FORM - NASDAQ

Thank you, and welcome, everyone, to FormFactor's First 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.

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 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-19 pandemic; anticipated industry trends; potential disruptions in our supply chain; the impact of regulatory changes, including the recent U.S.-China trade restrictions; the anticipated demand for products; our ability to develop, reduce 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-K 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, May 1, 2024, and we assume no obligation to update them. With that, we will now turn the call over to FormFactor's CEO, Mike Slessor.

Thanks, everyone, for joining us today for FormFactor's First Quarter Earnings Call. Although FormFactor's first quarter revenue was near the top end of the outlook range we provided in February, non-GAAP EPS fell short of the midpoint due to lower-than-expected gross margins, primarily from a weaker product mix in both segments, along with higher warranty costs in the Probe Cards segment. In the current second quarter, we're experiencing a significant sequential step-up in demand and expect a corresponding increase in gross margin and non-GAAP EPS. This is driven primarily by strength in both DRAM and foundry and logic probe cards as industry adoption of advanced packaging accelerates. To ensure FormFactor fully leverages and benefits from our strong position in enabling advanced packaging, we recently completed an important series of coordinated organizational and talent changes. First, we've realigned our organizational structure to consolidate the company's global operations, including manufacturing, quality, supply chain, environmental health and safety and facilities, in a central group. This operational consolidation provides the critical mass and scalability to create commonality and efficiency as we continue to grow. With our operations now consolidated, our business unit's sole focus is on customer-facing innovation and competitive differentiation in FormFactor's product roadmaps. Second, we deepened our bench, recruiting and onboarding 2 experienced executives to lead our operations and commercial functions and realign responsibilities for other executives to ensure FormFactor has the required skills and experience in critical roles. Finally, we added Kevin Brewer to our Board of Directors, who is the former Executive VP of Operations and CFO of Axcelis Technologies, brings significant operational experience and knowledge. Kevin replaces Lothar Maier, who's retiring after nearly 18 years of service to FormFactor. And on behalf of our shareholders, employees and customers, I'd like to take this opportunity to thank Lothar for his many contributions. These coordinated changes are designed to position the company for our next phase of growth, by enhancing our capability to develop and introduce highly differentiated products while advancing our ability to manufacture these products at world-class operational levels. This will allow us to capture the secular growth in our served markets being driven by advanced packaging and to gain market share, enabling us to outgrow these markets. While the full benefit of these changes will be realized over a multiyear time frame, we do expect short-term improvement in our gross margins, for example, by focusing on areas like quality to reduce unexpected costs. Turning now to market and segment level details. DRAM probe card demand continues to be robust, and as expected, first quarter DRAM revenue reached the peak levels last experienced in 2021 with strong growth in high-bandwidth memory, layered on top of steady DDR5 new design activity. In the first quarter, HBM was nearly half of FormFactor's DRAM revenue and was double the quarterly levels we delivered in the second half of 2023. We've previously stated that we expected HBM revenue to reach these levels sometime in mid- to late 2024. Achieving these doubled quarterly run rate HBM revenue levels in the first quarter of the year is a good indicator of how quickly HBM capacity and output is accelerating across our customer base. We expect this trend to continue and are forecasting a similar incremental growth contribution from HBM in the second quarter. HBM chips, which are a stack of 8, 12 or even 16 individual DRAM die, continue to offer powerful example of how advanced packaging is driving our current results and foreshadows our long-term opportunity. As we mentioned in the past, advanced packaging applications, like HBM, produce both higher test intensity, which expands the number of probe cards required per good die-out and higher test complexity, which raises the performance requirements for each probe card. To ensure high yields of the stacked HBM DRAM chip, customers probe and test each component DRAM die prior to stacking and then 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 speeds and more challenging thermal scaling specifications. We believe our superior performance capabilities in meeting these requirements will drive both market share and profitability gains as HBM continues to grow, driven by the accelerating adoption of generative AI. Even though HBM applications comprise a small portion of the total DRAM bits produced by our customers, because of the stacked die architecture, HBM represents a much larger portion of the total silicon area and wafers produced and, because of the increased test intensity and test complexity, an even larger part of the overall test and probe card spending by our customers. This compounding power of advanced