each of the three and six months ended June 25, 2016 and an income tax provision of $24 thousand and $0.1 million for the three and six months ended June 27, 2015, respectively. The income tax benefit for the three and six months ended June 25, 2016 was primarily due to the release of valuation allowance of our deferred tax assets ("DTAs"). In connection with our acquisition of Cascade Microtech on June 24, 2016, deferred tax liabilities ("DTLs") were established on the acquired identifiable intangible assets. These DTLs exceeded the acquired DTAs by approximately $43.9 million and created additional sources of income to realize a tax benefit for our DTAs. As such, authoritative guidance under United States GAAP requires the impact on the acquiring company's deferred tax assets and liabilities caused by an acquisition be recorded in the acquiring company's financial statements outside of acquisition accounting. Accordingly, the valuation allowance on a portion of our DTAs was released and resulted in an income tax benefit of approximately $43.9 million.

Note 18 — Commitments and Contingencies
 
Contractual and purchase obligations
We lease facilities under non-cancelable operating leases with various expiration dates through 2024. The facilities generally require us to pay property taxes, insurance and maintenance costs. Further, several lease agreements contain rent escalation clauses or rent holidays. For purposes of recognizing minimum rental expenses on a straight-line basis over the terms of the leases, we use the date of initial possession to begin amortization. We have the option to extend or renew most of our leases, which may increase the future minimum lease commitments.
Purchase obligations are primarily for purchases of inventory and manufacturing related service contracts. Purchase obligations are defined as agreements that are enforceable and legally binding and that specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. Timing of payments and actual amounts paid may be different depending on the time of receipt of goods or services or changes to agreed-upon amounts for some obligations.
Our lease and purchase obligations have not materially changed as of June 25, 2016 from those disclosed in our Annual Report on Form 10-K for the year ended December 26, 2015, apart from Cascade Microtech's lease and purchase obligations which are disclosed below as of June 25, 2016, and arising as a result of our acquisition of Cascade Microtech on June 24, 2016. See Note 3 to the Condensed Consolidated Financial Statements - Acquisition, for further details. 
 
Remainder of 2016
 
2017-2018
 
2019-2020
 
2021 and Beyond
 
Total
 
(In thousands)
Operating leases
$
1,225

 
$
4,091

 
$
1,868

 
$
384

 
$
7,568

Purchase order commitments obligations (1)
5,227

 
169

 

 

 
5,396

Total
$
6,452

 
$
4,260

 
$
1,868

 
$
384

 
$
12,964

(1)
Purchase order commitments primarily represent open orders for inventory and capital expenditures.


23



Also, our contractual obligations as of June 25, 2016 include our commitments under the senior secured term loan facility, as disclosed below. See Note 5 to the Condensed Consolidated Financial Statements - Debt for further details.
 
