FormFactor, Inc.

Thank you and welcome everyone to FormFactor's first quarter 2022 earnings conference call. On today's call are Chief Executive Officer Mike Schleser and Chief Financial Officer Shai Shahar. Before we begin, Stan Fickelstein, 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 include those with respect to the projections of financial, and business performance, future macroeconomic and geopolitical conditions, the benefits of acquisitions and investments in capacity and in new technologies, the impacts of the COVID-19 pandemic, anticipated industry trends, the disruptions 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 its 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 27, 2022, and we assume no obligation to update them. With that, we will now turn the call over to FormFactors CEO, Mike Thresser.

Mike, thanks, Dan, 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 Tiger 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 component 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 have helped us partially mitigate the effect of these headwinds and have 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 front. 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 honors. 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, with the expected decline in RF offset by stronger Foundry demand. Both the top Foundry and the largest Logic IBM 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, phogoros, 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 route, 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. with the short delivery lead times needed to support our customers' rapid and dynamic production ramps. To maintain our competitive advantage, we are 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 to the first quarter. New design activity from each of the major DRAM manufacturers remains 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. Our 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 Lab2Fab strategy. These engagements range from 300 millimeter wafer probers for mainstream two nanometer CMOS development to optical metrology and inspection tools for yield improvement in advanced packaging and chiplet applications to wafer and chip scale cryogenic probers for development 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 of non-GAAP earnings per share on $850 million of revenue. There continue to be challenges to overcome for both form factor 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, Mike, and good afternoon. As you saw in our press release and as Mike 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 the high end of our 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 Q421 record quarterly revenue, and an increase of 6% year-over-year. Probe cart segment revenues were $160 million in the first quarter, a decrease of $6 million, or 4% from Q4 21. The decrease was driven by lower DRM revenue. System segment revenues were $37 million in Q1, a decrease of $2 million, or 5% from the fourth quarter. Within the probe cart segment, Q1 Foundry and Logic 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 17% 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 with the fourth quarter, And we're 6% of total revenues in Q1, same as in Q4. GAAP gross margin for the first quarter was 47.8% of revenues. That's 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 issue 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 cart segment. The increase as compared to our outlook is mainly due to revenue at the high end of the range, a more favorable product mix, lower manufacturing costs, and higher utilization. Our probe cut 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, freight, 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 gap 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. The $2.2 million increase relates mainly to the annual benefits and tax reset, higher ed count, and higher travel expenses. Company non-cash expenses for the first quarter included $7.5 million for stock risk compensation, and $2.4 million for the monetization of acquisition-related intangibles, both of which are at similar levels to the fourth quarter, and depreciation of $7 million, $0.5 million 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. Now 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 annual 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 benefits, also known as FDII, and thus a lower effective tax rate. We expect to be on the lower end of this 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 NAMGAP pre-tax income until we fully utilize our remaining U.S.-based R&D credits. First quarter NAMGAP net income was a record $38.7 billion, or $0.49 per fully diluted share, compared to $34.7 billion, 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 range, 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 sequential increase in free cash flow reflects the increase in profitability, as capital expenditures were at a similar level in the previous quarter. As of the end of the first quarter, we had two terminals remaining on 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 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 extensions. Regarding stock buyback, during the first quarter, we purchased 241,000 shares under our existing $50 million two-year repurchase plan. These brings our repurchases through the end of Q1 to 863,000 shares. At quarter end, $16.6 million remained available for future repurchases. Turning to the second quarter non-GAAP outlook. As Mike mentioned, we expect the strong momentum to continue in the second quarter with sequential increase mainly in Foundry and Logic. These factors result in a Q2 revenue outlook of $203 million plus or minus $6 million. Non-GAAP gross margin for the second quarter is expected to be 47% 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 $2-3 million, mainly due to additional hiring and annual salary increases. Non-GAAP earnings per fully diluted share for Q2 is expected to be $0.43 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 we issued today. With that, let's open the call for questions. Operator?

Certainly. Ladies and gentlemen, if you have a question at this time, please press star and then 1 on your touchstone telephone. If your question has been answered and you'd like to remove yourself from the queue, please press the pound key. Our first question comes from the line of Krishankar from Cowening Company. Your question, please. Hi.

Thanks for taking my question. I had a couple of them, and congrats on the really strong results, Mike and Shai. You kind of mentioned that one of the reasons for the gross margin in June was to be down relative to March is because of the higher manufacturing costs. I'm just kind of curious, given the fact that DRAM is 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, looks like really good margins in June too, but I thought it'd be much better given DRAM mix is lower.

