FormFactor Inc

NASDAQ:FORM

Earnings Call Analysis

FormFactor sees strong Q2, expects continued growth

FormFactor experienced a robust second quarter, with revenue growing to $197.5 million, up 17% sequentially and 26.7% year-over-year. The company saw significant growth in its Probe Cards segment, particularly driven by DRAM probe cards, and an increasing demand for high-bandwidth memory (HBM) products. Despite achieving record DRAM revenue, FormFactor anticipates a shift in its product mix for Q3, expecting an increase in DDR5 shipments and a slight drop in HBM. For Q3, revenue is projected to reach $200 million. Overall, the company remains optimistic about its diversification strategy and future growth prospects.

Strong Financial Performance in Q2 2024

In the second quarter of 2024, FormFactor showcased impressive financial results, with revenues reaching $197.5 million, surpassing the midpoint of their prior outlook by $2.5 million. This represents a 17% sequential increase from Q1 and a 26.7% year-over-year growth compared to Q2 2023. The success was largely driven by the Probe Cards segment, which saw revenue of $167 million—an increase of 22% from the first quarter. Notably, DRAM probe card revenue reached record levels, with high-bandwidth memory (HBM) sales nearly doubling to constitute about 75% of DRAM revenue by the end of Q2【4:1†source】【4:3†source】.

Steady Demand and Optimistic Q3 Outlook

FormFactor's outlook for the third quarter is equally promising, forecasting revenues of approximately $200 million, with expectations for sequential growth driven primarily by continued strength in DRAM and systems sales. The company anticipates a slight increase in revenue from DRAM probe cards compared to Q2, despite expecting a change in product mix with a higher share of DDR5 shipments at the expense of HBM【4:4†source】【4:3†source】.

Diversification Strategy Pays Off

One cornerstone of FormFactor's success is its diversification strategy. The company maintains a broad product portfolio, spanning various probe card markets, which mitigates the impact of downturns in specific areas. This strategy has provided stability during industry fluctuations and has enabled the company to capitalize on emerging opportunities, particularly in the sectors of co-packaged silicon photonics and advanced packaging technologies【4:1†source】【4:5†source】.

Decrease in Non-GAAP Gross Margin for Q3

While the revenue outlook remains upbeat, the company expects a slight decrease in non-GAAP gross margin to about 43%—a decline attributed to a less favorable product mix as DRAM revenues rise as a percentage of total revenues. This shift reflects a transition from higher-margin HBM products to lower-margin DDR5 products. The non-GAAP earnings per share for Q3 are forecasted to be approximately $0.31【4:3†source】【4:5†source】.

Future Growth Potential Driven by Advanced Technologies

Looking toward the future, FormFactor is well-positioned to benefit from the growing demand for advanced packaging technologies like HBM, chiplets, and silicon photonics, driven by increased semiconductor content and complexity. The company also aims to maintain its competitive edge in the rapidly evolving electro-optical testing space, especially in developing applications like quantum computing. Their investments in research and development and capacity enhancement are expected to facilitate this drive【4:5†source】【4:3†source】.

Cash Position and Capital Management

As of the end of Q2 2024, FormFactor reported total cash and investments of $366 million, reflecting a solid financial footing for future investments. During the quarter, the company also executed a share buyback totaling $2.9 million, with $53.5 million still available under the ongoing buyback program initiated in Q4 of 2023, aimed primarily at offsetting dilution from stock-based compensation【4:4†source】【4:3†source】.

Earnings Call Transcript 2024-Q2

[Operator]

Thank you, and welcome, everyone, to FormFactor's Second Quarter 2024 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, executive]

Thank you. Today, the company will be discussing GAAP P&L results and some important non-GAAP results intended to supplement your understanding of the company's financials. Reconciliations of GAAP to non-GAAP measures and other financial information are available in the press release issued today by the company and on the Investor Relations section of our website.

Today's discussion contains forward-looking statements within the meaning of the federal securities laws. Examples of such forward-looking statements include those with respect to the projections of financial and business performance; future macroeconomic and geopolitical conditions; the benefits of acquisitions and investments in capacity and in new technologies; the impact of global, regional and national health crises, including the COVID-19 pandemic; anticipated industry trends; potential disruption in our supply chain; the impact of regulatory changes, including the recent U.S.-China trade restrictions; the anticipated demand for products; our ability to develop, produce and sell products; and the assumptions upon which such statements are based. These statements are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from those expressed during this call.

