FormFactor Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
July 31, 2024

There are 10 speakers on the call.

Operator

Thank you, and welcome everyone to FormFactor's Second Quarter 2024 Earnings Conference Call. On today's call are Chief Executive Officer, Mike Slessor and Chief Financial Officer, Shai Shahar. Before we begin, Stan Finkelstein, 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 impact of global, regional and national health crisis, including the COVID-nineteen pandemic anticipated industry trends potential disruption in our supply chain the impact 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 30, 2023, 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, July 31, 2024, and we assume no obligation to update them. With that, we will now turn the call over to FormFactor's CEO, Mike Slessor.

Speaker 2

Thanks everyone for joining us today. FormFactor's 2nd quarter revenue, non GAAP gross margin and non GAAP EPS all exceeded the midpoint of the outlook range we provided in May. The expected strength in our probe card business drove 2nd quarter results as we recorded sequential increases in all 3 probe card markets. DRAM probe card revenue reached record levels with revenue from high bandwidth memory or HBM doubling for the 3rd consecutive quarter to nearly 75% of our DRAM revenue. In the current Q3, we're experiencing steady overall demand for FormFactor's products as we continue to make progress towards our target financial model.

Speaker 2

Our 2nd quarter results and 3rd quarter outlook illustrate the unique value of FormFactor's diversification strategy, which differentiates us from our direct competitors with a broad lab to fab product portfolio across foundry and logic, DRAM and flash probe cards together with our system segment products. This portfolio enables us to compete for business across diverse demand pools at all major customers, producing relatively stable results during last year's downturn and the top line growth we're delivering this year. Our revenue growth is being driven by exposure to expanding areas like high bandwidth memory and DRAM probe cards and co packaged silicon photonics and systems, enabling form factor to grow even as we await refresh cycles in important high unit volume end markets that drive foundry and logic probe card spending like mobile handsets and client PCs. FormFactor's 3rd quarter outlook also demonstrates several unique features of probe card demand. As we often note, probe cards are consumable that's specific to each new chip design, meaning we benefit from both technology node transitions and from the release of new designs on existing nodes.

Speaker 2

Together with our broad market and customer exposure, this produces a more stable demand profile than the more volatile demand cycles that characterize capital equipment. This difference is particularly evident in the current environment as FormFactor stable 3rd quarter outlook contrast sharply with the sequentially weaker 3rd quarter outlooks offered by several companies in the test and assembly capital equipment sector. Turning now to market and segment level details. As I noted, we set a record for DRAM probe card revenue in the 2nd quarter, driven by the sequential doubling of high bandwidth memory revenue layered on top of steady DDR5 new design activity. To put HBM's torrid growth into perspective, in the first half of twenty twenty four alone, we doubled the HBM revenue we delivered in all of 2023.

Speaker 2

In addition, our 2nd quarter HBM revenue is greater than FormFactor's total quarterly DRAM revenue in each quarter of 2023. This activity is a direct result of the large hyperscaler investments in generative AI infrastructure and our customers corresponding ramps of HBM capacity and output. HBM, which is a stack of 8, 12 or even 16 individual DRAM die assembled with advanced packaging processes like through silicon vias and thermal compression bonding continues to offer a powerful example how advanced packaging is driving our current results. It also foreshadows our long term opportunity as we benefit from the increased test intensity and increased test complexity that is inherent in advanced packaging architecture. In the Q3, demand for DRAM probe cards continues to be robust and we expect a slight increase in revenue from the 2nd quarter record.

Speaker 2

We do however expect a shift in our DRAM product mix with sequential increase in DDR5 shipments and a reduction in HBM shipments. We mentioned in the past that our customers often have 1 to 2 quarter periods of digestion following a strong quarter of shipments. With lead times of less than a quarter, our short term visibility remains challenging as always, but given our customers continued strong investment in HBM capacity, we expect the 3rd quarter pause in HBM growth will represent a temporary digestion phase and the growth will resume in 1 to 2 quarters. Shifting to the foundry and logic probe card market, we delivered the expected 2nd quarter sequential growth driven by the seasonal ramp of new mobile application processor designs and stronger probe card demand for client PC and server microprocessor designs. In the current Q3, we expect foundry and logic demand and product mix to be similar to that achieved in the Q2.

