Earnings Call Transcript - FORM Q2 2025

Operator, Operator

Thank you, and welcome, everyone, to FormFactor's Second Quarter 2025 Earnings Conference Call. On today's call are Chief Executive Officer, Mike Slessor; and Chief Financial Officer, Shai Shahar. Before we begin, Stan Finkelstein, the company's VP of Investor Relations, will remind you of some important information.

Stan Finkelstein, VP of Investor Relations

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, including the acquisition of a manufacturing facility; anticipated industry trends; potential disruptions in our supply chain; the impact of regulatory changes, including tariffs and changes in export controls; the anticipated volatility in demand for products; our ability to develop, produce and sell products; and the assumptions upon which such statements are based. These statements are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from those expressed during this call. Information on risk factors and uncertainties is contained in our most recent filing on Form 10-K with the SEC for the fiscal year ended December 28, 2024, 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 30, 2025, and we assume no obligation to update them. With that, we will now turn the call over to FormFactor's CEO, Mike Slessor.

Michael D. Slessor, CEO

Thanks, everyone, for joining us today. FormFactor reported sequentially stronger second-quarter revenue that exceeded the high end of our outlook range due to higher-than-anticipated growth in our probe card business. Despite this revenue strength, non-GAAP gross margin and overall profitability fell short of our outlook, mainly caused by an unfavorable shift in product mix and unforecasted ramp-up costs for a second HBM DRAM customer. In the current third quarter, we expect to deliver revenue comparable to the second quarter and slightly higher gross margin and operating profit. Before we dive into segments and market level details, I'd like to spend a few moments reviewing the year-to-date. FormFactor's business continues to be driven by two dominant themes: advanced packaging and generative AI. As front-end-driven Moore's Law slows, the innovation and performance offered by advanced packaging and chiplets allows our customers to accelerate their roadmaps and deliver spectacular performance improvements in compute and memory. These innovations, like the stacking of DRAM chiplets to produce HBMs that are then integrated with GPUs in multi-reticle CoWoS packages, co-packaged optics, and even chiplet-based processors deployed at the edge, are enabling the transformative capabilities of generative AI, fueling forecasts of semiconductor industry growth to $1 trillion early in the next decade. As the leading supplier of probe cards and systems that ensure the quality and performance of each individual chiplet and the stacks of chiplets in the advanced package, FormFactor is uniquely positioned to enable these innovations. We continue to be excited by our growth prospects as advanced packaging drives increased test intensity and test complexity, creating increased demand for our products. At the same time, we acknowledge that our recent financial results, especially gross margins, have not reflected our unique market leadership position. There are multiple reasons for this gross margin underperformance, including a product mix shift towards historically lower-margin markets like DRAM, operational cost increases, and the recent headwinds presented by tariffs. As we said in previous quarters, we're taking steps to address each of these root causes, including developing and commercializing differentiated new products to drive market share and pricing while improving our operational performance and manufacturing costs under the new global operations organization and leadership we put in place last year. In the first half of 2025, we've also utilized FormFactor's strong balance sheet to make two strategic investments designed to improve longer-term competitiveness and profitability: one, a minority equity investment in FICT, the leading global supplier of multilayer organic substrates, which are a critical enabling probe card subcomponent for us and our competitors; and two, the purchase of a fit-for-purpose brownfield manufacturing facility in Farmers Branch, Texas. The Farmers Branch facility acquisition allows us to rapidly and cost-effectively expand our process capability and capacity beyond our current manufacturing footprint. It also provides a clear path to lower our ongoing manufacturing costs as it's located in a region with lower operating costs and a variety of financial and regulatory incentives. Our team has made excellent progress in executing our planning and pre-startup activities since the June 2 purchase announcement, and we've recently obtained the certificate