FormFactor, Inc.

thank you and welcome everyone to form factors second quarter 2022 earnings conference call on today's call our chief executive officer mike slesser and chief financial officer shai shahar before we begin stan finkelstein the company's vice president of investor relations will remind you of some important information thank you today is a company

We'll 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 disruption in our supply chain, the impacts of regulatory changes, the anticipated demand for products, our ability to develop, produce, and sell products, and the assumptions upon which such statements are based. These statements are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from those expressed during this call. Information on risk factors and uncertainties is contained in our most recent filing, on Form 10-K with the SEC for physical year ended 2021 and in our other SEC filings, which are available on the SEC's website at www.sec.gov and in our press release issued today. Forward-looking statements are made as of today, July 27, 2022, and we assume no obligation to update them. With that, we will now turn the call over to FormFactor's CEO, Mike Schleser.

Thanks, everyone, for joining us today. FormFactor again posted strong results in the second quarter, delivering the second highest quarterly revenue in company history and again exceeding the non-GAAP gross margin of our target financial model. Together with good operating expense control in the current inflationary environment, This produced earnings per share at the high end of our outlook range. The second quarter financial results and overall themes were similar to the first quarters as major customers continued to release and ramp new designs to meet demand for their products, driving strong results in our probe card business in both Foundry and Logic and DRAM. Customers also invested in their technology roadmaps with development of innovations like gate all-around transistors, advanced packaging, silicon photonics, and quantum computing, driving solid results in our systems business. During the second quarter, we made a small but important acquisition to augment our capabilities as a key supplier in the emerging quantum computing market, buying the dilution refrigerator product line of JanusULT. Dilution refrigerators are a key enabler for the operation of quantum computers, being capable of tooling qubits to the ultra-low sub-10 millikelvin temperatures required for operation of superconducting quantum computers. This acquisition makes FormFactor the largest commercial dilution refrigerator supplier in the United States, strengthening and expanding our position with key customers as the leading supplier of not just test and measurement products, but also now enabling infrastructure for quantum computing. Turning now to our third quarter outlook. Our sequentially weaker outlook is due primarily to reduced demand for Foundry and Logic probe cards from several major customers in both mobile and compute applications. As these customers adapt to the changing conditions in their end markets, driven by global macroeconomic uncertainty and inflation, They're changing their short-term wafer start and design release roadmaps by delaying selected new design releases, and in some cases reducing their volume RAM plans for specific chip designs already in production. As a reminder, probe cards are a consumable specific to each new chip design, and so changes to production volumes of individual chip designs also change the number of probe cards required to manufacture that specific design. As Shai will discuss in detail, this reduction in anticipated founder and logic demand results in a significant reduction in forecasted third quarter gross margins and earnings. We view this reduction in founder and logic probe card demand as a short-term response by our customers to changing conditions in their end markets and not a structural change in our business. Lead times for probe cards remain less than a quarter, and although the past several years have been characterized by universally robust and growing demand across all probe card segments and end markets, changes like this are not uncommon in times of rapidly changing industry conditions as customers adapt their production plans to match short-term fluctuations in their product-specific demand profile. We continue to view Foundry and Logic as an exciting long-term growth driver for FormFactor. Customers are investing in both leading-edge capacity, as evident from continued wafer fab equipment spending, and early-stage innovative advanced packaging architectures like EMIB, Foveros, and 3D Fabric. As we've noted in the past, these chiplet or tile-based integration schemes drive both higher test intensity, which expands the number of probe cards required per wafer out, and test complexity, which raises the performance requirements for the probe card. Advanced probe card architectures like FormFactor's MEMS technology are essential to meet these challenging technical requirements at a compelling cost of ownership, with a short delivery lead time needed to support our customers' rapid and dynamic production ramps. For these reasons, despite the anticipated third quarter pause in the steady and gradual progress we've made towards our target financial model, we're continuing our planned capital investments and remain committed to our target financial model and the strategy that underpins it. The main tenet of this strategy is our expanding position as a diversified supplier to the broader semiconductor and electronics industry, with defensible leadership positions serving multiple consumables and equipment market segments. Over the past few years, while each of these segments has delivered robust demand and growth, We've been consistent in our beliefs that our markets are cyclical, with each market unlikely to deliver robust growth every quarter. Operating in multiple segments with a diversified set of demand drivers allows us to better amortize our fixed cost structure, including manufacturing overhead, facilities, and global customer support infrastructure. The segment span also provides the broadest set of technology and manufacturing capabilities in our served markets, offering significant value to our customers and competitive advantage for form factor. Our third quarter outlook offers a proof point to the value of serving multiple market segments, as we anticipate that the expected reduction in founder and logic demand will be partially offset by growth in the system segment, with steady demand for DRAM and flash probe cards. We remain committed to gross margin improvement in all of our product lines, so that this diversification strategy is fully effective in mitigating the impact of these product mix shifts on both revenue and profitability. I'd like to close by affirming that we remain confident in the long-term growth prospects for the industry overall, driven by the fundamental trends of semiconductor content growth and advanced packaging. These are trends where FormFactor is well positioned as an industry and technology leader, And we're confident that our resilience and agility will drive continued growth and share gains as form factor progresses towards our target model that delivers $2 of non-GAAP earnings per share on $850 million of revenue and beyond. Shai, over to you.

