FormFactor Q4 2023 Earnings Call Transcript

Quartr
Provided by Quartr
February 7, 2024

There are 11 speakers on the call.

Operator

Thank you, and welcome everyone to FormFactor's 4th Quarter 2023 Earnings Conference Call. On today's call are Chief Executive Officer, Mike Schlecher and Chief Financial Officer, Shay Shahar. Before we begin, Stan Mikkelstein, the company's VP of Investor Relations, will remind you of some important information.

Speaker 1

Thank you. Today, the company will be discussing GAAP P and L results and some important non GAAP results intended to supplement your understanding of the company's financials. Reconciliations of GAAP to non GAAP measures and other financial information are available in the press 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 and geopolitical conditions the benefits of acquisitions and investments in capacity and in new technologies The impacts of global, regional and national health crisis, including the COVID-nineteen pandemic, anticipated industry trends, potential disruptions in our supply chain the impacts of regulatory changes, including the recent U.

Speaker 1

S.-China trade restrictions The anticipated demand for products our ability to develop, produce and sell products 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 ks with the SEC for the fiscal year ended December 31, 2022, and in 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 7, 2024, And we assume no obligation to update you.

Speaker 1

With that, we will now turn the call over to FormFactor's CEO, Mike Sasser.

Speaker 2

Thanks everyone for joining us today on FormFactor's 4th Quarter Earnings Call. FormFactor's 4th quarter results were in line with the outlook we provided last November. Compared to that outlook, Moderately higher revenue and gross margins were offset by a higher tax rate, producing non GAAP EPS at the midpoint of the range. As we enter 2024, we continue to operate in an overall demand environment that remains similar to the levels we experienced during the past year And we expect Q1 results to be similar to those achieved in recent quarters. The relatively stable aggregate demand across our Combined served markets is a benefit of FormFactor's diversification strategy and sets us apart from our direct competitors.

Speaker 2

FormFactor has a broad lab to fab product portfolio across foundry and logic, DRAM and flash probe guards together with our system segment products. This unique portfolio enables us to compete for business across diverse demand pools at all major customers, producing relatively consistent top line results as we've demonstrated for the past 4 quarters and which we expect again in the current quarter. Customer investments in growing areas driven by generative AI like high bandwidth memory and co packaged silicon photonics is helping offset the impact of areas that are presently at cyclically low levels like mobile handsets and PCs and those entering cyclical downturns like automotive and industrial. The stability also enables FormFactor to keep investing in R and D for new product innovation and competitive differentiation, especially in our product roadmap for advanced packaging applications like chiplets and tiles, high bandwidth memory and co package optics. It also enables us to invest in capacity and other strategic initiatives designed to produce market share gains and above industry revenue and profit growth when the industry returns to growth, which will enable FormFactor to achieve and then surpass the levels of our current target financial model.

Speaker 2

Because of the strength and stability of our balanced product portfolio, we can make these investments while maximizing quarterly profitability and protecting our strong balance sheet throughout prolonged periods of industry softness. Turning now to segment level details. DRAM probe cards are an area of current strength And we expect Q1 DRAM revenue to approach the peak levels experienced in 2021. DRAM strength is being driven by 2 factors. 1st and perhaps surprisingly, we're experiencing strong demand generated by new DDR5 DRAM designs as customers prepare for high volume production when the eventual DRAM upturn arrives.

Speaker 2

This provides insight into the unique characteristics of probe card demand since probe cards are a device specific consumable customized to each individual chip design. Early production activity for these new DDR5 designs is driving demand for new probe cards, albeit at lower overall levels and with somewhat greater short term that we might expect to see in a full scale cyclical upturn. The second factor behind our strong DRAM outlook is the continuing Acceleration in demand from multiple customers for probe cards to test high bandwidth memory or HBM. Together with the headline grabbing GPUs, HBM is a key enabler for generative AI and we are forecasting nearly 50% sequential growth in our HBM probe card business in the Q1. HBM offers a great example of how advanced packaging is driving FormFactor's results.

Speaker 2

As we mentioned in the past, advanced packaging applications like HBM produce both higher test intensity, which expands the number of probe cards required for good die out and higher test complexity, which raises the performance requirements for each probe card. Each HBM chip is a stack of 8, 12 or even 16 individual DRAM die assembled with advanced packaging processes such as through silicon vias and hybrid bonding. To ensure high yields of the stack DRAM chip, customers probe and test each component DRAM die prior to stacking and probe and test the multi die DRAM stack at various points during the assembly process, leading to a substantial increase in the overall probe card intensity for good die out. In addition, the technical requirements for HBM test are significantly more advanced than for standard unstacked DRAM products, involving higher test speeds and more challenging thermal scaling specifications. FormFactor's MEMS based Smart Matrix probe card architecture meets these advanced requirements, providing significant value to our customers and differentiation for form factor.