of occupancy for the site. We're currently finalizing schedules for tool installation and specific product ramps, with the detailed timing and magnitude of the ramp governed by process tool lead times, CapEx requirements, and the specific financial incentives committed by the state and local governments. Turning now to segment and market level details. In DRAM probe cards, HBM drove the expected sequential growth in the second quarter. And in the current third quarter, we expect continued growth in both HBM and DRAM overall. FormFactor's top customer remains the market share leader in this market. In addition, we are now shipping in volume to all three major HBM manufacturers as we execute our strategy to be a key supplier to all the leading customers in the industry, thereby growing and diversifying our HBM demand profile. Even with this more diversified demand profile, we expect the quarter-to-quarter volatility in HBM demand we've seen over the past several quarters to continue as all three of our customers' output is concentrated in a relatively small number of designs that are ramping up on short lead times. More broadly, we're continuing to strengthen our leadership position in HBM probe cards as bit growth accelerates and are excited about growing this business with FormFactor's differentiated SmartMatrix and IntelliFusion DRAM probe card architectures. Shifting to the foundry and logic probe card market. Consistent with our outlook, second-quarter demand in this market was sequentially stronger as we delivered seasonal ramps of major mobile application processor designs and a family of client PC microprocessor designs. Given the seasonal nature of this strength, we expect a moderate reduction in third-quarter demand in this market. These segment results provide a proof point of FormFactor's industry leadership and strong customer partnerships as two foundry and logic customers topped the 10% threshold in the second quarter. In addition, we were recognized by our customers worldwide in the annual TechInsights' 2025 global customer satisfaction survey as the number one global supplier in both test subsystems and focused chip-making equipment categories, where we received high rankings for quality and technology leadership, far outpacing our direct competitors. I'd like to thank our customers for their partnership and commend our worldwide team for their commitment to our core FORM value of a focus on the customer as we strive to continuously improve our customer collaboration and support. Turning to our Systems segment. We experienced a slight sequential reduction in second-quarter revenue due to a variety of pushouts. These systems have now been shipped, and we expect this to result in sequential growth and an improved overall product mix in the third quarter. Our systems business continues to be driven by customer development and adoption of advanced technologies like co-packaged optics or CPO as well as the significant advancements being made in quantum computing. In CPO, we now have multiple CM300xi systems running pilot production for our primary customer and are working closely with them, their foundry, and partners like Advantest to ready this technology for high-volume production in the first half of 2026. In quantum computing, the first half of 2025 has seen significant advancements in the commercialization of this revolutionary computational technology with an acceleration of technical achievements like Google's progress in error correction with their Willow platform and statements from industry icons like NVIDIA's Jensen Huang that quantum computing is reaching an inflection point. FormFactor's IQ2000 and IQ3000 cryogenic probers are an important part of this advancement, with the systems helping customers characterize, test, and improve their quantum processors and the associated logic and communication circuits. Although high-volume production remains a few years out, testing of quantum computing chips is yet another area where FormFactor is ideally positioned. In closing, we remain committed to our target financial model, which delivers 47% gross margin on $850 million of annual revenue. At the same time, we acknowledge that our recent performance has not demonstrated a clear path to that level of profitability, which is why we're taking the steps I mentioned earlier to improve margins over the medium term, both organically and through strategic investments like FICT and Farmers Branch. These multipronged initiatives will improve our competitiveness and add capacity at a lower cost, enabling us to grow FormFactor as we meet the challenges of increased test intensity and higher test complexity associated with the adoption of advanced packaging in applications like high-bandwidth memory, co-packaged optics, and quantum computing. Shai, over to you.