packaging is clear in our first quarter results and our second quarter outlook for HBM. Shifting to foundry and logic probe cards. As expected, we delivered first quarter revenue comparable to the fourth quarter as we shipped probe cards for a variety of PC, server and mobile designs. As a reminder, since probe cards are a device-specific consumable that's customized to each individual customer chip design, production ramps of new chip designs generate demand for new probe cards even when these new designs are produced on the same technology node. This provides a more diverse and stable set of demand drivers than for capital equipment. We expect second quarter growth in our foundry and logic probe card business, primarily driven by the midyear ramp of new mobile application processor designs and stronger probe card demand for client PC and server microprocessor designs. As in DRAM with HBM, an increasing number of these foundry and logic designs are architected using advanced packaging processes like Foveros and 3DFabric. Similar to the die stacking in HBM, these processes drive both higher test intensity and higher test complexity. This is driving increased customer spending on FormFactor's products to both improve yields and reduce costly scrap. In the Systems segment, the sale of FRT in the fourth quarter produced the anticipated sequential reduction in revenue in the first quarter. However, product mix was weaker than expected with fewer high complexity thermal systems ship. We believe this mix of lower complexity configurations is a short-term dynamic and not a structural change in this market. Our customers continue to engage us to solve the most complex challenges in test and measurement, utilizing our engineering probers, cryostats and other Systems segment products to test, measure and characterize new technologies, like co-packaged silicon photonics, infrared detectors and quantum computers that are at the forefront of industry innovation. Systems segment products are also an important element of our lab-to-fab diversification strategy. Our uniquely broad portfolio enables us to compete for business across diverse demand pools at all major customers, providing a measure of stability in downturns and inherent exposure to fast-growing areas of the industry, like high-bandwidth memory. Finally, I want to share an important customer highlight from the first quarter. FormFactor was one of 27 suppliers to receive the exclusive Intel EPIC Program Distinguished Supplier Award for 2024. This award marks the third consecutive year we've been recognized as a top performer in the Intel supply chain. I'm extremely proud of the global FormFactor team for the dedication and performance that resulted in this recognition from Intel, and I'd like to take this opportunity to thank and congratulate our team. In closing, we're excited about both the strength of our second quarter outlook and the accelerating adoption of advanced packaging underpinning that strength. 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. 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, along with the organization and talent changes we've made recently, position FormFactor as a stronger and leaner competitor. This will enable us to achieve and then surpass 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, Q1 revenues were $3.7 million above the midpoint of our outlook range. Non-GAAP gross margin was 0.8 percentage points below the bottom end of the range, and non-GAAP EPS was $0.01 below the midpoint of the range. First quarter revenues were $168.7 million, a 0.3% sequential increase from our fourth quarter revenues and a year-over-year increase of 0.8% from our Q1 '23 revenues. The increase is due to stronger revenues in our Probe Cards segment. Probe Cards segment revenues were $136.7 million in the first quarter, an increase of $9.7 million or 7.6% from Q4. The increase was driven by a small increase in foundry and logic revenues and a significant increase in DRAM revenues, partially offset by a decrease in flash revenues. The Systems segment revenues were $32 million in Q1 and $9.2 million decrease from the fourth quarter and comprised 19% of total company revenues, down from 24.5% in Q4. The main reason for the decrease is the sale of FRT in Q4 '23. Within the Probe Cards segment, Q1 foundry and logic revenues were $86.8 million, a 3.6% increase from Q4. Foundry and logic revenues increased to 51.5% of total company revenues compared to 49.8% in the fourth quarter. DRAM revenues were a record $45.9 million in Q1, $10 million or 27.9% higher than in the fourth quarter and increased to 27.2% of total quarterly revenues as compared to 21.3% in the fourth quarter. Flash revenues of $4 million in Q1 were $3.3 million lower than in the fourth quarter and were 2.4% of total revenues in Q1 as compared to 4.3% in Q4. GAAP gross margin for the first quarter was 37.2% as compared to 40.4% in Q4. Cost of revenues included $2.6 million of GAAP to non-GAAP reconciling items, which we outlined in our press release issued today and in the reconciliation table available in the Investor Relations section of our website. On a non-GAAP basis, gross margin for the first quarter was 38.7%, 3.4 percentage points lower than the 42.1% non-GAAP gross margin in Q4 and 0.8 percentage points below the low end of our outlook range. The decrease compared to Q4 and to the midpoint of our outlook range was a result of lower gross margins in both the Probe Cards segment and the Systems segment. Our Probe Cards segment gross margin was 37.2% in the first quarter, a decrease of 2.4 percentage points compared to 39.6% in