Information on risk factors and uncertainties is contained in our most recent filing on Form 10-K with the SEC for the fiscal year ended December 30, 2023, 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 31, 2024, and we assume no obligation to update them.

With that, we will now turn the call over to FormFactor's CEO, Mike Slessor.

[Mike Slessor, executive]

Thanks, everyone, for joining us today.

FormFactor's second quarter revenue, non-GAAP gross margin and non-GAAP EPS all exceeded the midpoint of the outlook range we provided in May. The expected strength in our Probe Card business drove second quarter results, as we recorded sequential increases in all 3 probe card markets. DRAM probe card revenue reached record levels with revenue from high-bandwidth memory, or HBM, doubling for the third consecutive quarter to nearly 75% of our DRAM revenue.

In the current third quarter, we're experiencing steady overall demand for FormFactor's products as we continue to make progress towards our target financial model.

Our second quarter results and third quarter outlook illustrate the unique value of FormFactor's diversification strategy, which differentiates us from our direct competitors with a broad lab-to-fab product portfolio across foundry and logic, DRAM and flash probe cards, together with our Systems segment products. This portfolio enables us to compete for business across diverse demand tools at all major customers, producing relatively stable results during last year's downturn and the top line growth we're delivering this year.

Our revenue growth is being driven by exposure to expanding areas like high-bandwidth memory and DRAM probe cards and co-packaged silicon photonics and systems, enabling FormFactor to grow even as we await refresh cycles in important high-unit volume end markets that drive foundry and logic probe card spending like mobile handsets and client PCs.

FormFactor's third quarter outlook also demonstrates several unique features of probe card demand. As we often note, probe cards are a consumable that's specific to each new chip design, meaning we benefit from both technology node transitions and from the release of new designs on existing nodes. Together with our broad market and customer exposure, this produces a more stable demand profile than the more volatile demand cycles that characterize capital equipment. This difference is particularly evident in the current environment as FormFactor's stable third quarter outlook contrasts sharply with the sequentially weaker third quarter outlooks offered by several companies in the test and assembly capital equipment sector.

Turning now to market and segment-level details. As I noted, we set a record for DRAM probe card revenue in the second quarter, driven by the sequential doubling of high-bandwidth memory revenue layered on top of steady DDR5 new design activity. To put HBM's torrid growth into perspective, in the first half of 2024 alone, we doubled the HBM revenue we delivered in all of 2023. In addition, our second quarter HBM revenue is greater than FormFactor's total quarterly DRAM revenue in each quarter of 2023.

This activity is a direct result of the large hyperscaler investments in generative AI infrastructure and our customers' corresponding ramps of HBM capacity and output. HBM, which is a stack of 8, 12 or even 16 individual DRAM die assembled with advanced packaging processes like through silicon vias and thermal compression bonding, continues to offer a powerful example how advanced packaging is driving our current results.

It also foreshadows our long-term opportunity as we benefit from the increased test intensity and increased test complexity that's inherent in advanced packaging architectures.

In the third quarter, demand for DRAM probe cards continues to be robust, and we expect a slight increase in revenue from the second quarter record. We do, however, expect a shift in our DRAM product mix, with sequential increase in DDR5 shipments and a reduction in HBM shipments.

We've mentioned in the past that our customers often have 1 to 2 quarter periods of digestion following a strong quarter of shipments. With lead times of less than a quarter, our short-term visibility remains challenging as always, but given our customers' continued strong investment in HBM capacity, we expect the third quarter pause in HBM growth will represent a temporary digestion phase and the growth will resume in 1 to 2 quarters.

Shifting to the foundry and logic probe card market. We delivered the expected second quarter sequential growth driven by the seasonal ramp of new mobile application processor designs and stronger probe card demand for client PC and server microprocessor designs. In the current third quarter, we expect foundry and logic demand and product mix to be similar to that achieved in the second quarter.

Advanced packaging processes like Foveros and CoWoS are being increasingly used to architect foundry and logic chip designs. As with HBM and DRAM, this disaggregation of a chip into subcomponent chiplets or tiles increases both test intensity and test complexity compared to an equivalent monolithic chip.