Shai Shahar, CFO

Thank you, Mike, and good afternoon. As you saw in our press release, Q2 revenues were $195.8 million, $0.8 million above the high end of our outlook range, and non-GAAP gross margin of 38.5% was at the low end of the range. These, together with OpEx slightly higher than the midpoint of the outlook, resulted in a non-GAAP EPS of $0.27, $0.1 above the low end of the outlook range. Second-quarter revenues increased 14.3% from the first quarter and decreased 0.8% year-over-year from our Q2 '24 revenues. Probe Cards segment revenues were $162.1 million in the second quarter, an increase of $25.6 million or 18.7% from the first quarter. The increase was driven by higher revenues in all the markets we serve, most notably in foundry and logic and DRAM. Within the Probe Cards segment, Q2 foundry and logic revenues were $100 million, a $14 million or 16.7% increase from the first quarter. Foundry and logic revenues increased to 50.8% of total company revenues compared to 49.8% in the first quarter. DRAM revenues were $57.1 million in Q2, $8.2 million or 16.8% higher than the first quarter, an increase to 29.1% of total quarterly revenues as compared to 28.5% in the first quarter. Within DRAM, HBM revenues increased $7.4 million from $29.5 million in Q1 to $37 million in the second quarter. Flash revenues of $5.5 million in Q2 were up $3.1 million from the first quarter and were 2.8% of total revenues in Q2 as compared to 1.4% in Q1. Systems segment revenues were $33.7 million in Q2, a $1.1 million decrease from the first quarter and comprised 17.2% of total company revenues, down from 20.3% in the first quarter. GAAP gross margin for the second quarter was 37.3% as compared to 37.7% in Q1. Cost of revenues included $2.4 million of GAAP to non-GAAP reconciling items, which we outlined in our press release issued today and in the reconciliation table available in the Investor Relations section of our website. On a non-GAAP basis, gross margin for the second quarter was 38.5%, 0.7 percentage points lower than the 39.2% non-GAAP gross margin in Q1 and at the low end of our outlook range. The decrease as compared to Q1 is driven mainly by lower non-GAAP gross margins in the Systems segment. The decreases compared to the midpoint of our outlook range are attributable mostly to a decrease in systems revenues, which have higher margins, as well as higher manufacturing spend and higher ramp-up costs related to shipments to an HBM DRAM customer. We incurred these additional ramp-up costs to meet some unique performance requirements for an HBM4 design specific to this customer. Our engineering team has partnered closely with this customer's technical team to identify and validate the resolution of the issue, and we expect to have fully incorporated the necessary modifications to the specific design during the current third quarter. Our Probe Cards segment gross margin was 38.3% in the second quarter, an increase of 0.5 percentage points compared to 37.8% in Q1. The increase from Q1 was driven by several factors, including favorable absorption and higher revenues that were partially offset by higher manufacturing spend, which includes higher costs from tariffs and the ramp-up cost I just mentioned. Our Q2 Systems segment gross margin was 39.4%, a decrease of 5.1 percentage points compared to 44.5% gross margin in the first quarter. The decrease from Q1 was mainly a result of lower revenues and unfavorable product mix and higher manufacturing spending, which includes costs from tariffs. Our GAAP operating expenses were $60.6 million for the second quarter as compared to $61.3 million in the first quarter. Non-GAAP operating expenses for the second quarter were $52.5 million or 26.8% of revenues as compared with $50.2 million or 29.3% of revenues in Q1. The $2.3 million increase relates mainly to higher performance-based compensation, increased labor costs from higher headcount and annual salary adjustments, and increased operating expenses from the new Farmers Branch manufacturing facility we purchased late in the second quarter. Non-GAAP expenses for the second quarter included amortization of acquisition-related intangibles and depreciation of $9.6 million, $0.7 million higher than the first quarter, and $9.4 million for stock-based compensation, $0.4 million lower than the first quarter. GAAP operating income was $12.3 million for Q2 as compared to the GAAP operating income of $3.3 million in Q1. Non-GAAP operating income for the second quarter was $22.8 million compared with $16.9 million in the first quarter, an increase of $6 million or 35.2%. This increase in operating income is due to higher revenues, partially offset by lower gross margins and an increase in operating expenses. GAAP net income for the second quarter was $9.1 million or $0.12 per fully diluted share compared with a GAAP net income of $6.4 million or $0.08 per fully diluted share in the previous quarter. The non-GAAP effective tax rate for the second quarter was 16.5%, 1.8 percentage points higher than the 14.7% rate for the first quarter. The recent passage of the One Big Beautiful Bill or OBBB provided a permanent repeal of capitalization of R&D expenditures while also lowering foreign-derived intangible income, or FDII, tax benefits. As a result, we now expect an increase in our effective tax rate for the full year to the range of 19% to 