Q3 2022 FormFactor Inc Earnings Call
Thank you.
The company will be.
Costume GAAP P&L results and some.
Some important non-GAAP results intended to supplement your understanding of the company's financials.
You conciliation from GAAP to non-GAAP measures and other financial information.
We're available in the press release issued today with the company.
The Investor Relations section of our website.
Today's discussion contains forward looking statements within the meaning of the federal Securities laws.
Examples of such forward looking statements includes also with respect to the projections of financial and business performance.
So what's your macroeconomic and geopolitical conditions.
The benefits of acquisitions and investments in capacity and in EG.
Acknowledges.
The impact of global and regional.
And National Health crisis.
Excluding the COVID-19 pandemic.
Anticipated industry trends.
Potential disruptions in our supply chain.
Impact of regulatory changes, including some recent U S China trade restrictions.
Dissipated 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 FCC for its physical year end of 2021 and in our other SEC filings, which are available on the SEC's website at Www Dot FCC Dunn golf and in our press release issued today.
Robert would you statements I've made ourselves today October 26 2022.
We assume no obligation to update them.
With that I will now turn the call over to follow past, our CEO Mike <unk>.
Thanks, everyone for joining us today.
As anticipated foreign factors third quarter revenue was down sequentially from the second quarter chiefly due to the expected reduction in demand for foundry and logic probe cards and that's produced the forecasted decline in gross margins and profitability.
Partially offsetting this reduction and probe card demand was record strengthen our systems business highlighting the benefits of our lab to fab diversification strategy.
Compared to our outlook range revenue was slightly below the midpoint.
non-GAAP gross margin was at the midpoint and non-GAAP earnings per share were near the top of the range.
We do not view the current reduction in probe card demand, there's a fundamental change in our business rather we see it as a response by our customers to cyclical declines in their businesses, especially in consumer driven segments like client PC and mobile.
Based on the customer industry and macroeconomic data we have at present, we expect this reduced demand to extend well into next year.
In response today, we announced decisive steps to better align form factors cost structure with these temporarily reduced demand levels.
Shai will describe in more detail the steps we are implementing during the fourth quarter.
You are designed to preserve profitability at the revenue run rates, we believe are likely to prevail until the current downturn ends.
This operational restructuring notwithstanding we believe the core tenets of our strategy remains firmly in place and we remain committed to achieving our target financial model.
These core strategic tenants are first sustained semiconductor content growth in both consumer and enterprise applications.
Second the industry's relentless investments in new technology and capacity.
And third the device specific consumable nature of advanced probe cards, which when combined with our customers' innovation driven investments in engineering systems have historically resulted in less volatile demand cycles and wafer fabrication equipment.
Consistent with this strategy, we are continuing to invest in both R&D for new product innovation and competitive differentiation.
As well as in the long lead time facilities and equipment portions of our capacity increased plans.
These investments are designed to position form factor for market share gains and above industry revenue and profit growth when we emerge from the current cyclical downturn.
Turning now to our fourth quarter outlook are sequentially weaker outlook is due to three primary factors one the new U S. China trade restrictions announced on October 7th.
Two weaker DRAM probe card demand and three further softness in foundry and logic probe card demand with specific weakness in RF probe cards.
As we're a U S based supplier with significant exposure to the leading edge foundry and memory technologies affected by the recent U S. China trade regulations. These restrictions are a headwind in all of form factors businesses.
An example is our DRAM probe card business, where approximately half of our four forecasted fourth quarter sequential decline in that market is due to hold on shipments and service of advanced DRAM probe cards to leading edge domestic customers in China.
Yeah.
Form factor has taken the necessary steps to ensure full compliance with the new rules by holding shipments in support as required by U S. China trade restrictions.
As the situation evolves, our local China team is working closely with customers and our trade compliance team to obtain releases and licenses to enable permitted shipments of the existing backlog.
In foundry and logic probe cards, our largest business, we expect a further reduction in demand for core microprocessor and logic probe cards in the fourth quarter, although not as steepest sequential decline as we experienced in the third quarter.
Inside the foundry and logic market RF probe card demand continues to decline as customers burn off excess inventory of existing bonds saw filters and other RF front end components like modems switches and power amplifiers, especially in low to mid tier <unk> mobile handsets.
Significantly in the microprocessor business, we've begun volume shipments of probe cards to support pilot production of our major chip based client CPU product.
Advanced packaging chip with architectures like E M I, B <unk> and <unk> fabric are an exciting opportunity for form factor.
As we've noted in the past whether based on conventional solder based assembly processes, where more revolutionary process like copper to copper hybrid bonding.
<unk> chip flip where tile based integration schemes drive both higher test intensity, which expands the number of probe cards required per wafer out.
And higher test complexity, which raises the performance requirements for the probe card.