The increase in test intensity is driven by the need for our customers to probe and test each component chiplet prior to stacking and then to probe and test the multi-chiplet stack at various points during the assembly process. The resulting increase in probe card use per good die out is the same dynamic that is driving the strong probe card spending by our customers for HBM DRAM and is the source of relatively strong midyear foundry and logic demand despite the lack of recovery in important end markets like mobile handsets and PCs.

At the same time, the technical requirements for probe cards for foundry and logic designs built using advanced packaging processes are significantly more demanding than for standard unstacked products involving higher test speeds and more challenging thermal and power specifications.

As we've seen with HBM and DRAM, our differentiated ability to meet these performance requirements will drive both market share and profitability gains as the adoption of advanced packaging and foundry and logic continues.

In the Systems segment, we expect a slight sequential increase in third quarter revenue as customers continue to engage us to solve the most complex electrooptical test-and-measurement challenges in areas like quantum computing and co-packaged silicon photonics.

In co-packaged optics, which is poised to revolutionize chip-to-chip communication in the data center by significantly reducing power consumption at high data rates, we're collaborating with key customers in the early stages of the lab-to-fab transition from R&D to low-volume production.

In these collaborations, customers are deploying FormFactor's turnkey electrooptical measurement systems, built on our CM300 and SUMMIT200 engineering probers together with our proprietary ferrous optical probes. These highly differentiated optical probes enable either surface or edge coupling to the photonic die with unrivaled coupling efficiency, providing our customers with higher yields and shorter test times.

As silicon photonics matures and moves to high-volume production in the coming years, we expect that our leadership positions in combined electrical and optical tests will provide a new growth vector for both our Systems and Probe Card businesses.

In closing, we're excited about both our strong second quarter results and our solid third quarter outlook as the accelerating adoption of advanced packaging drives increased demand across FormFactor's lab-to-fab product portfolio.

Longer term, we're confident in the growth prospects for FormFactor in the industry overall, driven by the fundamental trends of semiconductor content growth and advanced packaging innovations like HBM, chiplets and co-packaged silicon photonics.

As is evident from our recent results and outlook, these are trends where FormFactor is well positioned, and we're confident that our investments in R&D, capacity and talent will further enhance FormFactor's market leadership. This will enable us to achieve and then surpass our target model that delivers $2 of non-GAAP earnings per share on $850 million of revenue.

Shai, over to you.

[Shai Shahar, executive]

Thank you, Mike, and good afternoon.

As you saw in our press release, Q2 revenues were $197.5 million, $2.5 million above the midpoint of our outlook range, and non-GAAP gross margin of 45.3% was 0.3 percentage points above the midpoint of the range. These, together with OpEx slightly lower than the midpoint of outlook, resulted in a non-GAAP EPS at the top end of the range.

Second quarter revenues increased 17% sequentially from the first quarter and increased 26.7% year-over-year from our Q2 '23 revenues. The upside versus the midpoint of the outlook range was due to higher revenues in our Probe Cards segment.

Probe Cards segment revenues were $167 million in the second quarter, an increase of $30 million or 22% from the first quarter. The increase was driven mainly by higher foundry and logic and DRAM revenue.

The Systems segment revenues were $30.7 million in Q2, a $1.3 million decrease from the first quarter and comprised 15.5% of total company revenues, down from 19% in the first quarter.

Within the Probe Cards segment, Q2 foundry and logic revenues were $104 million, a 19.5% increase from the first quarter. Foundry and logic revenues increased to 52.5% of total company revenues compared to 51.4% in the first quarter.

DRAM revenues were a record $58 million in Q2, $12.1 million or 26.5% higher than in the first quarter and rose to 29.4% of total quarterly revenues as compared to 27.2% in the first quarter.

Within DRAM, HBM revenue almost doubled from $22 million in Q1 to over $43 million in the second quarter. Flash revenues of $5.1 million in Q2 were $1.1 million higher than in the first quarter and were 2.6% of total revenues in Q2 as compared to 2.4% in Q1.

GAAP gross margin for the second quarter was 44% as compared to 37.2% in Q1. Cost of revenues included $2.5 million of GAAP to non-GAAP reconciling items, which we outlined in our press release issued today and in a reconciliation table available in the Investor Relations section of our website.

On a non-GAAP basis, gross margin for the second quarter was 45.3%, 6.6 percentage points higher than the 38.7% non-GAAP gross margin in Q1 and 0.3 percentage points above the midpoint of our outlook range. The increases compared to Q1 was mostly the result of higher gross margins in the Probe Cards segment. While we expect fluctuations quarter-over-quarter, mainly due to product mix changes, achieving this 45.3% gross margin in the second quarter validate our progress towards our 47% target financial model non-GAAP gross margin at annual revenue of $850 million.

