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, uncertainties and assumptions that are difficult to predict. 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 are based upon information available to us as of the filing date of this Quarterly Report. You should not place undue reliance on these forward-looking statements. We undertake no obligation to update any of these statements for any reason. 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" in our Annual Report on Form 10-K for the year ended December 27, 2008, and in the section titled "Risk Factors" elsewhere in this Quarterly Report. 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. 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 precision, high performance advanced semiconductor wafer probe card products and solutions. Semiconductor manufacturers use our wafer probe cards to perform wafer sort and test on the semiconductor die, or chips, or the whole semiconductor wafer, which is prior to singulation of the wafer into individual separate chips. We work closely with our customers on product design, as each wafer probe card is a custom product that is specific to the chip and wafer designs of the customer. We operate in a single industry segment and have derived substantially all of our revenues from the sale of wafer probe cards incorporating our proprietary technology, including our MicroSpring® interconnect technology.

The oversupply of memory devices coupled with the overall global economic downturn and uncertainty in fiscal 2008 had a significant impact on global semiconductor device manufacturing. In the first half of fiscal 2009, we saw our markets continue to be affected by the continuing global macroeconomic downturn which resulted in a significant decrease in demand and continuing market challenges for our advanced wafer probe cards. In the third quarter of fiscal 2009, we saw improvement across all of our business segments. In the DRAM market, demand and supply conditions tightened, as PC and memory module makers along with digital consumer electronics makers increased their DRAM procurement in anticipation of future demand trends. Given these conditions, DRAM device pricing took an upward turn in the third quarter of fiscal 2009. Additionally, we also experienced market share gains in DRAM, acceleration in DDR III, positive mobile DRAM activity and improved results in both Flash and Logic markets. As a result, revenue was up 40.3% sequentially from the three months ended June 27, 2009. Compared to the third quarter of fiscal 2008, revenue was down 16.8%, an improvement from the 40.0% year over year decline we saw in the second quarter of fiscal 2009. While this may signal increased market confidence, we believe the global economic environment remains volatile, creating an uncertain demand environment.

We incurred a net loss of $23.9 million in the third quarter of fiscal 2009 as compared to net loss of $14.0 million for the third quarter of fiscal 2008 primarily due to lower revenues. We incurred a net loss of $127.7 million in the first nine months of fiscal 2009 as compared to net loss of $50.7 million for the first nine months of fiscal 2008 primarily due to lower revenues, the recognition of a valuation allowance of $44.7 million for our deferred tax assets as well as the $5.0 million provision for bad debts due to the heightened risk of non-payment of certain accounts receivable. Net loss for the first nine months of fiscal 2008 included $0.5 million in provision for doubtful debts. In the first quarter of fiscal 2009, we initiated a global reorganization and cost reduction plan designed to lower our cash breakeven level in the current market environment. As part of the plan, we reduced our workforce by approximately 22% and implemented certain non-severance measures that we expect to result in future cost savings.

In addition, we are restructuring our operations through our global regionalization strategy by, for example, placing more decision-making in regions close to our semiconductor customers to enhance customer relationships, strengthening our local design, application and service capabilities to improve customer responsiveness, changing our manufacturing structure for shorter cycle time and improved product delivery capabilities, and realigning our research and development efforts. We have accelerated our regionalization efforts by bringing up back-end manufacturing in Asia. We qualified our back-end manufacturing in Korea during our first quarter of fiscal 2009 and plan to do so in Japan in the fourth quarter of fiscal 2009, followed by Singapore in fiscal 2010. The combination of these initiatives is intended to result in a lower manufacturing cost, a simplified manufacturing process and decreased cycle times for our customers.

We established a valuation allowance of $44.7 million in the second quarter of fiscal 2009 against the excess tax benefits recognized in prior quarters. This charge resulted in an income tax provision, rather than an income tax benefit, for the nine months ended September 26, 2009. This valuation allowance was based on our quarterly assessment of the realizability of our deferred tax assets. Significant management judgment is required in determining any valuation allowance recorded against deferred tax assets. In evaluating the ability to recover deferred tax assets, we considered available positive and negative evidence giving greater weight to our recent cumulative losses, ability to carryback losses against prior taxable income and lesser weight to our projected financial results due to the challenges of forecasting future periods. We also considered, commensurate with its objective verifiability, the forecast of future taxable income including the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies. The necessity for this valuation allowance and any future adjustments will be based on the available positive and negative evidence at that time, commensurate with its objective verifiability. Under current tax law, this valuation allowance will not limit our ability to utilize Federal and state deferred tax assets provided we can generate sufficient future taxable income. Our tax provisions in future periods will primarily consist of income taxes on our profits in certain jurisdictions outside of the US in the event they materialize.

