FormFactor Inc (FORM) Q1 2019 Earnings Call Transcript

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FormFactor Inc (NASDAQ: FORM)Q1 2019 Earnings CallMay. 01, 2019, 4:30 p.m. ET

Contents:

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  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Thank you and welcome everyone to FormFactor’s First Quarter’s 2019 Earnings Conference Call. On today’s call are Chief Executive Officer, Mike Slessor; and Chief Financial Officer Shai Shahar. As a reminder, this call is being recorded.

Before we begin, Jason Cohen the company’s General Counsel will remind you of some important information.

Jason CohenGeneral Counsel

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 conditions, foreign exchange rates, business momentum, business seasonality, the anticipated demand for products, customer requirements, our future ability to produce and sell products, the development of future products and technologies, 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 2018 and our other SEC filings which are available on the SEC’s section of our website at www.sec.gov and in our press release issued today. Forward-looking statements are made as of today May 1st, 2019, and we assume no obligation to update them.

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

Mike SlessorPresident and Chief Executive Officer

Thank you, Jason, and thanks everybody for joining us today. FormFactor again delivered solid financial performance in the first quarter of 2019 with revenue and non-GAAP earnings per share at the high end of the outlook we provided three months ago. This performance was driven by a combination of steady overall demand and good execution augmented by unusually strong mix-related gross margins in our engineering system segment. As is evident from our current outlook, we expect to deliver modest sequential growth in the second quarter as we continue to experience steady overall demand.

To put our recent results into context, over the last four quarters a period during which semiconductor capital equipment spending has fallen by 20% or more, FormFactor’s revenue has been largely stable varying within a range of only 6%. Our diversified opportunity set provides us multiple demand drivers and revenue opportunities with each of our underlying customers, segments and markets experiencing individually fluctuating demand levels. This of course produces variations in product mix and gross margins evident in each quarter’s result, but the net effect is a more stable overall revenue stream through the cycle. In addition, as we’ve explained in the past probe cards are consumable that is specific to each new chip design.

As a result, our underlying demand drivers are less cyclical than capital equipment because we benefit both from node transitions and the release of new designs on existing mature nodes. While we do supply capital equipment through our engineering systems business, this segment is driven primarily by new capability requirement and customer’s R&D budgets, and less by production capacity additions. Together with our leadership positions across the breadth of our served markets these demand characteristics combine to give us the ability to deliver relatively consistent financial results allowing us to continue to invest in innovation, product roadmaps and our factory network, strengthening our competitive advantage so that we can lead and gain share in exciting new areas like advanced packaging. I’d like to touch on VLSIresearch’s annual survey of the probe card market published last month. The report reinforces our observation of probe cards as a design specific consumable possess a less volatile demand cycle than capital equipment.

In particular the advanced probe card market is expected to contract in 2019 by a relatively modest 5% to just under $1.4 billion. The report also revealed that FormFactor again led all suppliers in the advanced probe card market by a wide margin. Our leadership position is built on strong relationships with the semiconductor industry’s leaders and our ability to serve the most challenging and relevant electrical test and measurement requirements, such as those emerging in advanced packaging and chiplet applications. Our top customers remain consistent and despite some natural variation in our disclosed 10% customers continue to include the world’s leading logic manufacturer, the world’s foremost foundry and the world’s top memory manufacturer.

Moving to market-level details. Our Foundry and Logic probe card business continues to be driven by multiple components of demand. Our largest customer continues to release and ramp designs on it’s mature 14-nanometer node while at the same time increasing activity consistent with the expected timeline required for it’s well-publicized 10-nanometer transition later this year. In the first quarter this customer again exceeded the $100 million annual run rate level. And we expect to ship a comparable if perhaps slightly higher levels in the second quarter. At the world’s leading foundry we continue to broaden our footprint with wins on multiple designs from multiple fabulous design houses serving both the mobile and the high-performance computing applications.

In RF we are currently experiencing a mid-year increase in RF front-end driven demand as bond saw filter manufacturers release and ramp their new products to meet planned second half handset launches. In addition, we continue to work with customers to enable test strategies for their longer-term 5G product roadmaps and are currently shipping RF probe cards in volumes consistent with 5G engineering sampling activity. In automotive, as you’ve heard recently from our customers serving this end market, overall demand is relatively weak and we’re experiencing similar dynamics in our automotive focus products.

During this time we are advancing our roadmap and qualifying technologies that enable higher parallelism low-cost wafer test at 175 degrees Celsius helping it address a stringent high temperature quality and reliability requirements of the automotive OEMs.