Our Probe Cards segment gross margin was 45.1% in the second quarter, an increase of 8 percentage points compared to 37.2% in Q1. Our Q2 Systems segment gross margin was 46.2%, an increase of 0.9 percentage points compared to 45.3% gross margin in the first quarter.

As compared to Q1, approximately 2/3 of the increase in non-GAAP gross margin is attributable to the higher volume and the remaining 1/3 relates to a more favorable product mix.

Our GAAP operating expenses were $69.4 million for the second quarter as compared to $61.7 million in the first quarter. Non-GAAP operating expenses for the second quarter were $60.9 million or 30.8% of revenues, as compared with $52.3 million or 31% of revenues in Q1. The $8.5 million increase relates mainly to higher performance-based compensation.

Company noncash expenses for the second quarter included $10.2 million for stock-based compensation, $0.6 million for the amortization of acquisition-related intangibles and depreciation of $7.4 million, all similar to the first quarter.

GAAP operating income was $17.8 million for Q2 compared with GAAP operating income of $21.3 million in Q1. Non-GAAP operating income for the second quarter more than doubled to $28.5 million compared with $13 million in the first quarter, an increase of $15.6 million or 120%, demonstrating the leverage in our operating model.

GAAP net income for the second quarter was $19.4 million, or $0.25 per fully diluted share compared with a GAAP net income of $21.8 million, or $0.28 per fully diluted share in the previous quarter. GAAP net income in Q1 included a gain of $20 million from the divestiture of our Chinese subsidiaries.

The non-GAAP effective tax rate for the second quarter was 15.4%, 1.7 percentage points higher than the 13.7% in the first quarter, and we continue to expect our annual non-GAAP effective tax rate to be between 14% and 18%.

Second quarter non-GAAP net income almost doubled to $27.3 million, or $0.35 per fully diluted share compared to $14.3 million, or $0.18 per fully diluted share in Q1.

Q2 EPS was $0.17 higher due to significantly higher revenues and higher gross margins, with relatively flat OpEx as a percentage of revenue.

Moving to the balance sheet and cash flow. We generated free cash flow of $14.2 million in the second quarter compared to $19.7 million in Q1. The main reason for the decrease in free cash flow was increased working capital attributable to the revenue growth, partially offset by lower capital expenditure spending of $5 million.

We invested $8.4 million in capital expenditures during the second quarter compared to $13.4 million in Q1. There's no change in our previously communicated expected CapEx range for 2024 of $35 million to $45 million.

At quarter end, total cash and investments were $366 million, an increase of $8 million from Q1.

At the end of the second quarter, we had 1 term loan remaining with a balance totaling $14 million.

Regarding stock buyback. During the second quarter, we used $2.9 million to buy back shares under the $75 million 2-year buyback program that was approved in Q4 2023. At quarter end, $53.5 million remained available under that authorization. As a reminder, the main purpose of the share repurchase program is to offset dilution from stock-based compensation.

Turning to the third quarter non-GAAP outlook. We expect Q3 revenue of $200 million, plus or minus $5 million, with a slight increase over Q2 coming from DRAM and Systems. Within DRAM, we also expect a mix shift with a higher percentage of DDR5 versus HBM revenue.

Third quarter non-GAAP gross margin is expected to be 43%, plus or minus 150 basis points. The expected decrease in non-GAAP gross margins in the third quarter at the midpoint of the outlook range on slightly higher revenues relates to a less favorable product mix, with DRAM revenues as a percentage of total revenues expected to increase and HBM revenue within DRAM is expected to decrease.

At the midpoint of these outlook ranges, we expect Q3 operating expenses to be $61 million, plus or minus $2 million, similar to Q2.

Non-GAAP earnings per fully diluted share for Q3 is expected to be $0.31, plus or minus $0.04.

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]

[Operator Instructions] Our first question comes from the line of Craig Ellis of B. Riley Securities.

[Craig Ellis, analyst]

Congratulations on the execution, guys. Mike, I wanted to start just by following up on a point you made with regard to high-bandwidth memory. I think you indicated the company expected that after some digestion, the third quarter growth could reaccelerate there. I was hoping you could just share some of the either customer interaction or things that you're seeing that lend confidence to the reacceleration and any color on timing would be helpful.