Advanced probe card architectures like form factors Mems technologies are essential to meet these challenging technical requirements and a compelling cost of ownership. While also meeting the short delivery lead times needed to support our customers' rapid and dynamic production ramps.
Turning to memory probe cards, we expect a significant sequential fourth quarter reduction in DRAM probe card demand, partially offset by moderate strength in flash probe cards.
As discussed above approximately half of the reduction in DRAM is directly attributable to the new U S. China trade restrictions with the other half the result of well publicized weak end market conditions for DRAM chips, which is causing our customers to reduce the magnitude and speed of their new product ramps.
It's worth noting that the third quarter, all time high and system segment revenues is expected to sustain in the fourth quarter showing the benefit of participating in customers early stage R&D programs and the positive impact of successfully integrated tuck in acquisitions completed during the last several years.
Even in the current downturn customers are aggressively investing in their technology Roadmaps with development of innovations like gate, all around transistors advanced packaging silicon photonics and quantum computing together producing solid results in our systems business.
I'd like to close by affirming that we remain confident in the long term growth prospects for form factor and the industry overall, driven by the fundamental trends of semiconductor content growth and innovations like advanced packaging.
These are trends were form factor as well positioned as an industry and technology leader and we're confident that our resilience and commitment to invest in R&D and capacity will position form factor to emerge from the current downturn, a stronger and leaner competitor, enabling us to achieve our target model that delivers $2 of non-GAAP earnings per share.
On $850 million of revenue.
Shai over to you.
Thank you, Mike and good afternoon.
As you saw in our press release and as Mike mentioned Q3 revenues were slightly below the midpoint of our outlook range non-GAAP gross margin was at the midpoint of the range and non-GAAP EPS were the I end of the range.
Third quarter revenues were $181 million and 11, 3% sequential decrease from our second quarter revenues and a decrease of four 8% year over year.
Probe card segment revenues were $139 $4 million in the third quarter, a decrease of $28 3 million or 16, 9% from the record Q2.
The decrease was driven mainly by lower foundry and logic revenue.
System segment revenues were a record $41.5 million in Q3, an increase of $5 3 million or 14, 6% from the second quarter.
Within the probe card segment, Q3 foundry and logic revenues were $90 6 million at.
26% decrease from Q2.
Andrea logic revenues comprised 50% of total company revenues 10 percentage points lower than the 60% in the second quarter.
DRAM revenues were $35 million in Q3, $1 $9 million or five 2% lower than in the second quarter and were 19% of total quarterly revenues as compared to 18% of revenues in the second quarter.
Flash revenues of $13 $9 million in Q3 or $5 $4 million higher than in the second quarter and were 8% of total revenues in Q3 higher than the 4% in Q2.
GAAP gross margin for the third quarter was 34, 4% of revenues as compared to 46, 3% in Q2.
Cost of revenues included $8 3 million barrels of GAAP to non-GAAP reconciling items, which we outlined in our press release issued today and in the reconciliation table available within the Investor Relations section of our website.
Q3, reconciling items included a $6 million inventory write offs related to the restructuring we announced in September 2021.
On a non-GAAP basis gross margin for the third quarter was 39% eight four percentage points lower than the 47, 4% non-GAAP gross margin in Q2 with a lower gross margin in the probe card segment, partially offset by an increase in system segment gross margin.
Our probe card segment gross margin was 34, 6% in the third.
Third quarter, a decrease of 12, two percentage points compared to the 46, 8% in Q2.
The decrease was mainly due to higher inventory reserves and lower overall segment revenues, specifically lower foundry and logic revenues, partially offset by higher flash revenues revenues, which resulted in less favorable product mix.
Our Q3 system segment gross margin was 53, 7% 320 basis points higher than the 55% gross margin in the second quarter.
This increase is due to higher revenue and a more favorable product mix.
Our GAAP operating expenses were $58 million for the third quarter $4 million lower than in the second quarter.
non-GAAP operating expenses for the third quarter were $49 5 million or 27, 4% of revenues as compared with 50, $454 5 million or 26, 7% of revenues in Q2.
The $5 million decrease relates mainly to lower performance based compensation, lower R&D spend and higher PTO utilization.
Company noncash expenses for the third quarter included $8 million for stock based compensation $1 $6 million higher than in the second quarter due to the increase in fair value of art of the annual RSC grants as a result of a higher stock price at the time of grant.
$8 million for amortization of acquisition related intangibles, similar to the second quarter and depreciation of $7 million zero point $2 million lower than in the second quarter.
non-GAAP operating income for the third quarter was $21 million compared with $42 3 million in the second quarter.
GAAP net income for the third quarter was $4 $4 million or <unk> per fully diluted share compared with $30 million or <unk> 38 cents per fully diluted share in the previous quarter.
