Thank you. And welcome, everyone, to FormFactor’s First Quarter 2022 Earnings Conference Call. On today's call, our Chief Executive Officer, Michael Slessor, and Chief Financial Officer, Shai Shahar. Before we begin, Stan Finkelstein, the Company's Vice President 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 includes those with respect to the projections of financial and business performance, future macroeconomic and geopolitical conditions, the benefits of acquisitions and investments in capacity and in new technologies, the impacts of the COVID-19 pandemic, anticipated industry trends, the disruption in our supply chain, the impacts of regulatory changes, the anticipated demand for products, our ability to develop, produce, and sell products, and the assumptions upon which such statements are based.

These statements are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from those expressed during this call. Information on risk factors and uncertainties is contained in our most recent filing on Form 10-K with the SEC for physical year ended 2021.

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, April 27th, 2022, and we assume no obligation to update them. With that, we will now turn the call over to FormFactor's CEO, Michael Slessor.

Michael?.

Thanks, Stan. And thanks everyone for joining us today. FormFactor again posted strong results in the first quarter, delivering the second highest quarterly revenue in company history, exceeding the non-GAAP gross and operating margin levels of our target financial model, and producing the highest quarterly free cash flow in company history.

This momentum continues in the second quarter, as we manage through a variety of challenges to utilize our added capacity in meeting growing customer demand for our products. Like many manufacturing companies, we continue to face supply chain and labor headwinds, both in terms of availability and cost.

We expect these issues to continue at least through the middle part of 2022, and our team remains focused on tactically resolving components and labor constraints as they emerge, while taking steps to moderate the impact of inflation in both manufacturing and operating expenses.

Our long-term investments in automation and vertical integration has helped us partially mitigate the effect of these headwinds, and has contributed to our strong results for the past several quarters. Before we move to market level details, I'd like to share some exciting news on the customer plan.

FormFactor was recently recognized by Intel as a 2022 distinguished supplier in their Epic award program for our dedication to excellence, partnership, inclusion, and continuous quality improvement. Only 26 of Intel's thousands of suppliers worldwide earned this award this year.

And we're extremely proud that Intel recognized FormFactor's recent performance and commitment to supplier excellence with its second-highest honor.

Turning now to segment and market level details; in Foundry and Logic Probe cards, our largest business, demand sustained at an overall level comparable to the strong fourth quarter which we expected to find in RF, offset by stronger Foundry demand. Both the top Foundry and the largest logic IDM, were 10% customers in the quarter.

Key drivers for the Foundry business were 7 and 5 nanometer designs in high performance compute, along with mobile and RF. And we expect a similar demand profile in the second quarter. IDM microprocessor demand continues to be a diverse mix of client PC and server designs, primarily on the 10-nanometer node.

Foundry and Logic customers are investing in both leading edge capacity, as evident from record levels of wafer fab equipment spending, and early stage innovative advanced packaging architectures, like EMIB, Foveros, and 3D Fabric.

These chiplet, or tile-based integration schemes, drive both higher test intensity, which expands the number of Probe cards required per wafer out, and test complexity, which raises the performance requirements for the Probe card.

Advanced probe card architectures like FormFactor's MEMS technology are essential to meet these challenging technical requirements at compelling cost of ownership. These are short delivery lead times needed to support our customers’ rapid and dynamic production ramps.

To maintain our competitive advantage, we're investing heavily in R&D while collaborating with our key foundry and logic and memory customers to meet these challenging technical and commercial requirements with our proprietary 2D and 3D MEMS technologies.

At the same time, we're investing to ensure we have sufficiently vertically integrated MEMS production capacity to meet the growing demand for our innovative and differentiated MEMS probe card technologies. Turning now to DRAM.

As expected, first quarter demand for DRAM probe cards reduced from the near record levels we delivered throughout much of 2021, and we expect second quarter DRAM probe card demand to be comparable through the first quarter.

New design activity from each of the major DRAM manufacturers remained healthy with a mix of new DDR4 and DDR5 designs in both mobile and PC server applications. As we often note, probe cards are consumable specific to each new chip design, and so we benefit both from node transitions and from the release of new designs on existing nodes.

The current DRAM activity is a diverse mix of designs across multiple technology nodes and memory architectures from each of the leading DRAM manufacturers. Orr systems business also delivered strong results in the first quarter, with revenue near $40 million. A level that we expect to achieve again in the second quarter.

Paired with its solid financial contribution and revenue diversification, the systems business provides significant strategic value, enabling us to engage with key customers in early characterization and yield improvement of novel new devices as part of our Lab to Fab strategy.

These engagements range from 300 millimeter wafer probers, for mainstream 2-nanometer seam loss development, to optical metrology and inspection tools for yield improvements in advanced packaging and chiplet applications, to wafer and chip-scale cryogenic probers for developments of tomorrow's quantum processors.

