FORM - NASDAQ

Thank you. And welcome everyone to FormFactor’s Third Quarter 2023 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.

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 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 Web site. 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 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-19 pandemic; anticipated industry trends; potential disruptions in our supply chain; the impact of regulatory changes including the recent US-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 and 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 for the fiscal year ended December 31, 2022 and in our other SEC filings, which are available on the SEC’s Web site at www.sec.gov and in our press release issued today. Forward-looking statements are made as of today November 1, 2023, and we assume no obligations to update them. With that, we will now turn the call over to FormFactor’s CEO, Mike Slessor.

Thanks everyone for joining us for FormFactor's third quarter earnings call. Stronger than anticipated demand for Foundry and Logic probe cards, coupled with record revenue in our systems business, produced third quarter revenue near the high end of our outlook range. This, together with higher than expected gross margin and leverage on our operating expenses, produce non-GAAP earnings per share above the top end of our outlook range. We continue to operate in an overall demand environment that remains relatively stable at the levels we've experienced throughout 2023. The moderate sequential decrease in our fourth quarter revenue outlook range is due to the reduction in system segment revenue from the sale of FRT to Camtek, which we completed today and weaker foundry and logic probe card demand due to a short term reduction in customer spending, partially offset by stronger DRAM probe card demand. While we continue to operate in a cyclical downturn and see no near term acceleration of demand, we're encouraged by broader signs of bottoming in our most important high unit volume end markets like client PC and mobile. In this environment, we continue to carefully balance short term results and long term investments with disciplined cost control that prioritizes quarterly profitability and sustains our strong balance sheet. We're maintaining our investment in R&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- packaged optics. As you'll hear from Shai, we've completed the majority of the long lead time facilities and equipment capacity increases required to reach our target financial model and have slowed our CapEx to ensure a better balance between our capacity and anticipated long term demand. Turning now to segment level details. Foundry and logic probe cards, our largest business, delivered higher than expected sequential growth in the third quarter as key customers ramped several major designs more aggressively than originally forecast. This inter-quarter acceleration provides insight into FormFactor's demand profile. Because probe cards are a device specific consumable customized for each individual chip design, increased wafer starts for a specific chip design can drive incremental demand for the corresponding probe cards. Since our lead times are less than a quarter and demand is correlated to the specific mix of customers dynamic wafer start plans for their new chip designs, we can experience inter-quarter changes in demand as we did in the third quarter. In the foundry space, we experienced strong third quarter demand for probe cards testing two major high performance compute designs. In these HPC applications, FormFactor’s differentiated vertical MIMS probe card products meet demanding power and speed requirements with best in class, test sell, uptime and productivity, delivering significant value to our customers. We do expect a smaller contribution from foundry probe cards in the current quarter as our strong third quarter shipments are utilized to ramp fourth quarter foundry wafer production volume. In the microprocessor space, we delivered on higher demand for probe cards testing a major tile based client PC design. Like the high performance compute foundry example I just shared, probe card demand for this design accelerated within the third quarter as our customer expanded their wafer start plans to meet increased end customer demand. This client PC microprocessor is assembled from multiple tiles or chiplets into a single die using leading edge advanced packaging processes. This is a great example of how advanced packaging is driving FormFactor’s business. As