[Mike Slessor, executive]

Yes. So Craig, good question. Just to level set everybody, we, again, in the second quarter doubled HBM revenue to 75% of our DRAM revenue. So a really significant contribution from that.

As I think most of you know, it's pretty concentrated with a single customer, although each of the 3 major DRAM manufacturers do have contributions in there. And it's not unusual when we ship at that scale for a customer to have a period of digestion, where they then use the probe cards for a quarter or 2. You can see this historically through our major customers as they're in their cadence quarter-to-quarter that we report for 10% customers.

So what gives us confidence that this is that digestion? I think a couple of things. If I look at it from a macro level, continued hyperscaler investments in generative AI, which in turn is driving our customers, our DRAM customers to increase their capacity and output of HBM3 and 3E currently and beginning to do development on HBM4 in pilot production. And really, in conversations with those customers, there's no pause in that. They really are continuing to invest very heavily in this pretty lucrative part of the DRAM market, again, driven by hyperscaler investments.

Our direct visibility, as most of you know, is pretty limited. We operate with lead times of less than a quarter. And so in terms of POs and backlog, we can't see much past the end of the third quarter here. But when we look at the conversations we're having with these customers, when we look at the investments the hyperscalers are making, it does seem like it's pretty reasonable to attribute this Q3, still HBM still at pretty healthy levels to a digestion period.

[Craig Ellis, analyst]

That's really helpful, Mike. And then the follow-up question is somewhat similar. Three months ago, you noted that a foundry and logic customer, formerly the largest customer before this last quarter where it's now DRAM, would, at times in the past, go through a period of digestion after a really strong quarter. Are you seeing signs? And is it baked in the guidance that we will see that digestion in the third quarter? Or how are you thinking about the risk that, that could happen at this point?

[Mike Slessor, executive]

Yes. Foundry and logic overall, we see in the third quarter, pretty comparable to the second quarter, both from overall levels and customer and product mix. And I think this is really another proof point associated with how advanced packaging is driving our business.

You see major customers certainly in compute, but also, to some extent, in mobile, beginning to adopt advanced packaging. In fact, we're beginning to adopt advanced packaging. And we see that with -- across the compute sector, technologies like Foveros and CoWoS. Even as the PC end market remains somewhat muted, we're seeing pretty solid demand for probe cards because of the increase in test intensity and complexity driven by advanced packaging in these sectors.

So third quarter, pretty similar to second quarter in foundry and logic from an overall customer and product mix perspective, again, driven by advanced packaging.

[Craig Ellis, analyst]

That's really helpful. And then just the observation on that, Mike, would be since those heterogeneous die-based products are such a small part of mix now, but over time will become a majority of mix, that would seem to be a real nice long-term secular tailwind for the business.

[Mike Slessor, executive]

Yes. I think across the industry, it's a really interesting and compelling secular opportunity for those of us exposed to advanced packaging.

[Operator]

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

[Yu Shi, analyst]

The first one, it's about DDR5 versus HBM. I think prior to this quarter, the way you characterize the DRAM probe card market was if you back out HBM, the standard DRAM or DDR probe card, were still run rating around that, I would say, $20 million-ish, the downturn level basically. It looks like the next quarter, the September quarter, you're expecting a somewhat similar DRAM total revenue. But since you talked about mix shift away from HBM, more to DDR5, would you characterize maybe this is the beginning of the standard DRAM recovery? Or this is maybe just a one-off quarter? I just want to know the sustainability of the DDR5 probe card growth from here.

[Mike Slessor, executive]

Yes. It's an interesting question. And as you might imagine, we're having similar discussions internally and with our customers. I think if you look at the overall non-HBM DRAM market, we're characterizing it as DDR5, but that's a pretty broad brush that's low power, server and compute. It is seeing a significant step-up here in the third quarter to levels that are comparable to the previous cyclical highs.

Now, when we see where HBM is, we said there's a bit of a 1-quarter digestion period, and that's not unusual. Remember, probe cards are specific to each customer chip design. And so as customers move their wafer starts in, back and forth between technologies and different products for them to optimize their output for their market, we can see these pretty significant swing between designs and markets and submarkets.