Q4. Our Q1 Systems segment gross margin was 45.3%, a decrease of 4.3 percentage points from the 49.6% gross margin in the fourth quarter. The decrease in consolidated non-GAAP gross margins from the midpoint of our outlook range is due to the net effect of 3 main factors: first, a less favorable product mix in both segments, which contributed to a 1.9 percentage point decrease; second, higher-than-expected warranty expense in Q1 contributed to a 0.4 percentage point decrease; partially offsetting these 2 factors was 0.5 percentage points related to higher-than-expected revenues. First quarter GAAP operating expenses were $61.7 million compared to $59.6 million in the fourth quarter. The 2 main reasons for the increase were higher stock-based compensation of $1.2 million related to the benefit from futures in the previous quarter that did not recur in Q1 and transaction costs of $0.6 million related to the sale of our China operations. During the quarter, we entered into a definitive agreement to sell our China operations for $25 million, subject to customary working capital adjustments. The transaction closed on February 26th, and Q1 includes results from our China operations for the first 2 months of the year. Net proceeds from the transaction after adjustments and expenses were approximately $21.1 million. Non-GAAP operating expenses for the first quarter were $52.3 million or 31% of revenues as compared with $51.6 million or 30.7% of revenues in Q4. The $0.7 million increase relates mainly to the typical annual benefits reset, partially offset by lower performance-based compensation and the reduction in costs related to the sale of FRT and our China operations. Company noncash expenses for the first quarter included $10.4 million for stock-based compensation, $1.1 million higher than in the fourth quarter, as well as amortization of intangibles of $0.6 million and depreciation of $7.2 million, both slightly lower than in the fourth quarter. GAAP operating income was $21.3 million for Q1 compared with $81.3 million in Q4, which included the $73 million gain from the sale of FRT. Q1 included $20 million gain from the sale of our China operations. Non-GAAP operating income for the first quarter was $13 million compared with $19.1 million in the fourth quarter, a decrease of $6.2 million or 32%, mostly due to the decrease in gross margins. GAAP net income for the first quarter was $21.8 million or $0.28 per fully diluted share compared with GAAP net income of $75.8 million or $0.97 per fully diluted share in the previous quarter. As discussed, the prior quarter included the gain from the sale of FRT. The non-GAAP effective tax rate for the first quarter was 13.7%, 7 percentage points lower than the 21.2% in the fourth quarter. We continue to expect our annual non-GAAP effective tax rate to be between 14% and 18%. First quarter net -- sorry, first quarter non-GAAP net income was $14.3 million or $0.18 per fully diluted share compared to $15.7 million or $0.20 per fully diluted share in Q4. Q1 EPS was $0.02 lower sequentially due to lower gross margins and higher OpEx on flat revenue, partially offset by higher other income and lower effective tax rate. Moving to the balance sheet and cash flows. We generated free cash flow of $19.7 million in the first quarter compared to negative $0.3 million in Q4. The increase in free cash flow of $20 million is mainly due to higher operating cash flows, primarily driven by more efficient working capital of $19.4 million, partially offset by an increase of $3.5 million in capital expenditures. We invested $13.4 million in capital expenditures during the first quarter compared to $9.9 million in Q4. There is no change in our previously communicated 2024 expected CapEx range of $35 million to $45 million. At quarter-end, total cash and investments were $357.2 million, an increase of $25 million from Q4. The increase relates to cash provided by operating activities and net cash received from the sale of our China operations, partially offset by CapEx and stock repurchases. At the end of the first quarter, we had one term loan remaining with a balance totaling $14 million. Regarding stock buyback, during the first quarter, we purchased $17.4 million worth of shares under our $75 million 2-year buyback program that was approved in Q4 2023. As of quarter-end, $56.4 million remains available under that authorization. As a reminder, the main purpose of this share repurchase program is to offset dilution from stock-based compensation. Turning to the second quarter non-GAAP outlook. We expect Q2 revenue of $195 million, plus or minus $5 million. At the midpoint of our outlook range, Q2 revenue is expected to be approximately $25 million higher than in Q1. We expect DRAM revenues in Q2 to be approximately $10 million higher than in Q1 and foundry and logic revenues to be approximately $15 million higher than in the first quarter. Second quarter non-GAAP gross margin is expected to be 45%, plus or minus 150 basis points. The expected increase in non-GAAP gross margins in the second quarter is related to higher volumes and a more favorable mix. At the mid point of these outlook ranges, we expect Q2 operating expenses to be $60 million, plus or minus $2 million. The expected increase is mainly due to higher performance-based compensation related to higher profitability. Non-GAAP earnings per fully diluted share for Q2 is expected to be $0.31, plus or minus $0.04. A reconciliation of our GAAP to non-GAAP Q2 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 Instructions]. And our first question comes from the line of Brian Chin from Stifel.