Remainder of 2016
 
2017-2018
 
2019-2020
 
2021
 
Total
 
(In thousands)
Principal payments
$
5,625

 
$
39,375

 
$
91,875

 
$
13,125

 
$
150,000

Interest payments*
1,613

 
5,339

 
2,765

 
65

 
9,782

Total
$
7,238

 
$
44,714

 
$
94,640

 
$
13,190

 
$
159,782

* Represents our minimum interest payment commitments at 2.00% per annum

Environmental Matters
 
We are subject to U.S. Federal, State, local, and foreign governmental laws and regulations relating to the protection of the environment, including those governing the discharge of pollutants into the air and water, the management and disposal of hazardous substances and wastes, the clean-up of contaminated sites and the maintenance of a safe workplace. We believe that we comply in all material respects with the environmental laws and regulations that apply to us, including those of the California Department of Toxic Substances Control, the Bay Area Air Quality Management District, the City of Livermore Water Resources Division, County of Santa Clara Department of Environmental Health, County of San Diego Hazardous Materials Division and Encino Water District, and the California Division of Occupational Safety and Health. We did not receive any notices of violations of environmental laws and regulations during the six months ended June 25, 2016, or in our fiscal 2015. In the future, we may receive notices of violations of environmental regulations, or otherwise learn of such violations. Environmental contamination or violations may negatively impact our business.
Indemnification Arrangements
We have entered, and may from time to time in the ordinary course of our business enter, into contractual arrangements with third parties that include indemnification obligations. Under these contractual arrangements, we have agreed to defend, indemnify and/or hold the third party harmless from and against certain liabilities. These arrangements include indemnities in favor of customers in the event that our products or services infringe a third party's intellectual property or cause property or other damages and indemnities in favor of our lessors in connection with facility leasehold liabilities that we may cause. In addition, we have entered into indemnification agreements with our directors and certain of our officers, and our bylaws contain indemnification obligations in favor of our directors, officers and agents. These indemnity arrangements may limit the type of the claim, the total amount that we can be required to pay in connection with the indemnification obligation and the time within which an indemnification claim can be made. The duration of the indemnification obligation may vary, and for most arrangements, survives the agreement term and is indefinite. We believe that substantially all of our indemnity arrangements provide either for limitations on the maximum potential future payments we could be obligated to make, or for limitations on the types of claims and damages we could be obligated to indemnify, or both. However, it is not possible to determine or reasonably estimate the maximum potential amount of future payments under these indemnification obligations due to the varying terms of such obligations, a lack of history of prior indemnification claims, the unique facts and circumstances involved in each particular contractual arrangement and in each potential future claim for indemnification, and the contingency of any potential liabilities upon the occurrence of events that are not reasonably determinable. We have not had any material requests for indemnification under these arrangements. We have not recorded any liabilities for these indemnification arrangements on our condensed consolidated balance sheet as of June 25, 2016.
Legal Matters

From time to time, we may be subject to legal proceedings and claims in the ordinary course of business. In the first quarter of fiscal 2016, we were named in a proceeding in connection with our acquisition of Cascade Microtech and in the second quarter of fiscal 2016, we entered into a memorandum of understanding with the plaintiff in connection with the proceeding. We identify below in "Other Litigation", a proceeding filed in fiscal 2013, which, if not resolved amicably, either (i) includes allegations that could potentially result in a material legal proceeding, or (ii) the cost to defend the allegations through trial could be material. In the future we may become a party to additional legal proceedings that may require us to spend significant resources, including proceedings designed to protect our intellectual property rights. Litigation can be expensive and disruptive to normal business operations. Moreover, the results of legal proceedings are difficult to predict, and the costs incurred in litigation can be substantial, regardless of outcome.


24



On March 8, 2016, an individual plaintiff filed a putative class action lawsuit on behalf of Cascade Microtech's shareholders against Cascade Microtech, its directors, FormFactor and Cascade Merger Sub, in connection with Cascade Microtech and FormFactor entering into a merger agreement. The lawsuit, captioned Lum v. Cascade Microtech, Inc., et al., No. 16CV07293, was filed in Washington County Circuit Court in the State of Oregon.

On April 8, 2016, another individual plaintiff filed a similar putative class action lawsuit against the same defendants. The lawsuit, captioned Solak v. Cascade Microtech, Inc., et al., No. 16CV11809, was filed in Multnomah County Circuit Court in the State of Oregon.

On April 20, 2016, the Lum lawsuit was dismissed without prejudice at the request of the plaintiff. The litigation proceeds in Multnomah County Circuit Court with the Solak complaint as the operative complaint. The Solak lawsuit alleges that the individual members of Cascade Microtech’s board of directors breached their fiduciary duties owed to Cascade Microtech’s shareholders by approving the proposed merger for inadequate consideration; approving the merger to obtain unique benefits not shared equally with Cascade Microtech’s other shareholders; failing to take steps to maximize the value paid to Cascade Microtech shareholders; failing to take steps to ensure a fair process leading up to the proposed merger; and agreeing to preclusive deal protection devices in the merger agreement. The lawsuit also alleges claims against FormFactor and one of its subsidiaries for aiding and abetting the alleged breaches of fiduciary duties by the individual members of Cascade Microtech’s board of directors. In the Solak lawsuit, the plaintiff has sought, among other things, rescission of the merger, plaintiff’s attorney’s fees and costs, and other relief.