Whether this is the start of a DRAM upturn, I think is still to be seen, but it is encouraging if you've seen DRAM spot pricing, if you've heard the narrative from our customers on the overall DRAM market improving, it certainly may be the beginning of an upturn. For now, we just don't have the visibility to say so, whether it is or not, but nice to be, again, operating our DRAM business, a very important business for us, up at record levels.

[Yu Shi, analyst]

I want to have a follow-up on the foundry and logic side of the business. It's up in Q2. It was up foundry and logic probe card was up in Q2 by quite a lot, but your largest microprocessor customers, the revenue you do disclose on a quarterly basis, it didn't really go up, I mean, as much. I mean it doesn't explain all the incremental you're seeing in the foundry and logic side. So this kind of a midyear strength, mind if you clarify a little bit of what's driving that outside of this microprocessor company? And more importantly, going into next quarter, who is driving that incremental growth in the foundry and logic probe card?

[Mike Slessor, executive]

Yes. We often see this midyear strength in mobile application processors. If you look at phone release cadences and work back to the timing where customers are going to need probe cards for this, that's exactly what we're seeing right now. And we talked about it on the last call with the anticipated second quarter strength, which materialized, being associated both with microprocessors, but also midyear releases of these mobile application processors. That's a theme that we see carrying through the second quarter. Again, we see foundry and logic having a similar level and profile in the third quarter as in the second quarter.

And so beyond that, again, visibility pretty limited, but we're pretty happy with how we're executing in the broader foundry and logic market. Always some improvements, always some share to gain. But that's -- both of those factors driving our foundry and logic strength in the middle part of the year.

[Yu Shi, analyst]

And maybe a quick follow-up to that. Do you see a little bit of a mix shift in foundry and logic probe card from Q2 to Q3?

[Mike Slessor, executive]

No. It's very similar, Charles.

[Operator]

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

[Thomas Diffely, analyst]

Mike, I was curious, when you look at the high-bandwidth memory ramp that you've had this year, how much of that was driven by just increasing volumes of high-bandwidth memory versus a design change? And then if there is a big shift to the next-generation design, what does that do to your business?

[Mike Slessor, executive]

Yes. As we've said, probe cards are a design-specific consumable. And so there's these 2 pieces. There's the release of a new design, but there's also the number of wafer starts and number of test cells and, therefore, probe cards that need to run on this design.

I'd characterize the growth in the second quarter of the HBM business being concentrated across, let's call it, in round numbers, 10 designs that are really the high runners driving the growth. And so that could be 1 chip. Remember, HBM, a stack of mostly 8 high DRAM, but there's a base die, there's test insertions for the 8-core die and then there's also a test insertion when the customer is done stacking. Each of those 3 sets of probe cards is a unique fleet of probe cards.

And so that's part of the test intensity increase associated with HBM in particular and advanced packaging in general, but more than a handful of designs really driving the strength.

[Thomas Diffely, analyst]

And then when you look at the business next year in '25, do you think it's pretty well split between the 3 main suppliers? Or are you still going to be very leveraged to one of the players?

[Mike Slessor, executive]

No. I think as I said, we currently see contributions from all 3 manufacturers, although we're over-indexed to the leader in HBM market share. A fundamental tenet of our strategy is to make sure that we're a key supplier at the leading edge to all major customers. And so qualification work is ongoing at both of them. We're in a position to compete for that business. As HBM3 and HBM4 come out, those are opportunities for our customer share to go up and for us to go compete for new business as well.

[Thomas Diffely, analyst]

Great. And then final question, Shai, when you look at the margin guidance for the next quarter, is it simply the decrease of high-bandwidth memory as a percentage of product mix issue?

[Shai Shahar, executive]

Well, it's a combination of DRAM revenue overall as a higher percentage of revenue and within DRAM, the shift from HBM to DDR5. So it's both of them.

[Operator]

Our next question comes from the line of Christian Schwab of Craig-Hallum.

[Christian Schwab, analyst]

So just, again, on high-bandwidth memory, we can kind of back into the math, pretty modest revenue from the other 2 big guys. As we get into 2025, do you think you have 3 meaningful customers in that space? Or do you think that there's the potential for -- as the other 2 guys get up to speed, that they begin to take share? I'm just trying to size what your expectations in '25 and '26 are for high-bandwidth memory as the other 2 guys come to market and have talked about being sold out for next year.