Speaker 2

We believe our superior performance capabilities will drive both market share and profitability gains as HBM continues to grow, driven by the accelerating adoption of generative AI. Shifting to foundry and logic probe guards, our largest business, We experienced the expected sequential reduction in the 4th quarter as key customers digested the significant third quarter of probe cards for a major tile based client PC design and 2 major high performance compute designs in the foundry space. We expect similar demand levels for foundry and logic probe cards in the current quarter as customers continue to closely manage their output now that inventories have stabilized at healthy levels in high unit volume end markets like client PC and mobile. Looking further ahead, The adoption of advanced packaging processes like chiplets and tiles by major foundry and logic customers continues to accelerate as they seek to advance their roadmaps in the face of a slowing Moore's Law. As in high bandwidth memory, Advanced Packaging and Foundry and Logic applications again demands both higher test intensity and higher test complexity.

Speaker 2

The positive impact of this trend together with the potential for increased compute power and PCs and handsets to support AI at the edge will drive significant growth in the foundry and logic probe card market. As anticipated, We experienced a sequential reduction in systems segment revenue in the 4th quarter, mainly due to the sale of our FRT metrology business. The systems business continues to be driven by strong demand for our market leading test and measurement products for early development of applications like co packaged silicon photonics and quantum computing. More broadly, systems is an important element of our diversification strategy, As spending in this segment is primarily driven by customer innovation and R and D budgets and is not directly correlated with semiconductor production activity. Co package optics enabled by silicon photonics remains an important and exciting driver for FormFactor's current systems and future probe card The transition of silicon photonics from early R and D to low volume production continues and we have now installed a CM300 silicon photonics system at the world's leading foundry to support low volume production as well as serve as a platform for the co development of the enhancements needed for high volume electrical and optical test of co package optics.

Speaker 2

As production volumes increased over the next several years, Our product mode rep delivers both systems and consumable probe cards to test these electro optical devices and improve yields, enabling our customers to seamlessly transition from the lab to the fab. Finally, Earlier today, we announced an agreement to divest our subsidiaries in China to Grand Junction Semiconductor together with a long term exclusive distribution and partnership agreement. This transaction is designed to adjust our operational strategy in the region in light of export controls that have caused our China revenues to decline over the past several quarters. In closing, we continue to operate efficiently and prudently in what we see as a relatively stable demand environment across our diversified product and technology portfolio. Longer term, we remain excited and confident in the growth prospects for form factor and the industry overall, driven by the fundamental trends of semiconductor content growth and exciting innovations like HBM, chiplets and co packaged silicon photonics.

Speaker 2

These are trends where FormFactor is well positioned as an industry and technology leader and we're confident that our investments in R and D and capacity position form factor to emerge from the current cyclical downturn, a stronger and leaner competitor, enabling us to achieve our target model that delivers $2 of non GAAP earnings per share on $850,000,000 of revenue. Shay, over to you.

Speaker 3

Thank you, Mike, and good afternoon. As you saw in our press release, Q4 revenues and non GAAP gross margin were at the high end of our outlook range, and non GAAP EPS was at the midpoint of the range. 4th quarter revenues were $168,200,000 a 2% sequential decrease from our 3rd quarter revenue and a year over year increase of 1.3% from our Q4 2022 revenue. Probe Card segment revenues were $126,800,000 in the 4th quarter, a decrease of $1,500,000 or 1.3% from the 3rd quarter revenues and a year over year increase of 1.9%. The decrease from Q3 was driven by lower foundry and logic revenues, partially offset by an increase in DRAM and Flash revenues.

Speaker 3

System segment revenues were $41,200,000 in Q4, a $2,000,000 decrease from 3rd quarter record revenues and essentially flat year over year. The decrease from the 3rd quarter is mainly due to the sale of FRT, which closed on October 31. Systems segment revenues comprised 24.5% of total company revenues, slightly down from 25.2% in the 3rd quarter. Within the probe card segment, Q4 Foundry and Logic revenues were $83,600,000 a 13.3% decrease from the 3rd quarter revenues. Foundry and Logic revenues decreased to 49.8% of total company revenues compared to 56.2% in the 3rd quarter.

Speaker 3

DRAM revenues were $35,900,000 in Q4, $8,500,000 or 31 percent higher than in the 3rd quarter, an increase to 21.4% of total quarterly revenues as compared to 16% in the 3rd quarter. Flash revenues of $7,300,000 in Q4 were $2,800,000 higher than in the 3rd quarter and were 4.3% of total revenues in Q4 as compared to 2.6% in Q3. GAAP gross margin for the Q4 was 40.4%, same as in Q3. Cost of revenues included $2,800,000 of GAAP to non GAAP reconciling items, which we outlined in our press release issued today and in a reconciliation table available in the Investor Relations section of our website. On a non GAAP basis, gross margin for the Q4 was 42.1%, 0.3 percentage points higher than the 41.8 percent non GAAP gross margin in Q3 and 1.1 percentage points above the midpoint of our outlook range.

Speaker 3

The increase as compared to Q3 and the upside versus the midpoint of our outlook range were mostly a result of higher gross margin in the probe card segment, partially offset by lower system segment gross margin. Our probe card segment gross margin was 39.6% in the 4th quarter, an increase of 1.1 percentage points compared to 38.5 percent in Q3. The increase from Q3 is mainly due to improved factory utilization and lower excess and obsolete inventory expense, partially offset by a less favorable mix and lower volume. Our Q4 Systems segment gross margin was 49.6 percent, 220 basis points lower than the 51.8% gross margin in the 3rd quarter. The decrease relates mainly to the sale of FRT during the quarter, which resulted in a less favorable mix and inventory adjustments related to the transaction close.