Under a memorandum of understanding signed by the parties and filed with the court in the Solak case, Cascade Microtech and FormFactor agreed with the plaintiff’s counsel to supplement the disclosures made in connection with the merger. The supplemental disclosures were made on June 14, 2016. Under the memorandum of understanding, the parties to the Solak lawsuit agreed to use their collective best efforts to obtain final approval of the proposed settlement and the dismissal of the Solak litigation with prejudice. Subject to completion of certain confirmatory discovery by counsel to the plaintiff, the memorandum of understanding contemplates that the parties will enter into a stipulation of settlement. The stipulation of settlement will be subject to customary conditions, including court approval following notice to Cascade Microtech’s former shareholders within the proposed class.

As stated in the memorandum of understanding, if the settlement is finally approved by the Oregon court, the parties anticipate that it will resolve and release all claims in the Solak lawsuit pursuant to terms that will be disclosed to Cascade Microtech shareholders prior to final approval of the settlement. In addition, in connection with the settlement, the parties contemplate that plaintiff’s counsel in the Solak lawsuit will file a petition in the Oregon court for an award of attorneys’ fees and expenses. Cascade Microtech will pay any attorneys’ fees and expenses awarded by the Oregon court. There can be no assurance that the parties will ultimately enter into a stipulation of settlement or that the Oregon court will approve the settlement even if the parties were to enter into such stipulation. In such event, the proposed settlement as contemplated by the memorandum of understanding may be terminated.

Other Litigation

In August 2013, a former employee filed a class action lawsuit against the Company in the Superior Court of California, alleging violations of California’s wage and hour laws and unfair business practices on behalf of himself and all other similarly situated current and former employees at the Company’s Livermore facilities from August 21, 2009, to the present. On January 4, 2016, the court certified the plaintiff class. The lawsuit is currently proceeding to notice to class members and merits discovery. The Company denies the allegations contained in the lawsuit, and, based on available information, believes it has significant defenses to the allegations of the lawsuit. The Company currently believes that any settlement reached would be an amount that is not material to the Company's financial statements. If the matter is not settled, the Company could incur material attorneys’ fees in defending the lawsuit.


Note 19 — Derivative Financial Instruments
 
We operate and sell our products in various global markets. As a result, we are exposed to changes in foreign currency exchange rates. We utilize foreign currency forward contracts to hedge against future movements in foreign exchange rates that affect certain existing foreign currency denominated assets and liabilities. Under this program, our strategy is to have increases or decreases in our foreign currency exposures offset by gains or losses on the foreign currency forward contracts to mitigate the risks and volatility associated with foreign currency transaction gains or losses. We do not use derivative financial instruments for speculative or trading purposes. Our derivative instruments are not designated as hedging instruments. We

25



record the fair value of these contracts as of the end of our reporting period to our Condensed Consolidated Balance Sheet with changes in fair value recorded within “Other income (expense), net” in our Condensed Consolidated Statements of Income for both realized and unrealized gains and losses.
 
The following table provides information about our foreign currency forward contracts outstanding as of June 25, 2016 (in thousands): 
Currency
 
Contract Position
 
Contract Amount (Local Currency)
 
Contract Amount (U.S. Dollars)
Japanese Yen
 
Buy
 
(629,473
)
 
$
(6,173
)
Taiwan Dollar
 
Buy
 
(36,695
)
 
(1,137
)
Korean Won
 
Buy
 
(1,528,806
)
 
(1,350
)
Euro
 
Buy
 
(2,200
)
 
(2,525
)
Euro
 
Sell
 
1,099

 
1,245

Euro
 
Sell
 
17,011

 
19,406

Japanese Yen
 
Sell
 
179,263

 
1,661

Japanese Yen
 
Sell
 
140,000

 
1,256

Total USD notional amount of outstanding foreign exchange contracts
 
 
 
$
12,383

 
The contracts were entered into during the second quarter of fiscal 2016 and matured in July 2016. Our foreign currency contracts are classified within Level 2 of the fair value hierarchy as they are valued using pricing models that utilize observable market inputs. Approximately $0.3 million of unrealized gains was recorded as a current asset in the balance sheet of Cascade Microtech which was acquired as of June 24, 2016 (and subsequently recorded as a current asset in our condensed consolidated balance sheet of June 25, 2016) relating to foreign currency forward contracts.