We continue to expand the served markets for our systems products, as evidenced by our first quarter introduction of the Tesla 300 high-power wafer probing system for automotive, renewable energy, and industrial applications.

Let me close by noting that our first quarter results and second quarter outlook, demonstrate another step towards our target financial model that delivers $2 million of non-GAAP earnings per share on $850 million of revenue.

There continue to be challenges to overcome for both FormFactor and the industry as a whole, including supply chain constraints and inflationary cost pressures. Our recent results and outlook have demonstrated the resilience and agility of our team and operational model.

And together with our leadership positions and our attractive served markets, this resilience and agility will drive continued growth and share gains as FormFactor progresses towards our target model, and beyond. Shai, over to you..

Thank you Michael, and good afternoon. As you saw in our press release, and as Michael mentioned, FormFactor posted strong first quarter results. Revenues were at the high-end of our outlook range, and non-GAAP gross margin and EPS exceeded value in the outlook range.

We also achieved record GAAP and non-GAAP operating income, record non-GAAP net income, and record free cash flow in the quarter. First Quarter revenues were $197 million, a 4% sequential decrease from our Q4 of 21 record quarterly revenue, and an increase of 6% year-over-year.

Probe card segment revenues were $160 million in the first quarter, a decrease of $6 million or 4% from Q4 of 21. The decrease was driven by lower DRAM revenue. System segment revenues were $37 million in Q1, a decrease of $2 million, or 5% from the fourth quarter.

Within the probe card segment, Q1 found the unlogic revenues were flat with Q4 at $114 million, comprising 58% of total company revenues, slightly higher than the 56% in the fourth quarter.

DRAM revenues were $35 million in Q1, $6 million or 14% lower than in the fourth quarter, and were 70% of total company quarterly revenues as compared to 20% of revenue in the fourth quarter. Flash revenues of $11.4 million in Q1 were essentially flat through the fourth quarter, and were 6% of total revenues in Q1 same as in Q4.

GAAP gross margin for the first quarter was 47.8% of revenues, as compared to 43.7% in Q4. Cost of revenues included $2.4 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 49%, 200 basis points above the high end of our outlook range and 470 basis points higher than the 44.3% non-GAAP gross margin in Q4, with higher gross margins in both our segments. More significantly so in the Probe card segment.

The increase as compared to our outlook, is mainly due to revenue at the high-end of the range and more favorable product mix, lower manufacturing costs, and higher utilization. Our Probe card segment gross margin was 48.3% in the first quarter. An increase of 420 basis points compared to 44.1% in Q4.

The increase is mainly due to the factors I just mentioned. Our Q1 system segment gross margin was 52.2%, 670 basis points higher than the 45.5% gross margin in the fourth quarter. This increase is due to a more favorable mix and lower expenses, primarily warranty, face, and inventory reserves.

As we've said previously, we expect our system segment gross margin to range between the high 40s to low 50s. We are encouraged by achieving a gross margin above our target model in the first quarter. However, we continue to expect that margins will fluctuate from quarter-to-quarter.

Our GAAP operating expenses were $60 million for the first quarter, $2 million higher than in the fourth quarter. Non-GAAP operating expenses for the first quarter were $51.9 million, or 26.3% of revenues, as compared with $49.7 million, or 24.2% of revenues, in Q4.

$2.2 million increase relates mainly to the annual benefits and tax effect, higher headcount, and higher travel expenses.

Company non-cash expenses for the first quarter included $7.5 million for stock-based compensation and $2.4 million for the amortization of acquisition-related intangibles, both of which are at similar levels for the fourth quarter, and depreciation of $7 million, $0.5 per fully diluted share higher than in the fourth quarter as a result of our capacity expansion.

GAAP operating income for Q1 was a record $34.2 million as compared with $31.8 million in Q4. Non - GAAP operating income for the first quarter was $44.8 million, breaking the record set last quarter by $3.5 million.

GAAP net income for the first quarter was $30 million or $0.38 per fully diluted share, compared to $26 million or $0.33 per fully diluted share in Q4. The non-GAAP effective tax rate for the first quarter was 13.8%, 290 basis points lower than the 16.7% in Q4, and below our estimated non-GAAP annualized effective tax rate of 15% to 20%.

During the first quarter, the required capitalization of R&D expenses changed, resulting in a higher foreign derived intangible income benefit, also known as FDII, and that's a lower effective tax rate. We expect to be on the lower end of these 15% to 20% range for the remainder of the year.

As a reminder, our annual cash tax rate is expected to remain around mid-to-high single-digits of non-GAAP pre -tax income, until we fully utilized our remaining U.S. based R&D credit. First quarter non-GAAP net income was a record $38.7 million or $0.49 per fully diluted share, compared to $34.7 million or $0.44 per fully diluted share in Q4.