Speaker 3

Our GAAP operating expenses were $59,600,000 for the 4th quarter as compared to $66,600,000 in the 3rd quarter. The main reasons for the decrease versus Q3 were non recurring M and A expenses in the 3rd quarter and only 1 month of FRT OpEx in the 4th quarter, partially offset by higher performance based compensation in Q4. Non GAAP operating expenses for the Q4 were $51,600,000 or 30.7% of revenues as compared with $54,500,000 or 31.8 percent of revenues in Q3. The decrease relates to similar reasons I mentioned regarding GAAP operating expenses. Company non cash for the Q4 included $9,300,000 for stock based compensation, dollars 1,600,000 lower than in the 3rd quarter due to timing of grants, $800,000 for the amortization of acquisition related intangibles, dollars 500,000 lower than in Q3 and depreciation of $7,700,000 similar to the 3rd quarter.

Speaker 3

GAAP operating income was $81,300,000 for Q4 and includes a $73,000,000 gain from the sale of FRT compared with GAAP operating income of $2,700,000 in Q3. The gain from the sale of FRT has been excluded from our 4th quarter non GAAP results. Non GAAP operating income for the Q4 was $19,100,000 compared with $17,300,000 in the 3rd quarter, an increase of $1,900,000 or 10.8%. GAAP net income for the Q4 was $75,800,000 or $0.97 per fully diluted share compared with a GAAP net income of $4,400,000 or $0.06 per fully diluted share in the previous quarter. The main reason for the increase is the gain on the sale of FRT.

Speaker 3

The non GAAP effective tax rate for the Q4 was 21.2% as compared with a 12.2% in the 3rd quarter, mainly due to usual year end adjustments and changes in mix of foreign versus domestic taxable income. For the full fiscal 2023, The non GAAP effective tax rate was 15.6 percent within the range of 13% to 17% previously communicated and similar to the 15.4% in 2022. We estimate that our annual non GAAP effective tax rate for 2024 will be between 14% 18%. 4th quarter non GAAP net income was $15,700,000 or $0.20 per fully diluted share compared to $17,300,000 or $0.22 per fully diluted share in Q3. Moving to the balance sheet and cash flows.

Speaker 3

We used $300,000 in free cash flow in the 4th quarter compared to generating $16,900,000 in Q3. The main reasons for the change were timing of shipments to and collection from customers during the Q4 and higher capital expenditures. We invested $9,900,000 in capital expenditures during the Q4 compared to $5,900,000 in Q3. This brings our 2023 annual capital expenditures to $56,000,000 within the range previously communicated. The decrease in CapEx in the second half of twenty twenty three as compared to the first half and as compared with the $65,300,000 invested in 2022 is due to completing the majority of the long lead time facilities and equipment investment required to reach our target financial model.

Speaker 3

Accordingly, we expect CapEx in 2024 to be between $35,000,000 $45,000,000 At quarter end, total cash and investments were $332,000,000 an increase of $84,000,000 from Q3. The increase was mainly a result of approximately $104,000,000 received from the sale of FRT, partially offset by the $9,900,000 of capital expenditures I just described and by stock buyback in the amount of $20,000,000 As of the end of the Q4, we had one term loan remaining with a balance totaling $14,000,000 Regarding the stock buyback, as I mentioned, during the Q4, we purchased $20,000,000 worth of shares To fully utilize our $75,000,000 2 year buyback program that was approved in May 2022 and started utilizing the new $75,000,000 2 year plan was approved in October 2023. As of Q4 quarter end, dollars 73,800,000 remain available for future repurchases under this plan. As a reminder, the main purpose of these share repurchase programs is to offset dilution from stock based compensation. Turning to the Q1 non GAAP outlook.

Speaker 3

We expect Q1 revenues of $165,000,000 plus or minus $5,000,000 At the midpoint of our outlook range, Q1 revenues is expected to be approximately $3,000,000 lower than in Q4. The expected decrease relates to lower system segment revenues, mainly due to the sale of FRT in Q4. And in the probe card segment, we expect flat Foundry and Logic and lower Flash revenues in the Q1, partially offset by an increase in DRAM revenues. The sale of our Chinese subsidiaries we announced today is expected to close in the first half of twenty twenty four, and it is not expected to have a significant impact on our financial results. 1st quarter non GAAP gross margin is expected to be 41 percent plus or minus 150 basis points.

Speaker 3

Expected decrease at the midpoint of this range as compared to Q4 'twenty three gross margin is a result of a less favorable product mix, mainly the expected decrease in system segment revenues and the increase in DRAM revenues. Although we expect HVM revenues to grow in the 1st quarter, Non HBM DRAM revenues, which has a lower gross margin profile, is also expected to grow. At the midpoint of these outlook ranges, expect Q1 operating expenses to be $53,000,000 plus or minus $1,000,000 The increase as compared to Q4 is mainly a result of the annual benefits reset. Non GAAP earnings per fully diluted share for Q1 is expected to be $0.19 plus or minus 0 point 0 $4 A reconciliation of our GAAP to non GAAP Q1 outlook is available on the Investor Relations section of our website and in our press release issued today. With that, let's open the call for questions.