The -- maybe -- sorry, just first to get a clarification because I don't have eyes or this [indiscernible]. But could -- Shai, do you mind kind of going back over what the implied growth is for the 3 main areas: foundry/logic, DRAM and Systems in Q2 relative to the guide? And also on Q1, with HBM being a bigger component of the mix, why was that also less favorable mix even on the memory side of that revenue in Q1?

Sure. So regarding your first question, we said that with $195 million being the midpoint of the outlook range, we -- that's about $25 million increase quarter-over-quarter, of which $15 million is foundry and logic and $10 million is DRAM and the rest is relatively flat. These are the big movers. And regarding your questions on gross margin and HBM, yes, so HBM is indeed high -- relatively higher gross margin product for us, but it's still a DRAM product. And DRAM, as we said many times before, has a relatively low gross margin or lower gross margin than foundry and logic. So we had less favorable mix between the markets, even within the market. And also, the Systems business had a lower gross margin than usual at 45%, 46% while our target model for Systems is to be around 50% or low 50s in gross margin. So if you put all of this together and add the warranty expenses that were unusual in Q4 -- in Q1, that's why we ended up with gross margin lower than that. With Q2 at $195 million, we are very encouraged to see the gross margin growing to 45% at the midpoint of the range, even with DRAM and HBM or higher DRAM and HBM mix than before.

Okay. That's helpful. And then I guess for my follow-up, there might be 2 parts to this. But I guess, firstly, it's not often that you have sort of a step-up of this magnitude Q-on-Q. I guess the first part of this question is, are there constraints and some unfulfilled demand that maybe you have in the second quarter that gives you some of that visibility, I think, that you referenced in the release on Q3? And the second part of that is maybe -- can we unpack a little bit about the sequential pickup in foundry and logic? Obviously, not the best overall unit demand, but clearly, you're seeing a premium on growth here tied to maybe the mix in advanced packaging. Can you maybe, Mike, talk about sort of what you're seeing foundry basis, logic basis and just the breadth of that and kind of what -- maybe unpack that a little bit?

Yes, absolutely. Let me take the second part of the question first, and then we can parse out some of the foundry and logic growth. We didn't leave anything on the table in Q1. This has been a fairly rapid step-up in demand, and it's fairly concentrated among HBM, microprocessor applications and the usual midyear mobile application processor ramps. But if we take a look at the foundry and logic piece, it is interesting. Our customers in foundry and logic haven't had great earnings reports. But if you think about how they manufacture and their overall cycle times and flow, as they release new designs, most of them on advanced packaging and advanced packaging platforms in this process, they have to get the tooling and the probe cards in place several months, often even several quarters in advance of them shipping and realizing revenue for the part. So we're going to, in any kind of a new product ramp, lead our customers, be ahead of our customers in time, in the demand and revenue. And so I think that partially helps explain. You also alluded to another piece. A lot of the step-up in the second quarter is associated with new designs in HBM, in microprocessor applications and in mobile applications that are all being architected on advanced packaging platforms, whether it's die stacking and TSVs in HBM, whether it's Foveros in the microprocessor space, all of these things, as we said in the past and reiterated today, drive higher test intensity and higher test complexity. So the spending on test for these new designs is going up to make sure that the yields are high in these advanced packaging processes.

And our next question comes from the line of Charles Shi from Needham & Company.