The non-GAAP effective tax rate for the third quarter was 19% 460 basis points higher than the 14, 4% in Q2 and within our estimated non-GAAP annual effective tax rate of 15% to 20%.
We expect to be on the lower end of the strange for Q4 and for the full 2022 fiscal year.
As previously communicated our annual cash tax rate is expected to remain around the mid to high single digits of non-GAAP pretax income until we fully utilize our remaining U S based R&D credits.
Third quarter non-GAAP net income was $18 $3 million or <unk> 24 per fully diluted share compared to $36 8 million or <unk> 46 per fully diluted share in Q2.
Moving to the balance sheet and cash flows we generated $15 $5 billion of free cash flow in the third quarter $12 $8 million lower than the $28 $3 million in Q2.
Net cash provided by operations was $18 $4 million lower than in Q2, and capital expenditures were $5 $6 million lower than the previous quarter.
At quarter end total cash.
Cash and investments were $255 million.
As of the end of the third quarter, we had two term loans remaining on our balance sheet totaling $17 5 million.
We invested $8 $9 million in capital expenditures during the third quarter compared to $14 $5 million in Q2.
With the core drivers underpinning our strategy is still in place we continue to execute on our capacity increase plans, albeit at a slower rate.
As we approach year end, we're narrowing the range of the full year expected capex to $60 million to $70 million.
We still expect Capex to return to three 5% to 4% of revenues in our target financial model. After we complete these capacity increases.
Regarding stock buybacks during the third quarter, we purchased approximately 570000 shares under our $75 million two year buyback program for a total of $19 2 million.
At Q3 quarter and $27 $5 million remained available for future repurchases.
Turning to the fourth quarter non-GAAP outlook, we expect lower revenue in the fourth quarter due to the three factors that Mike mentioned.
In this environment, we are focused on reducing spending while investing to capture both short and long term demand in our markets.
Accordingly, we today announced an operational restructuring plan to reduce costs and improve the efficiency and effectiveness of our business.
The plan includes lowering head count by approximately 13% of our workforce, mostly in the probe card segment and SG&A.
We expect these actions will be largely completed by the end of 2022.
We estimate that these actions once fully implemented will reduce our cost structure by $25 million to $30 million on an annual basis with approximately two thirds of the savings benefiting cost of sales and one third benefiting opex.
The reduced demand, resulting in a Q4 revenue outlook of $155 million plus or minus $5 million.
Since the restructuring plan was implemented in mid quarter.
Savings that I mentioned will only partially benefit Q4.
Accordingly, together with the impact of the declining revenue and a less favorable product mix fourth quarter non-GAAP gross margin is expected to be 33% plus or minus 150 basis points.
At the midpoint of these outlook ranges, we expect Q4 operating expenses to be similar to Q3, mainly due to lower performance based compensation and a lower head count as a result of the restructuring we announced today offset by the impact of one additional or working with.
Accordingly, non-GAAP earnings for fully diluted share for Q4 is expected to be three plus or minus.
A reconciliation of our GAAP to non-GAAP Q4 outlook is available on the Investor Relations section of our website and in our press release issued today.
Let's open the call for questions operator.
Thank you at this time to ask a question. Please press star one one on your telephone again Thats Star one one on your telephone to ask a question.
Our first question comes from the line of Brian Chin.
Of Stifel.
Go ahead, Brian Chin.
Thanks for letting me ask a few questions maybe just to start here.
Can you just clarify I guess in terms of the revenue step down from the <unk> and the <unk> about $25 million.
Yes.
At the mid point.
How much I guess is DRAM half of which is tied to the China restrictions how much is RF and.
And then how much larger.
Logic Foundry X Rs.
Yes.
Brian This is Mike good question.
As you said $25 million reduction at the midpoint sequentially I'll start with the biggest impact which is the impact of the October 7th China regulations.
This is between 10 and $15 million sequentially.
And to calibrate you to that if you remember we've talked about our China revenues being approximately two thirds coming from multinationals, which all the multinationals have received licenses so they're not part of the step down in the quarter, but one third a significant chunk of what's been a 40% to $50 million.
Quarterly run rate comes from the domestic customers and given our exposure at the leading edge.
In both foundry and logic and in DRAM.
These these regulations do have a significant impact so about $10 million to $15 million in the quarter.
Call it $50 million annualized associated with these.
Moving to the next biggest component is DRAM.
Projecting.
A little over $10 million step down in DRAM demand sequentially.
More than half of that is an overlap with the China regulations.
We've talked about in the past I think we've done a good job supporting and gaining share inside the high end, China domestic DRAM market, but these regulations.
Really kind of a crimp that at least in the short term.
And then in foundry and logic.
A smaller impact most of the reduction in foundry and logic associated with RF unsurprisingly because of the softness in mobile.