Speaker 3

Operator?

Operator

Our first question comes from the line of Brian Chin from Stifel. Your question please.

Speaker 4

Hi there. Good afternoon. Thanks for letting us ask A few questions. Maybe first, and I know, Shay, you just said that I think you said that upon closure in first half, the China divestiture kind of has no impact. But I mean, I imagine there are some financial implications either in terms of cost and margins, Some expectation as it relates to revenue, even maybe some cash on the balance sheet.

Speaker 4

Can you maybe break that down a little bit more? And also whatever regulatory hurdles or other hurdles need to be cleared to consummate the transaction?

Speaker 3

Sure. So as I said, we don't expect it to have a significant impact on our When it comes to the balance sheet, once the deal closes, we will make the appropriate disclosure with more details. But since the details of the transaction were not disclosed, you can imagine that we concluded it's immaterial. When it comes to the P and L, again, not a material impact. Since we maintain we continue to maintain the direct relationship with the multinational customers In the region and with respect to the local China customers, we have the new distribution agreement and we And hope that this will continue to grow our China business as we move forward.

Speaker 3

And that's the conclusion we don't expect it to have a material impact. And Mike, do you want to refer to the regulatory?

Speaker 2

Yes. But Brian, this has been structured in a way where We don't believe there are significant regulatory approvals required. Basically, what we're doing is divesting what's in China already. And so there's no technology transfer, no significant technology licensing. It really is a focus and a shift to our operational and customer channel strategy in the region, given some of the challenges we've had with the export controls, you've seen our domestic China revenue contract over the past several quarters and this is a response to that.

Speaker 2

We are hopeful that Grand Junction can bring some more resources and focus to those business and through the distribution channel help grow our domestic China business for us.

Speaker 4

Okay. Yes, it's helpful. And for maybe my follow-up, Can you quantify, I guess, it's been operating maybe around $10,000,000 a quarter, but what the HBM contribution was to this 36,000,000 DRAM in Q4? And then also kind of more broadly, do you see wafer probe card Test intensity continuing to increase alongside your customers' roadmaps based on more diastec and hybrid bonding, etcetera. Do you see test intensity leveling off at some point as customers yield and manufacturing efficiency improves?

Speaker 4

Yes.

Speaker 2

I think it's a question of timing on the second one. I think for the medium term, certainly through 2024 and into 2020 5 with HBM, customers are still riding up a pretty significant yield burning curve. And so the increase in test intensity that we talked about associated with dye stacking and advanced packaging of 20% to 30%. I think we're pretty confident is going to hold here as we go through the early part of The HBM3 and into the HBM4 ramp. Over time, as with anything, we see this in new nodes as well.

Speaker 2

Customers accomplish the yield learning using products like ours, reducing the overall test intensity, improving their yields. And so we would expect it to go down over time. But I think we're pretty confident in increased test intensity as all the different yield reduction modes associated with die stacking are worked through in HBM and in the logic space as well. On the numbers, HBM in the Q4 was approximately $10,000,000 as you said, maybe a little bit more of the $36,000,000 of DRAM revenue. And as we said in the prepared remarks, we expect that to increase around 50% sequentially.

Speaker 2

So up into the call it mid teens in the Q1 outlook.

Speaker 4

Okay, great. Thank you.

Speaker 3

Thanks, Brian.

Operator

Thank you. One moment for our next question. And our next question comes from the line of David Duley from Steelhead. Your question please. David Dooley, you might have your phone on

Speaker 5

Yes, you're right. Thanks. I noticed the Founders Project revenue was down and it looks it's similar decline that we saw in the revenue out of the geographic region of Taiwan. I was just wondering if you could make some more elaborate comments about that. That's my first question.

Speaker 5

My second question is, could you remind us what percentage of the overall DRAM It uses MEMS based probe cards. And I think you mentioned that all the high bandwidth memory stuff is going to be on MEMS. Does the growth in high bandwidth memory really kind of benefit you guys since you're a MEMS based provider?

Speaker 6

Yes.

Speaker 2

I'll take the second one first. The DRAM wafer probe market is Almost entirely MEMS based. Us and our primary Japanese competitor, in high end DRAM, really the only way to build these probe cards which test the entire wafer at once and have approximately 100,000, 150,000 individual contacts on them. The only way to do that in a cost effective and high quality way and deliver the speed performance, the high power performance is with a MEMS technology. And so, I don't view HBM in and of itself as a headwind or a tailwind for MEMS adoption considering we're already largely adopted with MEMS and DRAM.

Speaker 2

But the requirements, as we talked about in the prepared remarks, are more stringent. And so It increases, 1, the value to our customers. It also increases our competitive differentiation on things like speed, high speed performance, and thermal scaling. And so it's not purely a MEMS adoption story, but really raising of the bar of the existing MEMS probe card for HBM, which as Shay commented helps our gross margins in the segment a little bit. On the foundry and logic observation, if you recall back on our previous call, We had a very strong Q3 with some of our major foundry and logic customers.