I mean, the guidance kind of reminds probably everybody what happened in fourth quarter '19. That was also a pretty significant step-up at a similar time of the cycle. So maybe my question here, last time in fourth quarter '19, you were trying to maybe a bit cautious, right, and ignore [indiscernible]. Well, maybe some of the strength was a little bit transient. Well, it turns out it was not, and it was actually quite sustaining. This time, you didn't mention anything about transient or anything. So want to get you a -- get a sense how sustainable at the [indiscernible] close to $200 million per quarter level you're going to see in June? What's the [indiscernible] in the second half of this year? And maybe more importantly, I think that it does feel like you flagged about microprocessor being one of the strength areas you're going to see in Q2. And what's the sustainability of the protocol demand microprocessor going into Q3 and Q4?

Yes. Thanks, Charles. This is Mike. I'll take that. I think a couple of comments. First of all, remember that our business operates on very short lead times, well within a quarter. And so visibility into the third quarter and beyond, the second half in general, really isn't there for us. The other comment I'll make about the second quarter strength is it's fairly concentrated in a few applications and customers. HBM, obviously, a highlight, we talked about the microprocessor strength and some strength in mobile. But if I think about automotive, general DRAM, flash, some of the other parts of mobile, like RF, they're pretty much flat. And so it's not like we're seeing a broad-based recovery here. We're seeing some real strength and momentum in some of the areas where we are over-indexed and intentionally so because of our strategy. So I can't -- I don't have any hard visibility into the second half. But if you think about the position we're in, in HBM, in microprocessors, especially driven by the move to advanced packaging in a lot of these areas, we feel pretty comfortable with continuing to grow secularly with the industry. The only other caution I'd add is, often when we've seen a quarter of heavy spending by 1 customer or 2 customers on specific designs that ramp, we can see a digestion period for a subsequent quarter. But I think we're all expecting continued HBM growth. When you look at the recent comments from the hyperscalers on data center investments in AI, that's directly tied to that. And at some point here, we are going to see some sort of PC refresh cycle. I think all of you on the call have different opinions of when that'll be, whether it's Windows 11-driven or just age of the COVID buys-driven, there's going to be a PC refresh cycle at some point. But we don't have the visibility to know whether we're seeing the start of that or whether this is really just some of the design release activity associated with our customers' roadmaps.

Mike, I really appreciate the usual conservatism. But maybe a follow-up, in terms of HBM, if I remember correctly, probably second half last year is mainly driven by primarily one customer. Do you see a broadening of the demand and maybe you're seeing 2 customer demand right now? Or -- and specifically, I want to ask. We did hear chatters about the second one -- not the leader, but one of the follower having some real issues. And is that reflected in probably higher probe card demand in the short term or you don't see that as an issue?

Yes. Our HBM business is still relatively concentrated with one customer, although there are contributions from the other 2 DRAM manufacturers as they quickly sample and start to ramp HBM 3 and HBM 3E here in 2024. And we would expect that market to broaden a little bit. But at present and with the visibility we have, it really is continued to be driven and pretty concentrated by the leader in HBM market share. I think it'd be interesting to see as we go through the back half of the year and all 3 start to supply HBM3 in volume and then transition in 2025 to HBM4, we expect that business to broaden quite significantly and be a supplier to all 3 of them. But again, pretty concentrated with one customer right now.

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

I just had a couple of follow-up questions on the high-bandwidth memory market. You did a great job of talking about the number of insertions. I was just wondering if you could kind of just quickly review 2 things. If you could just tell us how much you think high bandwidth memory, how much more test and probe intense it is over, let's say, a standard DDR5 memory. And then could you just review, it sounds like you have with the 6 -- so you have 8 in the stack, you're going to have at least 8 probe insertions for each individual one. How many more -- how many more probe or testings are they when you build the stack?

Yes. Thanks, David. So a couple of things. Your math is correct. Each individual die, whether it's a 8-high stack, a 12-high stack, a 16 stack, each of those individual die gets probed and tested before it goes into the stack. Because as you can imagine, especially when you get high in the stack, if you're adding a bad die to it, that has the potential to essentially cause a scrap event for all the previous die that have been stacked. So the notion of known good die for each of these input die is something we are seeing. There's also, for sure, a test once the thing is completely stacked, and that often happens at high speeds. And I reference some of the challenging thermal specifications. And at least for the initial parts of HBM ramps, we're also seeing intermediate test insertions as the stack is built. You can imagine there's -- suppose you get to 4-high, there can be a test insertion there depending on what yield loss modes the customers are seeing. There's been all kinds of challenges associated with HBM. It's driven results for some of the metrology and inspection suppliers in the back end as well as customers try and uncover these new yield modes, yield loss modes and improve them and drive. But for right now, we're seeing all the input die get tested, each of the component die get tested, a test at the end and often some intermediate tests as it's stacked up.