23% from the previously communicated range of 14% to 18%. While increasing our effective tax rate and income tax expenses by approximately $2.6 million for the first three quarters of 2025, this bill reduces our cash taxes for the year by approximately $5 million. I will say more about the impact of this new legislation on our Q3 effective tax rate and EPS later in the Q3 outlook section of my remarks. Second-quarter non-GAAP net income was $21.2 million or $0.27 per fully diluted share, up from $18 million or $0.23 per fully diluted share in Q1. Moving to the balance sheet and cash flows. We had a negative free cash flow of $47.1 million in the second quarter compared to a positive $6.3 million in Q1. The main reason for the decrease in free cash flows was CapEx, $47.7 million higher than in Q1 due to the $55 million purchase of the Farmers Branch manufacturing facility, and operating cash flows that were $4.6 million lower than in Q1, primarily driven by greater outflows for working capital of $9.3 million. If we exclude the $55 million investment in the Farmers Branch manufacturing facility, free cash flow would have been $8 million or $1.6 million higher than in Q1. We invested $66.3 million in capital expenditures during the second quarter compared to $18.6 million in Q1. As mentioned, the increase was due chiefly to the purchase of the Farmers Branch manufacturing facility. As Mike mentioned, since we purchased the facility last month, we have made excellent progress in executing our planning and pre-startup activities. We are currently finalizing our plans, and we will provide updates as we continue to make progress. With this purchase and additional related investments, we expect to make in the facility, we increased our expected annual CapEx for 2025 from the range of $35 million to $45 million to $110 million to $130 million. At quarter-end, total cash and investments were $253 million, a decrease of $50 million from Q1. The main reason for the decrease was the purchase of the Farmers Branch facility. At the end of the second quarter, we had one term loan with a balance totaling $13 million. I also would like to report that yesterday, we entered into a new $150 million revolving credit facility agreement. This facility, together with more than $250 million on our balance sheet, enhances our financial flexibility and provides us with additional liquidity to support our strategic initiatives, working capital needs, and general corporate purposes. During the second quarter, we used $2.4 million to repurchase shares. At quarter end, $72.6 million remained available for future purchases under the $75 million two-year buyback program that was approved and announced in April 2025. Our capital allocation strategy has not changed, and our share repurchase program goal is to offset dilution from stock-based compensation. Turning to the third quarter non-GAAP outlook. We expect Q3 revenues of $200 million plus or minus $5 million with increases in systems and DRAM, including in HBM, and a decrease in foundry and logic. This increase in revenues and a more favorable product mix are expected to result in a higher non-GAAP gross margin of 40%, plus or minus 150 basis points. This Q3 outlook range includes a 1 to 1.5 percentage point reduction in gross margins due to the impact of tariffs, assuming tariffs remain at their current level. If the tariffs on goods imported to the U.S. do increase, a possibility that was indicated by the administration, the impact of the tariffs on our gross margins could increase to 1.5 to 2 percentage points at the midpoint of our outlook range. As Mike mentioned, we remain committed to our target financial model, which delivers 47% gross margin on $850 million of annual revenue. At the same time, we acknowledge that our recent results and our Q3 outlook are not showing a clear path to achieving the model in the near term. And so we are taking steps to improve margins and make progress towards achieving our target financial model. At the midpoint of these outlook ranges, we expect Q3 operating expenses to be $55 million, plus or minus $2 million, approximately $2.5 million higher than Q2, mainly due to additional headcount and a full quarter of expenses related to operating our new manufacturing facility in Farmers Branch. Regarding income taxes. As I mentioned earlier, the passage of OBBB, effective retroactively from January 1, 2025, results in an increase in our annual effective tax rate. Our Q3 income tax provision will include a one-time catch-up for income taxes for the first and second quarters, which will result in an effective tax rate of approximately 31% in Q3. If we exclude the impact of the new tax legislation on the third quarter effective tax rate, it would have been in the previously communicated range. The Q4 effective tax rate, which will not have the one-time catch-up effect of the new tax legislation, is expected to be within the new annual range of 19% to 23%. Non-GAAP earnings per fully diluted share for Q3 is expected to be $0.25, plus or minus $0.04. If we exclude the impact of the new tax legislation, the midpoint of the EPS Q3 outlook range would have been $0.32. A reconciliation of our GAAP to non-GAAP Q3 outlook is available on the Investor Relations section of our website and in our press release issued today. With that, let's open the call for questions.