The location and amount of gains (losses) related to non-designated derivative instruments that matured in the three and six months ended June 25, 2016 and June 27, 2015 in the Condensed Consolidated Statements of Operations are as follows (in thousands):
 
 
 
 
 
Amount of Gain (Loss) Recognized on Derivatives
 
 
 
 
Three Months Ended
Six Months Ended
Derivatives Not Designated as Hedging Instruments
 
Location of Gain (Loss) Recognized on Derivatives
 
June 25, 2016
 
June 27, 2015
 
June 25, 2016
 
June 27, 2015
Foreign exchange forward contracts
 
Other income (expense), net
 
$
(141
)
 
$
847

 
$
(1,703
)
 
$
685


Note 20—Operating Segments
Until the acquisition of Cascade Microtech, we operated in one reportable segment consisting of one operating segment relating to the design, development, manufacture and sale of high performance advanced probe cards. Our chief operating decision maker ("CODM") is our Chief Executive Officer, who reviews operating results to make decisions about allocating resources and assessing performance for the entire company.

Upon the acquisition of Cascade Microtech (See Note 3 to the Condensed Consolidated Financial Statements - Acquisition, for further details), we re-evaluated our CODM's decision process for allocating resources and assessing performance for the company and determined that we now operate in two reportable segments consisting of Probes and Systems segments, and four operating segments consisting of FormFactor Probes, Cascade Microtech Probes, Systems, and Integrated Measurement Solutions ("IMS") segments. These four operating segments have been aggregated into two reportable segments as noted above based on common economic and qualitative characteristics.
For the purposes of our goodwill impairment analysis, until and up to the acquisition of Cascade Microtech, we concluded that we had one reporting unit, which relates to the design, development, manufacture and sale of high performance advanced probe cards. Upon the acquisition of Cascade Microtech, we now believe that we have five reporting units consisting of FormFactor Probes, Cascade Microtech Probes, Systems, Advanced Temperature Test Systems GmbH ("ATT") Systems, and IMS.

26



Long-lived assets, comprising of net property, plant and equipment, goodwill and net intangibles assets are not disclosed by geographic location as our CODM does not review these assets in order to make decisions about allocating resources and assessing performance for the entire combined company.
The following table summarizes the operating results by reportable segments for the three months ended June 25, 2016 (in thousands):
 
Probes
 
Systems
 
Total
 
 
 
 
 
 
Revenues
$
83,083

 
$

 
$
83,083

Operating loss
(6,646
)
 

 
(6,646
)
Operating results provides useful information to our management for assessment of our performance and results of operations. Components of our operating results are utilized to determine executive compensation along with other measures.

Note 21 — Business Interruption Insurance Claim Recovery

During the six months ended June 27, 2015, we received approximately $1.5 million as a result of a payment from our insurer arising from a business interruption insurance claim related to a factory fire at a customer during the second half of fiscal 2013. We recorded this cash receipt within “Other income (expense), net” in our Condensed Consolidated Statements of Operations.

Note 22 — Subsequent Events

On July 25, 2016, we entered into an interest-rate swap agreement with HSBC to hedge the interest payments on our Term Loan entered into on June 24, 2016. The Term Loan has a LIBOR based floating interest rate and matures on 31st March 2021. As future levels of LIBOR over the life of the loan are uncertain, we entered into an interest-rate swap agreement to hedge the exposure in interest rate risks associated with movement in LIBOR rates. See Note 5 to the Condensed Consolidated Financial Statements - Debt, for further details of the Term Loan. The interest-rate swap contract was designated as a hedge instrument under ASC 815, Derivatives and Hedging.









27



Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
 

Cautionary Statement Regarding Forward-Looking Statements
 
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Securities Exchange Act of 1934 and the Securities Act of 1933, which are subject to risks and uncertainties. The forward-looking statements include statements concerning, among other things, our business strategy (including anticipated trends and developments in, and management plans for, our business and the markets in which we operate), financial results, operating results, revenues, gross margin, operating expenses, products, projected costs and capital expenditures, research and development programs, sales and marketing initiatives and competition. In some cases, you can identify these statements by forward-looking words, such as "may," "might," "will," "could," "should," "expect," "plan," "anticipate," "believe," "estimate," "predict," "intend" and "continue," the negative or plural of these words and other comparable terminology.
 