Thank you, Mike, and good afternoon. As you saw in our press release, and as Mike mentioned, form factor again posted strong second quarter results. delivering the second highest quarterly revenues in company history, with revenues and gross margin above the midpoint of our outlook ranges, EPS at the high end of the range, and non-GAAP gross margin again exceeding our target financial model. Second quarter revenues were $204 million, a 3.4% sequential increase from our first quarter revenues, and an increase of 8.4% year-over-year. Probe card segment revenues were a record $167.7 million in the second quarter, an increase of $7.7 million or 4.8% from Q1. The increase was driven mainly by higher Foundry and Logic revenues. System segment revenues were $36 million in Q2, a decrease of $1 million or 2.7% from the first quarter. Within the probe card segment, Q2 Foundry and Logic revenues were a record $122 million, a 7.3% increase from Q1, comprising 60% of total company revenues, slightly higher than the 58% in the first quarter. DRAM revenues were $37 million in Q2, $2 million or 7% higher than the first quarter, and were 18% of total quarterly revenues, as compared to 70% of revenues in the first quarter. Flash revenues of $8.5 million in Q2 were $3 million lower than in the first quarter and were 4% of total revenues in Q2, lower than the 6% in Q1. GAAP gross margin for the second quarter was 46.3% of revenues, as compared to 47.8% in Q1. Cost of revenues included $2.3 million of GAAP to non-GAAP reconciling items, which we outline 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 second quarter was 47.4%, 160 basis points lower than the 49% non-GAAP gross margin in Q1, with lower gross margin in both our markets. Our ProCards segment gross margin was 46.8% in the second quarter, a decrease of 150 basis points compared to 48.3% in Q1. The decrease is mainly due to a less favorable mix, higher manufacturing headcount and spending. Our Q2 system segment gross margin was 50.5%, 170 basis points lower than the 52.2% gross margin in the first quarter. The decrease is due to lower revenue and a less favorable product mix. Our gap operating expenses were $62 million for the second quarter, $2 million higher than in the first quarter. Non-GAAP operating expenses for the second quarter were $54.5 million, or 26.7% of revenues, as compared with $51.9 million, or 26.3% of revenues in Q1. The $2.6 million increase relates mainly to an annual salary increase, higher ed count, and higher R&D project spend. Company non-cash expenses for the second quarter included $6.4 million for stock risk compensation, $1.1 million lower than in the first quarter, $2.7 million for the amortization of acquisition-related intangibles, $0.3 million higher than in the first quarter, and depreciation of $7.2 million, $0.2 million higher than in the first quarter. GAAP operating income for Q2 was $32.6 million as compared with a record $34.2 million in Q1. Non-GAAP operating income for the second quarter was $42.3 million, lower than the last quarter's record by $2.5 million. GAAP net income for the second quarter was $30 million, or $0.38 per fully diluted share, same as in the previous quarter. The non-GAAP effective tax rate for the second quarter was 14.4%, 60 basis points higher than the 13.8% in Q1. and slightly below our estimated non-GAAP annual effective tax rate of 15 to 20%. As a reminder, during the first quarter, the required capitalization of R&D expenses changed, resulting in 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 previously communicated, our annual cash tax rate is expected to remain around mid to high single digits of non-GAAP pre-tax income until we fully utilize our remaining U.S.-based R&D credits. Second quarter non-GAAP net income was $36.8 million, or $0.46 per fully diluted share, second to the record set in the first quarter of $38.7 million, or $0.49 per fully diluted share. Moving to the balance sheet and cash flows. We generated $28.3 million of free cash flow in the second quarter, similar to the record $28.7 million in Q1. Net cash provided by operations and capital expenditures were at a similar level to the previous quarter. Total cash and investments were $270 million at the end of the quarter. As of the end of the second quarter, we had two term loans remaining on our balance sheet, totaling $20 million. We invested $14.5 million in capital expenditures during the second quarter, compared to $15.6 million in Q1. As Mike mentioned, we are executing on our capacity expansion and continue to expect full-year CapEx 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 this capacity expansion. Regarding stock buyback, During the second quarter, we fully utilized our existing $50 million stock repurchase program, and our board of directors approved an additional two-year $75 million program. We purchased 1.2 million shares under these two buyback programs during the second quarter for a total of $45 million, and this brings our repurchases under these two programs to the end of Q2 to 2.3 million shares. At quarter end, $46.6 million remained available for future repurchases. Turning to the third quarter non-GAAP outlook. As Mike mentioned, we expect decrease in Foundry and Logic revenues, partially offset by growth in the system segment, with a steady demand for DRAM and Flash Probe cards. These factors result in a Q3 revenue outlook of $183 million, plus or minus $6 million. Non-GAAP gross margin for the third quarter is expected to be 39%, plus or minus 150 basis points. At the midpoint of our outlook range, about one-third of the expected decrease in non-GAAP gross margins relates to a less favorable product mix, reflecting the expected decline in foundry logic revenues, as well as a less favorable mix in the other markets we serve. Another third of the expected decrease relates to the overall lower revenue levels and similar fixed costs, and the last third is attributable to higher manufacturing costs. At the midpoint of these outlook ranges, we expect Q operating expenses to be lower than Q2 by approximately $2 to $3 million, mainly due to lower performance-based compensation and other employee-related benefits expenses, partially offset by the impact of new hires. Accordingly, non-GAP earnings per fully diluted share for Q3 is expected to be $0.21 plus or minus $0.04. The reconciliation of our GAAP to non-GAAP Q3 outlook is available on the Investoration section of our website and in the press release issued today.