[Mike Slessor, executive]

Yes. Yes. Well, remember, if we back out a little bit, we're a key supplier to all 3 major DRAM manufacturers in DDR4, DDR5, and we hope to be for HBM as well. Currently, one of them owns the lion's share of HBM shipments. And so that's why we're over-indexed to that customer.

But again, as Tom asked, we do expect as the other 2 DRAM manufacturers gain share in the transition from HBM3 to HBM4, work their way through some pretty significant technical and yield challenges in ramping this up, we do expect that share to balance out a little bit.

So as we look into '25, the transition to HBM4, certainly exciting for us. It raises the speed requirements for the probe card. So again, a notch up in complexity. And as customers go to stacking 12- and even 16-high die, that obviously is going to increase the overall test intensity and complexity and testing that overall stack. So we feel like we're in a pretty strong competitive position even as the share starts to balance among all 3 DRAM manufacturers.

[Christian Schwab, analyst]

And a follow-up to that, on the high-bandwidth memory 4 transition, given, as you said, the speed and increased stacking capabilities, I would assume that there should be some pricing power on those probe cards, not all the way, obviously, to foundry and logic levels, but potentially higher than where we sit today. Is that fair?

[Mike Slessor, executive]

Yes, that's fair. And one of the reasons, right, we touched on it in a question a couple of minutes ago, but the mix shift away from HBM towards DDR5 inside DRAM at these high levels, certainly is a gross margin headwind. And so you can connect the dots there.

Our ability to build probe cards that are highly differentiated and provide a lot of value to our customers in testing at speed and across multiple temperatures in a very complex mechanical situation. You're testing a whole 300-millimeter wafer of the stacked die across a temperature range of over 100 degrees Celsius. And you can imagine the thermal scaling challenges associated with that are significant. And then that's why an HBM probe card is worth more.

[Christian Schwab, analyst]

Great. And then my second question, now we've got 2 quarters and call it at roughly $200 million, which is kind of the target model, do you guys have a set of expectations when you plan on updating your target model?

[Shai Shahar, executive]

Sure. I'll take this one, Christian. So we are 2 quarters at $200 million, but the target model is a little higher than that, right? If you take the $850 million, it's about $210 million, $212 million. So what we want to do is what we have done in the past. Once we have a quarter or 2 at this model run rate, and I agree we're getting closer to it, but we are not there yet, then we'll set up a date, schedule a new Analyst Day and then work on publishing the new target model. So we're not there yet, but stay tuned.

[Operator]

[Operator Instructions] Our next question comes from the line of Brian Chin of Stifel.

[Brian Chin, analyst]

A few questions. Mike or Shai, did you comment whether you expect sort of that -- the mix shift you're seeing in the DRAM business to persist into Q4? I guess that's kind of the first question because maybe it's like 150 to 200 basis point headwind or something relative to what it was in 2Q. And so that's, I guess, the first question.

[Mike Slessor, executive]

Yes, Brian. It's Mike. I'll take that. I think in terms of timing, I'll again caveat this with our visibility, our direct visibility doesn't really go much past the end of 3Q here. We're operating with short lead times. We certainly have forecasts from our customers, but the dramatic shift in DRAM towards production capacity for DDR5 is something that's a relatively dynamic situation. Whether it persists or not is something that probably we need a few more weeks or months to really get a read on from our direct backlog.

Having said that, if you do look at the underlying DRAM market, DDR4 and DDR5, low-power server and PC, they do seem to be strengthening. And so it wouldn't be all that surprising if there was a shift of some capacity towards those markets, and we saw a bit growth in the non-HBM parts of the market.

A little bit early to tell. And again, our visibility doesn't go that far into the future, but some of the fundamental factors are in place for a DRAM recovery, a general DRAM recovery.

[Brian Chin, analyst]

Yes. I was even thinking Samsung seemed pretty confident last night that their HBM3 shipments, they aren't the dominant player, but that they would accelerate substantially in the back half of the year. So maybe it's not 3Q, but I imagine that could factor into your outlook for HBM at some point in the second half.

[Mike Slessor, executive]

That's right.

[Brian Chin, analyst]

Okay. And I don't know if anyone asked but in terms of the -- I missed this part, but the China increase Q-on-Q, is that mainly just multinational? Is there any kind of additional color on what drove that?

[Mike Slessor, executive]

Yes. No, that wasn't asked, so a good topic to touch on. Reminder, so in Q2, a little over 10%, China as a percentage of revenue. And inside the Q3 outlook, we are forecasting a moderate increase, but it'll still be in the teen, nowhere near the 40% to 50% some of the WFE suppliers have for China concentration.