But again, some overlap with China as well less so than in DRAM. So those are the three components in the rough magnitudes of each but as we look forward.
We think that the restructuring op restructuring plan, we've put in place allows us to protect the profitability of the company while still investing in the long term growth. These are obviously short term headwinds but.
We like the position we're in in these markets and looking forward to demand returning to some robust levels as we get through the middle part of 2023.
Okay got it.
Further clarification within that.
With $10 million to $15 million sequential.
The local China.
And excluding backing out the $5 million that might be tied to DRAM I guess that gives you a residual $5 million to $10 million.
Did I hear correctly that youre seeking licenses that possibly shipped to some of those.
Entities.
Could you provide some sort of upside maybe this quarter, maybe next or at some point moving forward.
So the China DRAM impact is more than $5 million, it's it's more than half of the overall $10 million to $15 million, China impact, but to the core of your question.
Both we and our customers are working at shipment releases, a variety of different license that could help us.
Realize that revenue I think as I said in the prepared remarks, we're taking a balanced view of this and making sure. We're both compliant with these new regulations.
But also doing the best we can to support our customers in the region.
And is it pretty actively evolving situation with the regulation something like 19 days old where we're working through this.
With both our trade compliance team, our China team and our customers to either obtain licenses or convince ourselves that.
The regulations do not apply to some of the shipments that were trying to release.
Got it got it my next question I guess is.
Do you have any indications that this revenue run rate kind of the mid $150 million level that either in terms of the discrete segments or in the aggregate. This represents some sort of a stabilization.
In terms of the revenue run rate and also kind of enjoying with that.
How low how low can you lower quarterly revenue breakeven too.
I'll take the first part of the question and then I'll, let Charles talk about that.
The cost structure and the run rate profitability.
Obviously theres a lot of headwinds right now in the fourth quarter. We're in the middle of a pretty substantial DRAM downturn as you heard from all of our customers, but most recently one of our major customers, who was a 10% customer.
On their earnings call last night.
The world's largest foundries talked about an inventory correction in place and then on top of that we've got these new China restrictions. So theres a lot a lot of headwinds right now we are.
Cautiously optimistic that some of these things are going to turn as we work our way into 2023 and through the middle part of 2023 typically.
Typically DRAM cyclical DRAM downturns and inventory corrections in the foundry space do take several quarters to work their way through but we're now well into the second maybe even the third quarter of those things. So I think we are optimistic that some of these things can turn a little bit in terms of <unk>.
Market headwinds at least become neutral if not if not tailwind.
And when it comes to their breakeven question Brian .
After these cost reduction measures are fully implemented we expect the breakeven point of revenue between 40 and 145 million in the quarter.
That's the breakeven.
Got it.
Clarify something you just mentioned there when you talk about that optimism sort of things turning middle part of 'twenty three.
Are you kind of discreetly factoring in.
Things like that.
Moving from pilot to volume production for marquee products next year that used <unk> packaging and <unk>.
Some of those devices is that sort of.
Part of what Youre, saying, there or is that sort of even incremental discreetly in terms of what could get better next year.
Well I think as we look at advanced packaging and the impact it can have on our business. There is definitely a positive impact there in the prepared remarks, I highlighted that we'd begun volume shipments for a major client base chip processor and Thats, a big step forward in the validation of the technology.
<unk> in the industry moving forward I think timing is still pretty uncertain. We are we are assuming some of that is going to start to ramp in the middle part of 'twenty. Three so that is definitely an element of our cautious optimism.
But I think a lot of the other pieces as well whether their advanced packaging related or a three nanometer ramp inside the foundry space Theres a few things that do offer some degree of hope as we work our way through mid 2023 into the back half of 'twenty.
Thank you.
Thank you. Our next question comes from Charles <unk> of Needham. Your line is open Charles Good afternoon, Mike shy.
Certainly want to look at your restructuring plan.
Lowering head count by approximately 13%, obviously business is never easy and probably quite painful.
But.
It sounds like you are expecting the current weakness to probably continue.
It's not that.
It's going to be just a one quarter two quarter thing, maybe a little bit more prolonged otherwise I would imagine you would be taking decisive actions like this I mean, it's quite painful for sure.
Sure.
If you give us some sense I mean compared to let's say one two months ago, what exactly have deteriorated.
Because.
I remember there was a quite a some rapid and abrupt inventory correction actions in late June late June early July August maybe a little bit while slowing down in terms of that the actions by the it seems to accelerate again in September to October can you kind of walk us.
What exactly happened over the last three months to really.
Lead you to take decisive actions like what we just announced today.
Thank you.
Charles This is Mike I think you touched on it in the first part of the question. It's really the duration that we're seeing that motivates us to protect the cost structure the profitability of the company.
So that where we're generating cash so that were profitable as we work our way through but certainly based on all of the available data we have looks like a fairly sustained not a one to two quarter demand.