With that, let's open the call for questions. Operator? Thank you.

Ladies and gentlemen, if you have a question at this time, please press star 1-1 on your telephone. Please stand by while we compile the Q&A roster.

And our first question comes from the line of Craig Ellis.

Yeah, thanks for taking the questions and appreciate all the color on the dynamics in the business team. Mike, I wanted to go back to some of your comments on what's happening in Foundry Logic as you look ahead to the third quarter. I think you identified compute and mobility issues were at play. Can you give us some sense of the degree to which this is a mobility issue or a compute issue? And as you work with your customers as they're managing product cycles, what's your sense for when we actually work through what we're seeing in the third quarter and potentially rebound back to those 200 million plus revenue levels for the company?

Yeah, thanks, Craig. You know, as I said in the prepared remarks, we are seeing... Multiple sources of reduced sequential demand in Foundry and Logic probe cards coming from multiple customers in both mobile and compute. And there's a lot of different puts and takes in that. I would say the components of each are similar in nature. And the result of the customers changing their way for start plans on specific designs as they adapt their product release roadmaps to their changing end market conditions. And since probe cards are specific to each design, lead times, as you well know, are well within a quarter. There's some short-term volatility there we're dealing with in our demand profile. I do want to draw a parallel, you know, it's a while ago, but back to the fourth quarter of 2019, where we saw exactly the same dynamic, but in reverse. If you remember, we guided up inside the fourth quarter as Foundry and Logic customers, many of them similar Foundry and Logic customers we're seeing now, responded to stronger demand and drove our business up on these short lead times. So we have seen these dynamics at work before. We remain excited about Foundry and Logic, as I said on the call. Advanced node WFE investments, advanced packaging, driving up test intensity and spending on probe cards. And I think still an exciting growth opportunity for form factor, despite the short-term volatility we see here.

Got it. That's really helpful, Mike. So Shai, I'll ask the follow-up to you and then go back in the queue. So appreciate the gross margin color and the breakdown, a third, a third, a third across mix volume and higher manufacturing costs. The question is this, you know, at some point, and I suspect in the not too distant future, we're going to move through these transitions and be back to much higher volume and more normalized mix. But how should we think about the higher manufacturing cost element that you talked about When does that become a neutral or a tailwind of the business? Is there a revenue level that's needed or what should investors think about for that to become less of a headwind?