Speaker 2

And in particular, in the foundry space, delivered high volumes of 2 high performance probe cards for high performance compute projects And those are in a digestion mode right now. So the inference you've drawn is correct. It also ties to the expectations we said on the previous call about some digestion in the foundry space as we go through Q4 and now Q1.

Speaker 5

And just as my follow on, you talked about in your prepared comments, I think some place about you saw unusually strong demand In DDR5, is that associated with a specific end market? Or could you just maybe just elaborate further on that particular comment? Thank you.

Speaker 2

Sure. The overall DRAM guidance as we said, our outlook is that we're going to approach the levels that we approached in the middle part of 2021. So somewhere in the low $40,000,000 of quarterly DRAM revenue. And that's composed you can do the math from The previous question and answer session, you can do the math on how much of that is HBM, which leaves you with some pretty solid growth associated with non HBM memory. We're seeing DDR5 for both mobile and serverPC applications be pretty strong in the Q1.

Speaker 2

I want to be clear that we're not calling a DRAM upturn at this point, it's pretty concentrated on a couple of designs and mostly at one customer. But it is an interesting indication of our customers beginning to invest in new designs because we know DRAM is and we know it's going to turn at some point. So this represents some investments in them getting ready for the ramp when it does turn.

Operator

Thank you. Thank you. And our next question comes from the line of Chris Shanker from TD Cowen. Your question please.

Speaker 7

Yes. Hi. Thanks for taking my question. I have 2 of them. First one, if I look at your guidance, I'm just kind of curious, Mike or Shah, you said foundrylogic revenue is flat, HBM growth 50% and overall DRAM revenue is approaching peak levels in Q2 of 2021, it was $42,000,000 and DDR5 is going too.

Speaker 7

But if I do the math, it looks like HBM as a percentage of DRAM revenues is going to be higher in March versus in the December quarter. So why is gross margin still lower? Shouldn't gross margin be better than December then?

Speaker 3

Well, let's not forget the Systems segment, right? We did I did talk about the call that Systems segment is expected to go down in Q4. And as you recall, our systems segment gross margin historically is higher. So we're going to have less favorable mix between systems and probes, and that's another driver that pushes gross margin a little lower than Q4.

Speaker 7

Got it. Got it. And then I just had 2 other quick questions. Mike, Look at your HBM, Sheryl, you clearly have done a great job in HBM3 and 3E versus HBM1 and 2. I'm just kind of curious, do you expect the momentum to continue next year or so when we get into HBM4 and beyond?

Speaker 2

Yes. Krish, I think we see the same progression of test complexity There really shifts competitive advantage towards us as we move from HBM III to IV. I think one of the obvious ones is, It's a higher more die being stacked and that clearly, as we look at customers' test strategies, As I said in the prepared remarks, they're not just probing each individual component die, but they're probing the stack as they build it up. And so, Higher stacks probably mean less yield, but also probably mean higher test complexity, higher test intensity as we move to HBM-four. In addition, obviously, the clock speeds go up, the densities go up.

Speaker 2

And so those are all good trends. And I think it's one of the things where We're spending a good fraction of our R and D budget on making sure we can continue to drive that capability roadmap forward and serve the increased complexity of HBM4 and derive some competitive advantage from it. If I go back to your Initial comment that Shay answered, actually the mix between regular DRAM and HBM DRAM in the low 40s is nominally the same as it was in Q4. So that's one of the reasons why you're not seeing a margin uplift associated with DRAM.

Speaker 7

Got it. Got it. And then a quick clarification, I think Brian asked this on the China To the multinationals in China, is this still going to go through the Grand Junction Semi or is it going to be directly from Form?

Speaker 2

Yes, no. Because the multinationals that operate in the region are global customers for FormFactor, they are not part of this distribution agreement. FormFactor continue to support those customers in a global way and where we need local resources, we'll contract those things out. But you can think of the multinationals, which historically have been the vast majority of our China revenue, continue to be managed by form factor and are not part of the distribution arrangement.

Speaker 7

Got it. Thank you very much, Mark. Thank you.

Operator

Thanks, Chris. Thank you. One moment for our next question. And our next question Comes from the line of Tom Diffely from D. A.

Operator

Davidson. Your question please.

Speaker 8

Yes. Thank you and good afternoon. I guess, first of all, when you look at the memory segment, you talked about some next generation DRAM chips. Are you seeing anything on the flash side, any next generation flash chips that require new designs?

Speaker 2

Tom, as I think you know, our flash market share and consequently our flash revenue is pretty minimal compared to DRAM. It's a market where the requirements are not that challenging from a speed or perspective, which is really where we derive competitive advantage and why we're strong in DRAM. Flash, because of die sizes, because of test speeds, because of things built in self test of the chips, really hard to drive a competitive advantage. So we do have some share there. But as you can tell from our historical financial results, it's not significant.

Speaker 2

We do see some new designs, but given my statement about our market We don't have the broad view of the flash market that would allow us to make the same kind of observations we can in DRAM. Having said that, I think the general view, when we talk to customers and other suppliers is that Flash is probably going to trail DRAM in terms of recovery that inventories are still high and pricing is not where it should be to drive an upturn, but we are continuing to be opportunistic in the flash market and where we can differentiate With speed and or capability, we're taking advantage of it.