Operator, Operator

Our first question comes from the line of Brian Chin from Stifel.

Brian Edward Chin, Analyst

Could you please clarify how much residual customer or HBM4 product cost is still included in the gross margin guidance for the third quarter?

Shai Shahar, CFO

I'm not sure I understand the question. Are you asking about the ramp-up cost when we...

Brian Edward Chin, Analyst

Yes. Ramp-up cost, yes. Anything that hasn't already been reflected in second quarter.

Shai Shahar, CFO

Got it. Yes. There is no additional ramp-up cost assumed in Q3 for this HBM customer or others.

Brian Edward Chin, Analyst

Okay. Got it. So you're comfortable that, that's behind relative to the product ramps for that customer.

Shai Shahar, CFO

Correct. As we said in the prepared remarks, we resolved the issue with the customer in the third quarter.

Brian Edward Chin, Analyst

Got it. Got it. Maybe just on the broader business trends relative to how you talked about third quarter across your markets. Surprise to nobody, but consumer PC phone markets continue to feel somewhat underwhelming. I know you don't want to guide 4Q per se, Mike. But as of today, do you think that trend of higher sequential DRAM systems and lower sequential logic/foundry could persist in the 4Q as well? And any thoughts about how that kind of trend impacts gross margins?

Michael D. Slessor, CEO

Yes. While we won't provide guidance for Q4, current trends indicate that our business and the industry are being influenced by two main factors: advanced packaging and generative AI. In expanding our foundry and logic business, we are not simply waiting for a recovery in the mobile and PC sectors. We're also qualifying new areas, such as GPUs, hyperscalers, and custom ASICs. In fact, our second quarter results included significant contributions from custom ASIC chips developed for hyperscalers. I agree that the PC and mobile markets remain weak, and relying on them for strong growth in foundry and logic is not a wise strategy. We did see some typical seasonal strength in Q2, but our primary focus for growing the foundry and logic business will be on areas driven by generative AI, where we are allocating more resources. We expect DRAM growth to continue, particularly due to HBM strength, as well as systems leveraging co-packaged optics and the ongoing development of quantum computing. Overall, this presents a challenging product mix for our gross margins, which is why we are implementing the steps mentioned earlier to enhance gross margins and align with our target model of 47%.

Brian Edward Chin, Analyst

Got it. As you begin to ramp up with your largest customer HBM4, and then presumably with the second and third customers HBM4 as well, do you see a better wafer test intensity, but also maybe a margin potential out of those products? How significant is that sort of Q2 into Q3? Where do you think that goes in the next couple of quarters as a percent of the HBM business?

Michael D. Slessor, CEO

Yes. it's still a pretty balanced demand profile between HBM3 and 4, but definitely increasing trend on HBM4. And as we said, I think, in the last call, we expect that crossover to happen sometime in the latter part of 2025. HBM4 does have, at least for certain test insertions, more challenging test requirements, what we refer to generally as increased test complexity with things like higher speeds, different temperature and scaling ranges. So HBM4 does offer the opportunity, at least for some of these high-speed insertions, for us to deliver more value. And when we do deliver more value, higher yields, and higher performance envelope, we do get compensated for that by our customers. So HBM4, at least part of the test insertions, we do expect to have higher ASPs for the high-speed cards.

Operator, Operator

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

Craig Andrew Ellis, Analyst

The first question I wanted to ask is just a follow-up on gross margins to clarify that I've got all the pieces correct. So Shai, for the third quarter 40% guide, there isn't any customer HBM start-up costs in there. But did you say there were any headwinds from tariffs? And given the level that we're at, is there anything happening with competitor pricing at these levels or any other one-offs that might be adversely affecting gross margin?

Shai Shahar, CFO

So I'll say again, yes, we don't expect additional ramp-up cost in Q3. So the 40% gross margin assumes no repetitive expenses like we had in Q2. When it comes to tariffs, what we said is that the 40% assumes 1 to 1.5 percentage points headwinds from tariffs as they stand today. There are some things that might increase tariffs on August 1, and there are other rules that might be imposed by the government. And that's what we say that if these things will actually happen, the headwinds might increase to up to 2 percentage points. When it comes to competitors' pricing, we don't see significant changes in that. And it goes back to Mike's answer on the previous questions. It all depends on the value we deliver to our customers.

Craig Andrew Ellis, Analyst

Got it. And then the second question is for Mike. Mike, I was hoping that you could just step up to a higher level and talk about the business and how it performs toward target model parameters given that, that was an emphasis in your commentary. And specifically, the question is that we're only about 7% or 8% from target parameter revenue levels on a run rate basis, but we're 700 basis points away on gross margin. So if you were to bin out the three or four things that can help us bridge that gross margin gap, how would those prioritize? And what would be the relative contribution?