Speaker 2

Advanced packaging processes like Foveros and COOS are being increasingly used to architect foundry and logic chip designs. As with HBM and DRAM, this disaggregation of a chip into subcomponent chiplets or tiles increases both test intensity and test complexity compared to an equivalent monolithic chip. The increase in test intensity is driven by the need for our customers to probe and test each component chiplet prior to stacking and then to probe and test the multi chiplet stack at various points during the assembly process. The resulting increase in probe card use per good die out is the same dynamic that is driving the strong probe card spending by our customers for HBM DRAM and is the source of relatively strong midyear founder and logic demand despite the lack of recovery and important end markets like mobile handsets and PCs. At the same time, the technical requirements for probe cards for foundry and logic designs built using advanced packaging processes are significantly more demanding than for standard unstacked products involving higher test speeds and more challenging thermal and power specifications.

Speaker 2

As we've seen with HBM and DRAM, our differentiated ability to meet these performance requirements will drive both market share and profitability gains as the adoption of advanced packaging and foundry and logic continues. In the systems segment, we expect a slight sequential increase in 3rd quarter revenue as customers continue to engage us to solve the most complex electro optical test and measurement challenges in areas like quantum computing and co packaged silicon photonics. In co packaged optics, which is poised to revolutionize chip to chip communication in the data center by significantly reducing power consumption at high data rates, we're collaborating with key customers in the early stages of the lab to fab transition from R and D to low volume production. In these collaborations, customers are deploying FormFactor's turnkey electro optical measurement systems built on our CM300 and Summit 200 engineering probers together with our proprietary Pharos optical probes. These highly differentiated optical probes enable either surface or edge coupling to the photonic die with unrivaled coupling efficiency, providing our customers with higher yields and shorter test times.

Speaker 2

As silicon photonics matures and moves to high volume production in the coming years, we expect that our leadership positions in combined electrical and optical test will provide a new growth vector for both our systems and probe card businesses. In closing, we're excited about both our strong second quarter results and our solid third quarter outlook as the accelerating adoption of advanced packaging drives increased demand across FormFactor's lab to fab product portfolio. Longer term, we're confident in the growth prospects for FormFactor in the industry overall, driven by the fundamental trends of semiconductor content growth and advanced packaging innovations like HBM, chiplets and co packaged silicon photonics. As is evident from our recent results and outlook, these are trends where FormFactor is well positioned. We're confident that our investments in R and D, capacity and talent will further enhance FormFactor's market leadership.

Speaker 2

This will enable us to achieve and then surpass 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, Q2 revenues were 100 and $97,500,000 $2,500,000 above the midpoint of our outlook range and non GAAP gross margin of 45.3 percent was 0.3 percentage points above the midpoint of the range. This together with OpEx slightly lower than the midpoint of the outlook resulted in a non GAAP EPS at the top end of the range. 2nd quarter revenues increased 17% sequentially from the Q1 and increased 26.7% year over year from our Q2, 2023 revenues. The upsize versus the midpoint of the outlook range was due to higher revenues in our probe card segment.

Speaker 3

Probe card segment revenues were $167,000,000 in the 2nd quarter, an increase of $30,000,000 or 22% from the Q1. The increase was driven mainly by higher foundry and logic and DRAM revenue. The systems segment revenues were $30,700,000 in Q2, a $1,300,000 decrease from the Q1 and comprised 15.5% of total company revenues, down from 19% in the Q1. Within the probe card segment, Q2 foundry and logic revenues were $104,000,000 a 19.5% increase from the 1st quarter. Foundry and Logic revenues increased to 52.5 percent of total company revenues compared to 51.4% in the 1st quarter.