Yeah, thanks, Chris, 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 BRM is going to be kind of comparable, but F&O is going to go up, it doesn't necessarily mean that product mix will be better. So 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 is expected to result in lower absorption and higher manufacturing expenses in Q2. Now, Q2 midpoint of our outlook range is 47%, plus or minus 150 basis points, which is our target model, so we are very encouraged by that.

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

Chris, it's Mike. I'll take that. I think it's continued over the past six 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. We have 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 pushouts per se. We've got a broad mix of DDR4 and DDR5 designs running through the factory. with all the major DRAM manufacturers. And in any quarter, we expect those to ebb and flow a little bit.

And if we could just squeeze in one along that path, Mike, is there any margin differential between DDR4 and DDR5 probe cards?

Not systematically. I mean, as Shai said, we do see gross margin differences from different designs. So different DRAM designs, regardless of whether they're DDR4 or DDR5, can bear significantly different gross margins based on things like whether it's a single touchdown probe card, whether that probe card tests the whole way for a 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 do with the details of the configuration. That's true in DRAM. It's true in Foundry and Logic as well. Thanks a lot, Mike.

Thanks, Sean. Thanks, Rick. Thank you. Our next question comes in line. Brian Chen from Steeple. Your question, please.

Hi there. Good afternoon, and thanks for letting us ask a few questions, and congratulations again on the execution in the quarter. Maybe I definitely have to start with gross margins here again. You know, on the surface, there doesn't seem to be any wild swings in 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 kind of about sustainability of margins more at these higher levels, right? Maybe not, you know, quarter out, quarter in, quarter out above the target model, but, you know, closer to the 47% level, which is definitely higher than we've been modeling. Is it fair to say that there were some kinds of 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 unlocked something that allows you to maybe put a bigger floor under your gross margins?

Well, I would say gross margin has always been an area of focus for us. We always invest at all levels of the company on making improvements to gross margins and Our operational team is doing an excellent job on being more efficient, on having more efficient design, on securing supply at the right prices. It's been such an important strategic action for the company. This is something that I'm very happy to see good results there. These excellent results in Q1 really validate our ability to achieve our target financial model, gross margin of 47% at revenue of $850 million a year. And maybe one more point about that. We are approaching our target model. If you look at Q2 revenue output range, we are within 5% of this target model. And the growth really came from mostly Foundry and Logix. As expected, as we said, it's going to happen. So, gross margin is what we expected it to be. It will continue to fluctuate, as we said before, but it validates our ability to achieve it.

Okay, 49% is still big, I think a pretty big number, but fair enough. And I guess, you know, thinking about the CapEx plan for this year and also thinking about just 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 maybe flex up, you know, if need be towards the end of this year, you know, maybe it's next year? And also that, you know, 60 to 80 million capex, is there a way to sort of translate that into annual incremental revenue output?

I think... Go ahead, Mike. 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 multi-year 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. You know, 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 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 later market has turned out to be an equal challenge to the equipment supply.

Got it. Maybe just speaking one last one, Mike. I feel like there's increasing confidence in various sort of FoundryLogic customers, three nanometer roadmap and output in next year, IDM in terms of seven nanometer output. And yeah, I feel like this will coincide with the substantial increase attachment rate in terms of advanced packaging, architected designs. Is your confidence level increasing sort of commensurate with those things? I guess I'll stop it there.

Yeah, I think it's a great point that these advanced calendrian logic nodes, whether they be three nanometer or the 7 nanometer node at 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, chiplets, different tile-based strategies that we've 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 up 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 can 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, and 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 founder and logic market.

Okay, great. Thanks a lot.

Thanks, Brian. Thank you. Our next question comes from the line of Charles C. from Needham & Company. Your question, please.

Good afternoon, Mike and Shai. Thank you for letting me ask a couple of questions. Number one, I want to get your thoughts on your CapEx plan. Your closest competitor during the quarter went public and we got a chance to really dive into their financials. One thing that jumped out to me is that it seems like you were outspent by your competitor in CapEx over the past three years. But 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 overcapacity was quite a big issue in the early 2010s, around the time right before you became the CEO of OneFactor. Maybe that influenced a little bit your decision in terms of capacity expansion. Can you give us some thoughts on capacity expansion, CapEx strategy here, and especially I believe that the probe car demand is likely going to accelerate from here for manufacturers. Brian Chin just mentioned advanced packaging, et cetera. Thank you.