Our cash, cash equivalents and marketable securities totaled approximately $462.6 million as of September 26, 2009 as compared to $522.9 million at December 27, 2008. We believe that we will be able to satisfy our working capital requirements for the next twelve months with the liquidity provided by our existing cash, cash equivalents and marketable securities. If demand for our products does not increase or if we are unsuccessful in improving our operating efficiency, reducing our cash outlays or increasing our available cash through financing, our cash, cash equivalents and marketable securities will further decline in the fourth quarter of fiscal 2009.

We believe it is likely that the global economic and semiconductor industry downturns will persist; however, we cannot predict their severity or duration. Given the overall weakness of the United States and global economy, and the ongoing downturn in the semiconductor industry and its effects on demand for our products, we are unable to precisely forecast when or if revenues and profitability will return to previous levels.

Revenues. We derive substantially all of our revenues from product sales of wafer probe cards. Revenues from our customers are subject to fluctuations due to factors including, but not limited to, design cycles, 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 and the penetration of new markets. We expect that revenues from the sale of wafer probe cards will continue to account for substantially all of our revenues for the foreseeable future.

Cost of Revenues. Cost of revenues consists primarily of manufacturing materials, payroll and manufacturing-related overhead. 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 and inventory provisions as cost of revenues.

We design, manufacture and sell a fully custom product into the semiconductor test market, which is subject to significant variability and demand fluctuations. Our wafer probe cards are complex products that are custom to a specific chip design and must be delivered on relatively short lead-times as compared to our overall manufacturing process. As our advanced wafer probe cards are manufactured in low volumes and must be delivered on relatively short lead-times, 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 wafer probe cards. We record an adjustment to our inventory valuation for estimated obsolete and non-saleable inventories equal to the difference between the cost of inventories and the estimated market value based upon assumptions about future demand and market conditions.

Research and Development. Research and development expenses include expenses related to product development, engineering and material costs. Almost all research and development costs are expensed as incurred. We plan to continue to invest in research and development activities to improve and enhance existing technologies and to develop new technologies for current and new markets and for new applications.

Selling, General and Administrative. Selling, general and administrative expenses include expenses related to sales, marketing, and administrative personnel, provision for doubtful accounts, internal and outside sales representatives' commissions, market research and consulting, and other sales, marketing, and administrative activities. These expenses also include costs for protecting and enforcing our patent rights and regulatory compliance costs.

Restructuring Charges. Restructuring charges include expenses related to employee termination severance pay and benefits, and property and equipment impairment charges incurred as part of our global cost reduction plans.

Use of Estimates. Our discussion and analysis of our financial condition and results of operations are based upon our unaudited condensed consolidated financial statements. The preparation of consolidated financial statements in conformity with generally accepted accounting principles in the United States of America ("GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Estimates may change as new information is obtained. Significant items that are subject to such estimates include the fair value of revenue elements, fair value of marketable securities, allowance for doubtful accounts, reserves for product warranty, valuation of obsolete and slow moving inventory, valuation and recognition of stock-based compensation, provision for income taxes and valuation allowance for deferred tax assets and, tax liabilities and accruals for other liabilities.

Results of Operations



The following table sets forth our operating results as a percentage of revenues
for the periods indicated:



                                         Three Months Ended                Nine Months Ended
                                   September 26,    September 27,    September 26,    September 27,
                                       2009             2008             2009             2008
Revenues                                   100.0 %          100.0 %          100.0 %          100.0 %
Cost of revenues                            83.2             77.2             97.7             79.1
Gross profit                                16.8             22.8              2.3             20.9
Operating expenses:
Research and development                    31.5             32.4             40.9             28.9
Selling, general and
administrative                              39.7             45.0             60.5             40.5
Restructuring charge                           -              0.3              7.8              5.1
Total operating expenses                    71.1             77.7            109.2             74.5
Operating loss                             (54.4 )          (54.9 )         (106.9 )          (53.6 )
Interest income, net                         1.6              5.3              2.5              6.4
Other income (expense)                      (0.9 )            0.5             (0.9 )            0.2
Loss before income taxes                   (53.7 )          (49.1 )         (105.3 )          (47.0 )
Provision for (benefit from)
income taxes                                 0.9            (22.4 )           19.5            (17.3 )
Net loss                                   (54.6 )%         (26.7 )%        (124.8 )%         (29.7 )%