Speaker 3

DRAM revenues were a record $58,000,000 in Q2, dollars 12,100,000 or 26.5 percent higher than in the Q1 and rose to 29.4 percent of total quarterly revenues as compared to 27.2% in the Q1. Within DRAM, HBM revenue almost doubled from $22,000,000 in Q1 to over $43,000,000 in the 2nd quarter. Flash revenues of $5,100,000 in Q2 were $1,100,000 higher than in the first quarter and were 2.6% of total revenues in Q2 as compared to 2.4% in Q1. GAAP gross margin for the Q2 was 44% as compared to 37.2% in Q1. Cost of revenues included 2 point $5,000,000 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.

Speaker 3

On a non GAAP basis, gross margin for the 2nd quarter was 45.3%, 6.6 percentage points higher than the 38.7 percent non GAAP gross margin in Q1 and 0.3 percentage points above the midpoint of our outlook range. The increases compared to Q1 was mostly the result of higher gross margins in the probe card segment. While we expect fluctuations quarter over quarter, mainly due to product mix changes, achieving this 45.3% gross margin in the 2nd quarter validates our progress towards our 47% target financial model non GAAP gross margin at annual revenue of $850,000,000 Our ProMed Card segment gross margin was 45.1% in the 2nd quarter, an increase of 8 percentage points compared to 37.2 percent in Q1. Our Q2 Systems segment gross margin was 46.2%, an increase of 0.9 percentage points compared to 45.3% gross margin in the 1st quarter. As compared to Q1, approximately 2 thirds of the increase in non GAAP gross margin is attributable to the higher volume and the remaining third relates to a more favorable product mix.

Speaker 3

Our GAAP operating expenses were $69,400,000 for the 2nd quarter as compared to $61,700,000 in the 1st quarter. Non GAAP operating expenses for the Q2 were $60,900,000 or 30.8 percent of revenues as compared with $52,300,000 or 31 percent of revenues in Q1. The $8,500,000 increase relates mainly to higher performance based compensation. Company non cash expenses for the Q2 included $10,200,000 for stock based compensation, $600,000 for the amortization of acquisition related intangibles and depreciation of $7,400,000 all similar to the Q1. GAAP operating income was $17,800,000 for Q2 compared with GAAP operating income of $21,300,000 in Q1.

Speaker 3

Non GAAP operating income for the 2nd quarter more than doubled to $28,500,000 compared with $13,000,000 in the Q1, an increase of $15,600,000 or 120 percent, demonstrating the leverage in our operating model. GAAP net income for the 2nd quarter was $19,400,000 or $0.25 per fully diluted share, compared with a GAAP net income of $21,800,000 or $0.28 per fully diluted share in the previous quarter. GAAP net income in Q1 included a gain of $20,000,000 from the divestiture of our Chinese subsidiaries. The non GAAP effective tax rate for the Q2 was 15.4%, 1.7 percentage points higher than the 13.7% in the Q1. And we continue to expect our annual non GAAP effective tax rate to be between 14% 18%.

Speaker 3

2nd quarter non GAAP net income almost doubled to $27,300,000 or $0.35 per fully diluted share compared to $14,300,000 or $0.18 per fully diluted share in Q1. Q2 EPS was $0.17 higher due to significantly higher revenues and higher gross margins with relatively flat OpEx as a percentage of revenue. Moving to the balance sheet and cash flow. We generated free cash flow of $14,200,000 in the 2nd quarter compared to $19,700,000 in Q1. The main reason for the decrease in free cash flows was increased working capital attributable to the revenue growth, partially offset by lower capital expenditure spending of $5,000,000 We invested $8,400,000 in capital expenditures during the Q2 compared to $13,400,000 in Q1.