Speaker 8

Okay. And would you expect your flash share to go up over time given the acquisition you made a couple of years ago of some technology there or is it kind of in this segment or in this range for a bit?

Speaker 2

Yes, I think it's in this range for a bit. So the acquisition you're talking about, we acquired Advantest's probe card businesses a few years ago or business a few years ago. And if you remember, we we primarily did that, although it is a flash test platform, a flash probe card platform. We primarily did it because it feeds elements of our DRAM roadmap that we're now in the final qualification stages at with a key customer. That'll help us from an overall market share perspective, at least at that customer.

Speaker 2

So we again acquired at more for the DRAM capability, although being engaged in Flash does help you work out the bugs at a lower complexity level.

Speaker 8

Great. Thanks. And as a follow-up, Shay, when you look at the target model, going from where we were in 2023 to the target model, Like 700 basis points of margin improvement. Is most of that just coming from overhead absorption or are there some cost reduction programs that need to take place?

Speaker 3

I would say 3 things. 1 is volume. Yes, as you pointed out, we have been adding capacity. So we need volume to go up to fully utilize this capacity and improve absorption and utilization. The second element is mix.

Speaker 3

We expect the growth from where we are today to our target model to come mostly from foundry and logic, which is an area that has a higher gross margin. And the 3rd component is the cost reductions. We have few initiatives across the company, some task forces to improve our gross margins, focusing on cost, Things like automation and vertical integration, more efficient production and these things also expect to contribute on our way to reach the target model of 47%.

Speaker 8

Okay. Would you say that overhead absorption is the biggest factor?

Speaker 3

I would say it's distributed kind of equally between the 3 components.

Speaker 8

Okay. That's helpful. Appreciate your time today. Thank you.

Speaker 6

Thanks, Tom.

Operator

Thank you. One moment for our next question. And our next question comes from the line of Christian Schwab from Craig Hallum Capital. Your question please.

Speaker 9

Great. Mike, on the DRAM business and the 50% sequential revenue growth, is that driven by your currently customer or is that expansion starting to ramp with the second customer?

Speaker 2

Yes. When you break down the increase, it really is driven by our HBM customer, who also leads the overall HBM market and share. So that's the primary driver. I did Probably a subtlety, but I did in the prepared remarks say that we expect revenue from all 3 major DRAM manufacturers in HBM. So there's engagements for those that when we think about the Q1 step up, it's very much driven by our lead customer.

Speaker 2

It's a key 2024 strategic objective for us to make sure that we capitalize on HBM growth at all major DRAM and I think we're making some pretty good progress with that.

Speaker 9

Once you have all 3, how big could The high bandwidth memory portion of the business be?

Speaker 1

Yes. It's a good

Speaker 2

question. And I'm So I think we'll stick with the idea that our HBM revenue in 2024 on a quarterly basis could double from the quarterly run rate that we had in And the reason for that is it's a little difficult right now to sort out how much double counting is going on in terms of forecasting between the different suppliers of HBMDRAM, our customers. I think if you back out the forecast, the growth and add them all together, the growth assumptions are probably there's some double counting in there. So I think our The expectation that we communicated on the last call and through some of the investor conferences as we've gone through the back part of the year and to start 2024 of the HBM run rate doubling on a quarterly basis from where it was in 2023, the right expectation. And then you can see in Q1, we've made some good steps towards that.

Speaker 9

Okay. That's great. On the foundry and logic business, The leading manufacturers of chips, whether it's Intel or AMD or TSM, are kind of Pretty optimistic regarding aggregate unit growth and the huge volume markets of PCs and smartphones, they're just Not all that enthusiastic about it in March, but they are as we go throughout the course of the year. And given some of the new design ramps and new chips coming to market throughout the course of the year, I

Speaker 1

mean, is it logical that that

Speaker 9

business exits the year at 100 plus 1,000,000 run rate again?

Speaker 2

Yes, I think you've identified the key drivers for it. Certainly in the 1st part of the year, whether you look at our Q1 guidance, kind of extrapolate what Some of those customers in the high unit volume markets like PCs and handsets are conveying. There's some optimism associated with the second half. Given our visibility, right, remember that probe cards have lead times well within a quarter, much less than a quarter. And so our direct visibility doesn't extend anywhere close to that.

Speaker 2

But I think the combination of, inventories being at much healthier levels and probably now a balance between output at these key customers and the actual sell through. That's now been resolved. So that puts things in a better place. And I think if there's some end demand pickup in these large unit volume markets like PCs and handsets in the second half, we should see some growth there. But it's beyond our visibility, beyond the headlands.

Speaker 2

What I would say to close that topic is, when I compare things to a year ago and people were Optimistic about a second half recovery in 2023. I feel like the industry is in much better shape from an inventory and production and capacity standpoint a year later here in the 1st part of 2024.

Speaker 9

Great. And then I'll just slip in one more question if I can. You've been working on a qualification with a potential large customer for some time, I think a few quarters anyway, I guess. Is there any update on where we sit with that? And do you feel better about that?

Speaker 9

Do you feel better about potential timing of that? Any update, great.