In summary, EPS came in higher than our outlook range due to revenue being at the high-end of the wind, higher gross margin, and lower effective tax rate, partially offset by higher operating expenses due to higher performance-based compensation. Moving to the balance sheet and cash flows.

We generated a record $29 million of free cash flow in the first quarter, compared to $24 million in Q4, bringing total cash and investments to $300 million, at the end of the quarter.

The $5 million dose sequential increase in free cash flow, reflects the increase in profitability, as capital expenditures were at the similar level, in the previous quarter. As of the end of the first quarter, we had two term loans remaining in our balance sheet, totaling $22 million.

We invested $15.6 million in capital expenditures during the first quarter, compared to $15.1 million in Q4. As mentioned in our previous earnings call, in 2022 we expect to continue to invest in increasing capacity to meet customer demand with full-year CapEx planned to be between $60 million and $80 million.

As a reminder, we expect CapEx to return to the 3.5% to 4% of revenues in our target financial model, after we conclude these capacity expansions. Regarding stock buyback, during the first quarter, we purchased 241,000 shares, under our existing $50 million two-year repurchase plan. This brings our repurchases through the end of Q1, 363,000 shares.

At quarter-end, $16.6 million remain available for future repurchases. Turning to the second quarter of non-GAAP outlook, as Michael mentioned, we expect the strong momentum to continue in the second quarter, with sequential increase mainly in Foundry and Logic. These factors resulting in Q2 revenue outlook of $203 million, plus or minus $6 million.

Non-GAAP gross margin for the second quarter is expected to be 47%, plus or minus 150 basis points, on a similar product mix to Q1, offset by higher manufacturing costs.

At the midpoint of these outlook ranges, we expect Q2 operating expenses to be higher than Q1 by approximately $2 million to $3 million, mainly due to additional hiring and annual salary increases. Accordingly, non-GAAP earnings per fully diluted share for Q2 is expected to be $0.43, plus or minus $0.04.

A conciliation 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] Our first question comes from the line of Krish Sankar from Cowen Inc. Your question, please..

Yeah. Hi. Thanks for taking my question. I had a couple of them and congrats on the really strong results, Michael and Shai. You mentioned that one of the reasons for the gross margin in June could be down relative to March, is because of the higher manufacturing costs.

I'm curious, given the fact that DRAM with less of the mix in June relative to March, the manufacturing costs, is that a one-time headwind or how should we think about margins going forward given the fact that it's really good margins in March, it looks like really good margins in June too, but I thought I'd be much better given DRAM mix is lower?.

Thanks, Kris, for the question. I want to talk about two components when I talk about Q2 margin being lower than Q1. As we said in the past, it's important to know that even with the changes in revenues in the specific or all the markets we serve, there can be changes in the product mix within these markets.

So even though we say DRAM is going to be comparable but foundry luggage is going to go up, it doesn't necessarily mean that the product mix will be better. We expect a similar product mix when it comes to the impact on the gross margin in Q2. So that's one point.

The other one I mentioned in the call as well, is that we expect higher manufacturing expenses in Q2.

As many of our peers, we see increases in raw material prices, we're seeing higher labor costs, there is also the impact of our capacity expansion coming online, and also there is an impact of some timing of our production flow which expected to result in lower absorption and higher manufacturing expenses in Q2.

Now, Q2 midpoint of our outlook range is 47% plus -- we said plus or minus 150 basis points, which is our target model. So we're very encouraged by that..

Got it. Very helpful, Shai. And then a follow-up. You guys did about $34.5 million or $35 million in DRAM revenues.

Is there a way to think about the split between DDR4 and DDR5? And the DRAM weakness relative to maybe six months ago, is that all driven by DDR5 push-out?.

Krish, it's Michael. I'll take that. I think, it's continued over the past 6 months to be a pretty even mix of DDR4 and DDR5.

I think, when we think about our quarterly DRAM revenues, although through much of 2020, we were operating up around $40 million a quarter, but we had talked about a more realistic median level being somewhere around the mid-30s, which is right where we expect it to be in the second quarter. So I don't know that I can point to DDR5 push-outs per se.

We've got a broad mix of DDR4 and DDR5 designs running through the factory with all of the major DRAM manufacturers. And in any quarter we expect those to ebb and flow a little bit..

And if I could just squeeze in one along this path.

Michael, is there any margin differential between DDR4 and DDR5 growth costs?.

Not systematically. As Shai said, we do see gross margin differences from different designs, so different DRAM designs, regardless to whether they're DDR4 or DDR5, can bear significantly different gross margins based on things like whether it's a single touchdown probe card.

But does that probe card test the whole wafer at once, or two touchdown probe card requiring two touches. The one touchdown card, higher-value, higher complexity probe card, and our customers compensate us accordingly for that, and so that drives a margin uplift.

So much less to do with the actual technology nodes or memory architectures, and much more to deal with the details of the configuration, that's true in DRAM. It's true in foundry logic as well..