Speaker 3

There is no change in our previously communicated expected CapEx range for 2024 of $35,000,000 to $45,000,000 At quarter end, total cash and investments were $366,000,000 an increase of $8,000,000 from Q1. At the end of the second quarter, we had one term loan remaining with a balance totaling $14,000,000 Regarding stock buyback, during the Q2 we used $2,900,000 to buy back shares under the $75,000,000 2 year buyback program that was approved in Q4 2023. At quarter end, dollars 53,500,000 remain available under that authorization. As a reminder, the main purpose of the share repurchase program is to offset dilution from stock based compensation. Turning to the Q3 non GAAP outlook.

Speaker 3

We expect Q3 revenue of $200,000,000 plus or minus $5,000,000 with a slight increase over Q2 coming from DRAM and systems. Within DRAM, we also expect a mix shift with a higher percentage of BBR5 versus HBM revenue. 3rd quarter non GAAP gross margin is expected to be 43% plus or minus 150 basis points. The expected decrease in non GAAP gross margins in the 3rd quarter at the midpoint of the outlook range on slightly higher revenues relates to a less favorable product mix with DRAM revenues as a percentage of total revenues expected to increase and HBM revenue within DRAM is expected to decrease. At the midpoint of these outlook ranges, we expect Q3 operating expenses to be $61,000,000 plus or minus $2,000,000 similar to Q2.

Speaker 3

Non GAAP earnings per fully diluted share for Q3 is expected to be $0.31 plus or minus 0 point 4 dollars A reconciliation of our GAAP to non GAAP Q3 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. Operator?

Operator

Our first question comes from the line of Craig Ellis of B. Riley Securities.

Speaker 4

Thanks for taking the question and congratulations on the execution guys. Mike, I wanted to start just by following up on a point you made with regard to high bandwidth memory. I think you indicated the company expected that after some digestion in the Q3 growth could reaccelerate there. I was hoping you could just share some of the either customer interaction or things that you're seeing that lend confidence to the reacceleration and any color on timing would be helpful. Thank you.

Speaker 2

Yes. So Craig, good question. Just to level set everybody, we again in the second quarter doubled HBM revenue to 75 percent of our DRAM revenue. So a really significant contribution from that. As I think most of you know, pretty concentrated with a single customer, although each of the 3 major DRAM manufacturers do have contributions in there.

Speaker 2

And it's not unusual when we ship at that scale for a customer to have a period of digestion where they then use the probe cards for a quarter or 2. You can see this historically through our major customers as they're in their cadence quarter to quarter that we report for 10% customers. So what gives us confidence that this is that digestion? I think a couple of things. If I look at it from a macro level, continued hyperscaler investment in generative AI, which in turn is driving our output of HBM III and III currently and beginning to do development on HBM IV and pilot production.

Speaker 2

And really in conversations with those customers, there's no pause in that. They really are continuing to invest very heavily in this pretty lucrative part of the DRAM market, again driven by hyperscaler investments. Our direct visibility as most of you know is pretty limited. We operate with lead times of less than a quarter. And so in terms of POs and backlog, we can't see much past the end of Q3 here.

Speaker 2

But when we look at the conversations we're having with these customers, when we look at the investments the hyperscalers are making, it does seem like it's pretty reasonable to attribute this Q3 pause still HBM still at pretty healthy levels to a digestion period.

Speaker 4

That's really helpful, Mike. Thanks. And then the follow-up question is somewhat similar. 3 months ago, you noted that, that a foundry logic customer, formerly the largest customer before this last quarter where it's now DRAM, would at times in the past go through a period of digestion after a really strong quarter. Are you seeing signs and is it baked in the guidance that we will see that digestion in the Q3 or how are you thinking about the risk that that could happen at this point?

Speaker 2

Yes, as Foundry and Logic overall, we see in the 3rd quarter pretty comparable to the second quarter, both from overall levels and customer and product mix. And I think this is really another proof point associated with how advanced packaging is driving our business. You see major customers certainly in compute, but also to some extent in mobile beginning to adopt advanced packaging, in fact more beginning to adopt advanced packaging. And we see that with across the compute sector. Technologies like Foveros and COOS, even as the PC market remains PC end market remains somewhat muted, We're seeing pretty solid demand for probe cards because of the increase in test intensity and complexity driven by advanced packaging in these sectors.