Speaker 2

Yes. We don't have a huge update for you, but we have talked about this in the past. Obviously, The large fabless microprocessor and GPU customer is a place where we do not have significant share. And given our strategy of diversification, different customers, different markets, that's an important place for us to qualify and hold a significant share position, especially given their leadership in some of the end markets. We have made some as you know, we've been at this for a while.

Speaker 2

We have made some changes in how we're resourcing that. The good news is the customer has a clear 2 supplier strategy and there's really only 2 suppliers that can do this and form factor is one of them. So it's really up to us to improve our execution and get there. I'm confident that we can qualify at least in 2024. That will take a while to build into a significant share in revenue position, but we're setting the groundwork now and it's a very

Speaker 9

Great. No other questions. Thank you.

Speaker 2

Thanks, Christian.

Speaker 1

Thank

Operator

you. Our next question comes from the line of Craig Ellis from B. Riley Securities. Your question please.

Speaker 10

Yes, thanks for taking the question. So Mike, hard to believe there could be even more DRAM questions, but there was a nuance I wanted to better understand. As we look at high bandwidth memory here in the Q1, understandable that it's ramping given What's going on more broadly, but the question

Speaker 2

is this, as you look at

Speaker 10

the mix of your high bandwidth memory Exposure in 1Q from high bandwidth memory 3 to potentially 3E, which I think really launches commercially On a system in 2Q and high bandwidth memory 4, which I think everybody expects to come out in early 2020 5, how much of the mix in 1Q is 3 versus 3E and 4? And to the extent we're not Really generating revenue on the outer tube, when would you expect that to hit?

Speaker 2

Yes, there actually is a little bit of revenue on 3. So most of the production volume as you'd note is on 3rd generation or HVM III. But 3, The mini step, we are shipping probe cards in some significant volume. I don't have the mix off the top of my head, but I guess it's something like 2 thirds HBM III, 1 third HBM III and then a sprinkling of HBM IV in early R and D

Speaker 10

Yes. And then part of that, just so I don't offend the moderator with too many questions. There's growing chatter that in PCs we could see a format change from SODIMMs to LP cans and I don't know if that has any impact on probe card intensity, but are you seeing anything on the personal computer side that would drive up probe card intensity that's there?

Speaker 2

I don't think so, Craig. I think those format changes, especially that's 2 steps downstream from us in integration when they get integrated into the package and then into the module. I don't anticipate that having and we of course interact with the die at the wafer level. I don't anticipate that would have a significant impact. What we really need is a PC refresh cycle to drive unit volume increases of PCD.

Speaker 10

Yes, hear you on that one. And then for the second question, typically, I think in the first half of the year, the business within foundry and logic And do you still expect to hold the same share that you've historically had there?

Speaker 2

Yes, I think so. It's going to be an interesting year with In the foundry business, a lot more high performance compute than just application processor. Although I think the application processor projects in the foundry space generally continue to be big middle of the year drivers of revenue. Those are key customers and very important focus areas for us as we move through 2024. There are one element of the overall diversification strategy we talked about, right?

Speaker 2

The DRAMs Running pretty hot right now. HBM, not so surprisingly, but DDR5 being, as I said in the prepared remarks, A bit surprising given where we are in the DRAM cycle, but it's exactly a case study of why we've put these different businesses together to try and produce a relatively stable top line demand profile so that we can weather this subcyclicality and continue to invest in things like R and D for competitive differentiation and capacity.

Speaker 10

Got it. Thanks, Mike. Appreciate the help.

Speaker 3

Thanks, Greg.

Operator

Thank you. One moment for our next question. And our next question comes from the line of David Silver from C. L. King and Associates.

Speaker 6

Yes. Hi. Thank you. I'd like to ask maybe a strategic question regarding Capital deployment at this point in time. So, Mike, with the sale of the metrology business, I mean, you've You kind of had to make a strategic decision not to invest to grow that business.

Speaker 6

And I don't believe the Livermore capacity, you have some extra capability at Livermore now. So when I look at your The balance sheet, I mean, it's certainly highly liquid. Could you just maybe discuss some of your thoughts about The highest and best use for that, what you would call maybe incremental or excess portion of your cash. In other words, Does vertical integration either forward or back make sense? Are there parts of your global footprint that You could profitably expand or would there be something from the Equity investment that your large competitor received recently that maybe requires a counter move or some kind of step to retain or maintain your competitive balance.

Speaker 6

But sitting here with a highly liquid balance sheet, What goes through your mind in terms of optimizing the use of at least a portion of that?

Speaker 2

Yes, I'll let Shay talk through the details. But I think in an environment where we still expect consolidation in the space, We don't think holding on to some cash, especially with decent returns is a bad strategic move. We're going to need dry powder for M and A. We continue to be believers in M and A and consolidation, not necessarily inside our served segments, but to expand our served available market And cash is a very useful asset to have. So with that, I'll turn it over to Shay to talk a little bit about capital allocation priorities.

Speaker 3

Right. So as Mike mentioned, our priorities really didn't change as compared to what we communicated before. We're focusing on reinvesting in R and D. We're still investing in capacity, although we slowed it down recently, things like vertical integration that you mentioned and automation. And we have the share repurchase program that I talked about.