And then just the test intensity of an HBM die versus a standard DDR5?

Yes. And we've estimated this in the past on a like-for-like basis is something like 20% to 30%, and I think that's a reasonable rule of thumb and continues to be a reasonable rule of thumb. There are situations where the test intensity is higher than 20% to 30%. Often, if it's a new product or when you're moving from 12-high to 16-high, new defect modes appear that need to be maybe over tested compared to that 20% to 30%. But I think that remains a pretty good rule of thumb for the uplift associated with advanced packaging chips on a like-for-like basis.

Okay. If I could just slip in a follow-up here. As far as your foundry and logic business, it's great to see a nice buildup. Do you think you've increased your market share? Or is that just what your big running customers inside these 2 big customers are kind of [indiscernible]?

Yes. So a couple of points on share. We, and I think most of the people who follow the industry, rely on the TechInsights, the formerly VLSIresearch report. That should be out any day now for 2023. So that will be the definitive word on market share. Having said that, as you can imagine, we do, do some pretty high-frequency internal benchmarking and data collection. And based on that, we do believe we've grown share through 2023, not just in foundry and logic but in our other served markets as well. As we talked about with you in the past, share gains and market leadership is a real core tenet of our long-term strategy, and we need to continue to drive share gains.

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

So Mike, I'll just join the party and ask one on high-bandwidth memory, and maybe I'll position it this way. So it looks like in 2Q, we should be at around $30 million in quarterly revenues. And as I listened to some of your commentary and look at the different times where probing die at input intermediate steps, final stack, et cetera, is there anything that you see, as we look out from high-bandwidth memory 3 to 3E to 4, that would cause probe intensity to go down? And if so, what would that be? And what would be the -- either the yield improvement or the other process improvements that a manufacturer might make to achieve that?

Yes. It's an interesting question, Craig. So as you go from 3 to 3E to 4, especially the 3 generation to 4, there's a couple of things that are really increasing the probe card intensity and complexity. One is, generally, the transitions involve more die stacked. And so as we talked about, each of the component die gets probed, and so you can imagine more component die in a higher stack is going to drive higher test intensity for the finished part. I think the other piece, certainly going from 3E to 4, there's a significant step-up in speed. And that's one of the areas where FormFactor has a very differentiated set of DRAM products in delivering high-speed test to screen out die that don't meet the speed standard to participate in the whole stack at the spec speed for something like an HBM 4- or 16-high stack. On the other hand, the other side of the ledger, I do anticipate that customers are going to be able to continue to drive yields up. And as they do that, they're going to drive test times down. Now they're not going to sample right? We're still going to have 100% test to screen out these die. But I'd imagine they'd be able to eliminate some of those test vectors once they get those -- the preponderance of those specific defect modes down.

Got it. That's really helpful. And then the question on foundry and logic would be -- it seems like when you framed up 2Q dynamics -- and I know that lead times or shorts. I'm not asking what lead times are doing and telling. But it seems like there's a very seasonal factor on the APU side. But it seems like the other factors that were at play, the move to 2.5 [indiscernible], et cetera, on more product platforms and, frankly, a good pace on those movements, it seems those are more structural. So is that fair? And how do you feel about the business' ability to see more sustained, steady foundry and logic revenue gains from here with these inflections now certainly become more material?

Yes. So if you go back to even when we presented our long-term target model, we expected the growth to come from foundry and logic because of some of the dynamics you talked about. Advanced packaging, a very, very strong driver of that business long term. Now some of our caution and conservatism is, as I mentioned in the response to a previous question, we have seen quarter-to-quarter digestion periods. The long-term secular trend associated with advanced packaging adoption in microprocessors and, more broadly, in foundry and logic, whether it's GPUs or apps processors, is quite clear. What I would caution against is drawing a straight line that goes up into the right quarter after quarter after quarter. There are going to be some lumpy spots in this as customers ramp, as customers digest. But the secular long-term trend associated with foundry and logic growth, we're very confident.