Speaker 2

So 3rd quarter pretty similar to 2nd quarter in foundry and logic from an overall customer and product mix perspective, again driven by advanced packaging.

Speaker 4

That's really helpful. And then just the observation on that Mike would be since those heterogeneous dye based products are such a small part of mix now, but over time become a majority of mix that would seem to be a real nice long term secular tailwind for the business?

Speaker 2

Yes. I think across the industry, it's a really interesting and compelling secular opportunity for those of us exposed to advanced packaging.

Speaker 4

Thanks, Mike. Good luck in 3Q.

Speaker 2

Thanks, Craig.

Operator

Thank you. Our next question comes from the line of Charles Shi of Needham and Company.

Speaker 5

Hi, Mike, good afternoon. Thanks for letting me ask two questions. The first one, it's about DDR5 versus HBM. I think prior to this quarter, the way you characterized the DRAM probe card market was if you back out HBM, the standard DRAM or DDR probe card, we're still run rating around that, I would say, dollars 20,000,000 ish, the downturn level basically. Looks like next quarter, the September quarter, you're expecting a somewhat similar DRAM total revenue, but since you talked about mix shift away from HBM, more to DDR5, would you characterize maybe this is the beginning of the standard DRAM recovery or this is maybe just one off quarter?

Speaker 5

I just want to know the sustainability of the DDR5 probe card growth from here.

Speaker 2

Yes. It's an interesting question. As you might imagine, we're having similar discussions internally and with our customers. I think if you look at the overall, non HBM DRAM market, we're characterizing it as DDR5, but that's a pretty broad brush that's low power server and compute. It is seeing a significant step up here in the Q3 to levels that are comparable to the previous cyclical highs.

Speaker 2

Now when we see where HBM is, we said there's a bit of a 1 quarter digestion period and that's not unusual. Remember probe cards are specific to each customer chip design. And so as customers move their wafer starts in back and forth between technologies and different products for them to optimize their output for their market, we can see these pretty significant swing between designs and market submarkets and submarkets. Whether this is the start of a DRAM upturn, I think is still to be seen, but it is encouraging if you've seen DRAM spot pricing, if you've heard the narrative from our customers on the overall DRAM market improving, it certainly may be the beginning of an upturn. For now, we just don't have the visibility to say so, whether it is or not, but nice to be again operating our DRAM business, a very important business for us up at record levels.

Speaker 5

Thanks, Mike. I want to have a follow-up on the foundrylogic side of the business. It's up in Q2. It was up foundrylogic was up in Q2 by quite a lot, but your largest microprocessor customers, the revenue you do disclose on quarterly basis didn't really go up, I mean, as much. I mean, it doesn't explain all the incremental, you're seeing in the foundry logic side.

Speaker 5

And so this kind of a mid year strength, mind if you clarify a little bit of what's driving that outside of this microprocessor company? And more importantly, going into next quarter, who is driving that incremental growth in the foundry logic probe card?

Speaker 2

Yes. We often see this mid year strength in mobile application processors. If you look at phone release cadences and work back to the timing where customers are going to need probe cards for this, that's exactly what we're seeing right now. And we talked about it on the last call with the anticipated second quarter strength, which materialized being associated both with microprocessors, but also mid year releases of these mobile application processors. That's a theme that we see carrying through the Q2.

Speaker 2

Again, we see Foundry and Logic having a similar level and profile in the Q3 as in the Q2. And so beyond that, again, visibility pretty limited, but we're pretty happy with how we're executing in the broader foundry and logic market. Always some improvements, always some share to gain, but that's both of those factors driving our foundry and logic strength in the middle part of the year.

Speaker 5

Maybe a quick follow-up to that. Do you see a little bit of a mix shift in foundrylogic probe card from Q2 to Q3? Thanks.