we've noted in the past, advanced packaging integration schemes drive both higher test intensity, which expands the number of probe cards required per good die out and higher test complexity, which raises the performance for each probe card. Probe card architectures like FormFactor’s MEMS technology are essential to meeting these challenging performance requirements on short lead times at a compelling cost of ownership. In memory as expected, we experienced stable overall demand for DRAM probe cards while flash remained weak. As in the second quarter, DRAM was driven by DDR 5 as well as third generation high bandwidth memory designs, which are enabling the rapid growth in generative artificial intelligence and we expect a similar HBM rich DRAM revenue profile in the current fourth quarter. The positive impact of high bandwidth memory is evident in the product mix profile at one of our largest DRAM customers where probe cards for testing HBM comprise more than half our revenue to that customer in the third quarter. As in the tile based microprocessor example I discussed earlier, the need for sophisticated probe cards to test HBM illustrates how advanced packaging is driving FormFactor’s results. As a reminder, 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 tests are significantly more advanced than for standard unstacked DRAM products, involving higher test feeds and more challenging thermal scaling specifications. FormFactor's MEMS based SmartMatrix probe card architecture meets these advanced requirements, providing significant value to our customers and differentiation for FormFactor. 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 now to systems. As anticipated, our systems business delivered record revenue in the third quarter as we shipped systems that were pushed out of the second quarter. This business continues to be driven by strong demand for our market leading test and measurement products for early development of applications like copackaged silicon photonics, quantum computing, and advanced packaging metrology. Copackaged optics enabled by silicon photonics remains an important and exciting driver for FormFactor's current and future business. We're engaged with major customers in the transition of silicon photonics from early R&D to low volume production. And in the fourth quarter, we plan to ship a CM300 silicon photonics system to a leading foundry to support low volume production. As silicon photonics production volumes increase over the next several years, our product roadmap 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. Moving forward, we do expect a short and medium term reduction in system segment revenues from the third quarter's record levels due to the sale of our FRT metrology business. We grew FRT substantially following our 2019 acquisition of the business, and I want to thank all of the FormFactor team worldwide for the contributions to this growth and value creation. Operationally, the transaction enables the FRT team to leverage Camtek's established scale and expertise in inspection in metrology to deliver the next stage of growth. Financially, the transaction maximizes FormFactor shareholder value by realizing a robust return on our investment, while also allowing us to focus our resources on strategic initiatives and businesses where we have market leadership and significant scale in enabling advanced packaging like the tile based microprocessor and copackaged optics examples I shared earlier. Shai will update you with more details later, but our capital allocation priorities of focused reinvestment in R&D and capacity together with M&A and share repurchases to offset dilution are unchanged. M&A remains one of the primary pillars of FormFactor's growth, and we continue to evaluate a broad funnel of targets that add complementary technologies and expand our served addressable markets. In closing, we continue to operate efficiently in what we see as a relatively stable near term demand environment across our diversified product and technology portfolio. Longer term, we remain excited and confident in the growth prospects for FormFactor and the industry overall, driven by the fundamental trends of semiconductor content growth and exciting innovations like chiplets, high bandwidth memory and copackaged silicon photonics. These are trends where FormFactor is well positioned as an industry and technology leader, and we're confident that our investments in R&D and capacity position FormFactor 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 million of revenue. Shai, over to you.