Remember, we've been pretty proactive in managing the situation. We divested our China operations and then formed an exclusive distributorship with the purchaser of that business. And we're opportunistically serving the domestic China business as best we can in the face of some pretty significant geopolitical headwinds, both from direct export controls and the China industry semiconductor response to stand up its own domestic semiconductor industry.

So we see a moderate increase. I don't see it as a theme where we're going to get significant contribution from the China business, again, because of these almost structural geopolitical headwinds.

[Brian Chin, analyst]

Great. Let me just kind of get a little off-topic here for one last question. Energy efficiency usage bandwidth, these are obviously key themes in data center.

[Mike Slessor, executive]

Yes.

[Brian Chin, analyst]

Understanding that silicon photonics is an area the company has invested in. Where are we on the adoption curve for co-packaged optics? And how significant of a market opportunity could that be in maybe a couple of years?

[Mike Slessor, executive]

Yes. We are very, very early. As I said, just inching out of the lab where we've been engaged with customers for years in co-developing the fundamental measurement technologies like our ferrous optical probe that allows customers faster test times and better overall yield because of its better signal to noise and coupling efficiency. But we've got a handful of tools inside production sites that are in the very early stages of pilot production.

As you note, though, this is one of the ways to help solve, it's not going to entirely solve, but it helps solve a pretty significant problem associated with data centers and that's energy consumption.

Going to silicon photonics on chip-to-chip communication in the data center has the potential to impact the energy usage, energy budgets for these data centers. And that's something the broader compute industry is going to have to confront as data centers become bigger and bigger users of electricity worldwide. So we view silicon photonics as something that's a when, not an if. I think the timing, probably at the earliest, late '25 into '26 where we start to see moving into the knee of the curve of adoption and running significant volumes inside the foundries worldwide.

[Operator]

Our next question comes from the line of Robert Mertens of TD Cowen.

[Robert Mertens, analyst]

This is Rob Mertens on for Krish. You mentioned the better-than-expected gross margins in the Probe Card business, largely due to higher volumes and maybe around 200 basis points or so attributed to the mix. Was the positive mix largely the high-bandwidth memory increase? Or more of a general mix throughout both the foundry logic and memory end markets?

[Shai Shahar, executive]

So if you refer to Q2, we were right on spot, right? So gross margin was 45.3% versus midpoint of the outlook of 45%. So I'm not sure what miss you refer to.

[Robert Mertens, analyst]

Sorry, just in terms of the gross margins, I thought I heard 2/3 driven by volumes and 1/3 driven by mix. I'm not really sure.

[Shai Shahar, executive]

That's the increase from Q1. So Q1 gross margin, if you recall, was in the high 30s, 38.7%. So the increase from Q1 to Q2 from the 38.7% to the 45.3%, 2/3 of it relates to volume and about 1/3 to mix. And that change in mix is more HBM, more foundry and logic Q2 over Q1.

[Robert Mertens, analyst]

Okay. And then could you just provide a little more color on the progress with qualifications of MEMS-based probe cards for GPU tests and maybe what the size of the market opportunity could look like?

[Mike Slessor, executive]

Yes. I think sizing it is interesting. Maybe to get everybody on the same page, as the largest GPU manufacturer transitions to advanced packaging, primarily CoWoS at the world's largest foundry, that requires MEMS probe cards, right? The legacy probe cards they use for monolithic GPUs no longer work.

And so we are in a qualification process there. I'd say our major competitor is -- has been ahead of us and has got the initial business, kind of what we've been more focused on HBM and that opportunity. But it's a strategic imperative us to qualify there here in 2024 and make some progress.

I do think, again, relatively difficult to size the opportunity. But as you heard from some of the memory manufacturers, there's an interesting asymmetry associated with some of these AI products where the amount of memory in the package is almost 10x that of the GPUs. And so for unit-driven businesses like ours, HBM becomes a much more compelling opportunity. That's not to diminish the importance of qualifying during this important transition of GPUs to meeting MEMS-based technologies for probe, but we like, obviously, the exposure to HBM as well.

[Operator]

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

[Mike Slessor, executive]

All right. Thanks, everybody, for joining us today. We've got a couple of conferences in late August and early September that we hope to see you at.

Until then, take care.

[Operator]

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