Yeah, thanks, Greg. So most of these additional manufacturing expenses in Q3 actually relates to capitalized variances that we were capitalizing to our inventory as part of the Q1 and Q2 inventory build. And they're going to be amortized in Q3. So that big change, I don't expect it to happen again. There is some element of higher labor cost and higher cost of materials. We talked about it in previous calls as well. But these are built into the forecast and are built into our longer-term target model of 47% gross margin, which we are still committed to.

Got it. Thanks, Tim. Thank you.

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

Hi, good afternoon. Thank you for taking my question, Mike and Shi. I want to dig into the weakness you're seeing in a mobile for a minute. I believe you, within a mobile, you have both the SOC probe card and RF probe card. Can you kind of tell us which one may be the bigger factor here in terms of the weakness in smartphones you're seeing here.

Yeah, Charles, it's Mike. It's mostly related to SOC, applications, processors, modems, things like that. As we've told you as we've moved through the first half of the year, coming off a very strong 2021, The RF business has moderated some in the first half of the year. But as you saw from the SOC results, the general founder and logic results, and our narrative around it in the first part of the year, we're seeing some real strength there. In the third quarter, we're seeing that sequentially down. Again, associated in mobile with design release roadmap changes, customers pushing out and in some cases reducing volume for certain chip designs. And that has an impact on the overall probe card demand for those individual designs. So going Q2 to Q3, I'd say the delta primarily associated with reduced mobile SOC demand, if I carve it up between the mobile and compute sections.

Got it, got it. On compute... Is that more related to one specific customer? That's one part of the question. The other part is, is it more related to the change of the release schedule or it's more related to the adjustment of the volume that your compute customer is thinking about renting?

Yeah, as I said in the prepared remarks, it is multiple customers. Right now, although we're dealing with this nearly real time, it really does feel like mostly changes in design release schedules. You can imagine that with lead times much less than a quarter, the movement of a few weeks in and out to wafer ramp schedules can have a significant impact on our quarterly revenue. And again, in my response to Craig's question, I drew your attention back to Q419 where this worked in the opposite direction. There have been times where we can see this volatility of design release roadmaps, design release plans, and wafer start plans impact things in a pretty significant way in any given period.

Got it. Maybe allow me very quick for the last question. You want to proceed your CapEx investment this year, despite that Q3 seems to be a little bit of down take in terms of business. I wonder whether you consider maybe you should delay a little bit of a CapEx or you think the current weakness is maybe probably very short-term in nature. You probably see more like a V-shaped kind of recovery in terms of demand. So you want to proceed with a CapEx. Thank you.

Yeah, I'll take that. So we believe these Edwins are temporary in nature. We remain confident in both our strategy and the market position. And we are continuing the planned capital investment as we track towards the long-term target model. These investments that we started a couple of years ago, they're required to maintain our industry leadership. That's why we didn't change the CapEx plans for the year and continue to expect to be between $60 to $80 million for 2022. This is mainly in expanding capacity. Now, I think it is important to understand our customers are adding capacity. which means they will need more prop cards and they will need, we need to be ready to capture the growth and the market share gain here.

Thank you all. Thank you.

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

Hi there. Good afternoon. Thanks for letting us ask a few questions. Maybe we happen to lack the gross margin for a little bit here. I appreciate sort of the bucketing and the attribution, but, you know, to be blunt, and I understand there's some effects, and that's what I kind of want to unpack a little bit here, but, you know, the revenue level we're talking about, even with, say, you know, like a 20% decline in Foundry Logic Q&Q, sort of implied in 3Q, if that's right, I would expect still sort of mid-40% gross margins, not necessarily, you know, the 800 basis points decline Q&Q from the revenue level in the second quarter. And so, yeah, I mean, it's like math in terms of segmentation kind of right. And then I guess, you know, if we just did sort of like a, yeah, I know this is not guidance, but if revenues were just flat in Q4, and sometimes you can get a bit of a late kick from your customers in Q4 in terms of foundry. But if Q4 revenues were flat, what sort of, are some of these impingements on gross margins going away And where would your gross margins kind of normalize out to on, say, this flat revenue, not a guidance, but just sort of a scenario for Q4?