Thank you, Mike, and good afternoon. As you saw in our press release and as Mike mentioned, Q3 revenues were near the high end of our outlook range and non-GAAP gross margin and non-GAAP EPS were above the high end of the range. Third quarter revenues were $171.6 million, a 10% sequential increase and a year-over-year decrease of 5.1%. Q3 revenues were $0.4 million below the high end of our outlook range and benefited from strong revenues in both probe cards and system segment revenue. Probe card segment revenues were $128.3 million in the third quarter, an increase of $13 million or 11.3% from Q2. The increase was driven by higher foundry and logic and flash revenues, partially offset by a decrease in DRAM revenues. System segment revenues were a record $43.2 million in Q3, a $2.6 million increase from the second quarter and comprised 25.2% of total company revenues, down slightly from 26% in Q2. Within the probe card segment, Q3 foundry and logic revenues were $96.4 million, a 17.7% increase from Q2. Foundry and logic revenues increased to 56.2% of total company revenues compared to 52.5% in the second quarter. DRAM revenues were $27.4 million in Q3, a $3.1 million decrease or 10.2% lower than in the second quarter and decreased to 16% of total quarterly revenues as compared to 19.6% in the second quarter. Flash revenues of $4.5 million in Q3 were $1.6 million higher than in the second quarter and were 2.6% of total revenues in Q3 as compared to 1.9% in Q2. GAAP gross margin for the third quarter was 40.4% as compared to 38.7% in Q2. Cost of revenues included $2.5 million of GAAP to non-GAAP reconciling items, which we outlined in our press release issue today and in a reconciliation table available in the investor relations section of our Web site. On a non-GAAP basis, gross margin for the third quarter was 41.8%, 1.2 percentage points higher than the 40.6% of non-GAAP gross margin in Q2 and 0.3 percentage points above the high end of our outlook range. The increase as compared to Q2 and the upside versus our outlook range were a result of higher probe card segment gross margin. Our probe card segment gross margin was 38.5% in the third quarter, an increase of 2 percentage points compared to 36.5% in Q2. The increase from Q2 is due to the net effect of three main factors. First, higher revenues contributed at 2.1 percentage points increase. Second, improved factory utilization at higher production levels contributed to a 0.3 percentage points increase. Partially offsetting these two positive factors was 0.3 percentage points related to a slightly less favorable product mix. Our Q3 system segment gross margin was 51.8%, basically flat with a 52% gross margin in the second quarter. Our GAAP operating expenses were $66.6 million for the third quarter as compared to $61.6 million in the second quarter. The two main reasons for the increase were $1.8 million higher stock based compensation related to timing of grants and a higher grant date share value and transaction expenses of $2.1 million related to the sale of the FRT business. As previously disclosed, we entered into a definitive agreement during the quarter to sell FRT to Camtek for $100 million in cash, subject to customer repurchase price adjustments. The transaction closed today and the outlook and the results of operations for Q4 will include FRT for the month of October. Net proceeds from the transaction after adjustments, expenses and taxes, are expected to be approximately $95 million. Non-GAAP operating expenses for the third quarter were $54.5 million as compared with $52.1 million in Q2, declining to 31.8% of revenues from 33.4% in the prior quarter. The $2.4 million increase relates mainly to higher performance based compensation. Company noncash expenses for the third quarter included $10.8 million for stock based compensation, $1.6 million higher than in the second quarter, as I said earlier, $1.3 million for the amortization of acquisition related intangibles, which was $1.1 million lower than in Q2 due to certain intangible assets reaching full amortization, and depreciation of $7.8 million similar to the second quarter. GAAP operating income was $2.7 million for Q3 compared with GAAP operating loss of $1.3 million in Q2. Non-GAAP operating income for the third quarter was $17.3 million compared with $11.2 million in the second quarter, an increase of $6.1 million or 55%. GAAP net income for the third quarter was $4.4 million or $0.06 per fully diluted share compared with a GAAP net income of $0.8 million or $0.01 per fully diluted share in the previous quarter. The non-GAAP effective tax rate for the third quarter was 12.2%, 200 basis points lower than the 14.2% in the second quarter, mainly due to discrete items arising from normal differences between estimated and actual US taxes. We continue to expect our annual non-GAAP effective tax rate to be between 13% and 17%. Third quarter non-GAAP net income was $17.3 million or $0.22 per fully diluted share compared to $11.2 million or $0.14 per fully diluted share in Q2. Moving to the balance sheet and cash flows. We generated free cash flow of $16.9 million in the third quarter compared to $2.1 million in Q2. The main reason for the increase in free cash flow was a decrease of $14.6 million in capital expenditures. We invested $5.9 million in capital expenditures during the third quarter compared to $20.5 million in Q2. The decrease in CapEx in Q3 is partially due to timing of payments but it is also aligned with our intent to slow down capacity expansions to ensure capacity does not significantly outpace demand as we have completed the majority of the long lead time facilities and equipment investments required to reach our target financial model. There's no change in our previously communicated expected CapEx range for 2023 of $55 million to $65 million. Overall, at quarter end, total cash and investments were $249.4 million, an increase of $9 million from Q2. As of the end of the third quarter, we had one term loan outstanding with a balance of $15 million. Regarding stock buyback during the third quarter, we did not purchase shares under our $75 million two year buyback program approved in Q2 2022. On October 30, our Board of Directors approved a new two year $75 million share repurchase program, which is in addition to the $18.6 million that remains available under the existing authorization. As a reminder, the main purpose of these share repurchase programs is to offset dilution from stock based compensation. Turning to the fourth quarter non-GAAP outlook. We expect Q4 revenues of $165 million plus or minus $5 million. At the midpoint of this outlook range, Q4 revenues is expected to be approximately $7 million lower than in Q3 with half of the decrease related to the sale of FRT metrology business at the end of October. We also expect lower foundry and logic revenues in the fourth quarter, partially offset by an increase in DRAM revenues. Fourth quarter non-GAAP gross margin is expected to be 41% plus or minus 150 basis points. At the midpoint of these outlook ranges, we expect Q4 operating expenses to be $51 million plus or minus $1 million. Non-GAAP earnings per fully diluted share for Q4 is expected to be $0.20 plus or minus $0.04. A reconciliation of our GAAP to non-GAAP Q4 outlook is available on the investor relations section of our Web site and in our press release issued today. With that, let's open the call for questions. Operator?