Speaker 2

No, it's very similar, Charles.

Speaker 3

Thank you.

Operator

Thank you. Our next question comes from the line of Tom Diffely of D. A. Davidson.

Speaker 6

Yes, good afternoon. Thank you. Mike, I was curious when you look at the high bandwidth memory ramp that you've had this year, how much of that was driven by just increasing volumes of high bandwidth memory versus a design change? And then if there is a big shift to the next generation design, what does that do to your business?

Speaker 2

Yes. As we've said, probe cards are a design specific consumable. And so there's these two pieces. There's the release of a new design, but there's also the number of wafer starts and number of test cells and therefore probe cards that need to run on this design. I'd characterize the growth in the Q2 of the HBM business being concentrated across, let's call it in round numbers, 10 designs that are really the high runners driving the growth.

Speaker 2

And so that could be one chip. Remember HBM, a stack of mostly 8 high DRAM, but there's a base die, there's test insertions for the 8 core die, and then there's also a test insertion when the customer is done stacking. Each of those 3 sets of probe cards is a unique fleet of probe cards. And so that's part of the test intensity increase associated with HBM in particular and advanced packaging in general. But more than a handful of designs really driving the strength.

Speaker 6

And then when you look at the business next year in 'twenty five, do you think it's pretty well split between the 3 main suppliers? Are you still going to be very leveraged to one of the players?

Speaker 2

No, I think as I said, we currently see contributions from all 3 manufacturers, although we're over indexed to the leader in HBM market share. A fundamental tenet of our strategy is to make sure that we're a key supplier at the leading edge to all major customers. And so qualification work is ongoing at both of them. We're in a position to compete for that business. As HBM III and HBM IV come out, those are opportunities for our customer share to share and for us to go compete for new business as well.

Speaker 2

Great.

Speaker 6

And then final question, Shay, when you look at the margin guidance for the next quarter, is it simply the decrease of high bandwidth memory as a percentage of product mix issue?

Speaker 3

Well, it's a combination of DRAM revenue overall as a higher percentage of revenue. And within DRAM the shift from HBM to DDR5. So it's both of them.

Speaker 5

Okay, great. Thank you.

Speaker 3

Thank you, Tom.

Operator

Thank you. Our next question comes from the line of Christian Schwab of Craig Hallum.

Speaker 7

Great. Thanks for taking my questions. So just again on high bandwidth memory, we can kind of back into the math, pretty modest revenue from the other 2 big guys. As we get into 2025, do you think you have 3 meaningful customers in that space? Or do you think that there's the potential for as the other 2 guys get up to speed that they begin to take share?

Speaker 7

I'm just trying to size what your expectations in 2025 and 26 are for high bandwidth memory as the other 2 guys come to market and have talked about being sold out for next year?

Speaker 2

Yes. Well, remember, if we back out a little bit, we're a key supplier to all 3 major DRAM manufacturers DDR4, DDR5 and we hope to be for HBM as well. Currently, one of them owns the lion's share of HBM shipments. And so that's why we're over indexed to that customer. But again, as Tom asked, we do expect as they as the other 2 DRAM manufacturers gain share in the transition from HBM III to HBM IV, work their way through some pretty significant technical and yield challenges in ramping this up.

Speaker 2

We do expect that share to balance out a little bit. So as we look into 2025, the transition to HBM4, certainly exciting for us. It raises the speed requirements for the probe card. So again, a notch up in complexity. And as customers go to stacking 12 and even 16 high die, that obviously is going to increase the overall test intensity 3 DRAM manufacturers.

Speaker 2

And the follow-up to that, 3 DRAM manufacturers.

Speaker 7

And the follow-up to that on the high bandwidth memory 4 transition, given as you said the speed and then increased stacking capabilities, I would assume that there should be some pricing power on those probe cards, not all the way obviously to foundry and logic levels, but potentially higher than where we sit today. Is that fair?

