FormFactor, Inc.

Thank you and welcome everyone to FormFactors' fourth quarter 2020 earnings conference call. On today's call are Chief Executive Officer Mike Flesser and Chief Financial Officer Shai Shahar. Before we begin, Jason Cohen, the company's general counsel, will remind you of some important information.

Thank you. Today the company will be discussing GAAP P&L results and some important non-GAAP results intended to supplement your understanding of the company's financials. Reconciliations of gap to non-gap measures and other financial information are available in the press release issued today by the company and on the investor relations section of our website. Today's discussion contains forward-looking statements within the meaning of the federal securities laws. Examples of such forward-looking statements include those with respect to the projections of financial and business performance, future macroeconomic conditions, the benefits of acquisitions and investments in capacity and information technology, the impacts of the COVID-19 pandemic, the impacts of regulatory changes, the anticipated demand for products, our future ability to produce products, the development of future products and technologies, and the assumptions upon which such statements are based. These statements are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from those expressed during this call. Information on risk factors and uncertainties is contained in our most recent filing on Form 10-K with the SEC and our other SEC filings, which are available on the SEC's website at www.sec.gov and in our press release issued today. Forward-looking statements are made as of today, February 3, 2021, and we assume no obligation to update them. Also, as an aside, since this is an entirely remote earnings call for us, please bear with us on any audio delays. With that, we will now turn the call over to FormFactor CEO, Mike Slessor.

Thanks, Jason, and thank you, everyone, for joining us today. FormFactor delivered strong results in the fourth quarter of 2020, setting all-time quarterly and annual company records for revenue, non-GAAP operating profit, and net profit. I want to thank and congratulate the Global Form Factor team who demonstrated a combination of agility and tenacity to overcome a myriad of challenges and deliver these record results. As we begin 2021, robust demand for our products continues, and we're adding capacity to meet that demand. However, even with the strength that produced these results, the fourth quarter had its unique challenges, as evident from gross margins below our October outlook range. Shia will provide more details later, but I'd like to start our call by addressing this issue. This gross margin reduction was caused by two primary factors of approximately equal impact. First, in our probe card segment, we reserved warranty costs for some early life reliability failures on a new Foundry and Logic product release. Since mid-November, our team has worked closely with the affected customer to resolve the issue, and this customer has qualified a modified architecture that eliminates the problem. This issue is now closed, as we are shipping replacement units in volume and have implemented improvement actions in our product development and release processes. Second, in our system segment, we executed against an unusually unfavorable product mix as we shipped several significant lower margin orders to end the quarter. These orders contained fewer high-value features and options than in our typical mix, as customers configured systems to meet a variety of end-of-year budget, lead time, and volume purchase requirements. Some unfavorable product mix continues in our system segment backlog, but less than in the fourth quarter. As we've described in the past, the diversified nature of form factor's design-specific consumable and R&D-driven product mix will produce quarterly fluctuations in gross margin. Despite these short-term fluctuations, our long-term trajectory towards the 47% gross margins of our target model remains intact. And as you can see from our outlook, we expect a sequential increase in gross margin for the current quarter. Turning to market-level details, Demand for Foundry and Logic probe cards was extremely strong in the fourth quarter. This strength is the result of new design releases in the fabulous Foundry ecosystem that ramped aggressively in both high-performance compute and mobile applications, with continued strong growth associated with 5G handset launches. In the first quarter, these specific ramps are mostly behind us, and we do expect a slight sequential decrease in Foundry and Logic probe cards. On a longer-term basis, driven by 5G and advanced packaging, this market is a major growth opportunity as customers utilize form factor's differentiated market-leading products to meet their highly complex test requirements for millimeter wave RF front ends, next-generation application processors, and high-power compute processors. In DRAM, we delivered the highest quarterly revenue of 2020 as customers released and ramped new designs in a combination of technology node migrations, 12 and 16 gigabit product ramps, and the beginning of the HBM2 to HBM3 transition. As a reminder, probe cards are consumable with a specific to each chip design, and so demand is generated not just by node migrations, but also the release of new chip designs, such as 16 gigabit LPDDR5. With this strong new design activity in place across our customer base, we expect first quarter and potentially first half DRAM probe card demand to continue at levels comparable to the fourth quarter. The HBM3 transition is especially exciting for ForumFactor. That's yet another example of industry adoption of advanced packaging. with customers stacking up to 16 individual silicon dye to meet memory bandwidth and power requirements in high-performance compute applications. In these stacked dye architectures, the value of testing increases as more dye are added to the stack to avoid incorporating bad component dye into an otherwise good stack. As a result, As advanced packaging schemes like HBM3 are adopted, we are seeing a substantial growth in test intensity. On top of that, the technologies required to test these devices are extremely complex and sophisticated. The dimensions of an individual MEMS-fabricated probe are comparable to a human hair. They carry power at over an amp of current and signals at tens of gigahertz while lasting millions of contact cycles. Moreover, a typical probe card contains tens of thousands, if not hundreds of thousands, of precisely assembled MEMS probes. This combination of increased test intensity, which expands the number of probe cards required per wafer out, and test complexity, which widens form factor's competitive advantage, is characteristic of all types of advanced packaging. As the industry's focus moves to post-fab integration to offset the slowing of front-end Moore's Law, Wafer test and probe cards are taking a prominent role in enabling a variety of advanced packaging schemes, like HBM stacking of DRAM die and heterogeneous integration of chiplets, and are at least partially responsible for the double-digit growth we've delivered in both 2019 and 2020. These secular growth trends support our investments in capacity with increased capital expenditures including our 2020 purchase of a new 90,000 square foot factory in Livermore, which is scheduled to begin revenue shipments in the second half of this year. Turning to M&A, following two acquisitions in the second half of last year, our team has focused on integrating our additions. The Advantest probe card assets we acquired in July are now fully integrated into our probe card operations. and we have launched an internal program to incorporate several technology subcomponents into FormFactor's probe card roadmap. We are also making progress introducing the acquired mainstream NAND flash probe card products into the global FormFactor channel and are working closely with multiple customers on first half 2021 qualification plans. Our addition of HPD in the fourth quarter is also proceeding according to plan. We've integrated SG&A functions with the broader form factor organization. The combination of form factors customer relationships and global footprint together with HPD's world-class cryogenic thermal control and test expertise has enabled us to engage companies and research institutes leading in the nascent field of quantum computing in the US, Japan, and the EU. Although we do not expect a significant financial contribution from these activities in 2021, we are excited about the long-term growth prospects enabling quantum computing with our emerging leadership position and cryogenic tested measurement. Finally, with record fourth quarter results and a solid first quarter outlook, we are making progress towards the target financial model we unveiled last year that delivers $2 of non-GAAP earnings per share on $850 million of revenue Test and measurement is becoming a more important and strategic place in the semiconductor industry, driven by trends like 5G and advanced packaging. Our leadership position in these attractive markets, paired with our differentiated strategy and disciplined execution, will drive continued growth and share gains as we progress towards our target model.