Michael D. Slessor, CEO

Yes, Craig. So I think an absolutely fair observation and one that we tried to point people to in the prepared remarks. We recognize that we're just shy of the revenue levels, at least on a quarterly run-rate basis of the model, yet a long way away from the gross margin levels. There is an element of volume that is helpful for gross margin. There's also a variety of different operating cost reductions that we are continuing to execute on. I'll remind people that around a year ago, we completely changed the operating organizational structure and have brought in some very talented people from the outside with strong semiconductor experience. We're now gaining momentum and improving our operations and lowering our operating costs. And so there's some short-term elements there as well. And then finally, the initiatives around growing our foundry and logic market share with things like GPU qualifications, with things like addressing the hyperscaler custom AI business as we continue to see a pretty lackluster PC and mobile environment. Those are roughly all three equal components as we think about bridging our way back up to the 47% of the target model at $850 million in revenue.

Operator, Operator

And our next question comes from the line of Tom Diffely from D.A. Davidson.

Thomas Robert Diffely, Analyst

Maybe for Shai, when you look at the ramping up of the new facility in Texas, what do you think the impact will be, if any, on the profit and loss statement over the next few quarters? And once it's fully operational, what do you expect the long-term impact or benefit to margins will be?

Shai Shahar, CFO

Yes. So we acquired this facility about a little over a month ago, right? We're still working on our plans, and it's been only a few weeks since we closed it. We will provide updates as we make progress, as I said in the prepared remarks. One of the reasons, I think it's a good reminder, that we acquired this manufacturing facility is that it is located in a lower-cost region. So we are committed to the target model. The Farmers Branch facility is part of our medium-term process as we expect lower cost of operations in that region, including environmental-related costs and labor costs. And also, as I said in the prepared remarks as well, we are seeking state and local incentives, which would lower our costs as well.

Thomas Robert Diffely, Analyst

But we won't see an impact on the P&L until after it's up and running?

Shai Shahar, CFO

We will provide an update on that as we make more progress.

Thomas Robert Diffely, Analyst

Okay. And then getting back to the start-up costs, would you expect to see start-up costs at some point down the road for your third high-bandwidth memory customer?

Michael D. Slessor, CEO

Tom, it's Mike. I'll respond to that. The key point from our second quarter results is that we are now shipping in significant quantities to all three major HBM providers. They have been our customers for many years mostly for commodity DRAM, but we are now qualified and shipping in volume. The issue with one customer in the second quarter was related to a specific design. As you know, probe cards are tailored to each chip design. In adapting our technology to fit this customer's particular design, our engineering team made a choice that we had to amend because we couldn't meet one of the critical specifications required by them. This is the main reason for the charge we've recorded this quarter, which we are labeling as a start-up cost. We do not foresee similar issues with that customer regarding other designs or with any other customer. The problem has been resolved. Unfortunately, it did affect our gross margin. However, as we continue to gain market share with the other two HBM manufacturers, we anticipate no further issues like this. These challenges are part of the ramp-up process and learning the intricacies of delivering for each specific application. Now that we are shipping in volume with all three companies and have addressed the issue with that particular design, I do not expect anything similar to arise again.

Operator, Operator

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

Yu Shi, Analyst

I'm looking at the ramp-up cost situation that occurred in Q2 with another HBM customer, and I actually see it as a positive issue. It seems like your team is more engaged in that customer's ramp. Reflecting on about a year ago or a bit more, I remember you had initially low market share expectations with that customer. How have things changed since then? Compared to your HBM leader, how is your current market share with this customer? Is it getting closer to what you have at the leader, and can you provide any quantification to help us understand your HBM ramp as we look ahead?

Michael D. Slessor, CEO

Got it. Well, I appreciate the glass is half-full approach to the ramp-up cost issue. Obviously, we aspire to execute more cleanly than that, both for our financial results and in delivering to our customers. But nonetheless, it is an indication of strong participation in a second customer's HBM4 ramps. I'd say we've got a lot of share opportunity there, right? If I contrast it to our number one customer, where we have a very strong share position based on a strong historical partnership with that customer that goes back essentially decades, as well as some great collaboration on aligning our technology road maps, that's a very strong share position. And as I've said in the past, I don't expect to duplicate that share position at the other two DRAM manufacturers. Having said that, if you want to view an entitlement share position as maybe a 50-50 split, we're a long way from there. So that opportunity is in front of us. We definitely need to improve our execution, as we've shown. And we need to increase our capacity, which is part of the optimization we're doing in our existing footprint, but is also longer term behind us deploying our balance sheet to buy the Farmers Branch facility and begin to ramp it up.