The forward-looking statements are only predictions based on our current expectations and our projections about future events. All forward-looking statements included in this Quarterly Report on Form 10-Q are based upon information available to us as of the filing date of this Quarterly Report on Form 10-Q. You should not place undue reliance on these forward-looking statements. We have no obligation to update any of these statements. These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to differ materially from those expressed or implied by these statements. These factors include the matters discussed in the section titled “Risk Factors” and elsewhere in our Annual Report on Form 10-K for the year ended December 26, 2015 and in this Quarterly Report on Form 10-Q. You should carefully consider the numerous risks and uncertainties described under these sections.
 
The following discussion and analysis should be read in conjunction with our condensed consolidated financial statements and the accompanying notes contained in this Quarterly Report on Form 10-Q. Unless expressly stated or the context otherwise requires, the terms “we,” “our,” “us” and “FormFactor” refer to FormFactor, Inc. and its subsidiaries.

Overview
We design, develop, manufacture, sell and support advanced semiconductor probe card products, and are the largest supplier worldwide of those products. With our acquisition of Cascade Microtech Inc., we also design, develop, manufacture and market advanced wafer probing, thermal and reliability solutions for the electrical measurement and testing of high performance semiconductor devices.
Semiconductor manufacturers use our probe card products to perform wafer test (also known as wafer sort), which is the testing of the semiconductor die, or chips, while those die are still constituted on the semiconductor wafer. Wafer test enables semiconductor manufacturers to determine whether chips will meet specifications and be saleable once the wafer is diced, and the die are singulated and individually packaged. The per-die costs of singulation and packaging processes are relatively high, and some of the die on a wafer are typically expected to be defective. Consequently, there is often a compelling economic reason to perform wafer test. Probe cards are a critical element in enabling that wafer test process.
Our advanced wafer probing, thermal and reliability solution products enable precision on-wafer measurement of integrated circuits and are often used in the early phases of the development of semiconductor processes where the accuracy and repeatability of measurements is critical to achieving yield from advanced process nodes. Many of our products are also used in production applications to test semiconductor devices prior to completion of the manufacturing process.
On June 24, 2016, we completed the acquisition of Cascade Microtech Inc. ("Cascade Microtech"), headquartered in Beaverton, Oregon. Our consolidated financial statement as of June 25, 2016 included the condensed consolidated balance sheet of Cascade Microtech as of June 24, 2016 whereas our condensed consolidated statements of income for the three and six months ended June 25, 2016 excluded the financial results of Cascade Microtech for the second quarter of fiscal 2016 as the one-day stub period between the acquisition of Cascade Microtech and the end of our second quarter of fiscal 2016 was deemed immaterial. See Note 3 to the Condensed Consolidated Financial Statements - Acquisition, for further details. 
To finance a portion of the acquisition consideration, we entered into a senior secured term loan facility in an aggregate amount of $150 million. See Note 5 to the Condensed Consolidated Financial Statements - Debt, for further details. Also see Note 18 to the Condensed Consolidated Financial Statements - Commitments and Contingencies, for a schedule of our principal and interest payment commitments under the Term Loan.
We generated net income of $23.1 million in the first six months of fiscal 2016 as compared to net income of $1.6 million in the first six months of fiscal 2015. The increase in the net income was primarily due to the release of valuation allowance on

28



a portion of our deferred tax assets as a result of the acquisition of Cascade Microtech resulting in an income tax benefit of approximately $43.9 million, which was partially offset by higher restructuring expenses and transaction costs related to our acquisition activities in the first half of fiscal 2016 as compared to the corresponding period in the prior year. Additionally, our revenues were lower in the first half of fiscal 2016 as compared to the corresponding period in the prior year due to a slower than planned capacity ramp required to meet increased demand for our Foundry & Logic probe cards during the first quarter of fiscal 2016.