[Operator Instructions] Our first question comes from the line of Krish Sankar from TD Cowen.

Mike or Shai, the first question is you said that December quarter has more DRAM in the mix but you also said it's more HBM. I was under the impression that HBM probe cards gross margins are pretty strong. So I'm just wondering, wouldn't that help overall gross margin or is it still below foundry and logic?

It's true that in general, HBM gross margin or HBA DRAM gross margin is higher than the other DRAM designs or on the higher end of that range but it's still, in general, lower or could be lower than the foundry and logic gross margin, and we do expect lower foundry and logic revenue in Q4 and we expect systems to be flat. So if you take all of this together, that's why -- and some lower overall revenue level, that's why the outlook range for Q4 gross margin is 41%, slightly below the 41.7% we accomplished in Q2.

And then a quick question for Mike. In the September quarter, you said foundry and logic was strong. Is it fair to assume there's more logic or NPU BIOS? I'm kind of curious with the largest foundry, what is your market share today, and is there a potential to increase market share as we get some of the AI applications?

I think in the September quarter, we highlighted two pieces in the foundry and logic business. Certainly, the ramping of a chiplet based or tile based client microprocessor was a key highlight adding to the strength. But we also commented on some high performance compute designs in the foundry space that drove some strong results. As we look at our market share across the industry, whether it be in foundry, foundry and logic, RF, memory, one of the key strategic pillars of the company is market leadership. And I think in the foundry and logic market, there is some opportunity to gain some share based on the investments we're making and the very strong customer relationships we have with those key customers.

Mike, is there a way to quantify that market share number or…

Yes, I think it moves around quarter-to-quarter. Again, because probe cards are design specific consumables, a key design win in any quarter can move it around. I would say for most major customers they have us and our primary competitor in foundry and logic in about a 60-40 window. They need to have two suppliers for supply chain continuity, a lesson that was hard learned through the pandemic and beyond. And so I think we're competing in this window. And I think in most of the major customers, there are a couple of exceptions that offer upside opportunity for us, and most of these customers were in that window. I think the Q3 performance because of these two designs was pretty strong based on the data we currently have.

And our next question comes from the line of Brian Chin from Stifel.

Mike, maybe first, just thinking about the fourth quarter guidance, and in terms of the order activity that you might normally see on the foundry logic side of the business versus kind of what's implied in the guidance. Is the breadth of the design activity pretty normal at this stage but maybe the release of volume against these designs still leaving something to be desired, is that a fair way to characterize?

Yes, you've hit it on the head, Brian and this has been a theme throughout 2023. Our design teams and design is a very important and kind of a unique part of the probe card business, because we are customizing our architectures to each individual customer chip design. Those design teams continue to be fully utilized. Where we're seeing that not translate into the peak revenues that we did, say, back in the first half of 2022, is except for a couple of counter examples like HBM and the client based microprocessor, the tile based client microprocessor, customers by enlarge are -- the reorder volumes of these new designs is somewhat less than it would be in a cyclical [indiscernible]. And I think that behavior is pretty easy to understand as inventories are still pretty elevated throughout various parts of the industry. And so customers, they want to innovate. Yes, they want to drive their new designs out, but they also want to minimize the obsolescence costs of driving them into a channel that still has pretty high inventory levels.

And then I guess kind of related, but when you think about augmenting that kind of environment for however long it sort of persists until things get better. HBM and AI related revenue opportunities are certainly larger than you probably thought a couple of years ago when you set that $850 million revenue target. And so when you look at sort of [co-ops] package and the individual HBM and GPU components under test there, do you have a sense of what the size of that served addressable market is for advanced probe cards now and what it could look like in two or three years?

I think I'll get to that in a second. But I think it's an important element of the different puts and takes, the reference, our target model or anybody's target model, we're still committed to the $850 million target model. But you can imagine that when we put that in place, there was pretty open trade with China for US suppliers. But on the other hand, we didn't have AI and high bandwidth memory and GPUs as front and center as we do now. So we're always going to have puts and takes on the way to a target financial model. Specifically with HBM and AI, for us, and I think most other equipment and consumable supplier in the industry, although the GPUs kind of get all the glory, HBM drives a tremendous increase in overall wafer volume. Again, because you're stacking individual DRAM die, each of those comes from its own wafer. But also just the memory, you look at the silicon area associated with the memory, it's much larger than the GPUs. So HBM looks like, as I said, for this quarter, the current -- just completed third quarter, was more than half our DRAM probe card revenue at one of our largest DRAM customers, that's a contribution that we hadn't contemplated. And if you look at industry forecasts, there's still quite a bit of bullishness associated with HBM and AI in general. Maybe we can get to it in a follow-up but we're working pretty hard on penetrating the GPU market as well.

[Operator Instructions] And our next question comes from the line of Dr. Charles Shi from Needham & Company.