Yu Shi, Analyst

Maybe another question. I think it wasn't really being addressed anymore. Your microprocessor company, the customer, microprocessor customer, they are going through quite a lot of restructuring recently, restructuring, cost-cutting, probably a lot of rethink of how they're going to do manufacturing, how they're going to do product development, etc. I don't think you actually mentioned about the revenue trend for that particular customer. It was nice to see that customer's contribution actually went up in Q2. But what's the thought going forward from here and especially the implication from the restructuring that is currently underway? What would be the implication based on what you see today?

Michael D. Slessor, CEO

Yes. Well, obviously, there is a lot going on at that customer. If we look at what we're executing to now and the dialogue between the company, there's been no significant change. But obviously, you see some revenue volatility in our results with that customer. And I don't think that's a reflection of any kind of share volatility. I think that's a reflection of changes in programs, changes in priorities, and changes in demand. Longer term, if I back out a little bit, this is why it's so important for us to continue to make progress around our strategy of being a supplier to all the leading customers in the industry. They're all going to go through headwinds and tailwinds and ups and downs. And we want to make sure that we're a supplier to all the major customers in the industry, so that we're somewhat insulated or at least buffered from these ups and downs of an individual customer. It's why it's so important for us to be now shipping in volume to all three major HBM providers. It's also why it's important that we continue to make progress, and we have made progress in the second quarter on qualifying and shipping in volume with the large fabless microprocessor company. So different elements, no big change on the ground with that customer, but certainly, many different scenarios, which could be either positive or negative that we're working hard to insulate ourselves by making sure we're exposed to the alternative demand streams.

Operator, Operator

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

David Duley, Analyst

I was curious if you could share your expectations for the hyperscaler and GPU customers in the latter half of the calendar year. You mentioned having some hyperscale revenue in the recently concluded quarter. Will we start seeing the GPU clients utilize advanced probe cards, and what are the qualifications and scheduling like for that? Additionally, I’m interested in your observations regarding the networking segment in the AI markets during the third and fourth quarters.

Michael D. Slessor, CEO

Yes. Let me begin with the hyperscalers and then discuss the GPU aspect. We have a solid overall presence in networking, although it is not our largest business. The significant opportunities for probe cards lie in high-volume, high-test intensity markets like GPUs and custom ASICs. Recently, we received a notable multimillion-dollar contribution in the second quarter from one of the hyperscalers and custom ASICs, where we provided advanced probe card technology for testing one of their custom ASICs. We're concentrating on a new segment and application area for the industry, as many hyperscalers are establishing their own chip design and test teams. This is a new initiative, and we, along with other players in the test ecosystem, are allocating considerable application engineering and R&D resources to it, and we're seeing positive progress. Concerning GPUs, we are advancing in qualifying for GPU testing mainly through foundries, which handle both wafer sorting and subsequent advanced packaging. A major GPU manufacturer has started using advanced probe cards, but they first went to our competitor. However, we're quickly catching up in qualifications and are moving into volume pilot production, where we anticipate generating revenue from that customer in the second half of the year.

David Duley, Analyst

I'm curious about the decision to add more capacity in Texas given the flat outlook for Q3 compared to Q2 revenue. I understand that Texas offers lower costs, but can you explain your current capacity utilization rate and the reasoning behind acquiring another facility now? What is your rationale for this decision, especially since many expect more growth from your company?

Michael D. Slessor, CEO

I want to provide a broader perspective because I understand your concerns about adding capacity with a flat outlook. Looking at our long-term prospects, the semiconductor industry is anticipated to grow to $1 trillion early in the next decade, around five years from now. Our markets are increasing at a pace faster than the industry average. For instance, HBM testing is a notable example, with 1% of HBM revenues going back into probe cards, which is a significant increase compared to the industry norm. If we consider this along with reasonable expectations for gaining market share, it's feasible to see FormFactor doubling in size. However, we need to have the necessary capacity established, which requires time. The acquisition of the Farmers Branch facility was driven by this long-term opportunity and its suitability for our needs. There were only a couple of U.S. facilities that matched our requirements in terms of size, equipment, and clean room capabilities. This acquisition was strategic, allowing us to secure future capacity that we anticipate needing by around 2026 or 2027, but preparation must start now to ensure we are ready to meet the demands of our key customers during that timeframe.

David Duley, Analyst

I'm going to ask about the revenue levels for the second half again. I understand you don't want to provide guidance for Q4, but can we expect the current HBM ramp at your two major customers to slow down in the near future considering what we've heard from their large customers and hyperscalers? I'd appreciate your insights on this.