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

So maybe starting with the HBM side of things. Can you help me understand what the competitive positioning looks like on the HBM side? Are you sort of the market share leader just for HBM specifically versus the traditional DRAM? Is that a good way to think about it?

Yes. I think that is a good way to think about it. Part of it's because we have a very strong historical relationship with the DRAM manufacturer as a customer who's leading in HBM market share. So you end up -- as in all of these situations, your native share at a customer, if they're successful in some of these submarkets, can drive share gains where, to be quite candid, you're getting fortunate with the situation that the company's in. I do think when we look at our differentiation and why we're leading in HBM, it goes back to 2 points I made in the prepared remarks. One is HBM, and I think this is fairly obvious to most people, involves higher test speeds as customers screen out those die. We've got a very differentiated DRAM offering for high speed, and so that drives share. The other piece to it, and different customers have different approaches to how they handle this, the thermal scaling behavior of an HBM stacked wafer is much, much different than a monolithic silicon DRAM wafer. And it turns out that our technology is able to deal with that variability. As the customer tests at high temperature, low temperature, room temperature, we're able to deal with that variability in a pretty elegant and efficient way. So that's another element of the differentiation that's driving the market share leadership.

So are you -- is it fair to say you're seeing market share gains at other 2 HBM manufacturers?

I'm not sure we have enough exposure there yet, given the relative volume of their HBM volume, to see any kind of movement to the needle on share at those other customers. But as we engage, that's certainly an aspiration and the goal we have as they get more engaged in the HBM market.

Got it. And maybe on the foundry/logic side, could you provide us an update on where you are in the qualification process when it comes to the MPU fabless customer or the leading GPU customer and [indiscernible] revenue?

Yes. So let's deal with them differently because they're slightly different situations and remind everybody that it is our strategy to be a leading supplier at all leading customers. So we want to make sure we're qualified in a key part of the supply chain for both of these customers. And of course, they want multiple, probably 2 qualified suppliers, and there's really only 2 companies that supply high-end foundry and logic probe cards at this performance level. So the first one, we continue to make progress with the fabless MPU manufacturer. As we told you, I believe on the last earnings call, we changed out our customer-facing team and have been engaging and seeing some progress there. We don't have qualification or material revenue to announce. But it really is a key initiative for the company, and we are making some progress. On the fabless GPU manufacturer, there's some interesting dynamics there. We're working with them with their foundry as they adopt some of the advanced packaging technologies to put GPUs together with HBM on new probe technologies. We're in a qualification stage associated with that. But one of the interesting things we've seen from that customer is nice contribution in the first half of 2024 associated with their switch business. That's a business that they acquired a while ago, rounds out their data center offerings. And that's been a strong area of growth for us as we go through the first half here.

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

Mike, I'm just wondering when you're going to feel comfortable, given the next phase of growth and our previous target of $850 million and $2 in earnings power. I don't think probably took into consideration the significant revenue in high-bandwidth memory. When do you think you'll be ready to maybe readdress that with investors?

Yes. Well, it didn't take into account HBM, but there were also some other puts and takes as there are in any target model. We've had some headwinds associated with China. That's one of the reasons why we divested the business. So there are some things that are positive. There are some things that are negative. And we're still tracking, as you can see from the second quarter guide and our comments on the call, we're still committed to the $850 million model. As we did last time around, we want to put the numbers up on the board, at least from a quarterly standpoint, so a quarterly run rate of $212 million, a gross margin of 47%, EPS of $0.50 in a quarter, before we publish a new model or -- now given our limited visibility, we'd certainly hope that happens sometime in the second half here, but we don't have the visibility to commit to that. And the discussions around HBM, digestion and some of the other pieces, yes, I would like to be able to do it in the third quarter or the fourth quarter, but we just don't have the visibility to be able to foreshadow that yet.

Okay. And then could the digestion period be maybe a little bit later than you may think, given -- I know Samsung just said that they're going to -- high-bandwidth memory is going to be up threefold this year, and then it's going to double again the following year. And we should have a third customer ramping with you shortly. Is that fair?

Yes. There's no question the digestion could be later at a different time. It doesn't need to be in sequential quarters, right? But again, based on the strength and the step-up in the second quarter, we want to make sure that we're producing the products that have been ordered for us, delivering a quality product on time to these customers and supporting whatever ramp they're then going to drive in the second half. But we just don't have the visibility there to be able to make a definitive statement.