Speaker 2

Yes, that's fair. And one of the reasons, right, we touched on it in a question a couple of minutes ago, but the mix shift away from HBM towards DDR5 inside DRAM at these high levels certainly is a gross margin headwind. And so you can connect the dots there. Our ability to build probe cards that are highly differentiated and provide a lot of value to our customers in testing at speed and across multiple temperatures in a very complex mechanical situation. You're testing a whole 300 millimeter wafer of the stack dye across a temperature range of over 100 degrees Celsius.

Speaker 2

And you can imagine the thermal scaling challenges associated with that are significant. And that's why an HBM probe card is worth more.

Speaker 7

Great. And then my second question, now we've got 2 quarters, call it, at roughly $200,000,000 which is kind of the target model. Do you guys set expectations when you plan on updating your target model?

Speaker 3

Sure. I'll take this one, Christian. So we are at 2 quarters at €200,000,000 but the target model is a little higher than that, right? If you take the €850,000,000 it's about 210, 212. So what we want to do is what we have done in the past.

Speaker 3

Once we have a quarter or 2 at this model run rate, and I agree we're getting closer to it, but we're not there yet, then we'll set up a date, schedule a new Analyst Day and then work on publishing the new target model. So we're not there yet, but stay tuned.

Speaker 7

All right. Sounds great. Thank you, guys. Thanks.

Speaker 3

Thank you, Christian.

Operator

Thank you. Our next question comes from the line of Brian Chin of Stifel.

Speaker 8

Hi, thanks for letting us ask a few questions. Mike or Shai, did you comment whether you expect sort of that the mix shift you're seeing in the DRAM business to persist into Q4? I guess that's kind of the first question because maybe it's like 150 to 200 basis point headwind or something relative to what it was in 2Q. And so that's I guess the first question.

Speaker 2

Yes, Brian. It's Mike. I'll take that. I think in terms of timing, I'll again caveat this with our visibility, our direct visibility doesn't really go much past the end of 3Q here. We're operating with short lead times.

Speaker 2

We certainly have forecast from our customers, but the dramatic shift in DRAM towards production capacity for DDR5 is something that's a relatively dynamic situation. Whether it persists or not is something that probably we need a few more weeks or months to really get a read on from our direct backlog. Having said that, if you do look at the underlying DRAM market, DDR4 and DDR5, low power server and PC, they do seem to be strengthening. And so it wouldn't be all that surprising if there was a shift of some capacity towards those markets and we saw a bit growth in the non HBM parts of the market. A little bit early to tell, and again, our visibility doesn't go that far into the future.

Speaker 2

But some of the fundamental factors are in place for a DRAM recovery,

Speaker 4

a general DRAM recovery.

Speaker 8

Got it. Yes, I was even thinking Samsung seemed pretty confident last night that their HBM 3 shipments, they aren't the dominant player, but they would accelerate substantially in the back half the year. So maybe it's not 3Q, but I imagine that could factor in your outlook for HBM at some point in the second half.

Speaker 2

That's right.

Speaker 8

Okay. And I don't know if anyone asked, but in terms of the I missed this part, but the China increase Q on Q, was that mainly just multinational? Any kind of additional color on what drove that?

Speaker 2

Yes. No, that wasn't asked, so a good topic to touch on. Reminder, so in Q2, a little over 10%, China as a percentage of revenue. And inside the Q3 outlook, we are forecasting a moderate increase, but it will still be in the teens, nowhere near the 40% to 50%, some of the WFE suppliers have for China concentration. Remember, we've been pretty proactive in managing this situation.

Speaker 2

We divested our China operations and then formed an exclusive distributor ship with the purchaser of that business. And we're opportunistically serving the domestic China business as best we can in the face of some pretty significant geopolitical headwinds, both from direct export controls and the China industry semiconductor response to stand up its own domestic semiconductor industry. So we see a moderate increase. I don't see it as a theme where we're going to get significant contribution from the China business again because of these almost structural geopolitical headwinds.