Michael D. Slessor, CEO

That's right. I want to emphasize that we are shipping HBM3 probe cards in volume to all three major DRAM manufacturers, which is diversifying our business. However, it's important to note that we will experience some quarter-to-quarter volatility. The direction is clear; investments by hyperscalers and the increased DRAM bit intensity linked to HBM and GPUs indicate a strong growth market, and we anticipate that our business will expand. Despite the HBM3 to 4 trajectory being influenced primarily by a single leading customer, some volatility exists. The long-term trend is upward, but not every quarter will consistently show growth. As we onboard all three HBM customers and their shares stabilize, we expect this to diversify our business and smooth out fluctuations. We fully agree with the secular growth in HBM, which is one reason we are investing in capacity at locations like Farmers Branch and enhancing our overall outputs and yields.

Operator, Operator

Our next question comes from Christian Schwab from Craig-Hallum Capital.

Christian David Schwab, Analyst

Most of my questions have been addressed, but I would like to follow up on the hyperscaler GPU and custom ASIC business. It's positive to see a few million dollars in the most recent quarter; however, regarding this initiative to enhance foundry and logic and improve overall gross margins for the company, what time frame do you anticipate before it becomes a more significant contributor and scales up?

Michael D. Slessor, CEO

Yes, I believe it's a good question and one that we're discussing internally because there are clearly different factors influencing the use of GPUs, merchant GPUs, and custom ASICs. As we consider the latter part of 2025 and into 2026, we are focusing on ensuring we are aligned with both of these trends. I provided some updates on the GPU and the hyperscaler aspect. Our performance in the hyperscaler custom ASIC sector will largely depend on the success of their product road maps, which are still undecided. Nevertheless, this presents a great opportunity to further diversify our foundry and logic business and shift demand drivers away from areas like PC and mobile, which currently seem to be experiencing slow growth.

Operator, Operator

And our next question comes from the line of Gus Richard from Northland Capital Markets.

Auguste Philip Richard, Analyst

Just on the tariffs, 1.5% is a reasonably good-sized impact. And I'm just wondering, first of all, is it your imported raw materials? And then if that's the case, what can you guys do to diversify your supply chain to minimize the impact?

Shai Shahar, CFO

Yes, you're right, Gus. This is a significant impact on our gross margins. It's because we are importing goods into the U.S. So what we do in response is we are working closely with our vendors on different scenarios. It's really on a case-by-case basis. But as we said in the previous earnings call, we are taking kind of a wait-and-see approach as we evaluate various tariff scenarios before committing to any significant change to our manufacturing footprint and our supply chain. And we're also looking into maybe getting drawbacks options. But we need to keep in mind that the semiconductor supply chain is complex, and we are developing our supply chain to mitigate the impacts of the tariffs as much as possible while acknowledging the negative impact on the gross margin as a result of the tariffs under the different scenarios.

Auguste Philip Richard, Analyst

Got it. And then my follow-up is on silicon photonics. I think in the second half, we should be entering into pilot production, at least in some programs. And I was just wondering if you could give us a little bit of a status on where those ramps are and what those pilot programs are.

Michael D. Slessor, CEO

Yes, I mentioned this in my prepared remarks. We now have several systems installed that are participating in pilot production, mainly at the foundry for our major driver customer. The current focus is on ensuring that this technology is robust and ready for high-volume production as we head into 2026. We have multiple tools operating at production levels that they haven't achieved before, specifically at pilot production levels with a limited number of designs. A significant amount of work and investment is occurring now, from us, our customers, and our partners, to ensure that we are all prepared for what is expected to be a substantial increase as we approach 2026. As you may be aware, CPO, which stands for silicon photonics and co-packaged optics, is one of the most effective methods for reducing energy consumption in data centers. In any plausible scenario, this is likely to become a critical factor limiting AI growth, as power supply for data centers is a challenge. Therefore, addressing the energy consumption and power usage of data centers is an exciting opportunity for us.

Operator, Operator

Thank you. This does conclude the question-and-answer session of today's program. I'd like to hand the program back to Mike Slessor for any further remarks.

Michael D. Slessor, CEO

Yes. Thanks for joining us today. If you take a look on our Investor Relations website, we're doing several conferences in late August and the early part of September and would hope to see you there. Until then, take care.

Operator, Operator

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