Yeah, I think it's a fair observation that 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, you know, the 2010-2011 timeframe. We also tend to be a fairly conservative executive team, and so that held us back some. But 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. 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. So our confidence level in 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 share that we 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-footed from a capacity expansion perspective in the 2019-2020 time frame.

Got it. So maybe my second question, I want to ask something more near term. The COVID lockdowns in China, I believe beginning 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 your, I mean, not exactly your peer, but the semi-cap equipment companies on two sides. One really is on the supply chain side, but the other is really the delivery side. So they probably have seen a little bit impact reflected in some of their financials. I wonder, obviously, Q1, you did manage your third your your supply very well but going to q2 what's your thought there um is your guidance kind of embed some of the risks there um for one thing you do have something like a high teens some in some quarters in the past the more than 20 of the revenue coming from china 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 I want to give us some thoughts on any of that risk factors are embedded in your guidance and how do you think about this? Thank you.

Yeah, so I would say there is a variety of supply chain headwinds we're dealing with, right? Just like everybody else, as you mentioned, including the lockdown in China. So obviously, it is a very dynamic situation. It continues to present new challenges, 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 overall 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 ourselves are to China or 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 estimate for the long-term impact.

Thank you.

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

Yeah, thanks so much for taking the question, and congratulations on the very strong execution, guys. I wanted to start with a 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 costs and utilization. So, what was the relative contribution of those four things to the upside about even or disproportionate 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. So what is it about what's happening with manufacturing costs 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 it, maybe even close to 80% of the upside came from a more favorable mix. Now, as you know, we are a turns business with lead times that can be as short as sometimes four to six weeks. So in the time, at least in the postcard business. So in the time between our previous earnings call and quarter close, revenue came in at the high end of the 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, about three-quarters of it. And the others were just contributed, each one of them, a little bit for the balance. When it comes to manufacturing expenses, as I move to Q2, so as I said, 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 higher manufacturing expenses. If you look at our balance sheet, you see that we did some inventory in Q1 to support and support the increase in the demand. So that has an impact of the timing of expenses as well.

Got it. And then just to put a bow on it, with the mix issue in the first quarter, was that primarily in the Foundry logic statement, or was that mix also something that benefited the DRAM segment, given that you know, there wasn't a lot of change on a segment-to-segment basis, so this is all intra-segment, next shift that's happening.

It's almost across the board, right? Not every design and every customer came in at a higher margin, but more than one market. I mean, even if you look at our systems business unit, also came in higher than Q1, so 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 Mike, 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 are at play as the top three OEMs move more towards heterogeneous die or or tile-based product, as you say, Mike. 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 from 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 sort of a diffusion 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. It's HBM-stacked VRAMs and things like that. And if you look at the relative number of wafer starts and probe card demand of that, it's not a very large fraction of the overall industry. But as you look at these customer roadmaps as they go through, mainly into 2023 – there's some significant adoption at significant volume of these advanced packaging technologies. And so that diffusion rate or attach rate of advanced packaging to 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. Mike, 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 want it, 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, right? If you look at our projected CapEx for 2022, it continues at essentially the same high levels we had in 2021. The efforts began in 2020. And so it's an ongoing story where, you know, if I were to point the milestones, certainly the first one, and I don't know that we'll get there in 2022, but, you know, a quarterly run rate at the model level, right? 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, you know, 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 high level is probably a 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. Your question, please.

Yeah, 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 slowdown 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, you know, 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.

Really no change in tone sort of systematically across the customer base. If you look at our large markets, our large share of markets and 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 subcomponents 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 there always has been. And we talked about RF going down sequentially. after a very strong 2021. Some of this is our RF ProCard business primarily serves the components to go into 5G handsets right now, so things like ball and saw filters, antenna and 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 point you just made, are your customers holding more inventory of either probe cards or of IC components?

They 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 tend to be not a very useful thing to try and hold inventory on because as our customer's production mix changes, that results in a very high overhead expense to build that option out. 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. Probe cards, again, really not a great item to have on the inventory shelf from a financial perspective.

Okay, my second question is, as far as one of your large customers, let's say, goes from 5 nanometers to 3 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 or guess that if you do see a 30% to 40% increase in transistors, how much more probe card or test intensive it might be?