Yeah, so on revenues level similar to Q2, you know, 200 and something million, on a similar revenue profile and product mix to Q2, we estimate that gross margins would have been our target model gross margin of 47%. So if you take the three components I was talking about, Some of them, for the mix, I think we understand that the fixed cost over lower level of revenue, I think I addressed that now when I talked about similar level, revenue level and similar gross margins to Q2. And the additional manufacturing expenses, and I answered that before as well, some of it is higher labor costs and higher cost of materials. But a big part of it in Q3 is timing of manufacturing costs. that we capitalized in the first half of the year, or mainly in Q2, and we're going to amortize in Q3, so we don't expect them to repeat. So taking all that into consideration, as I said earlier, we are committed and still confident with getting into our 47% response.

That capitalized cost then does still stay in the cost of goods sold in 4Q as well?

Well, it depends on the inventory building in Q4. I'm not going to drag you into all that accounting, but most of it will be amortized, if not all of it will be amortized in Q3. And how much is going to go into Q4 depends on how much inventory we're going to have at Q3 end. But I'll go back to my first remark. On a similar revenue level of $200 million plus, A similar revenue profile and product mix, we estimated gross margin at 47%. Okay.

And in terms of understanding, I'm not surprised by this adjustment phase for some of your customers. It kind of makes sense relative to my understanding of the business. What sort of duration or how long do you think this adjustment period will take based on history, based on your discussions? Okay. Because, you know, it could be a quarter, it could be two, but is the understanding here that they'll release, you know, probe cards against future products and wafer starts, you know, once they're through this adjustment period?

Yeah, Brian, it's Mike. I'll take that. You know, the timing... Yeah, Brian, it's Mike. I'll take that. You know, the timing... As always in this business and the visibility a little bit uncertain, given that lead times are well within a quarter. But as you might imagine, we're having some very detailed conversations with these customers to make sure we understand what their demand profile is going to be, what some of these rescheduling scenarios look like. And, you know, right right now, it does seem like a pretty short term event. I'm not sure I want to create expectations right now that there's a snapback in early Q4. But right now, you know, things like us continuing with our capacity expansions, continuing to invest in R&D, I think are pretty good indicators that we don't view this as a structural long-term change in the founder and logic market. We remain excited about the growth prospects for founder and logic.

Maybe if I could just ask one more, and this is sort of intertwined, I guess. Michael, what you just talked about, but would you say your key customers have determined their wafer test strategy needs for their upcoming heterogeneous integration ramp-ups? Yeah, maybe it's muddled a little bit in terms of some of the readjustments that are happening right now, but I know that was something that was still being decided, and I guess Based on your, I guess, response, do you envision this, when do you envision that being a meaningful contributor to the business? Could that happen in Q4? Is it maybe more like a first step next year?

Yeah, I think the different heterogeneous integration or chiplet or tile-based strategies, mostly still in the development phase with different customers. We are delivering probe cards in pilot volumes to major customers for those products. And I think it's probably, as we said in the past, an early 2023 event. There are contributions to our revenue right now associated with those pilot ramps. But again, as those customers adapt their product release roadmaps and ramp plans to their end market conditions, we might expect to see some changes there as well. But certainly, everything is setting up for 2023 to be a pretty major uh adoption year in terms of advanced packaging chiplets and heterogeneous integration okay thank you thank you and our next question comes from the line of david dooley with steelhead securities yeah thanks for taking my questions i guess i have a couple um just to clarify things

I think one of your big customers are going to progress to three nanometers sometime next year. When will that start to impact demand, you know, from moving from five or seven nanometers to three nanometers? When will you start to see an increase in three nanometer probe card demand?

Yeah, David, it's Mike. Again, given the lead time characteristics of the Foundry and Logic probe card business, you're pretty close to the wafer start ramps associated with those. So it's not like it's a, two to three quarter in front of the wafer ramp, maybe one quarter if I were to estimate it for you. Again, that goes to some of the dynamics we've talked about in the past that lead to our confidence in the founder and logic market. As customers continue to invest in wafer fab equipment, added these advanced nodes, whether they be three nanometer or others, we're pretty confident they're going to utilize those for new designs and ramp those new designs. But That's still in front of us, and again, probably a one-quarter, we'll lead it by one-quarter in terms of wafer starts and then wafer outs for a node like 3nm.

So, just to be clear, if wafer starts ramp up to 3nm in Q3 of next year, you'd start to see it in Q2?

Yeah, I think that's a fair kind of ballpark estimate.

Okay. Are you currently contemplating lowering expense levels because of the near-term reductions in demand? Given, as you mentioned, you have short lead time, so you have some idea of when demand is going to improve, but are you contemplating lowering operating expenses in the near term?