I just want to ask about the Q4 in terms of the seasonality. I think, Mike, if I really just add back or that FRT revenue for Q4 or maybe back to FRT revenue from Q3, looks like Q3 -- Q4 seems to be a little bit below seasonality and I think you might have touched upon this in your answers to the previous questions. But I really just want to get your thoughts on why things are still a little bit below seasonality into Q4, is it a more because of a lower than -- I mean, lower [indiscernible] spending on the PC side or the smartphone side? Any additional color would be great.

So Charles, I think as we've talked about in the past, seasonality has become a little bit elusive in this business, and I think that's true here in 2023 as well. If you look at the way Shai parsed the bridge from Q3 to Q4 for you, FRT at the midpoint of our guide, the absence of FRT is about half of that $7 million delta. We're then seeing weaker foundry and logic demand, which we believe is short term, really, given the outsized contribution from foundry and logic in Q3 from a set of major designs there's a bit of digestion going on of our customers as they use those probe cards for these major designs and major products. Offsetting that some is some incremental strength in DRAM which, as we highlighted, really is driven by HBM and some DDR5. But those are the different pieces to it. Again, calendar seasonality, although there are components to it, something like the strength in HBM is superimposing what might be the -- superimposed on top of what might be the regular calendar seasonality and cyclicality in DRAM. And as I said, I think we're seeing some degree of digestion of the strong third quarter results in foundry and logic.

I was hoping you can provide a little bit more clarity on how much HBM revenue you got in Q3 and how much you were expecting in Q4? Because you always said Q3, Q4 is like more than half of DRAM revenue of your largest DRAM customer stuff, but we actually don't know, right, your largest DRAM customer, how much revenue is it in there within that $28 million to $30 million revenue for -- I mean 2, 3-ish in Q4. So can you kind of help us understand what has been the progression of HBM revenue over the last two quarters and going to the next quarter? Because in June, you did say it's $10 million-ish in June. We just want to understand how lumpy is it, is it showing any sequential growth over the last two, three quarters?

Yes, there is going to be volatility quarter-to-quarter. I ballpark you that the absolute magnitude of it in the third quarter of HBM inside DRAM was about the same in round numbers, $10 million, we do expect that contribution to strengthen in the fourth quarter. But again, with probe cards being specific to each individual chip design and things like DDR5 also showing some significant activity and different customers ramping different designs at different times, we want to look at this on a multi-quarter basis, similar to the comments I made around market share. So on an absolute level, about stable. It was heavily concentrated in one customer. As I said, surprising perhaps that half of our DRAM revenue at this customer was associated with HBM. But we're looking at this as a longer term trend where we continue to want to ride this tailwind, but also build differentiation and share not just the one customer who's leading in HBM DRAM right now but each of the three major DRAM customers, and we've got activity with all of them.

And our next question comes from the line of Vedvati Shrotre from Jefferies.

I guess can you please help -- now that you have HBM and your chiplet die based microprocessors ramping, can you help me understand if there's a difference in test intensity for HBM devices versus chiplet MPU?

No, I think across the board, we see similar increases in test intensity and we've quantified that for you in the past somewhere between 20% to 30%,and I think that's a good rule of thumb for both HBM and some of the logic and foundry designs for that matter. Some of them are quite a bit higher than that, some of them are less than that, because it's a function of what the customer yields are for the individual chiplets, as well as the degree of complexity that they need to test each individual chiplet. HBM is interesting because you get another -- you get multiple test insertions. Each of the chiplets as in the MPU case is tested. But one of the interesting things we're seeing in HBM is as the stack is being assembled, there's some intermediate test insertions as well and some of them at very high speeds to make sure the die is going to work, that all kind of rolls up to a 20% to 30% test increase but there's a pretty good variance around that number, too.

And then for my second question, so it goes on to the earlier answers you provided. So in foundry logic that just you're competing with another competitor for each and every design. Do you -- when do you know if you were the market share leader on a particular design, is that -- like do you understand this before the design starts to ramp or is it kind of an aftermath?

No, you understand it before the design starts to ramp, because our customers don't really want to surprise us. Our lead times are relatively short. So you do have visibility into what designs you won and what designs that you have gone to your competitor. But that is not entirely predictive of the revenue, because as we saw in the third quarter, customers can accelerate or decelerate their wafer start plans on that particular design essentially in real time based on their customer demand. And so you can have won a majority of designs. But to put it simply, if you don't get lucky with the ones that are ramping, that might not result in a majority of the revenue based market share but that swings both ways. Our teams are very focused on working with our customers to make sure we've got the maximum number of design wins. But as I said, picking the winners is something that's extremely difficult to do and probably impossible to do, to be honest, given the dynamics in the industry.