Thanks, Michael and thanks, Shai..

Thanks, Krish..

Thank you all. Next question comes in the line of Brian Chin from Stifel Financial Corp. Your question, please..

Good afternoon, and thanks for letting us ask a few questions. And congratulations again on the execution in the quarter. Perhaps to start with gross margins here again, on the surface, there doesn't seem to be any wild swings and mix. But the one new variable that certainly was at your disposal in the quarter, was incremental output from Livermore.

And so we're thinking about sustainability of margins more at these higher levels. Maybe not quarter out, quarter in, quarter out above the target model, but closer to the 47% level, which is definitely higher than we've been modeling.

Is it fair to say that, there were some drags on your gross margin line as you were really constrained over the past few years, even, I think at this point? And that new capacity really unlocks something that allows you to maybe put a bigger floor under your gross margins?.

I would say gross margin has always been an area of focus for us, right? We always invest at all levels of the company on making improvements to gross margins and our operational teams is doing an excellent job on being more efficient on having more efficient design, on securing supply at the right prices.

And it's been such an important strategic action for the company, which is something that I'm very happy to see good results there. And these excellent results in Q1 really validates our ability to achieve our target financial model, gross margin of 47% at revenue rate on $60 million a year. And maybe one more point about that.

We are approaching our target model. If you look at Q2 revenue outlook range, we are within 5% of the target model, and the growth really came from mostly Foundry and Logic, as expected, as we said it's going to happen. So gross margin is where we expected it to be. So it will continue to fluctuate, as we said before.

But this validates our ability to achieve it..

You got -- 49% is still big. I think, a pretty big number. But fair enough.

And I guess, thinking about the CapEx plan for this year and also thinking about the constraints across the board in terms of getting equipment, that people certainly know about, are you doing some other safeguarding provisions to make sure you have the capacity in place to flex up if need be, towards the end of this year, maybe it's next year.

And also that $60 million to $80 million CapEx, is there a way to translate that into annual incremental revenue output?.

I think --.

Sorry, Michael..

It's difficult to translate the CapEx number into a revenue number.

As you know, since you've been following us for a while, this has been a multiyear capacity expansion plan that started off with some large fixed assets like buildings, transitioning into now this year being more tools but still some infrastructure and underlying platform footprint to allow us to continue to increase capacity.

It's a challenging situation for, I think, everybody in the industry to add enough capacity. We've heard big customers talk about them being growth-constrained, not by demand, but they're -- by their ability to get tools. I think that's the case for almost everybody in the industry.

So safeguards are difficult to put in place, but we are trying to increase capacity as fast as we can, both from an equipment perspective and from a people perspective which, obviously, in this labeled market, has turned out to be an equal challenge to the equipment supply..

Got it. Maybe just [Indiscernible] one last one, Michael. I feel like there's increasing confidence in various Foundry logic customers. Three nanometer roadmap and output in next year. IBM in terms of seven nanometer output.

And I feel like this will coincide with the substantial increase attach rate in terms of advanced packaging in architectures designs. Is your confidence level increasing for commensurate with those things? Agricola, I'll stop there..

Yeah, I think it's a great point that these advanced Foundry and Logic nodes, whether they be 3-nanometer, or the 7-nanometer node, as one of our other customers. Really, there's a strong coupling, or attach rate as you put it, now to these advanced packaging technologies.

Things like die stacking, chiplet, different tile-based strategies that we talked about for a while really drive up both test intensity, so the number of probe cards required per wafer out, and test complexity.

It drives that test intensity because very simply, if you're going to put four tiles together into a chip, you need to have relatively high confidence that each of those tiles is good, otherwise you couldn't have a situation where one tile can kill the other three, which economically is obviously, a very bad scenario.

Test complexity also going up, again associated with making sure each of these tiles or chiplets is good.

And so I think, as we get closer to 2023, in the ramps associated with these next nodes, with the increased attach rate of these advanced packaging technologies, we do think there's some potential tailwinds there for the overall probe card intensity, and the opportunity in front of us, as we lead in the Foundry and Logic market..

Okay, great. Thanks a lot..

Thanks Brian..

Thank you. Our next question comes from the line of Charles Shi from Needham & Company, LLC. Your question, please..

Good afternoon Michael and Shai, Thank you for letting me ask a couple of questions number one, I want to get your thoughts, your CapEx plan, your closest competitor during the quarter went public and we've got a chance to really dive into their financials, one thing that jumped out to me is that seems it's like you were out spend by your competitor in CapEx over the past three years? The concern I heard is you might have lost some upside opportunities because you might be more capacity constrained than your competitor.

I do understand that that overcapacity was quite a big issue in early 2010s around the time right before you became the CEO of a FORM factor maybe that influenced a little bit about your decision in terms of capacity expansion.

So can you give us some thoughts, capacity expansion, CapEx strategy here, and especially I believe that the probe card demand is likely going to accelerate from here for manufacturers, Brian Chin just mentioned advanced packaging, etc. Thank you..

Yeah. I think it's a fair observation, but if I look back to maybe 2019 and 2020, we were too conservative in our capacity expansion plans. And some of that is definitely a hangover from the 2010/2011-time frame. We also tend to be a fairly conservative executive team. And so that held us back some.

And as you can see from the capital spending in the past couple of years, we've gotten a lot more aggressive to allow us to address the opportunities that Brian talked about, that you just referenced.

And if you look at the amount of WFE being spent by our customers on leading-edge capacity, that WFE, although it takes a few quarters to get installed and qualified, almost certainly is going to result in new designs, more wafers that require more probe cards.

And so our confidence level with utilizing these big capital investments and big capacity expansions, continues to increase.

We think these are good investments for the company to make, to continue to grow our business, to capture the market shares that we'll need at the high end of the foundry and logic and DRAM business, and continue to grow the company.

But I think it is a fair assumption that we were caught a little bit flat for this from a capacity expansion perspective in the 2019/2020-time frame..

Got it. Maybe my second question, I want to ask something more near-term.

The COVID lockdowns in China, I believe, began in end of March, now is still extending into good part of April, we don't know when that's going to end, seems to have been weighing, not exactly your peer but the semi cap equipment companies on two sides, one's that really is on the supply chain side about the job is really the delivery side.

So they probably have seen a little bit impact reflected in some of their financials.

But I wonder, obviously, Q1 you did manage your supply very well, but going into Q2, what's your thought there? Is your guidance having bad some of the risks there? One thing, you do have something like a high teen in some quarters in the past, and more than 20% of revenue coming from China, I understand that the domestic Chinese are like a single-digit part of that.

A lot of that is really shipping to the intel facility in China. So why don't you give us some thoughts on any of the risk factors that are embedded in your guidance and how do you think about this? Thank you..

So I would say, there is a variety of supply chain headwinds we are dealing with, right? Just like everybody else, as you mentioned. Including your look down in China. So obviously, it's a very dynamic situation. It continues to present new challenges itself, especially every week or every day, sometimes.

I think, our team is doing a great job dealing with it. It's a concern for the whole industry. It is for us, as well. So far, I think it's too early to estimate the longer-term impact on us. And as you mentioned, most of our sales to China are to multinational companies, not to local China.

And they have been dealing with it pretty well by moving things around. But specifically, I think it's too early for us to say what's the -- [Indiscernible] to make for the longer-term impact..

Thank you..

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

Yeah. Thanks so much for taking the question and congratulations on a very strong execution guys. I wanted to start with gross margin clarification so -- and it's got two parts to it. You said in your prepared remarks that there were four factors that led to upside gross margin, revenues at the high end mix lower manufacturing cost in utilization.

What was the relative contribution of those four things to the upside about even or just proportionate to some versus others? And then on the manufacturing cost point, it was lower in a benefit in the first quarter, but it's a headwind in the second quarter.

What is it about -- what's happening with manufacturing cost quarter-to-quarter, that gives it that inverse dynamic?.

Thank you for the question. So on the first one, I would say the majority of the upside, about three quarters of week, maybe even close to 80% of the upside came from a more favorable mix. And as you know, we are a turns business with lead times that can be as short as sometimes 4 to 6 weeks. So in the time, at least in the [Indiscernible] business.

So in the time between our previous earnings call and quarter close, revenue came in at the high-end of our outlook range. And it also came in with a more favorable mix, which amplified the positive effect on the gross margin line. So that's the majority of this, about three quarters of it.

And the other were just contributed each one of them a little bit for the balance. When it comes to manufacturing expenses as they move to Q2, as I said, that the mix is expected to be -- or the mix impact on the gross margin in Q2 is expected to be similar to Q1.

And most of the decrease in Q2 gross margin is expected to come from the manufacturing expenses that are expected to be higher. And we're talking about higher raw material prices that we and our peers see. We see higher labor costs as well. Our capacity expansion is online, but that has a small impact as well.

And there is an element of the timing of the production flow, which is expected to result in Q2, in lower absorption and in higher manufacturing expenses. If you look at our balance sheet, you see that we build some inventory in Q1 to support the increase in the demand. So that doesn't impact of the timing of expenses as well..

Got it. And then, just to put a bow on with the mix issue in the first quarter.

Was that primarily in the Foundry and Logic statement? Or was that mix also something that benefited that DRAM segment? Given that there wasn't a lot of change on a segment to segment basis, so this is all intra -segment mix shift that's happening?.

Well, it's almost across-the-board. Not every design and every customer came in the higher margin, but more than one market. Even if you look at our systems business unit, also came in higher than Q1, sorry, higher than Q4, and higher than what we built into the outlook when we produced it in the previous earnings call..

Got it. And then the next question is really for Michael, and it's a question that goes back to the point that you made that others have inquired about, which is probe card intensity and the dynamics that apply as the top three OEMs move more towards heterogeneous style, or tile-based product, as you say Michael.

But then the question is this, when we look at those three entities, one is pretty far along with advanced packaging. They've been at it for a number of years and it's been a growing part of their capital spending budget. And I think they're increasingly known for it. There's two others that are just getting started down that path.

So what I was hoping you could do is help us with a sense for how much benefit, you think the business is getting today from the shift towards advanced packaging? And if we look out to the end of this year and then maybe to the end of 2023, what would be a reasonable expectation for the contribution from that shift to advanced packaging from those big three manufacturers? Thank you..

Yeah. It's an interesting question because clearly different pieces of silicon that are going to end up in these advanced packages does drive up test intensity. Now, it's important to remember that the whole industry is not going to move all of its wafer starts over to advanced packaging.

So there is a [Indiscernible] or an adoption effect that needs to be modeled here. And as we do that, we're still in very early units. If you think about where advanced packaging is impacting our business now, it's a set of high-end processors. Its HBM stacked DRAMs, and things like that.

And if you look at the relative number of wafer starts in probe card demand to that, it's not a very large fraction of the overall industry. But as you look at these customer road maps, as they go through, mainly into 2023, there's some significant adoption, and significant volume of these advanced packaging technologies.

And so that diffusion rate or attach rate of advanced packaging, the wafer starts, it's still going to take many years for this to become the majority of high-end Foundry and Logic. But we're very encouraged that major designs from our major customers have all been slated for advanced packaging on these leading edge Foundry and Logic nodes in 2023.

So we do expect it to build from the very small contribution we're having right now..

Got it. And then if I could just squeeze in one more.

Michael, just qualitatively as you've got the new Livermore facility ramping up, and after a period of being very, very tight there and really doing some creative things to keep production going at levels that you wanted, can you give us some of your impressions with how the early ramp up is going? And what are some milestones we should look for as we look through 2022 and your ability to ramp up that capacity?.

Yeah. Well -- and it's not done. If you look at our projected CapEx for 2022, it continues at essentially the same high levels we had in 2021, the efforts were again in 2020.

And so it's an ongoing story where if I would appoint the milestones, certainly the first one, and I don't know that we'll get there in 2022, but a quarterly run rate at the model level. As Shai noted, we're within a few percent of it, so getting very close. And clearly, the additional capacity is contributing to that.

So maybe that's one milestone to look to.

The others are, as you look at our current footprint and our ability to continue to deploy capital and add capacity inside that footprint, as you look at our annual CapEx -- our quarterly CapEx, seeing that continue at higher levels probably is good indicator that we're continuing to add capacity to give us legs beyond the footprint we have now..

Got it. Thanks, guys..

Thank you. And ladies and gentlemen, we'd like to ask you to please limit yourselves to two questions. You may get back in the queue as time allows. Our next question comes from the line of Dave Dooley from Steelhead Securities, LLC. Your question, please..

My first question is, and I hate to be the guy to ask this, but I'm wondering if you're seeing any sort of slow down in any segments of your business, or any inventory build at your customer levels, and what your customers are saying about the second half of the year because clearly, investors are spooked about both the equipment space and the probe card space, given what the stocks have done recently.

So I'm just wondering if you've seen any change in tone from your customers..

There's really no change in tone sort of systematically across the customer base. If you look at our large markets, our large share of markets in places where we have significant share, everybody's got constraints that's limiting growth.

Whether it's getting enough wafer fab equipment in, for us, some simple things like different sub-components are constraining growth. But I don't see anything that would indicate a cyclical downturn in the second half. But having said that, there's different quarter-to-quarter puts and takes in our business, and they're all we've had then.

And we talked about RF going down sequentially after a very strong 2021. Some of the issues in our RF probe card business primarily serves the components, we're going to 5G handsets right now. So things like ball and SAW filters, intended package parts, some of the really interesting things associated with millimeter wave communication.

That's taken a bit of a pause, but I wouldn't call that a secular downturn. It's probably digestion that occurs for a quarter or two, fundamentally that's why we're trying to run a broadly diversified model, because there's always going to be puts and takes with individual customers and individual markets in any quarter.

But certainly we see no indications of a broad systematic slowdown in our customer base..

And just as a follow-on to this particular.

Are you do your customers or your customers holding more inventory of either probe cards or of IC components?.

I certainly don't seem to be. Again, one of the nuances of the probe card business is the probe cards are specific to individual customer chip designs. And so they came to be not a very useful thing to try and hold inventory on. Because as our customer’s production mix changes, that results. Very high overhead expense to build that optionality.

So part of the reason why we run on such short lead times, because our customer’s production mix changes. We need to be ready to adapt, to go support them and capture that upside. Prepared to again, really not a great item to have on the inventory shelf from a financial perspective..

My second question is, as far as one of your large customers, let's say goes from five nanometers to three nanometers. I think we heard on another back-end equipment company's conference call this morning that the number of transistors when that happens, will probably go up by 30% or 40% and that leads to obviously an increase in test intensity.

I was wondering if you might be able to quantify what or guess that if you do see a 30% to 40% increase in transistors.

How much more, how much more probe card or test intensity might be?.

Certainly, directionally it goes up. And I think the APE people see this pretty significantly. The APE install base has to go up to deal with the increased test times associated with this. But it's not linear.

A 20% increase in transistor count for die doesn't result in a 20% test time increase because customers are good at various elements of design for test, just understanding where they can drive down their samplings and things like that. But directionally, there's definitely an uplift. And I think you've seen that in the probe card market over time.

As transistor counts have gone up on leading edge parts, you've seen the intensity of probe card spend and APE spend in the foundry and logic market go up as well..

Thank you..

Thanks, Dave..

Thank you. Our next question comes from the line of Tyler Burmeister from Craig-Hallum Capital Group LLC. Your question, please..

Thanks, guys. This is Tyler on behalf of Christian Schwab. Thanks for letting us have the question. A lot of my question's been answered. I want to go back to supply chain headwinds, and that you commented about, but at the same time, put up very strong 49% gross margins and guided Q2 to a very strong level as well.

And I think you also said, you'd expect these to begin improving in the second half. Well, we've heard from a lot of your peers and other companies in the industry, that they're seeing these pressures out of the next year.

So I was wondering, what are some of the most significant headwinds that you're seeing and what gives you confidence that those could be improved in the second half? Thanks..

Tyler, I'll let Shai answer the details, but it was my comment and I want to make sure I was not forecasting an improvement in the second half. What I was saying was, our fog lamps only go through the middle part of the year, and we see the constraints continuing through the middle part of the year.

So I am not forecasting improvements in the second half, it's just, we continue to see these challenges emerging for about as far as we can see, which is through the middle part of the year..

You've answered -- yes. I think you've answered most of the questions about that. I'll repeat some of the things I said earlier. As we see -- the supply chain issues that we see in Q2, they include inflationary cost increases in components, we see higher labor costs. And whether it's going to be stronger or weaker, as Michael said, we still don't know.

We can say that so far, we haven't seen any major disruptions to our business. We see similar logistical issues as we've seen in the past. And so fairly for Q2 versus Q1 when it comes to impact of supply chain issues, I think we're at similar level of disruption this quarter..

Fair enough. I appreciate the color, that's all for me guys. Thanks..

Thanks..

Thank you. Our next question comes from the line of David Silver from CL King & Associates, Inc. Your question, please..

Hi. Thank you very much. I have a more targeted question, then maybe a bigger picture one. First, I wanted to just ask you about the workstation engineering systems results. I guess this quarter and the fourth quarter, the revenue totals, I think are the highest, in at least several years, maybe longer.

First, I had a couple of questions about that but, firstly, maybe if you could talk about the breakdown and the revenue increase, maybe from a volume versus mix perspective. And then secondly, I was wondering if you could just maybe highlight how you view the cadence, of the growth in that business.

In other words, is this a business that rises co-incident with new fab development, is it ahead maybe 6 to 12 months or how should we think about the growth trend in relation to fab development and WFE spend modeling going forward? Thank you..

So the systems segment -- I'll answer the second part of the question first. It is focused on helping customers develop entirely new process technologies. Now, as I've said in the past, that can be things like gate all around, CMOS structures.

But it's also where we've made some significant investments in helping the emerging quantum computing industry get on its feet and be able to test these devices and improve its yield. So it's a broad spectrum of early development activities. And as a result, it's not very well correlated with WFE.

It tends to be more correlated with essentially, the velocity of customer development programs, as they continue to develop news things and introduce new things, that's what really drives the activity in that segment for us. Now, that's the first part of the question, the composition of why we're at these levels.

You can think of the engineering systems business at present as a few different components. We got into this business with the 2016, acquisition of Cascade Microtech, which brought us first into the engineering probers business, as well as the RF probe card business. The engineering progress business inside the system segment has been the foundation.

And we've done a nice job, I think, of growing that since the acquisition. But we've also added two significant acquisitions for the segment. The first being the acquisition of FRT, which got into metrology and inspection for advanced packaging applications.

Again, this theme of chiplet or tile-based strategies drives all kinds of new metrology and inspection requirements and this is a place where we want to be advanced.

Packaging is a big perform factor so that's an element of growth and revenue on top of the if you like, the legacy systems business and the second one is our acquisition of HPD, which Bob this into good quantum computing space.