Yeah, I'll take that. So regarding expenses and both cost of sales and OPEX, some of our costs are designed to be variable. like performance-based compensation and overtime. And it is reflected in the Q3 outlook we provided today. We're seeing OPEX, for example, going down from 54.5 to around 52 million in Q3. But overall, we are maintaining our cost structure and capacity to support higher revenue quarters and stronger demand as we make progress towards the target financial model. So no significant structural changes to OPEX at this point. We'll continue to look into that and make adjustments if needed in the future.

Okay. Final one from me is I think you described a vast majority of your reduction in revenue sequentially from 204 to 183 was coming from the founding logic business. I guess that suggests that the memory business is going to be flat in Q3. Would you expect there to be weaknesses in that market as well, given all the kind of difficulties we've seen from, you know, players in that space and the weakness in PCs or other markets for DRAM absorbing that. And, you know, you feel like you can make it over the next few quarters without a reduction in DRAM demand.

At this stage of the game, David, I think it's, it's more the latter, um, It's something we're obviously keeping a very close eye on, given some of the CapEx announcements from our customers, most recently SK Hynix last night. But we are seeing DRAM probe card demand and flash probe card demand hold up reasonably well here. Part of that, I think, is customers are continuing to release new designs, DDR4 and DDR5, both mobile and server, They're definitely shifting mix around, as our Foundry and Logic customers are, between the different end market segments. But so far, that memory business seems to be holding up as well. The one caveat, again, that I'll remind you of is our lead times are relatively short. So memory probe cards, lead times well within a quarter as well. But for now, we do see decent design activity, continued strong demand at approximately the levels we've seen in the first half of the year.

Thank you. Thank you. And our next question comes from the line of Robert Mertens with Cowan.

Hi, this is Robert Mertens on behalf of Chris and Clark Cowan.

Just looking into the September quarter guidance, you'd mentioned a turn in the Foundry logic demand, both from the compute and mobile markets. Are you able to break down a bit more if this is a function of the in-unit cuts or push-outs on designs? Just trying to get a better sense of when the slowdown started or when you were able to see demand start to slow down and then maybe what the duration of the current pause would be. And then I have one follow-up.

Yeah, Robert, it's Mike. You know, this is a pretty rapidly changing situation. You know, we've seen customers, again, reacting to their end market conditions and changing design releases, ramps on different products and different, I'll call it volatility in the founder and logic. You know, it's obviously difficult for us with our industry vantage point to pinpoint exactly what the root cause of this is. But I think it's at least plausible that it's tied to some of the reduction in consumer spending we've seen on things like handsets and PCs. So, you know, in terms of duration, difficult to say right now. But again, I'll point back to our continued plan to increase our capacity, our continued commitment to the $2 non-GAAP earnings per share model at $850 million in revenue. We don't see a structural change here. We see some short-term volatility. And especially in Foundry and Logic, we remain awfully bullish about the growth prospects given all of the advanced node WFE investments and the shift to advanced packaging at those advanced nodes.

Great. Thank you. That's definitely helpful.

And then just real quick on, you know, recent guidance from other back-end peers are seeing a similar weakness into the second half of the year, but it doesn't seem like the same I think from the front end manufacturers, there hasn't been any sort of major cuts with WFCs. There's sort of a way to think about the discrepancy between the front end and back end, whether it's like a disconnect in demand or just a function of varying lead times between the two. I just wanted to see if you had any opinion on that.

Yeah, this may be a longer conversation, you know, but we have We have seen historically back-end test and assembly investments be shorter lead times and be more responsive to customer demand, obviously closer to the end of the line. And I think the other dynamic here, although to be clear, this is just my opinion, the very long lead times associated with the bulk of front-end equipment mean that customers are going to have to not necessarily cancel, but lose their priority in terms of deliveries. And so I think given the circumstances in the industry over the past couple of years where everybody's been trying to claw their capacity up, I think customers with the longer lead times associated with WFE are probably pretty reluctant to change those investment plans.

Okay. Yeah. Great, thank you. That's all for me.

Thank you. And our next question comes from the line of Christian Schwab with Craig Hallam.

Hey, good afternoon, guys. I'm wondering what your thoughts are, you know, just kind of bigger picture on when the foundry of logic demand could kind of come back, right? You know, we're seeing, you know, a pretty pronounced normalization of smartphone and PC demand, but Pre-COVID, PC demand was down five out of seven years, and smartphones shrank for four years going into it on a year-over-year basis as replacement cycles extended. Being the two most important markets as far as units are concerned, semiconductors, are you at all fearful that this could kind of be a prolonged level of you know, of less volume than maybe we've seen the last few years.