Demand reduction I think.
In discussions with our customers and looking at industry forecast.
Understanding.
The general macroeconomic conditions that are in place, we felt like and you're right. It is it is painful and a little bit frustrating given how hard we work to increase capacity, but we felt like based on all of that available data. This was not going to be a one to two quarter.
Downturn on reduction in demand, but one that extended into the middle part of 2023.
We're not calling an end to a downturn in the middle part of 2023 as you know our visibility is pretty limited, but in the answering Brian's question I think I touched on some of the things.
That leaves us cautiously optimistic as we work our way through 2023, but between now and then.
We really felt motivated.
To protect the profitability of the company. So that we can make the investments in R&D and long lead time capacity items like facilities to make sure as we come out of this and anybody who has been in the industry for a while knows we always come out of these cyclical downturns better prepared to win and gain market share and grow the company.
Thanks, maybe I wanted to next question I wanted to.
Double click some of the comments you made.
Foundry and logic probe card if I hear you correctly I think you are in.
Implying roughly $10 million ish kind of reduction in <unk>.
Foundry and logic segment into next quarter.
So a couple more specific things RF probe card are we going to see some wrong rate backfill blasting the teens like.
I remember that's around rate when you first acquired Cascade.
Micro tackle which is when you got the RF probe card business in 2016, that's number one number two definitely.
Second out that your number one customer may.
Sales to that particular customer may come down slightly.
Into Q4, maybe not at the same same same amount of decline you had in Q3, but it does sound like maybe the mobile side I mean, the foundry that pure play foundry side seems to be holding up relatively okay.
I just wanted to check with you where I try to think about the puts and takes up to a foundry and logic probe card business is that is that whats going out into Q4.
I think that's a pretty good summary, let me expand on that a little.
The magnitude of the total reduction definitely.
Dominated by a sequential reduction in RF probe cards, we are seeing quite a bit of weakness in the <unk>.
Our supply chain, whether it's filters power amplifiers all of the different new RF front end devices that drive RF probe card demand.
So thats by far the biggest element of the sequential step down we're not quite back to the levels.
As.
The run rate levels, when we acquired the business, but this is probably the weakest we've seen since we acquired the business integrated that had been growing at in the present quarter.
Some other elements to look at the.
The core foundry space.
Little bit of sequential weakness, there, but I think of all the different big chunks of revenue inside that foundry and logic market that one is holding up reasonably well.
And then in the microprocessor space.
We're seeing.
Continued weakness in the client.
Client PC client microprocessor space, probably not too surprising given how those customers have talked about their end market associated with client and given the volumes that the client drives and therefore, the number of probe cards required.
That's taking.
Nominal step down here as we go from Q3 to Q4.
Okay.
Thank you.
Our next question comes from Chris <unk> of Cowen.
Please go ahead, Christy hi, Thanks for taking my question I have two of them and as both of them upfront.
Mike The first one and I'm kind of curious.
You said there is some weakness because of besides China some of your memory customers slowing down but it doesn't most of the Capex cuts scheduled for next year.
This is Mike.
Probe card being a leading indicator Conversely, when I look at smartphones you mentioned auto is slowing but smartphones actually started flowing earlier. This year. So I'm kind of curious as this specific vertical smartphones are you seeing RF probe card slowdown.
The first question and then second question is that.
Brooklyn considered consumables and should be resilient in a cyclical downturn, but it looks like it's kind of following the same trend line as Wi Fi or equipment Capex, So I'm kind of curious.
How do I kind of think about probe card of the consumables on a go forward basis. Thank you, yes. Thanks, Chris.
Let me start with the memory.
Rfps.
There is.
Several elements to how primarily our DRAM customers are behaving as we said, we do see some sequential strength in flash, although off a lower market share position.
The.
In DRAM, what we see happening is customers essentially reducing the speed and the magnitude of their new device ramps, we haven't seen any device cancellations in the DRAM space nor have we in the in the foundry and logic space.
But the number of probe cards required per design is coming down as those customers manage their new design ramps their new design releases and make sure. They are consuming their inventory and I think that's probably that inventory consumption.
Consumption piece is probably one of the biggest dynamics, we're seeing in DRAM.
Similar dynamics in RF for sure the handset.
The handset softness in the end markets has been going on for a while we.
We started to see it in the RF business earlier in the year, but it's particularly acute here as customers re plan, they're different wafer start plans to meet new device cycles, maybe that happened in the early part of 2023, So again looks primarily like inventory digestion in that RF spa.
But.
Again, similar to memory, we haven't seen any.
Major device cancellations design activity stays pretty strong its just the magnitude of these ramps and the speed of these ramps is much slower than we've seen in the past.
Mike It is about.
Brook Cosmos.