And our next question comes from the line of Krish Shanker from TD Cowen.

This is Robert Mertens on for Krish. The first one, just jumping back to the high-bandwidth memory. It was roughly, say, $10 million or so during the December quarter and doubling this quarter and then should also be up another $10 million or so and the June outlook, assuming maybe like a 20% to upwards like 40% sequential growth for the high-bandwidth memory portion. Did I hear you correct for the second half of the year, that you would expect memory to be up half over half? Or was that a comment to the overall business and sort of -- what are the major potential upsides to the second half of the year that you want to call out?

Yes. We certainly didn't make any definitive comments about the second half of the year. My answer to Christian's question a moment ago, given our lead times are well within a quarter, we just don't have the visibility to make a statement on the second quarter. Now I do think for HBM, there's some interesting dynamics at work, given the strong investment plans that the hyperscalers have that are going to drive data center spending, that are going to drive more HBM shipments. And as somebody noted on this call, our customers are all conveying strong growth for HBM through the second half of the year. So I think potentially, sure, we can see that. But I just don't have the direct visibility right now, given the shorter lead times, to really commit to that or make any statements that set expectations for the second half.

Got it. That's helpful. And then just quickly, in terms of Intel and their ramping foundry business. I don't know if you -- could you provide any commentary in terms of if you're starting to see any sort of business there or expectations as their foundry starts to ramp? Would you expect that to be a similar -- same market share as your current market share with Intel? Or how that might shake out?

Yes. I think with any foundry customer, there's a couple of different business models. And certainly, when the foundry has a contract to not just produce the wafers, but then test and assemble the wafers, we compete for that business at the foundry. Now sometimes, the fabless customer manages their test and assembly and just buys the wafers from the foundry. But in this scenario -- in the first scenario, where the foundry is managing not just wafer production, but test wafer sort, assembly and final test, those are areas where we'd expect to have, if you like, our natural share position irrespective of the foundry.

[Operator Instructions] And our next question comes from the line of Tom Diffely from D.A. Davidson.

So maybe a question for Shai on the margin structure on the model. So when I look at the guidance for the out quarter and compare it to a couple of years ago, we were at the same revenue level. Margins are a few hundred basis points lower or the earnings quite a bit lower. Curious, what is the biggest difference between then and now? Is it just increase in capacity? Is it the mix of what you're selling today? Maybe just a little more color on that, if you could.

Yes, Tom, that's a good observation. I mean, if you go back as far as I recall, Q1 of 2022, with similar levels of revenue to the midpoint of the range, I think it was $197 million, gross margin was 49%. But the mix was very different. Two years ago, the Systems revenue was higher, and the gross margin was higher. It was about 50%. Foundry and logic was above $110 million, and at the midpoint of the guidance, we are talking about $100 million of foundry and logic. And DRAM was about $35 million 2 years ago, and now we're talking about $55 million. So you can see the difference in the mix. Higher -- now we are talking about lower foundry and logic versus 2 years ago, higher DRAM. That negatively impacts the margin. And that's why it's, let's call it, only 45% versus the 49% you saw 2 years ago. But it's a great step-up.on our way to achieve our 47% gross margin at $850 million of revenue.

So maybe just a follow-on to that then. If you look at your target model, was that based on a mix that was more favorable for you? Or is the increase in the amount of memory going to impact your target model?

Mike talked a little bit about it that since we published our target model, there have been many puts and takes. Some of them positive, some of them negative. We're encouraged to see the Q2 outlook with a significant step-up in both revenue and gross margin. It is true that DRAM, having a lower gross margin in foundry and logic, that the increase in DRAM put some pressure on our target model. But as we said, we were -- there were a few other positive and negative puts and takes. We do have few internal ongoing initiatives to improve gross margin, things like automation, manufacturing efficiency, the increased focus on quality that we talked about today, which is part of the reason for consolidating our operations. So these are all things that will help us to achieve the 47% gross margin, and we're still committed to it.

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 today. Over the next month, 1.5 months, we're going to be presenting and attending a variety of conferences and would welcome the chance to speak with any of you and provide more color on FormFactor, our current growth and our future growth prospects. Until then, take care.