Our cash, cash equivalents and marketable securities and restricted cash totaled approximately $118.8 million as of June 25, 2016, as compared to approximately $188.0 million at December 26, 2015. The decrease was primarily due to the consideration paid for the acquisition of Cascade Microtech partially offset by the use of proceeds from the $150 million Term Loan used to partially fund the acquisition. We believe that we will be able to satisfy our working capital requirements for at least the next twelve months with the liquidity provided by our existing cash, cash equivalents and marketable securities. If we are unsuccessful in maintaining or growing our revenues, or maintaining or reducing our cost structure in an industry downturn, or increasing our available cash through financing, our cash, cash equivalents and marketable securities could decline in future periods.

We believe the following information is important to understanding our business, our financial statements and the remainder of this discussion and analysis of our financial condition and results of operations:

Revenues.  To date, we have derived substantially all of our revenues from product sales of probe cards. Revenues from our Cascade acquisition have been excluded from the consolidated financial results for the three and six months ended June 25, 2016 as noted above. Revenues from our customers are subject to fluctuations due to factors including, but not limited to, design cycles, capacity ramps, technology adoption rates, competitive pressure to reduce prices, cyclicality of the different end markets into which our customers' products are sold and market conditions in the semiconductor industry. Historically, increases in revenues have resulted from increased demand for our existing products, the introduction of new, more complex products, the penetration of new markets and through acquisition. We expect that revenues from the sale of probe cards will continue to account for a substantial portion of our revenues for the foreseeable future, though our future revenues will also include revenues from the sales of probe stations, thermal sub-systems, reliability test systems and other product lines acquired in our acquisition of Cascade Microtech.

Cost of Revenues. Cost of revenues consists primarily of manufacturing materials, payroll, shipping and handling costs, manufacturing-related overhead and amortization of certain intangible assets. Our manufacturing operations rely upon a limited number of suppliers to provide key components and materials for our products, some of which are a sole source. We order materials and supplies based on backlog and forecasted customer orders. Tooling and setup costs related to changing manufacturing lots at our suppliers are also included in the cost of revenues. We expense all warranty costs, inventory provisions and amortization of certain intangible assets as cost of revenues.

We design, manufacture and sell custom advanced probe cards into the semiconductor test market, which is subject to significant variability and demand fluctuations. Our probe cards are complex products that are custom to a specific chip design of a customer and must be delivered on relatively short lead-times as compared to our overall manufacturing process. As our advanced probe cards are manufactured in low volumes, it is not uncommon for us to acquire production materials and start certain production activities based on estimated production yields and forecasted demand prior to or in excess of actual demand for our probe cards. We record an adjustment to our inventory valuation for estimated excess, obsolete and non-sellable inventories based on assumptions about future demand, past usage, changes to manufacturing processes and overall market conditions.
Research and Development. Research and development expenses include expenses related to product development, engineering and material costs. Research and development costs are expensed as incurred. We plan to continue to invest in research and development activities to improve and enhance existing product technologies and to develop new technologies for current and new products and for new applications.

Selling, General and Administrative. Selling, general and administrative expenses include expenses related to sales, marketing, administrative personnel, sales commissions, market research, consulting, acquisition-related costs and other sales, marketing, administrative activities, amortization of certain intangible assets, and provision for doubtful accounts. These expenses also include costs for protecting and enforcing our intellectual property rights and regulatory compliance costs.

Restructuring Charges. Restructuring charges include costs related to employee termination benefits, cost of long-lived assets abandoned or impaired, as well as contract termination costs.


29



Impairment of Long-Lived Assets. Asset impairment charges include charges associated with the write-down of assets that have no future expected benefit or for assets that have been determined to be impaired as well as adjustments to the carrying amount of our assets held for sale.