So cyclicality and yeah. So a great question and certainly one of the interesting things we've seen.
In both the third quarter and the fourth quarter is some very rapid changes from our customers on their design release Roadmaps as we talked about on the last earnings call. We had several customers react very quickly and decisively to softness in their end markets. We see the same thing happening here and even though.
Probe card your consumables and we're doing things like shipping.
The first volume probe cards for pilot production for chip based microprocessor driving advanced packaging forward.
Magnus <unk>.
Fact that we're operating on shorter lead times and our customers are responding pretty quickly to their end market conditions. I think is why youre seeing us.
Have two quarters here of sequentially pretty significant sequential declines in probe cards.
Thanks, a lot and I really appreciate it thanks guys.
Thank you.
Craig Ellis upbeat.
Packing.
Revenues, you should look cancun, putting the question really is helping us understand the degree to which some of these things. So I think it's.
More foundry logic.
Thanks, Tim and DRAM bench more cyclical and just do too.
Sudden decrease in demand that we're seeing in Q application areas.
Customer adjustments versus some things that.
That might be more structural such as the inability to ship to China and I think you indicated that.
The pis from cash flow.
The midpoint of about $12 5 million.
Reasonable to think that a more long term impact more structural impact.
$5 million decline is that piece and that we would just need to find growth.
In other parts of the business Tom set that Covid.
And would you see that coming back.
Okay.
Yes, I think I said in.
Interesting question as you might imagine Craig.
Thank you.
We're very very focused right now on making sure we do whatever we can to support our customers.
There are obviously depending on us.
To ramp their technologies, but we also have.
This compliance overlay, which is limiting our ability to do that I think in the very short term, we're focused on resolving that.
If we're able to do that at least in the short term.
We may see some some upside associated with that either as we move through the back part of the year or into 2023, but I think in this.
There are people who <unk>.
Eddie this all the time so.
I may not be the best one to opine on it but I think the direction associated with being a U S supplier to the China domestic semiconductor industry, certainly is not a tailwind you've heard some of the wf E suppliers talk about it providing a haircut to their businesses next year at least where they have high.
Exposure.
Probably the middle cases, this is definitely going to be a headwind.
Sort of around the magnitude that we talked about the $12 $5 million a quarter $50 million annualized.
We're going to have to go find other places.
To grow the business I think one of the highlights we haven't talked about it much on Q&A, where we have seen some nice growth is in the system segment, a record quarter even with.
Some of the China headwinds in the systems business, which or are less onerous because of the details of where we ship from Mt.
<unk> products, we expect similarly, strong Q4, and with things like Silicon Photonics and quantum computing that may be one area, where we can grow the business I wouldn't want to create the expectation that it makes up for a $50 million Delta in 2023, but there are some growth prospects inside there as well as in the broad.
Foundry and logic and DRAM probe card space.
Got it.
My question is really one more per site.
With regard to the.
Cost savings program.
At the midpoint I think that the 2017 can you talk about the timing with which that will be realized both on the Comscore Shang.
Fixed portion.
You may be able to different cadence.
Yeah.
Yes, the timing the timing is actually the same.
We expect to fully implement these cost saves.
Savings by the end of 2022. So if you think about Q1 2023 jets that should reflect.
All the savings for both Opex and cost of sales.
And.
I think you said that there are some things that are going to benefit the fourth quarter.
<unk> members are seeing opex and cost of sales so.
But whenever is executed through the fourth quarter.
What's the incremental benefit you would expect two pads in Q opex for the first quarter.
Yeah.
Well, we announced it today and which means we still have a third of regular run rate expenses in Q4, and then only two thirds of the quarter we reflect savings.
And now.
So I think that's a good approximate although we have some moving parts here right. If we go if you go into 2023, you have the annual benefits reset that's going to increase opex and into the beginning of the year, but the run rate. If we think about Opex run rate for Q4, which is about $49 million at the midpoint of the range we provided today.
<unk> and next year after we have more savings, but we have to benefits reset.
Yes.
And then lastly on that.
Mike I think you mentioned that there was an inventory reserve.
This includes age.
Okay.
Third quarter can you just quantify that.
Are there any such reserves included in fourth quarter's 33%.
Yes, we had a couple of inventory reserve in Q3, just to be clear about $6 million, whereas GAAP only that relates to the restructuring we did last year.
Just the last piece of it that we recorded in Q3.
The other inventory reserve we recorded in Q3 was kind of a normal Ian No reserve after running our usual.
Excess and obsolete inventory model and that was about $3 million in Q3.
Okay.
Okay.
And then lastly, Mike can you just provide a little bit more granularity in terms of how youre thinking about.
First quarter and into the second quarter.
We.
Well progressing perhaps slower pace.
Given where revenues are a little bit surprised that we're continuing to expand unless there are things that are just <unk>.