Speaker 8

Great. And may just kind of get real off topic here for one last question. Energy efficiency usage bandwidth, these are obviously key themes in data center. Understanding that silicon photonics is an area the company has invested in, where are we on the adoption curve for co packaged optics and how significant of a market opportunity could that be in maybe a couple of years?

Speaker 2

Yes. We are very, very early. As I said, just inching out of the lab where we've been engaged with customers for years in co developing the fundamental measurement technologies like our Pharos optical probe that allows customers faster test times and better overall yield because of its better signal to noise and coupling efficiency. But we've got a handful of tools inside production sites that are in the very early stages of pilot production. As you note though, this is one of the ways to help solve, it's not going to entirely solve, but it helps solve a pretty significant problem associated with data centers and that's energy conception.

Speaker 2

Going to silicon photonics on chip to chip communication in the data center has the potential to impact the usage, energy budgets for these data centers. And that's something the broader compute industry is going to have to confront as data centers become bigger and bigger users of electricity worldwide. So we view silicon photonics as something that's a when, not an if. I think the timing probably at the earliest, late 2025 into 2026, where we start to see moving into the near the curve of adoption and running significant volumes inside the foundries worldwide.

Speaker 8

Okay. Thanks Mike.

Operator

Thank you. Our next question comes from the line of Robert Mertens of TD Cowen.

Speaker 9

Hi, this is Rob Mertens on for Chris. Thanks for taking my questions. You mentioned the better than expected gross margins in the probe card business largely due to higher volumes and maybe around 200 basis points or so attributed to the mix. Was the positive mix largely the high bandwidth memory increase or more of a general mix throughout both the foundry logic and memory end markets?

Speaker 3

So if you refer to Q2, we were light on spot, right? So gross margin was 45.3% versus midpoint of the outlook of 45%. So I'm not sure what miss you referred to.

Speaker 9

Sorry, just in terms of the gross margins, I thought I heard 2 thirds driven by volumes and the third driven by mix.

Speaker 3

Yes, that's the increase from Q1. So Q1 gross margin, if you recall, was in the high 30s, 38.7%. So the increase from Q1 to Q2 from the 38.7% to 45.3 and 2 thirds of it relates to volume and about a third to mix. And that change in mix is more HBM, more foundry and logic, Q2 and Q1. Okay.

Speaker 3

And then

Speaker 9

could you just provide a little more color on the progress with qualifications of MEM based probe cards for GPU tests and maybe what the size of the market opportunity could look like?

Speaker 2

Yes, I think sizing it is interesting. Maybe to get everybody on the same page, as the largest GPU manufacturer transitions to advanced packaging, primarily COOS at the world's largest foundry, that requires MEMS probe cards, right. The legacy probe cards they use for monolithic GPUs no longer work. And so, we are in a qualification process there. I'd say our major competitor is has been ahead of us and has got the initial business kind of what we've been more focused on HBM and that opportunity.

Speaker 2

But it's a strategic imperative us for to qualify there here in 2024 and make some progress. I do think, again relatively difficult to size the opportunity. But as you heard from some of the memory manufacturers, there's an interesting asymmetry associated with some of these AI products where the amount of memory in the package is almost 10 times that of the GPUs. And so for unit driven businesses like ours, HBM becomes a much more compelling opportunity. That's not to diminish the importance of qualifying during this important transition of GPUs to meeting MEMS based technologies for probe, but we like obviously the exposure to HBM as well.

Speaker 9

Got it. Thank you.

Speaker 3

Yes.

Operator

Thank you. I would now like to turn the conference back to Mike Slessor for closing remarks. Sir?

Speaker 2

All right. Thanks everybody for joining us today. We've got a couple of conferences in late August early September that we hope to see you at. Until then, take care.

Operator

This concludes today's conference call. Thank you for participating. You may now disconnect. Thank you, Latif. We will see you on our next

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Earnings Conference Call
FormFactor Q2 2024
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