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

Mike, just another question on the photonics business. So obviously, it's been good for your systems business over the last several quarters. But what does that look like in a couple of years when it goes from the lab to the fab, what kind of opportunity is that for you?

Yes. I think we've mentioned on the past several calls and highlighted again today the progress in silicon photonics and copackaged optics. It has been a strong driver of our System segment revenues, somewhere around 10% to 20% of those system segment revenues as customers invest in early R&D. One of the key points we made in the prepared remarks is we're shipping really the first system for low volume production into one of the major foundries in the world so that they can serve their fabless customers with some of these copackaged optics applications. When we look at that transition, it sort of depends on whose market forecast you believe in. If silicon photonics really is going to take off as a data center application in the next several years and chip-to-chip communication because of the power efficiency it offers, the power reduction it offers, we could see a sizable increase there. Now we've got some work to do, right? Our systems business primarily focused on the lab. And as we bring this technology to the fab, together with the consumable probe cards that perform the electrical test together with the photonics test, there's a significant chunk of our R&D spend going forward to enable this. But I think it's one of the key areas where we see great engagement in early R&D, the transition to low volume production. And as we go from the 10% to 20% in R&D revenues, you could see that scale substantially, multiples of that if we get this right.

And then, Mike, if you look at just the revenue guidance for the fourth quarter, it's somewhat similar to what we had a year ago. Just wondering if you could step back from a big picture point of view and just talk about the health of the industry today versus a year ago when revenues were projected to be the same?

Although the revenue levels are the same, I think the rate of change and the state of the industry is very, very different. That was -- our third quarter revenue came down and then we gave, if I recall, fourth quarter guidance, as you noted, Tom, that's pretty similar to what we're seeing this year. But that was off a very strong first half -- first quarter and second quarter of 2022. We've really been operating at those levels as we go through 2023. And although there's puts and takes, HBM strengthening, some ups and downs in the foundry and logic business that are not atypical of different designs ramping at different times, we see the industry in a much more stable overall condition. We feel like we're in a bottoming phase. If you listen to some of our key customers, in the foundry space, in the PC space, I think there's some mobile earnings out here over the next couple of days, it does seem like things are bottoming and maybe even strengthening a little bit. So I think the industry is in much better shape. Obviously, there's a wide variety of views on when things are going to inflect and when the next upturn is. But I think we're in pretty good shape given the capacity investments we've made to capitalize on that.

Our next question comes from the line of Gus Richard from Northland.

A lot of them had been answered but I did want to ask you about the expansion of the system and package, and is that starting to reach to mobile customers or are they starting to look to put multiple tiles in a package and increase test intensity there?

So we gave you a couple of examples of where chiplets or tiles are really driving our business. One, the client microprocessor, the other HBM, which has been a theme for a while. I think we're probably in very early innings associated with those. There are some R&D projects going on, but it's going to be at least a few quarters, if not the better part of the year before we start to see chiplets and tiles really infused into the mainstream mobile roadmaps. Having said that, there are a variety of places in a high-end 5G mobile handset where you do see advanced packaging and system in a package kind of characteristics. One is the RF front end where now we have multiple filters packaged together with an antenna and package. And those are areas that, at least when mobile was ramping and 5G adoption was strong where we saw a great uptick in the RF business. I think thematically, it all goes to us wanting to continue to broaden our exposure to advanced packaging. We view this as a secular shift in where values created in the industry and then the supply chain and it's somewhere we're continuing to place bets, both from our R&D spending but also as we look to an M&A funnel.

And then just touching again on silicon photonics. You're shipping both system. Is that fully automated at this point? And can you talk a little bit about the mix going forward between systems and consumables as you ramp in volume?

We're still pretty early in the implementation into volume production. And so the system we're shipping in the quarter that goes into low volume production still really an optical only test. It's testing the optical part of the chip. Now we do have separate engagements on this combined when you copackage the photonic chip together with the electrical chip at least to do functional test and ensure that die works, it's going to need to be a combined electrical optical test. But that's in fairly early co-development with some of our key customers. So I'd expect, let's say, through 2024, the mix to continue to be pretty heavily systems based.

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

I just have a couple of quick questions. Is there any update on the large new customer opportunity that you could share?