Christian, it's Mike. I don't think fearful's, right, the way I'd like to describe it, but we're certainly watching that. And I think, as I said on one of the previous questions, I think this all comes back to consumer and macro drivers. You know, if demand for PCs, for handsets does materially slow down for a long period of time, This has to result in lower chip demand and therefore lower ProCard demand. One of the things we have seen historically, though, is in times like that, many of our customers accelerate their innovation roadmaps and start to release more new designs to try and differentiate their positions in tough market conditions for them. So, again, watching the situation, as I'm sure everyone on this call is. still seem to be structurally pretty strong in the industry. Again, that's why we're continuing to invest in capacity to make sure that we can meet continued growth and demand in Foundry and Logic and in our other segments as well.

Great. And then follow up on the investment in additional capacity. You know, when you guys decided to do that, was there an assumption on, you know, weight for starts or a million square inches of silicon or number of chips that you determined you know that you needed to to make these future investments or is there anything behind the scenes where you believe you know any of your three largest customers that you've talked about previously that there was an opportunity for market share gains versus other players in the space

Yeah, there's a set of different variables that led us to commit to the significant capacity additions and capital expenditures we've been making and are continuing to make. Some of it is wafer starts on advanced nodes in the industry and million square inches of silicon tends to be not a bad proxy for that. But the other is, and we brought this up before, the increasing test intensity associated with both advanced nodes and advanced packaging. Simply put, you know, each wafer start needs more probe cards because customers are investing more in wafer tests, both to improve yields and to reduce their overall cost. So, you know, when you put all those things together, along with some very detailed and specific conversations with our key customers about their long term capacity needs, that's what led us to, you know, embark on the capacity increases a couple of years ago. So that as Shai said, we can retain our leadership position and even increase our leadership position in the markets we serve.

Great. And if I could just squeak in one more last question. With the, you know, the slowdown that's happening kind of in the back end, you know, echoed by, you know, Teradyne earlier today as well. You know, do you think we're in an opportunity now where things kind of normalizing to some degree? Do you think there's an opportunity for increased M&A activity to create scale in the back end, or do you think there still isn't a significant interest in that?

Well, I can tell you we remain very interested in that. We've been public and consistent about our view that continued diversification, continued consolidation to drive scale in the back end is something of value. I guess I'm I'm hopeful that things stabilize a little bit here, that everybody understands where their businesses are headed. We resume on a bit of a growth path, and this becomes perhaps a catalyst for those conversations to start. But, you know, right now, very focused on making sure we're executing against the demand we do have, you know, strengthen the systems business, continue solid memory results, and staying close to our customers to make sure we're able to adapt to their changing wafer start schedules and deliver the probe cards when we need them.

Great. Thank you. No other questions.

Thank you. And our next question comes from the line of David Silver with CL King.

Yeah. Hi. Thank you. I think I'd just like to, first question would just be to kind of clarify things a little bit, but Beyond kind of the medium-term decision-making by your major customers regarding design releases and ramp-up schedules, there's, I guess, a longer-term effort by those same customers to add significant new wafer fab capacity in the U.S. My timetable says a lot of it is for the 2024 to 2026 timeframe. Can I assume that your discussion of, you know, maintaining CapEx and things like that for new capacity is that, you know, you're trying to align with those longer-term major capacity additions by your customers and, you know, hence it's kind of a sign that that next wave of new FAP development, a lot of it in this country, it remains on track. So, what we're talking about today and what we might be looking at in the 2024 to 2026 timeframe are, you know, different, right? There's the shorter medium term issue, but then the longer term in your view remains intact.

I think that's a good way to summarize it. And Shai sort of alluded to that when he talked about our capacity increases keeping pace with our customers, whether they're domestically based or other places around the world. We are a global supplier. And, you know, these capacity investments are going to be needed for us to continue to lead the industry forward and capture the demand associated with all of these new fabs, these new fabs producing at advanced nodes. So, yeah, there's there almost always in this business is this timing decoupling of adapting to the short term, but continuing to invest and strengthen the company for the long term.