Three and Nine Months Ended September 26, 2009 and September 27, 2008:



Revenues



                                     Three Months Ended                              Nine Months Ended
                         September 26,     September 27,                 September 26,     September 27,
                             2009              2008         % Change         2009              2008         % Change
                                                     (In thousands, except percentages)
Revenues by Market:
DRAM                    $        36,430   $        36,525       (0.3 )% $        85,243   $       108,421      (21.4 )%
Flash                             2,096             8,470      (75.3 )            4,567            36,207      (87.4 )
Logic                             5,247             7,589      (30.9 )           12,530            25,672      (51.2 )
Total revenues          $        43,773   $        52,584      (16.8 )% $       102,340   $       170,300      (39.9 )%

The decrease in revenue for the three and nine months ended September 26, 2009 was primarily due to weak demand for our advanced wafer probe cards caused by the ongoing downturn in the semiconductor market. For certain of our products we also experienced pricing pressure due to the availability of competitive products, which also contributed to the decrease in revenues.

Our revenues for the three and nine months ended September 26, 2009 were primarily generated by sales of wafer probe cards to manufacturers of DRAM devices. Revenues for our products that address the DRAM segment declined slightly in the three and nine months ended September 26, 2009 as compared to the comparable periods in the prior year, primarily due to a number of factors including the relative supply and demand of various semiconductor devices and end products incorporating those devices, semiconductor manufacturers' efforts to curtail spending and conserve cash by taking capacity offline, reducing production, delaying the transition to new technology nodes and postponing the implementation of tooling cycles. We also experienced pricing pressure on certain DRAM test products due to the competitive environment.

Revenues from sales to Flash memory device manufacturers also decreased significantly in the three and nine months ended September 26, 2009 compared to the comparable periods in the prior year, with the decrease driven by sales decline in both NOR and NAND Flash wafer probe cards. The weakness in NOR Flash can be attributed to a decline in purchases by certain key customers. The decrease was primarily driven by a decline in revenues from NOR Flash wafer probe cards resulting from our largest NOR customer filing for bankruptcy protection in the first quarter of fiscal 2009. Additionally, revenues from NAND Flash wafer probe cards declined as NAND Flash memory device manufacturers significantly reduced their output in the first quarter of fiscal 2009, in an attempt to promote industry absorption of excess inventories.

Revenues from manufacturers of Logic devices decreased in the three and nine months ended September 26, 2009 compared to the comparable periods in the prior year, primarily due to the overall downturn in the semiconductor industry which negatively impacted the revenues from sales of our wafer probe cards.

Current global economic and semiconductor market conditions have adversely impacted the profitability of our customers and their capital spending and are likely to result in product revenues in the near term that are lower than our revenue levels in comparable periods during prior fiscal years.

Revenue by Geographic Region



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



                                         Three Months Ended                                            Nine Months Ended
                      September 26,       % of       September 27,       % of       September 26,       % of       September 27,       % of
                          2009          Revenues         2008          Revenues         2009          Revenues         2008          Revenues
                                                                (In thousands except percentages)
Japan                $        22,895        52.0 %  $        14,371        27.3 %  $        56,780        55.0 %  $        55,036        32.3 %
North America                  7,046        16.0              9,959        18.9             16,226        16.0             34,440        20.2
Asia Pacific                  11,400        26.0             22,855        43.5             24,434        24.0             65,387        38.4
Europe                         2,432         6.0              5,399        10.3              4,900         5.0             15,437         9.1
Total revenues       $        43,773         100 %  $        52,584         100 %  $       102,340         100 %  $       170,300         100 %

Geographic revenue information is based on the location to which we ship the customer product. For example, certain South Korean customers purchase through their North American subsidiaries and accordingly, if the product is shipped to an address in South Korea it is reflected in the revenue for Asia Pacific.