I think a couple of updates, Christian. So just to orient everyone, when we look at our share in the logic segment and especially associated with microprocessor applications, it's pretty heavily biased towards one customer. And the share shifts in the industry have not been all that favorable recently for that customer. So we've said in the past, our fundamental strategy is to be a leading supplier at every major customer in the industry, and here's one of the gaps. It's an area where we continue to be very focused. We've made some changes in both our technology but also the technical team that's interfacing with that customer, because the primary gaps in qualifying really have been adapting our technology, they've been technical in nature. That customer needs a second supplier. There's really only two of us that can drive at the high end of foundry and logic probe cards, especially with the requirements driven by advanced packaging. And so longer than we would have liked we continue to make changes and we're continuing -- we continue to be committed to building a share position at this customer.

And then the other second question quick is the high bandwidth memory industry is looking to more than 2x the capacity of high bandwidth memory. Samsung is finally making it. Micron will get their act together probably shortly. So is it safe to assume that that is accurate in industry dialog that your high bandwidth memory business should go -- going from $10 million a quarter to easily $20 million plus a quarter at some point next year?

I think typically, probe card intensity does scale with wafer starts and output, right? If you look at -- over time there's a pretty good relationship between overall semiconductor revenue and probe card spending, although the intensity has gone up over time. I think the one potential caveat here, not to pour cold water on it, is as any technology matures like the TSV die stacking in HBM will mature yields go up. And so that's been a bit of a counterbalancing for us. But I think as all three DRAM manufacturers ramp and start to really supply for what the native demand for HBM is in enabling AI, I don't think that's an unreasonable expectation to have the business go from, let's call it, in round numbers, $10 million a quarter to something like $20 million a quarter. A lot of it will depend on when these other customers ramp, a lot of it will depend on the end pull-through from the AI markets. But if you believe those underlying assumptions, yes, I think it's reasonable that we'll be able to come close to doubling our HBM business as we go through some point in 2024.

And our next question comes from the line of Craig Ellis from B. Riley Securities.

Mike, I wanted to start just by following up on some of the conversation around foundry logic. It seemed like a lot of the strength in the quarter was compute related either more on the client side or HPC side and some similar things going on in the outlook, but I didn't hear too much about mobile and things related to RF and foundry logic. So how do you think that shapes up as we exit your heading into next year and any notable changes on the mobile side in foundry logic as we're looking at the business?

I think our RF business, which we report inside of foundry and logic really is indexed pretty heavily towards mobile handset growth. And I think anybody who follows that industry knows that that's been a pretty ugly 2023 for handsets and the mobile ecosystem in general. We do see things bottoming in the mobile space. And there were some nice application processor wins and RF wins in the third quarter that did contribute to the results. They just weren't as major as the compute designs. I still feel like if you look at inventories, whether they be filters or even some of the apps processors across the overall channel, there's some digestion, some usage for those chips before we really see the new chips that are driving our business to ramp in volume. But like most of the rest of our businesses, we've seen mobile and RF stabilize it, as I said, maybe even get a little bit better. Now one of the things to know about our RF business is some of the shortest lead times we operate in. So where our average lead times are better part of a quarter, RF lead times are actually shorter than that. And so we can see some very significant changes in the demand profile as customers change their wafer start plans. So not a lot of visibility, I guess, is one of the things I'm trying to say.

And then the second question earlier in the Q&A, you noted that there have been pluses and minuses vis-a-vis the target model one of the pluses would be AI, one of the minuses would be China. And I was just looking at the China country trends in the supplement that's released and noticed that China had ticked a few million in lower every quarter over the last four or five quarters. How much of that is cyclical versus anything that might be related to more structural things with shipment restrictions, et cetera? And more importantly, from here, what should we expect going forward in that geography?

So it's a good point, right? Our China business, I think, was again down sequentially, and probably at half the levels it was at the peak back in late '21 or early '22. To answer your question directly, it's almost entirely structural. As a US supplier operating at advanced nodes that are subject of expert controls from the Department of Commerce, we've been limited in our ability to supply customers. And I think we've been quite clear in our expectations that we expect the domestic China business to continue to increase and at some point here, probably go to zero as they cultivate probably not local China alternatives to us, but with our primary competitor in memory being based out of Japan, our primary foundry and logic competitor being based in the EU, they do have geographic alternatives that aren't restricted as strongly as we are. The part holding that business up is still the multinationals that operate in the region. And we've seen a recent relaxation of the export controls around them, they were granted extensions to the license and those businesses are holding up fairly well.

Our next question comes from the line of David Duley from Steelhead Securities.