Very long lead time since it would seem like given.
Peter.
Thanks again.
Okay.
Yes, and Thats exactly it Craig is the long lead time items, obviously in reducing.
Head count and capacity through labor, we've taken down the effective short term capacity of the company pretty significantly so that we can get the cost structure more in line with the revenue, but we've got some things associated with especially facilities, they're multiyear projects to really get.
Where we want to make sure that we have the footprint.
Facility is ready to go we probably don't fill them with tools, but we think those are good investments because again as I said in the prepared remarks.
Strategic tenants behind this business remain firmly in place. So it's purely an issue of timing, where we're feeling the need.
Got it okay. Thank you.
Thank you. Our next question comes from David Dooley.
Go ahead. Your line is open David Dooley.
Yes. Thanks for taking my question I was wondering if you could just help me understand I think you've guided gross margins down from about 47%.
In Q2 to 33% in the current quarter could you just talk about which is like roughly <unk> hundred or.
500 basis points could you just talk about what the biggest magnitude of that reduction is what are the three or four biggest pieces.
I have a follow up on the gross margin.
Sir.
Sure. So just to make sure we are talking about the same numbers. So Q2 of 2022 was 47, 4%, we guided down to 39% in Q3, and 39% and we're talking about 33% in Q4.
Two main factors impacting that.
It will be absorbed and when revenue go down from a level of 100.
$204 million in Q2 to 100.
55 at the midpoint of the range for Q4.
You can understand that.
The negative impact on the gross margin.
But more even more specifically, where we saw the increase was mostly in foundry and logic foundry and logic as a market is the highest of probe cards gross margin in the markets, we serve and with most of the decline coming from foundry and logic and then in Q4 with V in foundry and logic in the RF, which is even.
The highest within the foundry logic that is again a negative impact on the gross margin.
These are the two main factors impacting the decline in the gross margin.
Okay.
What would you expect gross margins to do if revenue were stay flat, let's say in Q1 and Q2, how much gross margin recovery would you expect.
Yes, I think.
I guess assumed the same product mix, because if we can assume breath right, but just kind of assume the same kind of breakout that you have now what can we expect for a trajectory of recovery of gross margins or is it all tied to revenue.
So I think in the in the midterm.
We've talked about Q4, and we're implementing the restructuring plan in Q4 once it's fully implemented at revenue levels similar to Q3 and the similar product mix as you said to Q3 I expect gross margin to be at the low forties.
Going forward longer term, we still expect to reach gross margin of 47% of our target mobile revenues of $850 million.
Again with a higher fixed cost. We currently have because we put some capacity in place mainly facilities and tools, we need to get back to above 200 medium $210 million of quarterly revenue and we need to grow growth to come from our higher margin foundry and logic market to achieve this target model.
So if just to ask it another way if you get back to $210 million in quarterly revenue will.
Will your gross margins to be back at the <unk>, 47% to 48% range or because of the incremental capacity that you added what do you need more than 210 to get to 47 or 48.
A similar effect.
Yes.
Sure.
746.
Margaret.
So for us.
Sure.
Around the corner.
One of them.
Yeah.
I talked about.
Good morning Charles.
Okay.
Okay.
Thank you.
Back to the high fours.
And then help me understand that.
I guess, it's a similar question on the gross margins.
If you just you have added capacity recently in your revenue has kind of declined. So currently what do you think your overall utilization rate is in and maybe help us understand.
<unk> cut costs, what your quarterly revenue.
The capability is there.
That's it for me thanks.
So thinking about the three components of overcapacity facilities is one of them and it's the less flexible, but the longer time to add <unk>.
Tools.
Elsewhere has long lingered long.
The lead time.
But we've been adding them.
Good rates recently.
Not everything is fully functional and operating but we have been adding capacity and labor as the therapies, which is the most flexible and this is where we need when we reduced.
The capacity in this restructuring.
This restructuring.
Should we should have we have the facilities in place we have the tools in place.
And we have enough labor to get to.
Q2 Q3 levels.
Probably more than that.
And.
We have the ability to add labor back if we need to on a relatively fast pace, because we usually use the tampa employees in the beginning yes. There is some training time, so its not immediate.
We have the ability to add back employees.
When we need to win the bid.
<unk> comes in so we have the facilities we have the tools.
Labor I would say Q3 levels.
Sufficient to work we have after the restructuring.
Going back will add as the demand comes in.
Yes.
Thank you.
Thank you. Our next question comes from Hans Chung of D. A Davidson your line is open Hans Chung.
Thank you for taking my question capital.
First.
So.
Basically.
So do you think Cleveland and then Elisa.
On the other hand.
<unk>.
So impacted by the unique.
Number of probe card demand pretty sank are being paid by the customer plant.
So can you help me understand.