Results of Operations
 
The following table sets forth our operating results as a percentage of revenues for the periods indicated:
 
 
Three Months Ended
 
Six Months Ended
 
June 25,
2016
 
June 27,
2015
 
June 25,
2016
 
June 27,
2015
Revenues
100.0
 %
 
100.0
%
 
100.0
 %
 
100.0
%
Cost of revenues
69.4

 
68.5

 
74.2

 
68.1

Gross profit
30.6

 
31.5

 
25.8

 
31.9

Operating expenses:
 
 
 
 
 
 
 
Research and development
13.4

 
15.2

 
16.1

 
15.4

Selling, general and administrative
16.9

 
15.4

 
19.4

 
16.1

Restructuring charges, net
8.3

 

 
5.1

 
0.4

Total operating expenses
38.6

 
30.6

 
40.6

 
31.9

Operating income (loss)
(8.0
)
 
0.9

 
(14.8
)
 

Interest income, net
0.1

 
0.1

 
0.2

 
0.1

Other income (expense), net
(0.4
)
 
0.1

 
(0.5
)
 
1.1

Income (loss) before income taxes
(8.3
)
 
1.1

 
(15.1
)
 
1.2

Provision (benefit) for income taxes
(52.7
)
 

 
(32.0
)
 
0.1

Net income
44.4
 %
 
1.1
%
 
16.9
 %
 
1.1
%
 

Three and six months ended June 25, 2016 and June 27, 2015:
 
Revenues
 
Revenues by Market

 
Three Months Ended
 
Six Months Ended
 
June 25,
2016
 
June 27,
2015
 
% Change
 
June 25,
2016
 
June 27,
2015
 
% Change
 
(In thousands, except percentages)
Foundry & Logic
$
57,888

 
$
34,573

 
67.4
 %
 
$
94,023

 
$
67,982

 
38.3
 %
DRAM
24,221

 
35,251

 
(31.3
)
 
40,510

 
69,825

 
(42.0
)
Flash
974

 
4,061

 
(76.0
)
 
2,161

 
6,907

 
(68.7
)
Total revenues
$
83,083

 
$
73,885

 
12.4
 %
 
$
136,694

 
$
144,714

 
(5.5
)%

The increase in Foundry & Logic revenues for the three and six months ended June 25, 2016 was primarily due to increased demand of our probe cards used to test server and personal computer processors. The decrease in our DRAM revenues for the three and six months ended June 25, 2016 was due to lower probe card demand driven by a slowing DRAM market, as compared to the same periods last year, and reduced demand for our SmartMatrix product. The decrease in Flash memory revenues for the three and six months ended June 25, 2016 was due to a slowing NOR Flash market and reduced demand for our TouchMatrix product.





30



Revenues by Geographic Region
 
The following table sets forth our revenues by geographic region for the periods indicated:

 
Three Months Ended
 
Six Months Ended
 
June 25,
2016
 
% of
Revenue
 
June 27,
2015
 
% of
Revenue
 
June 25,
2016
 
% of
Revenue
 
June 27,
2015
 
% of
Revenue
 
(In thousands, except percentages)
North America
$
31,599

 
38.0
%
 
$
17,325

 
23.4
%
 
$
49,154

 
36.0
%
 
$
35,852

 
24.8
%
South Korea
17,590

 
21.2

 
15,600

 
21.1

 
26,458

 
19.4

 
32,459

 
22.4

Taiwan
12,890

 
15.5

 
15,444

 
20.9

 
25,550

 
18.7

 
31,586

 
21.8

Europe
12,072

 
14.5

 
5,901

 
8.0

 
19,885

 
14.5

 
11,434

 
7.9

Japan
4,549

 
5.5

 
9,581

 
13.0

 
7,669

 
5.6

 
14,956

 
10.3

Asia-Pacific (1)
4,383

 
5.3

 
10,034

 
13.6

 
7,978

 
5.8

 
18,427

 
12.8

Total revenues
$
83,083

 
100.0
%
 
$
73,885

 
100.0
%
 
$
136,694

 
100.0
%
 
$
144,714

 
100.0
%
_________________________________________________________________________________________________
(1)
Asia-Pacific includes all countries in the region except Taiwan, South Korea, and Japan, which are disclosed separately.
 
Geographic revenue information is based on the location to which we ship the product. For example, if a certain South Korean customer purchases through their North American subsidiary and requests the products to be shipped to an address in South Korea, this sale will be reflected in the revenue for South Korea rather than North America.
 
The change in revenues from our geographical regions for the three and six months ended June 25, 2016, when compared to the corresponding periods in the prior year, were primarily driven by: