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

Thank you. Today the company will be discussing GAAP P&L results and some important non-GAAP results intended to supplement your understanding of the company's financials.

Reconciliations of GAAP to non-GAAP measures and other financial information are available in the press release issued today by the company and on the Investor Relations section of our 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 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 to our supply chain; the impact of regulatory changes including the recent US-China trade restrictions; the anticipated demand for products; our ability to develop, produce, and sell products and the assumptions upon which such statements are based.

These statements are subject to known and unknown risks and uncertainties 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 2022 and in our other SEC filings, which are available on the SEC's website at www.sec.gov and in our press release issued today.

Forward-looking statements are made as of today May 3rd, 2023 and we assume no obligations to update them. With that, we will now turn the call over to FormFactor's CEO, Mike Slessor. .

Thanks everyone for joining us today. FormFactor's first quarter revenue was comparable to the fourth quarter's, exceeding our outlook range due to shipments pulled in from the second quarter. We also generated significant sequential improvement in gross margin and profitability, achieving results at the top end of their ranges.

In the second quarter, we anticipate similar results as we executed against the demand environment that remains relatively stable at diminished levels.

While this cyclical downturn continues, we're carefully balancing short-term results and long-term investments with disciplined cost control to preserve quarterly profitability and protect our strong balance sheet.

We continue to invest in R&D for new product innovation and competitive differentiation as well as in the long lead-time facilities and equipment components of our capacity increase plans.

These investments are designed to produce market share gains and above-industry revenue and profit growth when we emerge from the current cyclical trough, positioning FormFactor to achieve and then surpass the levels of our current target financial model. Turning now to segment level details.

In our largest business, Foundry and Logic probe cards, revenue increased significantly in the first quarter as we benefited from multiple technology-driven wins at major foundry and IDM customers.

We expect some moderation in Foundry and Logic demand in the second quarter as customers digest these recent shipments in their initial production ramps of 5-nanometer and 3-nanometer mobile application processors, tile-based client microprocessors, and high-performance compute chips.

Advanced packaging processes like Foveros and 3D Fabric are increasingly being adopted on the leading-edge Foundry and Logic chips providing an exciting opportunity for FormFactor.

As we've noted in the past, these integration schemes drive both higher test intensity, which expands the number of probe cards required per good die out and higher test complexity which raises the performance requirements for each probe card.

Probe card architectures like FormFactor's MEMS technology are essential to meeting these challenging performance requirements at a compelling cost of ownership, while also fulfilling the short delivery lead-times that our customers' rapid and dynamic production ramps require.

In Memory, as expected, we experienced weak first quarter demand for both DRAM and Flash probe cards as each of the major memory manufacturers reduced wafer starts to consume elevated inventory levels.

However, even at these lower production levels each of our major memory customers continues to advance the road maps with new design activity and innovations like DDR5 and third-generation high-bandwidth memory, which are driving a modest expected sequential increase in second quarter DRAM revenue.

This provides insight into the unique characteristics of probe card demand. Since probe cards are a consumable specific to each customer's individual chip designs early low-volume production activity for new DDR5 and HBM designs is generating demand for new probe cards albeit at lower volume levels than we typically see in a cyclical upturn.

This new design activity extends beyond DRAM and is broad-based across our customer base and serve markets. As a result, FormFactor's design engineering teams are currently operating at full utilization as we work with customers' test engineering teams to adapt our MEMS probe card architectures to their upcoming new chip designs.

These diverse design projects span 3-nanometer processors RF bond SAW filters and HBM DRAM. And foreshadow demand acceleration for FormFactor when the industry returns to growth and these new designs ramp in volume.

Similar to Foveros and 3D Fabric and Foundry and Logic, the growth of HBM is an exciting opportunity in the DRAM market as well as the die stacking advanced packaging process increases both test intensity and test complexity of HBM products compared to standard single-die DRAM architectures.

This in turn increases both the number and complexity of probe cards required for good die out.

HBM is also a key enabler for generative artificial intelligence with one of our major DRAM customers recently stating they expect their HBM sales to increase more than 50% this year with expectations for further growth next year because of AI application's need for this higher speed memory.

With probe card lead times of typically less than a quarter, our visibility remains very limited, but we continue to be encouraged by the relatively stable overall demand for our products along with the strong new design activity we're supporting across the industry.

As is evident from the details of our outlook, we are experiencing underlying quarter-to-quarter shifts in spending between customers and markets, but our broadly diversified lab to fab product portfolio across Foundry and Logic, DRAM, and Flash probe cards together with our System Segment products enables us to compete for business across these diverse demand pools at all major customers producing the relatively stable overall top-line results we've demonstrated for the past several quarters and expect again in the second quarter.

Shifting now to Systems. Our Systems business continues to deliver strong results with revenue and gross margin at near record levels again in the first quarter and our second quarter outlook assumes record revenue.

The strength is driven by our market-leading test and measurement products for early development of applications like silicon photonics, quantum computing and advanced packaging metrology. Silicon photonics is an important and exciting driver in this segment.

Our turnkey electro optical measurement systems built on our CM300 and Summit200 engineering probers are tightly integrated with subsystems from leading partners like Keysight Technologies and PI.

Together with FormFactor's electrical probe cards these systems are enabling our customers to rapidly characterize, analyze and debug new silicon photonics devices in early development and pilot production.

Independent market research forecasts a 30-plus percent growth rate for silicon photonics devices over the next several years driven by the data center speed and power efficiency improvements that derived from co-packaged optics.

And FormFactor is well-situated to capitalize on this opportunity as silicon photonics undergoes the transition from the lab to the fab. Finally, we continue to manage export restrictions in serving domestic China semiconductor customers.

As a US-based supplier with significant exposure to the leading-edge foundry and memory technologies and customers affected by recent US-China export controls these regulations are a headwind in all of our businesses.

We believe this US-China trade headwind will persist over time and do not anticipate any relaxation of advanced semiconductor export controls. This of course provides a strong incentive for domestic China customers to onshore their supply base and deemphasize foreign suppliers like FormFactor to ensure their business continuity.

I'd like to close by reiterating that in the short-term, we're encouraged by the stabilization of demand across our diversified product and technology portfolio in the first half of 2023.

Over the longer term, we remain excited and confident in the growth prospects for FormFactor in the industry overall driven by the fundamental trends of semiconductor content growth and innovations like advanced packaging and silicon photonics.

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

Shai over to you..

Thank you, Mike, and good afternoon. As you saw in our press release and as Mike mentioned, Q1 revenues slightly exceeded the high end of our outlook range and non-GAAP gross margin and non-GAAP EPS were at the high end of the range.

First quarter revenues were $167.4 million, a 0.9% sequential increase from our fourth quarter revenues and a year-over-year decrease of 15.1% from our Q1 2022 revenue. Q1 revenues were slightly above the high end of our outlook range, mainly due to shipments pulled in from the second quarter.

Probe card segment revenues were $127.3 million in the first quarter, an increase of $3 million or 2.4% from Q4. The increase was driven by higher Foundry and Logic revenues mostly offset by decreases in DRAM and Flash revenues.

Systems segment revenues were $40.1 million in Q1, a $1.5 million increase from the record fourth quarter and comprise 24% of total company revenues slightly down from 25% in Q4. Within the probe card segment, Q4 Foundry and Logic revenues were $101.6 million, a significant 24% increase from Q4.

Foundry and Logic revenues increased to 61% of total company revenues compared to 50% in the fourth quarter. DRAM revenues were $19.8 million in Q1, $7.4 million or 27% lower than in the fourth quarter and were 12% of total quarterly revenues as compared to 16% in the fourth quarter.

Flash revenues of $5.9 million in Q1 were $9.1 million lower than in the fourth quarter and were 3.5% of total revenues in Q1 as compared to 9% in Q4. GAAP gross margin for the first quarter was 36.5% of revenues as compared to 27.2% in Q4.

Cost of revenues included $3.3 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 38.4%, 6.7 percentage points higher than the 31.7% non-GAAP gross margin in Q4. We achieved significant improvements in gross margin in the probe card segment and also delivered a higher gross margin in the Systems segment.

Our probe card segment gross margin was 34.3% in the first quarter, a significant increase of 8.8 percentage points compared to 25.5% in Q4.

The increase is due to the net effect of the following four factors; first, four percentage points of the increase relates to improved manufacturing expenses such as lower wafer processing cost and better production is.

Second, three percentage points is due to a more favorable revenue mix with higher Foundry and Logic revenues and lower memory revenues. And third, three percentage points relates to a lower excess and obsolete inventory reserve. Partially offsetting these three positive factors is a two percentage point decrease related to lower factory utilization.

In terms of labor cost, we achieved a full quarter of restructuring plan savings in the first quarter versus about one-third of the savings in Q4. In comparing Q1 to Q4, these additional savings were mostly offset by lower PTL taken in the first quarter and the typical beginning of the year impact of the annual benefits reset.

Our Q1 systems segment gross margin was 51.7%, 130 basis points higher than the 50.4% gross margin in the fourth quarter, reflecting slightly higher revenue and a more favorable mix. Our GAAP operating expenses were $61 million for the first quarter, similar to the fourth quarter.

Non-GAAP operating expenses for the first quarter were $51.2 million or 30.6% of revenues as compared with $47.9 million or 28.8% of revenues in Q4. The $3.3 million increase is primarily due to higher performance-based compensation annual benefits reset and less PTO taken.

Company non-cash expenses for the first quarter included $9.3 million for stock-based compensation, $2.9 million for the amortization of acquisition-related intangibles and depreciation of $7.6 million all at similar levels to the fourth quarter. GAAP operating income was $0.1 million for Q1 compared with GAAP operating loss of $16 million in Q4.

Non-GAAP operating income for the first quarter was $13.2 million compared with $4.8 million in the fourth quarter. GAAP net income for the first quarter was $1.3 million or $0.02 per fully diluted share compared with a GAAP net loss of $13.7 million or $0.18 per fully diluted share in the previous quarter.

The non-GAAP effective tax rate for the first quarter was 13.9%, 7.4 percentage points lower than the 21.3% in Q4. In our previous earnings call we discussed that we expected our non-GAAP effective tax rate in 2023 to decrease to 6% to 9% due to the expected benefits of the new advanced manufacturing investment credits or AMIC.

However, in accordance with the IRSs' recently issued proposed regulations, we plan to record the AMIC benefit as a reduction to our depreciation expense over the life of the assets rather than lowering our tax expenses. We have thus updated our outlook for the annual non-GAAP effective tax rate to mid-teens between 13% and 17%.

The benefit above the line to gross margins and operating expenses are not expected to be material in 2023, since the reduction in depreciation will be recognized over the service lives of the qualifying assets.

Maintaining profitability at the current reduced demand levels continues to be an important goal for us and the actions we took during Q4 to reduce our costs at the full impact in Q1, contributing to a first quarter non-GAAP net income of $12.5 million or $0.16 per fully diluted share compared to $4.1 million or $0.05 per fully diluted share in Q4.

Moving to the balance sheet and cash flows. We had negative free cash flow of $7.3 million in the first quarter compared to negative free cash flow of $5.4 million in Q1 -- sorry let me repeat that. We had a negative free cash flow of $7.3 million in the first quarter compared to negative free cash flow of $5.4 million in Q4.

Cash provided by operating activities in Q1 was $12.3 million lower than the $20.7 million in Q4. The main reason for the decrease in cash provided by operating activities is timing of both tax payments and payments from our customers. We invested $19.7 million in capital expenditures during the first quarter compared to $26.2 million in Q4.

With the core drivers underpinning our strategy still in place, we continue to execute on increasing our long lead time facilities and equipment portion of our capacity increase plan, albeit placing equipment in service at a lower rate -- at a slower rate to ensure capacity does not significantly outpace demand.

We expect CapEx for 2023 to range between $50 million and $60 million. During the quarter, we received an $18 million grant from the State of California which we plan to record as a benefit of the P&L, as we make progress in achieving the five years planned goals of headcount increases and capital investment. No P&L benefit is expected in 2023.

Overall, at quarter end, total cash and investments were $240 million, down $2 million from year-end. As of the end of the first quarter, we had one term loan remaining with a balance totaling $15.2 million. Regarding stock buyback, during the first quarter, we did not purchase additional shares under our $75 million two-year buyback program.

At Q1 quarter end, $18.6 million remained available for future repurchases. Turning to the second quarter non-GAAP outlook, as Mike mentioned, we expect Q2 revenues to be similar to Q1 with lower Foundry and Logic revenues, partially offset by higher DRAM revenues and expected record revenues from our Systems segment.

This demand results in a Q2 revenue outlook of $162 million plus or minus $5 million. Second quarter non-GAAP gross margin is expected to be 38%, plus or minus 150 basis points.

The impact of slightly lower revenue and a less favorable product mix within the probe card segment is forecasted to be offset by increased higher-margin systems segment revenues and lower projected E&O reserve.

At the midpoint of these outlook ranges, we expect Q2 operating expenses to be $52 million plus or minus $1 million, with the $1 million to $2 million increase as compared to Q1 mainly due to additional investments in R&D. Non-GAAP earnings per fully diluted share for Q2 is expected to be $0.12, 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?.

Thank you [Operator Instructions] Our first question comes from the line of Brian Chin of Stifel. Your question, please, Brian..

Hi, there. Thank you. Good afternoon and appreciate everyone. I will ask a few questions. Maybe to start with on gross margins, I know that mix plays a role certainly in how gross margins trend from here.

But what quarterly revenue in up level do you need to bring gross margins to sort of the 40% or let's say below 40% level? And I know kind of the second part of that is that, although all caveats typically apply in terms of limitations to your visibility, what would be the more likely drivers that would drive a sequential pickup that's needed to get to those revenue levels or maybe even beyond in the second half of the year?.

Sure, Brian. I'll take that. I think if I try to draw a trend line, I would say that, at the current revenue level is 160-something, 165 maybe a quarter, we expect to be at the high 30s. We saw 38.4%, we're talking about midpoint of 38% in Q2.

If you go back to Q3 of last year, once we get back to these revenue levels of around 180, we expect gross margin to be around 42%. And once we get to the 200 million level on a quarterly basis, we expect to see gross margins around our target model of 47% as we saw in the first half of 2022.

We need that increase to come mainly from Foundry and Logic, which is our higher margin market within the probe cards business to support these increases over this trend line. It's going to continue to fluctuate based on mix as you noted. But this trend line I think represents our thinking on this subject..

Okay. And then maybe even to expand on that and maybe also pull Mike in here as well. I guess the commentary you saw a little bit of pull-ins, pull-forward in Q1, drove some higher revenue, additional sequential for Foundry and Logic.

Is the right way to think about that if some of these initial ramps that those probe cards are against in terms of flagship smartphones, PCs, et cetera? If those ramps progress then there's potential for sort of follow-on orders or activities that could happen maybe in 3Q and that would sort of be the catalyst to start to drive revenues higher in the second half of the year.

What's kind of maybe the right way to think about how revenue can move from here?.

Yes, Brian, this is Mike. I'll take that. The pull-ins from what we currently thought we're going to be Q2 net into Q1 that led to revenue above the top end of the range, it really came from three places. One, we have some very short lead time products. RF is a good example, where there's perishable demand to meet a specific customer wafer out schedule.

And if we can ship it on time, we get the business. If we can't ship it on time, we don't. And so those are ones where we had a little bit more in Q1 than we thought we'd might. We had a few specific customer requests to accelerate delivery on specific designs, mostly associated with the ramps that you talked about.

There's some pretty prominent ramps in the industry, flagship smartphone, Aps, tile-based client microprocessors that are going on right now. And some of those wafer out schedules accelerated, a little bit. And we had some recognition of deferred revenue in Q1, that we didn't think we'd get until Q2.

As we look forward now to the second half, as you noted we have very limited visibility given the lead times we have.

But I think if we see, in demand in some of these areas, whether they be mobile handsets, whether they be client PCs, start to pick up a little bit and our customers start to more aggressively ramp those particular devices I think, we could see some upside.

Right now, we're as we said, reasonably pleased that we've sized the business for current levels, which as we go through the middle part of the year, appear to be kind of a baseline stable demand level that we're operating to. But the factors you talked about, could lead to some upside.

We don't have any visibility to that upside at this point, but longer term it's part of the reason why we're continuing to invest in capacity and R&D. .

Okay. All right. That’s helpful. Thank you..

Thanks..

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

Yes. Good afternoon. I appreciate the chance to ask the questions. I guess first of all, it sound like you had some really strong design activity during the quarter.

And I'm curious -- are these are the new designs more design-intensive on your part going forward? And are you capacity constrained on design, at this point?.

Yes, so we did make the point that our design teams are very busy, working with customer test engineering teams essentially, on the next generation of devices things like high bandwidth memory, DDR5 and some of the 3-nanometer foundry parts. This is essentially feeding the future for us.

As you know, probe cards are specific to each customer chip design. And although, things are not ramping in significant volume right now, all of this design work that's going on, I wouldn't cast it as being much more complex than we've had for the past couple of years.

But our design teams, are very busy across the customer end markets essentially getting first articles ready, making sure we're -- our technology will work for these future designs and shifting a handful of probe cards, that then customers can validate, so that once these new designs do ramp in volume, when we get to an upturn in growth in the industry, we're able to produce them and produce them in a high-quality predictable way.

.

So how much of your activity is based on design to a node versus design to a very specific chip itself?.

It's all the latter, right? You basically get qualified for a node or a set of requirements, 3-nanometer foundry is a good example, and you need to have the right mechanical and electrical characteristics to essentially accommodate the envelope of different specific chip designs, that are going to be produced on that node.

But then our design team goes to work with the foundry, with the fabless customer, to customize that architecture that MEMS probe architecture, to each individual chip design, so that we're ready to go when those individual chip designs for example, a 3-nanometer application processor that's ramping in the middle part of the year, were able to produce that probe cards as I said, in a high-quality predictable way and the architecture is validated on it.

.

Great. Very helpful. And then, for a follow-up moving to China, how big was China for you in the quarter? And it sounds like you expect that business to kind of decline over time.

What kind of tail, do you think there is there?.

Yes. It's an interesting question. So, we do post our regional revenues in on our Investor Relations website, so you can go look at how the world broke down. I think, we were something like 27 million in China in the quarter. Now that's -- we haven't been that low in quite a while. That's composed, as it always is, of two components.

One is, shipments to the multinationals that operate in the region. We have some large customers, large global customers who operate both Memory and Foundry and Logic operations in the region, and so they'll have a shift to those factories depending on where their production activity is.

The part, I'm really referring to declining over time is, supporting the domestic China customers. And the time line for that, we're still trying to figure out. Clearly, with the export controls, export restrictions with us as a US supplier, we're limited in our ability to provide and support leading-edge advanced semiconductor projects.

And really form factors leverage to advanced nodes and the leading edge. If you think about our systems business, we're enabling new capabilities there. The probe card business really has high test intensity on leading-edge nodes, new designs, complex designs where customers don't have great yields and need to improve those yields.

And so, where some of the WFE manufacturers have been talking about trailing edge opportunity in China, we're not exposed to a lot of that. And so, I do think over the next couple of years, let's call it, we're going to see that business drop to pretty de minimis levels..

Okay. I appreciate your time, Mike..

Thanks, Tom..

Thank you. Our next question comes from the line of David Duley of Steelhead. Please go ahead, David..

Yes. Thanks for taking my question. I have a couple technology questions. As far as in your Foundry and Logic probe card business, I know one of your big customers now is in production with a chiplet module type product.

I was wondering now that you've seen that in production, what sort of increases in probe card intensity are you seeing from that chiplet or module strategy whatever that might refer to..

Yes. This is one we've talked about in the past and I think some of the APE manufacturers have talked about in the past as well. Typically, on a like-for-like basis, we're seeing somewhere between a 20% and 25% increase in what we call test intensity. And loosely speaking that's the number of probe cards required per good die out.

And that comes from a couple of different reasons. One, fundamentally you're breaking what used to be one chip up into multiple chiplets. And so that requires an individual probe card for each of the chiplet.

If that was done perfectly, efficiently there wouldn't be an uplift there, but you need buffer probe cards and different elements like that, that do cause an increase. The more significant part of the increase really is associated with the move towards something close to what people call known good die.

You can imagine if you're going to stack eight chiplets together, you want to have very high confidence that each of those chiplets is good before you commit it to the stack, because it turns out there's not a lot of rework or redundancy in these chiplet architectures.

So customers are testing these chiplets much more comprehensively than they might test a single die package. And that's really what's responsible for the increase in intensity, something like 20% to 25% that we're seeing..

Okay. As my follow-up along the same lines, I think, you referred to it in your prepared remarks where you're seeing kind of a large increase in probe intensity in the high-bandwidth memory, specifically for AI-type applications.

I think, Mike, you might have said 5 or 7 times increase in the number of memory devices in one of the servers for an AI server or application.

Could you just talk or elaborate a little bit more about that?.

Sure. Well, HBM has been a pretty interesting opportunity for us over the years. We're now working on new designs for the third generation of HBM. And we -- as you know, we've had a couple of our customers talk about the demand for high-bandwidth memory in AI modules. So it's going to be a driver as we move through this adoption cycle of AI.

The interesting part for us as a provider of test consumables and probe cards is that, HBM is built essentially on a chiplet architecture. You have multiple DRAM die, up to 16 DRAM die that are stacked up to build this end HBM product. And each of those die needs to be individually tested.

Again, the same theme associated with something close to known good die being required for each of them. And you have extra insertions just because customers want to check the stack as it gets built up over -- as it goes from four die to eight die to 16 die. And so, you've seen our DRAM in previous quarters in past years.

Our DRAM revenues get up close to and exceed $40 million. A lot of that has been driven by adoption in ramps associated with HBM, with high-bandwidth memory. So another interesting opportunity where advanced packaging driving probe card intensity up..

And I'm sorry just as a follow-up to that.

Do you think that your high-bandwidth memory portion of your memory business is going to see a big uptick from AI since there's so much more per server?.

It's hard to say at this point, right? We're early in an adoption curve. There's no question directionally that AI requires more high-bandwidth memory. We talked about one of our customers talking about a 50% growth rate in their HBM business.

But, how much that is in relation to our overall DRAM probe card business and what that adoption curve looks like over time, I think are still open questions that we're going to see. But there's no question the direction is positive for us..

Thank you..

Thanks, Dave..

Thank you. Our next question comes from the line of Christian Schwab of Craig-Hallum. Your question please, Christian..

Hey, great. Hey, thanks guys. Just a quick follow-up on that Mike on the high-bandwidth memory.

So, if your largest memory customer continues to dominate that market and obviously we're taking off 20% of production and then after they get supply and demand imbalance in the memory market then they're going to increase utilization rates and they're going to tweak the equipment before they buy a ton more capacity.

So, probably a longer cycle, right? But on the high-bandwidth memory side, your commentary, should AI accelerate as some people assume it does.

I mean could that leading customer drive your DRAM business back into the 30 million category, even if we're still in a low and memory CapEx spending for adding new wafers?.

I think there's that possibility. Again, we're seeing and forecasting a sequential uptick in our DRAM revenue here in the second quarter off pretty low levels. I think in round numbers we were about $20 million in DRAM revenue for the first quarter, expecting to come up off of that. But obviously WFE is not coming up in Q1 to Q2.

And it's another interesting example where probe cards, is a design-specific piece of tooling. A design-specific consumable can be decoupled from WFE. If everything goes right and we do see a strong ramp associated with HBM and it becomes a major part of DRAM wafer starts, sure.

Even in a cyclical memory downturn that could provide enough uplift to get us up into the 30s per quarter. But again, it's not something -- we're not calling the term in DRAM here.

We're just highlighting one of the interesting opportunities that we have here in the second quarter and in front of us that really is helping our overall probe card revenue..

Right.

And the other thing that's kind of helping you correct me if I'm wrong in DRAM is the fact that we finally have working silicon from everybody out there for DDR5, right?.

Yes..

So, we have DDR5 for -- I don’t know, how -- a long time. But now we finally have the working silicon out there. We should certainly will accelerate the movement to there, because the memory prices for the manufacturers will be materially higher than DDR4. So, that's more wind at the back.

Is that more important than HBM or is HBM more important?.

I feel like HBM is more important because of the test intensity associated with the advanced packaging structure that HBM is built on. If we can see that become a significant part of wafer starts driven by AI, I think there's a lot more uplift there. DDR5 that transition is good.

As you note, the ASPs are higher, but it has been probably the slowest data rate transition, DRAM architecture transition in my career. We're still doing a reasonable amount of DDR4 in both mobile server -- in mobile server and PC on DDR4..

Okay. And then my last question talking about slow migrations. Your largest customer appears to possibly have fixed their ALs and it's in the process of rolling out five new generations of chips in four years versus trying to have a 14-nanometer chip compete with a 7-nanometer chip and lose market share everywhere.

So I saw that you guys saw some sequential growth there. And in your prepared comments you suggested that certain trends in the industry you could surpass your previous model expectations. It's just kind of math.

If they're successful that's materially good news for you correct?.

Sure of course. We have worked hard to diversify our customer base and business by growing elsewhere and growing in different segments. The systems business is a good example now up in the neighborhood and above $40 million a quarter. But how our largest customer goes right is obviously a key driver for FormFactor's success.

I'd also argue it's pretty important for the industry right? There's always been a technology pioneer a technology leader. And as they work on things like tile-based architectures I think the whole industry will benefit if they're able to accelerate and really execute on pushing the Foundry and Logic technology platform forward..

Great. Perfect. Thanks. No question. Thanks..

Thanks, Christian..

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

Yeah. Thanks for taking the question, and thanks for all the color so far guys. I wanted to start off just picking up on the last question with the largest customer. It was great to see the mix increased about 350 basis points quarter-on-quarter.

The question Mike is of that 350 basis points and knowing that you are trying to win back share at that customer this year how much of the increase in mix is that customer just executing better on their own road maps more consistently to the prior point more consistent with their nodes? And how much of that would have been share gain or form in programs that you may not have had last year or maybe new programs this year?.

Yeah. I think market share across the board has become a very important initiative for us, right? It's no secret certainly to the people on this call that we lost share in Foundry and Logic our biggest business in 2022 to our primary competitor.

But it's also we've been pretty transparent with you that, we've recommitted ourselves to share gains made some organizational changes, and people changes and compensation changes to really focus the team on market share.

As you note in Q1, we did see a good improvement there, but it's been our experience over the years that market share is not a one-quarter event, right? You can have different designs that you won different designs that your competitor won that can shift share in any given quarter depending on who's spending and who's the incumbent.

So this is going to continue to be an area of focus for FormFactor both at our largest customer but across the customer base as we continue to compete with our major customers our major competitors in Foundry and Logic in Memory and then in Systems. .

So is it fair to say Mike that to the extent there was short gain in 1Q that you think there's still a considerable ways to go until you're happy with the share you recapture to that customer?.

Absolutely. I think the way we think about it is you need to make small steps forward. It seems like there was some progress forward in Q1, but in no way would I call us satisfied with what we've accomplished. This is very much a work in progress..

As you look at the potential of getting back to more normalized high 20s to mid-30s level, can you just talk a little bit more about how you build the layer cake? High-bandwidth memory I think is a pretty small part of total server DRAM memory, but obviously very part intensive.

How much is that -- how much is just getting a lot more DDR5 volume on PCs and into smartphones? And how much is going to be other things? Just and not looking for a particular time, but as you see, getting back to a normalized shipment level, how do the pieces stack up?.

Yeah. I think if you build the layer cake as you said, it's going to require a couple of things. Obviously, DRAM end-markets are very weak. And I think it's clear that all of our customers are under shifting in demand to try and consume some of the persistently high inventory that's still out there.

So the first thing that has to happen is that, DRAM supply and demand get back into balance and essentially our customers start to ship to the actual demand that's out there. They all seem to have a slightly different view of when that's going to happen but that very much is probably the first piece of the layer cake and getting back to the mid-30s.

The second piece some of the stuff that Christian talked about in his question DDR5 will drive new memory designs. New memory designs require new fleets of probe cards. And certainly there's DDR5 in the mix a significant amount of DDR5 in the mix right now. But I think more DDR5 is probably a piece to that.

If we see adoption of that take off a little bit. And then, the third piece is we stack up the layer cake and the part that you probably inferred from my comments, I'm most excited about is HBM.

And it's exciting because it is yet another example of the industry moving to back-end integration and advanced packaging to drive its innovation road map forward. It's cool to be helping enable AI which is a fundamentally game-changing technology for the world and semiconductors are underpinning it.

And then finally, when you think about our advanced packaging and as you noted the high probe card intensity associated with advanced packaging, it's an outsized opportunity for us on a per wafer star basis. So I think it's probably the icing on the cake right now but probably becomes a bigger part of the cake if all these things line up for us..

Got it. And then the last question. Just looking at the supplemental materials I noticed Samsung wasn't listed as one of the 10% revenue customers.

Is that simply because they haven't been over the last five quarters, or was there any other reason why they dropped off? And can you just comment on how you're feeling about both on the DRAM and then on the Foundry and Logic side of that customer's business?.

Yeah. We had a few customers that have been on the 10% list that we're awfully close, right in Q1. And then, just the way the numbers worked out they didn't make the 10% list. So I wouldn't interpret it as anything significant. Getting back to the share topic, the comments I made about share in Foundry and Logic apply across the board.

We've refocused ourselves refocused our processes our incentives on making sure that we're delivering technology that drives share gains. These are segments where you only have really two suppliers that are able to deliver into the advanced requirements. And those are -- so we're investing in R&D.

So we have compelling products that we can charge a premium for drive gross margins up deliver value to our customers and gain share at the same time..

Got it. Clear message. Thanks for the help, Mike..

Thanks Craig..

Thank you. [Operator Instructions] Thank you. Our next question comes from the line of Krish Sankar of Cowen. Your line is open Mr. Krish..

This is Robert Mertens on for Krish.

Thank you for taking my questions and congrats on navigating through a difficult industry environment, I guess just to start off, I know, we've talked a bit about it but, on the gross margin side of things it looks like you're expecting 40 basis point contraction to the margins in the June quarter with sales slightly down and the mix shift more DRAM and less the Foundry and Logic compared to the first quarter.

Could you just give some of the puts and takes into the June quarter gross margin guide? Are there any incremental margin drivers expected from the cost reduction plan or manufacturing efficiencies that are baked in there?.

So, you listed most of the items. The restructuring cost reduction is already baked into Q1, so continue to impact us in Q2. We're talking about similar production levels so no changes there. The things that move the 38.4 in Q1 to a midpoint of 38 in Q2 is the factors you talked about. I can repeat them.

We're talking about overall lower -- slightly lower revenue, 162 is the midpoint of the range versus 167. So, that has a negative impact. The lower Foundry and Logic and higher Memory also have a negative impact.

And these are partially offset by the fact that that we expect a record systems revenue which means higher margin impact because the Systems segment has the highest gross margin for us. And we also expect less P&O in Q2 after high E&Os in Q4 of last year and still elevated in Q1, but kind of normalized in Q2..

Great, got it. And then just one more if I can. In terms of the systems business, obviously, it's been performing really well and capitalizing on the lab-to-fab strategy.

I was just trying to see if there's any way to parse out the current demand strength from a handful of technologies or specific R&D projects or is it sort of more broad-based a lot of different components in that side of the business? Thanks..

The systems business does tend to be pretty broad-based. You're dealing thematically with new technologies. We've talked on this call about silicon photonics. Last call I think we talked about silicon carbide a little bit.

Our investments in cryogenics for quantum computing tests are in that bucket, metrology and inspection for advanced packaging in there as well. So, it's a pretty broad spectrum of applications. But the common theme to them is you're working with customers in their very early development, things that will come to production for several years from now.

And that gives us I think some strategic value out of the systems business because we get foresight into some of these applications which are going to go to production and get us better equipped to deal with them when they get to the fab things like CMOS image sensors VCSELs have been nice examples of that where we've taken engagement systems business -- engagement from the systems business and turn them into production probe card products.

The other piece obviously, as Shai noted, it's a pretty good financial contributor.

And we've seen some the nice growth out of it, but nice growth with good profitability especially on the gross margin line helped buffer the cyclical downturn in the overall semiconductor industry in the probe card business, which is heavily levered to new design activity and ramping that new design activity, which given the current downturn across the industry customers have pulled back pretty significantly on ramping new products.

.

Got it. Thank you. That’s very helpful..

Thanks..

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

Thank you. Thank you for taking my question. Hey Mike and Shai, I think you went through several very detailed questions about quite a few corners of your business with various analysts asking questions ahead of me. I'm going to ask a little bit higher-level question.

I think in the second half last year on the way down in terms of the business you mentioned about design starts design projects getting optimized some got reduced and the existing surviving design actually the volume got adjusted downward.

So, I just want to ask you as where we stand in early in early May? What do you see in terms of those two vectors the design starts and the volume specific to each design starts? Are design starts coming back? Obviously, volume may not come back yet but I just want to get some thoughts on that regard. Thank you..

Yes, it is an interesting question Charles because we -- and we tried to touch on it in the prepared remarks. We are seeing very strong new design activity. So, this is where our design teams are working with customer test engineering teams to make sure we have first articles validated probe cards for when they do ramp their new designs and volume.

Now the things that are ramping in volume, you can count on – well, there's not a lot of them and they're not ramping at high volume. As you can see from overall industry levels from our customers' narratives from our revenue. But we wanted to point out to people that we have seen a return of this new design activity.

Even though these things aren't ramping in volume, they position us well for when the industry does return to growth to really be ready to ramp these new designs and volume. The quantitative piece of it our design teams, which we really didn't downsize at all in our restructuring in Q3 are operating at full capacity.

And so that's a very different situation than it was in the second half as you say on the way down. Strong design activity we're going to be ready when these designs ramp, but they are not ramping now. And as we said, we feel like we're in a trough through the middle part of the year.

When growth does return to the industry if it's late this year or next year, I'm pretty optimistic that we've won some designs that are going to help drive our revenue forward towards the target model..

Thanks Mike. I want to ask specifically about the part of the revenue exposed to mobile. Obviously, I want to exclude the discussion around microprocessor and high-performance compute here for a bit. On the mobile side, I think I did hear you some pull-ins for on the RF side of your business.

But any other green shoots, are you seeing right now in the SoC side of the mobile business for you? Maybe let's exclude the iOS side of the business. Because there seems to be some seasonality in Q4 or Q1 but going into Q2, do you see some moderate recovery in the mobile business on the SoC side or RF side? Thank you..

Yeah. So mobile for us is pretty broad-based. And if you look at FormFactor over the past several years, mobile handset growth and 5G adoption have been a big driver for us. Obviously that's pretty weak right now both from a component standpoint, but also from an end to handset market standpoint.

One of the things we're working on pretty aggressively here in the first part of the year is making sure that we've got the technology in place to ramp on some of the major mobile application processor designs in the industry. As they move to 3-nanometer foundry platforms there are some new requirements there that we've had to deliver.

Some of that was a contributor to Q1. We said we expected a little bit of digestion here in Q2 given the volumes we ship. But I think more broadly, we need to see whether it's SoC or application processor or the RF component side.

I think we need to see a return to broad-based handset growth in both the Android and the iOS ecosystems to really drive that business forward..

Got it. Maybe lastly if I may. Mike, the DRAM business I thought you were expecting another leg down in the middle of the year when a quarter ago, but it looks like that lag down is already here looking at the DRAM revenue numbers.

I just want to ask, are you still expecting another lag down, or you think maybe Q1 would be the low watermark for the DRAM business? Maybe the modest growth into Q2 there is more left to go into the second half of the year? Thank you..

Yeah. We're not -- to be clear we're not calling a turn in DRAM. This move -- the sequential move up Q1 off a very weak Q1 into Q2 is really associated with some of the specific DDR5 and HBM activity that we talked about.

With the lead times that we have and with the trajectory of inventory consumption and new product releases and ramps in the DRAM industry, I think the jury is still out on whether this is now a return to growth.

The best case it's gradual growth, feels to me more like we're going to be moving along the bottom of a trough here until the inventory situation gets in better shape with our customers..

Thanks Michael. I owe as always for the great color. Thank you..

Thanks Charles..

Thank you. [Operator Instructions] Our next question comes from the line of Gus Richard of Northland Capital Markets. Your question please, Gus..

Yes. Thanks for taking the questions.

You talked a little bit about the transition to 3-nanometer and I'm just wondering your designers sort of intersecting is that transition broadening out beyond apps processors to AI ASICs or GPUs CPUs? Can you just talk about the mix in those apps processors have more or less probe card intensity than some of the other types of silicon. .

Yes, 3-nanometer right now for us is pretty app processor focused. On the intensity question it really depends on the details of how the customer is testing and what their overall test strategy is.

A great example of that I'll go back and tie it to advanced packaging, right? If 3-nanometer is used for a set of chiplets that's going to have relatively higher test intensity whether it's an HPC part or a mobile part compared to a monolithic die because of the trend towards known good die that we talked about earlier in the Q&A session.

So there's -- I wouldn't say there's a broad-based rule of thumb for HPC being more intensive than apps processors or vice versa, but I would say that if any of those chiplets end up in advanced packages to drive then the end product we are seeing a significant increase in testing….

Got it. And then in your systems business I think you highlighted silicon photonics in your prepared comments.

I'm just wondering how close is that moving to commercialization? Is it a handful of customers or is it just light vendor? Any -- any color around how you see that unfolding over the next 6 months to 18 months?.

Yes. Well that’s a -- probably reaching -- there are a couple of customers that are already in production. Now they're pretty niche applications. I think the exciting part for us is we're seeing more and more potential customers in this market. As people pursue the value of co-packaged optics and integrating them into data center architectures.

The power benefits, the speed benefits are awfully compelling. But if you want to look at it when's it going to materially affect our customers' P&Ls and probably our P&Ls that's going to be closer to 18 months than it is six months in the time frame you gave. .

Okay. Okay. And it's a handful of customers that are doing this at this point. .

Yes. .

Very good. Thank you so much..

Thanks, Gus..

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

Great. Thanks everybody for joining us today. Thanks for some of the questions that allowed us to describe our view of the industry and its current state.

We're signed up to do several sell-side conferences in the months of May and June so we hope to see you at one of those and be able to answer more questions and update you on FormFactor's progress as we work through this cyclical downturn. Have a great day and take care. .

This concludes today's conference call. Thank you for participating. You may now disconnect..