So really the revenues up year, $40 million are the result of the composition of these different businesses and then the growth is resolve it some of the more exciting things we're doing with each of these different businesses in enabling the next-generation of semiconductor and electronics technology..

Okay. Thanks. And then, Michael, I heard you say a couple of times on this call you don't like to look too far over the horizon, but I'm going to just give it a crack here. There's been a number of announcements for new $10 billion plus fab developments in the U.S. A lot of your existing customers are included on those lists.

And to go by the announcements, virtually, all of them are due to be up and running by 2024, maybe 2025 at the outside, excluding maybe some of the Ohio projects. But for the ones that have been announced, a couple of things.

Firstly, do you believe the timetables? And secondly, if you do, then what does that mean for your company to capture at least your share of the overall opportunity, if not large? What incremental capabilities or capacity do you envision being necessary to -- like I say, to keep up with what your major customers are doing in terms of new fab development over the next three years to five years? Thank you..

Yes. Maybe to start it's not that we don't like to look too far downstream it's just that our binoculars kind of run other resolution given the lead times that we operate on.

So definitely there's longer-term discussions with these customers about how we support them in these very large capacity increases many of the fabs being here domestically in the U.S., but has been amount. I think the timeframe sort of 2024, 2025 when you look at the progress in the indicators associated with that.

I think as long as things continue on their existing trajectory that seems like a pretty solid assumption.

And is part of the reason for our continued capacity increases, when I look at what we need to do to make sure that we continue to lead the industry and capture the probe card and systems volume associated with these large expansions in the industry is too full. It's one of the reasons why we spend in round numbers a $100 million a year on R&D.

The innovation required for to test chips on these advanced nodes to support advanced packaging.

There's some significant innovation there and clearly our strategy is to continue to invest there, to build competitive advantage, at the same time, we do need to be ready with continuing to increase capacity, as these facilities come online maybe a few years from now.

But as we talked about earlier on the call, we did get caught a little bit out of capacity in 2019 and 2020, and it takes a little while to make those investments.

So we're continuing to plan, at least giving ourselves the optionality for the longer lead time elements like buildings facilities, and manufacturing footprint to make sure we're in a position to not just have the technology, but also have the capacity to capture this demand..

Thank you very much. Appreciate it..

Okay..

Thank you. Our next question comes from the line of Amanda Scarnati from Citigroup Inc. Your question, please..

Hi. The question I have is on the leading edge versus lagging edge, and the exposure that you have between the two.

Is there a difference between margin perspective or volume perspective, between those two different periods of nodes?.

Amanda, for sure there's a volume difference. Our exposure to trailing edge nodes is less than leading edge nodes, simply because the yields on the trading edge nodes are much higher than they are in the leading edge nodes. And if your yields are higher, you don't have to do as much wafer test.

The places where we do see significant exposure to trailing edge nodes are in very demanding applications like automotive, where high temperatures are required at -- both high and low temperatures is required. Thermal management is becoming a much bigger part of our business.

And so areas like automotive, where very high quality standards and some extreme requirements, maybe not on speed or some of the other things we see on leading edge nodes, drive our volume there. But there's no question, and you can see the way we talk about the expansions in WFE in our investments in leading-edge nodes and advanced packaging.

Our business is strongly driven by leading-edge expansion, much less so the lagging edge nodes..

And as we look at the DRAM for the balance of the year, last year was obviously, a very strong year for DRAM. Does that just set you up with a bad year-over-year comp and expectations for pretty significant decline in '22? Or are there opportunities for upside as we move into the second half? I know your fog lamps don't go that far, potentially.

But maybe there's something that you're seeing in terms of new product launches, or things like that, happening in second half in DRAM that could propel it up a little higher?.

Yes. There's no question, 2021 years a tough comp in DRAM. We operated at record and near record levels for much of the year based on some very strong design activity for major customers. We do see good solid design activity. And Chris noted there is a little bit of noise around DDR5 timing, which is some of the headwind for us.

But I think this is fundamentally why we've endeavored to build a diversified set of products, customers, and markets that we serve, rather than just focused on a single market, whether it'd be DRAM foundry and logic systems, we believe the long-term stability and earnings power associated with having a diversified set of markets and customers that we serve is a lot more valuable in the long term and we're doing it to replay in any form of them.

They're all going to fluctuate quarter-to-quarter and even year-to-year. And so what we're trying to do is build this broad exposure to the revenue opportunities in the industry, so then we can run a more stable and consistent business over the different ups and downs..

Thank you..

Thanks, Amanda.

Operator?.

Yes. Thank you, ladies and gentlemen. I'd like to now hand the program back to Michael Slessor for any further remarks..

All right. Thanks, everyone for joining us today. We're excited we have on our calendars actual in-person appearances at several investor conferences here as we go through May and June, and through the summer and we're really looking forward to seeing many of you again in person and talking about the prospects for form factor in the future ahead.

Until then, take care,.

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