Got it. Thank you for clarifying that. I did have a question, I guess, about, I guess, Tech Insights or VLSI, you know, published some survey results that, you know, once again had form factor at the very, you know, high end of the the rating scale, customer ratings. And when I looked through the results, in particular, I think what stood out was your performance in China or from China-based customers. And I was just wondering if you could make a couple comments on that. Was the increase or the improvement kind of across the board in your ratings? Was that due to a particular effort on form factor's part, maybe building out, you know, your footprint in that area. And then maybe just a tiny bit of background, but in China, you know, would this reflect mostly the Chinese operations of the multinationals or is this or are a significant portion of the survey results coming from, you know, Chinese headquartered companies? Thank you.

Yeah, I'll talk first generally about customer relationship. Actually, David, can you mute? I'm getting a lot of background noise. I'll talk first about customer satisfaction and customer relationships in general. You know, it's been one of the cornerstones of our strategy and our culture to really invest in these relationships with key customers. And I think our survey results are a reflection of that. This is a small, concentrated industry. There are only so many suppliers and so many customers, and so we work very closely together. But that customer intimacy is really important in driving market share and in making sure that we deliver to customer expectations and adapt along with them in all of the various fluctuations in their business models. I think the The improvement in the score results, probably several different factors. We don't know exactly which customers respond there. But if you look at the way we communicated through the pandemic, through supply chain issues, through different delivery challenges, through different logistical challenges, I think those are areas where we really paid attention on nurturing and cultivating these customer relationships, and that's probably reflected generally in the results. Again, I don't know exactly who responded to the survey, but speaking to our China business, it is still mostly the multinationals who operate in the region driving our revenue there. So if you make the assumption, and this is purely an assumption, that the survey results are aligned with the business we do, you'd have to assume it's mostly multinationals. But we have had some success in gaining market share with some of the key memory manufacturers there and some of the fabulous companies there. And so that's probably reflected in the results as well.

Thank you very much.

Thank you. And as a reminder, ladies and gentlemen, if you have a question, please press star one on your telephone. That comes from the line of Hans Chung with DA Davidson.

Hi, thank you for taking my question. So I have a couple. So first, regarding your commentary around the market demand in mobile and compute, So is that a weakness across the board, or is it more like low end on the mobile side and then maybe PC on the computer side? And do you see any changes in high end smartphone or the high performance computing?

No, I think as we tried to convey both in the prepared remarks and in the questions we've had so far, we have seen reduced demand pretty broadly in both mobile and compute. Now, it's difficult for us often to tell exactly whether a certain chip is going to be destined for a high-end handset or a mid-range handset. That's also true of the RF components. You know, we obviously have insight into the specific designs, but to be able to partition and segment exactly where this chip is going to end up in terms of its end markets can be difficult from where we sit. So, you know, it feels to me, again, I don't want to call it broad-based, but there is multiple customers across multiple segments that are changing their design release roadmaps and short-term wafer start plans.

Second question regarding the gross margin. So as we enter into 2023, then I think we have the three nanometer transition. We have DDR5. And then we have the hydrogenous integration, the chiplet. So it's fair to say all these could be a tailwind for gross margin from the product mix perspective. And if so, let's say if the quarterly revenue rebound to $200 million next year, then can we see the gross margin to go above the 47% level?

So mix, this is Shai, I'll take this one. Mix has always had a major impact on our gross margin, right? We saw it in previous quarter, we saw it in this quarter too. When we talk about our target model of $850 million of revenue and 47% gross margin, most of the growth should come from Foundry and Logic. And Foundry and Logic historically has a higher gross margin. So it's kind of in line, at least with some of the things you said, that the growth in Foundry and Logic will drive higher gross margin and will help us get to the 47% gross margin target model.

That kind of in line.

And as for revenue bouncing back to 200 million plus, and I mentioned it earlier in the call, and the simple answer is yes. At revenue levels similar to Q2 of 204 million, for example, with a similar revenue profile and product mix, we estimate the gross margin would have been our target model of 47%. So our target model overall, 850 million, 47%, we're making progress towards the model. But margin will fluctuate. We said it before, and we see it in this quarter as well, this quarter meaning Q3. Okay.

Okay. Got it. Thank you.

Thank you. I'm showing no further questions. So with that, I'll hand the call back over to CEO Mike Schlesser for any closing remarks.

Thanks everybody for joining us today. We're scheduled to attend several of the late summer investor conferences where we're eager to update you in our continued progress towards the target model. So hope to see you then. If we don't, stay safe and we'll talk to you on our Q3 results call. Take care. Ladies and gentlemen, we'll talk to you on our Q3 results.

Thank you for participating and you may now disconnect.