Yeah, certainly directionally it goes up, and I think the ATE people see this pretty significantly, right? The ATE installed base has to go up to deal with the increased test times associated with this. But it's not linear, right? A 20% increase in transistor count per die doesn't result in a 20% test time increase because customers are good at various elements of design for tests, BISs, 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 sound and logic market go up as well. Thank you. Thanks, Eric.

Thank you. Our next question comes from the line of Tyler Bremmeister from Craig Hallam. Your question, please.

Thanks, guys. This is Tyler on behalf of Christian Schwab. Thanks for letting us ask the question. So, you know, a lot of my questions have been answered. I wanted to go back to, you know, kind of supply chain headwinds that you commented about, you know, but at the same time put up a very strong 49% gross margins and, you know, guided Q2 to a very strong level as well. And I think you also said, you know, you'd expect these to begin improving in the second half, where we've heard from a lot of your peers and other companies in the industry that, you know, they're seeing these pressures out at next year. So I guess I was just wondering, you know, maybe, you know, what are some of the most significant headwinds that you're seeing and what gives you confidence that those could be improving 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 improvement 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.

Yeah. And I think it answers. Yeah. So I think it answers most of the question, but I'll repeat some of the things I said earlier, right? We see, um, The supply chain issues that we see in Institute 2, they include stationary cost increases in components. We see higher labor costs. Whether it's going to be stronger or weaker, as Mike 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. If I look at Q2 versus Q1 when it comes to the impact of supply chain issues, I think we're at A similar level of disruption, let's call it.

All right. Fair enough. Appreciate the color. That's all from me, guys. Thanks.

Thanks. Thank you. Our next question comes from the line. David Silver from CL King. Your question, please. Yeah.

Hi. Thank you very much. I have kind of a more targeted question than 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. 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 coincident with new FAB development? Is it ahead maybe six to 12 months? Or how should we think about the growth trend in relation to FAB development and WFE spend? you know, modeling that going forward. Thank you.

Yeah. So the systems segment, really, I'll answer the second part of the question first. It is really focused on helping customers develop entirely new process technologies. Now, you know, 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 its devices and improve its yields. So it's a broad spectrum of really 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 roadmaps. As they continue to develop new things and introduce new things, that's what really drives the activity in that segment for us. Now back to the first part of the question, the composition of sort 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 probers business inside the system segment really 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 to the segment, the first being the acquisition of FRT, which brought us into metrology and inspection for advanced packaging applications. Again, this theme of chiplets, 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 theme for form factor. So that's an element of growth and revenue on top of the legacy systems business. And the second one is our acquisition of HPD, which brought us into the quantum computing space. So really, the revenues up near $40 million are the result of the composition of these different businesses, and then the growth is the result of 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, Mike, I heard you say a couple 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 up 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, you know, at least your share of the overall opportunity, if not larger? I mean, what incremental capabilities or capacity, you know, do you envision being necessary to kind of, like I say, to kind of keep up with what your major customers are doing in terms of new FAB development over, you know, the next three to five years? Thank you. Yeah.

Yep. And 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 out of 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. that have been announced. I think the timeframe changes. So 2024, 2025, when you look at the progress and 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, It's twofold. It's one of the reasons why we spend, in round numbers, $100 million a year on R&D. The innovation required 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. It may be 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 footprints 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.

Thank you. Thank you. Our next question comes in line. I'm Amanda Scarnati from Citi. Your question, please.

Hi. The first question I have is on sort of 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?

So, 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, both high and low temperatures are required. Thermal management is becoming a much bigger part of our business. And so areas like automotive where very high quality standards and sort of 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 and our investments in leading edge nodes and advanced packaging. Our business is strongly driven by the leading edge expansion, much less so the the lagging edge nodes.

As we look at DRAM for the balance of the year, last year was obviously a very strong year for DRAM. Does that just set you up with sort of a bad year over year comp and expectations for a pretty significant decline in 2022? Or is there sort of 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.

Yeah, there's no question 2021 is 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 from major customers. You know, we do see good solid design activity, and Krish noted there's a little bit of noise around DDR5 timing, which is some of a headwind for us. But I think, you know, this is fundamentally why we've endeavored to build a diversified set of products, customers, and markets that we serve, rather than just focus on a single market, you know, whether it 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 than being a pure play in any one 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 that we can run a more stable and consistent business over the different ups and downs.

Perfect, thank you.

Thanks, Amanda. Operator?

Yes, thank you, ladies and gentlemen. I'd like to now hand the program back to Mike Schleser 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 and the future ahead. Until then, take care.

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