My question has to do with advanced packaging. Clearly, on the conference calls over the last few quarters, we've seen a whole bunch more chatter from both the test and assembly guys, Intel and AMD and whatnot. I'm just curious as far as more probe card business goes, what percent would you classify as advanced packaging and what do you think the growth rate of that segment is? And I'm assuming that includes both the tile, the high bandwidth memory stuff?

And that's the way we classify it, too, David, for clarity, right? Regular flip chip, although, some people would call that advanced packaging, we're really targeting that classification at chiplet multi-die architectures assembled using techniques like hybrid bonding and TSV, because that's really where the increase in performance, the decrease in cost, the innovation acceleration comes from. It can sometimes be a little bit difficult to break out. But given what we highlighted in the third quarter, my guess is that somewhere around 20%, 25%, maybe even 30% of our business at present is associated with advanced packaging. The combination of the client based microprocessor, HBM at the various customers and a smattering of other designs. So we're still clearly in very early innings associated with this. But if you look at the increase in test intensity associated with it, it's also one of the things that is underlying the strength in the third quarter results. The fact that some of the revenue concentration was associated with things in advanced packaging really does help out the overall top line. And that's why we're so optimistic of our exposure and the eventual growth advanced packaging will drive for us.

And when you look at both the unit volume growth that you see in advanced packaging plus this increased intensity and increased complexity, or more advanced packaging business over the next two years, what would you guess the growth rate is? Clearly, it's probably more than 2x the industry growth. But I'm just kind of curious if you have an idea of what it might be?

So we're going through annual planning and strategic planning right now, and it's one of the key things we're looking into. So over a two year time frame, we do expect it to outgrow the industry significantly. I think 2x may be a little bit aggressive. But again, it's one of the reasons given our competitive position, given the value we create for our customers in advanced packaging applications with things like our MEMS probe technology, with things like co-packaged optics, tthat outsized growth is somewhere where we got good exposure, and we're going to continue to prioritize and capitalize on.

And just one more clarification. As far as sub 7-nanometer and below foundry logic business, what percentage of those wafer starts are MEMS based probes versus other technology, is it a vast majority at this point?

Yes, it's a vast majority of MEMS probes. There are counter examples where MEMS probes have not been adopted in areas like very large footprint, single [indiscernible] GPUs, for example, because the interconnect density doesn't require a MEMS based probe, but it's a pretty reasonable rule of thumb that the vast majority of sub 7-nanometer foundry and logic devices do need to be probed with the MEMS probe cards.

And our next question comes from the line of David Silver from CL King and Associates.

I had a couple of questions maybe about planning for next year, but this is typically the time of year when budgeting and everything takes place. Just focusing on your CapEx budget. There has been the Livermore capacity expansion. But when you’re thinking about next year's CapEx spend, could you maybe call out where the biggest amount -- the largest amount of discretionary CapEx is going to be spending? In other words, what efforts or applications are you going to be committing discretionary resources to?

So as you said, we are going through the planning process. And given our big footprint in Livermore in California, I expect most of the additional CapEx to happen in that facility. In terms of magnitude, I did talk about completing majority of our capacity expansions that is required for achieving the target model and that's where we expect the CapEx in 2024 to decrease certainly compared to the $60 million midpoint CapEx we expect in 2023. I don't expect it to go down significantly like to the $20 million a year levels that we had before starting this capacity expansion, but somewhere in that range is what we expect CapEx to be in 2024, and most of it in the probe cards business and most of it in Livermore.

And then I'd kind of like to ask a similar question on your R&D spend. So I think the third quarter R&D spend was an all-time high. And again, when you look out to next year, what are the new or significantly increased efforts in your R&D budget, if you could call out maybe the top one or two, that would be very helpful?

Really go back to the themes we've talked about today, advanced packaging, chiplets, making sure our product roadmap is aligned with the key customers who are adopting advanced packaging and chiplets in volume and making sure we're focusing our R&D spend to have differentiated products in those applications are really the focus areas. So in DRAM, making sure we're keeping our competitive lead in HBM. But in foundry and logic, there's a variety of new requirements and new products that we're releasing associated with higher speed, higher power, smaller pads and higher pin counts that are really the focus of our envisioned R&D spend, I won't call it planned yet in 2024.

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

Thanks, everybody, for joining us again today. We have a couple of investor conferences on our docket to end the year. I believe they've been posted on our Web site. So we'll hope to see you there to wrap up an eventful 2023 and look forward to 2024. Take care.