Speaker 3

We still have $75,000,000 to invest in share repurchase. This is to offset dilution. And it's a 2 year plan and it's been 1 quarter since we announced it. So we still have 1 year 3 quarters to do that. And M and A, right.

Speaker 3

And with the current interest rates and cost of capital, accumulating cash is aligned with our M and A strategy. If you look at our historical acquisitions, the MicroProb acquisition in 2012, the Cascade Microtech acquisition back in 2016, We've been pretty good in creating value through our M and A activity and have been good steward of capital.

Speaker 6

Okay, that's great. I'll stop there. Thank you very much. Thanks, David.

Operator

Thank you. And our next question is a follow-up from the line of David Duley from Steelhead. Your question please.

Speaker 5

Yes. I was just kind of curious, Are you comfortable with unit volume I see unit volume growth in the 6% to 8% range for 2024 for the foundrylogic segments. And if that's the case, would do you guys think you can grow faster than that or slower than that as far as the market growth?

Speaker 2

Yes. I think as we look, there's a lot of variance in different assumptions for specifically the second half of the year to drive growth. I think where we're more focused in our planning and forecasting and resourcing activities is on the first half because I think there's enough different variables where sure you could see 6% to 8% growth, you could see more, you could see less. And as I think most of you know, our visibility really doesn't extend into the second half. The if you were to have that scenario, I do think there is a very good likelihood that we can outgrow the unit growth of the market, especially if the bulk of it is associated with advanced nodes and some of the high volume markets like PCs and mobile.

Speaker 2

And honestly, I don't see how you get to foundry and logic high double digit unit growth without PC and handset handset growth in the second half of the year. So in that scenario, yes, I think it's reasonable Given the adoption of advanced packaging, given the increase of test intensity, so we can outgrow the market, but I'm not sure I'd adopt that yet is a baseline scenario as we work our way through the first half.

Speaker 5

Fair enough. One final question I was just kind of curious from your point of view where you sit. You've talked a lot about increased intensity from advanced packaging, all sorts of form factors and whatnot. And I'm wondering, And that's generally been with Intel and TSMC, frankly. I'm wondering if you're seeing that start to spread out onto into the OSATs because there's certainly a lot more chatter on their conference calls and I think ASE's CapEx is up more than 50% year over year this year, focused on advanced packaging.

Speaker 5

And so I'm just wondering, are you starting to see a ramp up in kind of the middle part of the market for advanced packaging and are you well positioned to capture OSAT business? Thanks.

Speaker 1

Yeah. So typically the way

Speaker 2

the probe card market works is, we have a very large installed base at the OSATs, But the OSATs often are not the purchaser of the probe cards, it's the fabless semiconductor manufacturers or the foundries themselves. And so there's a lot of interaction with the OSATs, but they're often not issuing purchase orders to us. So I think for us, Advanced packaging, if it happens at the OSATs, if it happens at the foundries, if it happens at the IDMs, all a good trend because it's going to drive up test intensity. And if a fabless customer has adopted advanced packaging and they're going to do it at the foundry or at the OSAT, that's going to drive higher test intensity at either of those places no matter what. It's just a slightly different business model for us.

Speaker 7

Okay, thanks.

Speaker 6

All right. Thanks, David.

Operator

Thank you. One moment for our next question. And our next question is a follow-up from the line of Krish Shanker from TD Cowen. Your question please.

Speaker 7

Thanks for taking the follow-up. Mike, just a quick one. It looks like the high density GPU customers are finally evaluating MEMS based probe cards, how to think about when that EVA will be done? When to expect first revenues from them? And if you can prognosticate, what do you think the market share between you and TechnoPro would be in that specific category?

Speaker 2

Yes. I think as the leading GPU manufacturer adopts advanced packaging, that's really The discontinuity where they adopt MEMS probes. And it's an interesting case because of their large die sizes. They haven't really needed to adopt MEMS probes. But as they move to the COOS advanced packaging technology, MEMS probes are an absolute must.

Speaker 2

And so that's as you note for us and our primary competitor in Foundry and Logic. Those qualifications are happening right now. I think the and pilot production right now. I'd expect over time that to be an application and a customer where Shares in this 2 supplier kind of window, we typically talk about this as a 2 third, 1 third. Some most customers like the balance at fifty-fifty, but there's often places where either us or our competitor have some degree of differentiation and so it never quite works out to be fifty-fifty.

Speaker 2

So I think you're going to start to see that in a significant way here in 2024. But of course, you know, still the majority of silicon from that customer is not going to be on advanced packaging. That's a small but very lucrative part of their overall product portfolio. I still expect monolithic GPUs at least for 2024 to continue to stay on the legacy probe guard technologies.

Speaker 7

Got it. Got it. Thanks a lot, Mike. Thank you.

Speaker 2

All right. Thanks, Chris.

Operator

Thank you. This does conclude the question and answer session of today's program. I'd like to hand the program back to Mike Schlesser for any further remarks.

Speaker 2

Thanks everybody for joining us today and we'll talk to you again at some point in the spring, if not, at our next earnings call. Take care.

Operator

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.

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Earnings Conference Call
FormFactor Q4 2023
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