We look out into 2023, and I think last week I didn't see let's I'll talk about that.
The new design tape outs for three nanometer.
And then finally, let me tell you the first couple of years.
And think that would be signed momentum.
Still very robust right at least Alexandria, and then we also have the new.
Platform and from logic customer and then so by on the other hand, you automation the number of properties that would go again. So can you help me understand how should I think about.
The <unk> fee.
<unk>.
The outlook I mean relative to maybe the semiconductor industry.
Performance, let's say is the SME.
Something single digit percent in it.
How should we think about our.
For next year.
Yes, Hi, this is Mike I think you've parsed it accurately right Theres two components to this business. One is the new design activity. So this is customers releasing a new mask set a new chip and as I said that activity remains very robust our design team fully loaded.
We haven't seen any cancellations of any significant designs, but the thing that drives revenue is the number of probe cards you ship for each of those designs Austin. This number in the hundreds of probe cards and given and.
In the markets for our customers those volumes are down again, especially in consumer driven segments like client PC and mobile.
If I returned to the broader question on 2023 current industry forecasts have advanced probe cards growing somewhere between 1% and 2%.
There is an expectation going back to Christian statement that we are going to see some stabilization here and customers investing in new designs.
Help that market be a little bit more robust than it has here in the second half.
Okay.
Got it Okay and then.
The next question is about.
Your largest customer was in town and then.
If the customer outsource more.
Two foundries like TSMC.
Is there any implication.
Either positively or negatively incremental revenue opportunity Kevin.
Defend market share at two customer right. So I guess is probably.
EQ.
Whether the entails.
In terms of the wafer testing, whether they will outsource that as well so just wonder here your thoughts.
Yes.
It's always an interesting question for this business, where our customers.
If they are producing wafers at the foundry, whether theyre also doing test at the foundry and that depends for.
Different customers have different strategies.
Both major microprocessor customers actually own their own.
Test processes, so they purchase wafers from the foundry.
And then manage either internally inside their facilities or contracting out to the old SaaS like in ASE spill of EMCORE to do the test, but they own their own test processes. So I think in the microprocessor space.
The shift between.
Foundry front end and IDM front, and we don't feel like there's a really big swing there for US having said that clearly we want to be in a position, where we're qualified and competing for business and supporting all of the major customers in the industry irrespective of their test model.
Okay got it thank you.
Thank you again to ask a question. Please press star one one on your telephone again Thats Star one one on your telephone to ask a question.
Our next question comes from the line of David Silver of CL King. Your line is open David Silver, Yes, hi, Thank you very much.
Hi, I apologize if I make you repeat yourself here gentlemen, I did have to step away for just a minute or two.
Regarding the cost actions that you're taking here.
I'm just wondering if you provide any detail on kind of maybe the geographic spread of them in other words.
I'm just wondering how much might be in North America versus in particular Asia.
As you align the cost actions with the.
With the anticipated.
Software revenues. Thank you.
Yes, most of them.
Labor that we reduce tours in North America.
Factories in California, and Oregon.
And some was in Asia more on the SG&A side.
But the vast majority of them and then North America.
Very good.
Yeah.
My next question would just be maybe.
Your if you could share kind of the thinking of some of your major customers, but there is the wave of very large multibillion dollar new fab investments that are.
Due to come on mainly in the U S. Beginning maybe late 2023 or so so maybe just beginning may be a year or slightly more from now.
As you think about.
There.
Kind of anticipated.
Lines or road maps.
From your perspective are there going to be any major changes in other words is the demand declines that we're experiencing right now does that change your major customers thinking about.
Completing.
Those major investments.
On the original timetable thank you.
Well I think there's always a question in this industry of when you bring capacity online.
Our customers are.
Are facing the same set of decisions. We are in the very long lead time items things like facilities clean rooms in some cases.
Enabling tool sets for our customers things like lithography are multi year.
Have multiyear lead times, and so I think theres, a collective belief among the supply chain and the customer base.
This is a cyclical downturn in the industry.
Clearly there are some other factors associated with it whether they be U S China trade restrictions or.
The potential for <unk>.
Recession in 2023, but fundamentally if you look at the long term content growth and growth of the industry.
We're all.
In the same position, where we're confident in that growth the things that underpin that like advanced packaging and then.
We all want to be sure we have the fundamental capacity footprint in place to capitalize on the demand when it comes.
Yes.
That's great. Thank you very much.
Yeah.
Thank you at this time I would like to turn the call back over to Mike Lessor for closing remarks, Sir.
Yes, Thank you everyone for joining us today.
We'll talk to you again, either in January or I think we're doing a couple of conferences as we ended the year.
If we see there.
Have a great end of the year, otherwise, we'll see you take care.
This concludes today's conference call. Thank you for participating you may now disconnect.
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