The increase in Japan for the three and nine months ended September 26, 2009 as compared to the same period in the prior year was primarily due to the increase in our DRAM product sales in the region. The decrease in revenues in Asia Pacific for the three and nine months ended September 26, 2009 as compared to the same period in the prior year was primarily due to the decrease in our DRAM product sales in the region. The decrease in revenues in North America for the three and nine months ended September 26, 2009 compared to the same period in the prior year was primarily driven by decreased demand for all our products in this region. Revenue in Europe increased for the three months ended September 26, 2009 primarily due to the increased demand for our Logic products in this region.

The following customers accounted for more than 10% of our revenues:

                         Three Months Ended               Nine Months Ended
                    September 26,   September 27,   September 26,   September 27,
                        2009            2008            2009            2008
Elpida Memory (1)            53.0 %          15.5 %          55.0 %          23.4 %
Spansion                          *               *               *          13.1
Intel Corporation                 *               *               *          13.0

* Less than 10% of revenues.

Gross Profit



                       Three Months Ended                   Nine Months Ended
                September 26,      September 27,     September 26,     September 27,
                    2009               2008              2009              2008
                                 (In thousands except percentages)
Gross profit   $         7,338    $        12,001   $         2,333   $        35,674
Gross margin              16.8 %             22.8 %             2.3 %            20.9 %

Gross margin fluctuates with revenue levels, product mix, selling prices, factory loading, and material costs. For the three and nine months ended September 26, 2009, gross margin declined compared to the same period in the prior year, primarily due to the significant decline in revenue driving lower factory utilization, thereby increasing unit manufacturing costs, combined with declines in average selling prices as well as unfavorable change in product mix from higher margin to lower margin products. This decline was partially mitigated by lower personnel costs as a result of our fiscal 2008 and 2009 global cost reduction plans as well as a decline in inventory write-downs. Inventory provision decreased from $12.3 million or 7.2% of revenues in the first nine months of fiscal 2008 to $5.6 million, or 5.5% of revenues, in the first nine months of fiscal 2009. The higher inventory write-downs in first nine months of fiscal 2008 were associated with deterioration in the DRAM memory segment in that period. Excess custom inventories are not uncommon for us as our advanced wafer probe cards are custom designs manufactured in low volumes and must be delivered on relatively short lead times, which requires 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 wafer probe cards. Stock-based compensation included in gross margin was $1.0 million or 2.2% of revenues, and $1.1million, or 2.1% of revenues, in the three months ended September 26, 2009 and September 27, 2008, respectively, and $2.8 million, or 2.7% of revenues and $3.6 million, or 2.1% of revenues for the nine months ended September 26, 2009 and September 27, 2008, respectively. The decline of stock-based compensation, in absolute dollars, was primarily as a result of reductions in headcount as a result of our 2008 and 2009 global cost reduction plans.

In the near future, our gross margins will likely continue to be adversely affected by lower levels of product revenues in comparison to the same periods in the prior fiscal year, even though we have taken significant steps to reduce our production levels and operating cost structure. Additionally, we may be required to record additional inventory write-downs if estimated average selling prices of products held in finished goods and work in process inventories at a quarter-end date are below the manufacturing cost of those products. Also, as part of our global regionalization strategy, we continued our efforts to transition back-end manufacturing to Asia in the third quarter of fiscal 2009. We qualified our back-end manufacturing in Korea during our first quarter of fiscal 2009 and plan to do so in Japan in the fourth quarter of fiscal 2009, followed by Singapore in fiscal 2010. This initiative is intended, in part, to reduce manufacturing cost. However, as we go through our ramp up of new technologies over the coming quarters, we will see associated costs related to the transition before we more fully experience the benefits of lower manufacturing costs by the second half of fiscal 2010.

Research and Development



                                         Three Months Ended                       Nine Months Ended
                                  September 26,       September 27,       September 26,       September 27,
                                      2009                2008                2009                2008
                                                      (In thousands except percentages)
Research and development         $        13,775     $        17,079     $        41,823     $        49,288
% of revenues                               31.5 %              32.4 %              40.9 %              28.9 %

Research and development expenses decreased in absolute dollars for the three and nine months ended September 26, 2009 compared to the same period in the prior year primarily due to a decrease in certain new technology product development related costs, personnel costs and depreciation, facilities and information technology allocations. For the three and nine months ended . . .