Turning to memory. We are presently seeing reduced demand for NAND Flash probe cards consistent with reduced customer investments in this space and with our previous comments that our NAND Flash results should be expected to be lumpy.

Overall DRAM probe card demand on the other hand remains comparable to the solid levels of the past few quarters despite the well-documented softness in our DRAM customers end markets. Each major customer is pursuing slightly different node transition and design release roadmaps which provides some degree of smoothing to our DRAM probe card shipment timing and volumes. Our engineering systems business provided a big highlight for 2019 today with first quarter deliveries of multiple high ASP systems for both MicroLED and cryogenic temperature testing. Both of these applications like silicon photonics in advanced 5 nanometer and 3 nanometer CMOS development are proof points of our engagement early in the customer development cycle enabling characterization and yield improvement of novel new devices in the lab.

Devices that operate at and therefore need to be tested at cryogenic temperatures is an exciting new area, whether it be for ultra low noise detectors, energy efficiency data centers or even quantum computers. The capabilities offered by our engineering systems enable these advances and give us early visibility to applications to build the foundation of future production applications in our lab-to-fab engagement strategy. With average lead times of less than a quarter our visibility remains very limited, but we continue to be encouraged by the broad-based strength in our demand profile.

As we navigate through the current industry conditions we continue to take advantage of our relatively stable revenue stream to make investments to solidify our roadmap, capabilities and competitive advantage like the high temperature automotive and cryogenic testing examples I shared earlier. When market growth returns, as the market share leader we can capitalize on our growth and execute further shared gains from our line of sight opportunities in advanced packaging, mobile data and automotive applications. These gains will enable us to achieve our target financial model growing the top line to $650 million while delivering $1.25 of non-GAAP of EPS and $110 million of free cash flow.

Shai, over to you.

Shai ShaharChief Financial Officer

Thank you, Mike, and good afternoon. As you saw in our press release and as Mike noted, our first quarter of 2019 results exceeded the midpoint of our revenue and EPS outlook, and gross margin came in slightly ahead of our outlook range. These results again show the benefits from successfully executing the diversification elements of our strategy. FormFactor’s revenues for the first quarter of 2019 were $132.2 million, a 6.2% sequential decrease, and an 11.8% increase over the first quarter of 2018. Probe card segment revenues of $108.1 million in the first quarter decreased $8 million or 6. 9% from Q4 2018. System segment revenues of $24.1 million in Q1 decreased 2.5% from the fourth quarter. Within the probe card segment Foundry and Logic revenues decreased to $71.6 million, a 6.6% decrease from the fourth quarter and was 54% of total company revenue in Q1, same as in Q4.

DRAM revenues were $28.9 million in Q1, down slightly from $29.6 million in the fourth quarter and were 22% of total revenue as compared to 21% in the fourth quarter. Flash revenues of $7.6 million in Q1 were $2.3 million lower than in the fourth quarter, down from 7% in the fourth quarter to 6% of total revenue in Q1 consistent with our opportunistic approach to this market and expectation that Flash revenues will continue to be lumpy. Approximately $4.4 million of the Flash revenues in Q1 were from NAND Flash applications. GAAP gross margin for the first quarter of 2019 was $52.5 million or 39.7% of revenues very close to the 39.8% in the fourth quarter.

Cost of revenues included $5.8 million of GAAP to non-GAAP reconciling items which we outlined in our press release issued today and in the reconciliation table available on the Investor Relations section of our website. On a non-GAAP basis gross margin for the first quarter was $58.3 million or 44. 1% of revenues, the same margin as in Q4 and slightly above our outlook range, mainly as a result of a more favorable product mix as well as increased factory utilization. Our probe card segment gross margin was 41.9% in the first quarter, a decrease of 40 basis points compared to 42.3% in Q4. Our Q1 systems segment gross margin was 54% as compared to 52.4% in the fourth quarter. The increase of 160 basis points was driven by higher revenues and a favorable product mix.

As mentioned in prior earning releases, we expect our systems segment gross margin to be at high-40s to low-50s range. Q1 systems gross margin results were on the high end of that range. Our GAAP operating expenses were $44.9 million for the first quarter, $0.7 million higher than in the fourth quarter. The first quarter operating expenses included $6.8 million of GAAP to non-GAAP reconciling items. Non-GAAP operating expenses for the first quarter were $38.1 million or 28.8% of revenues compared to $37.2 million or 26. 4% of revenues in Q4. The increase of $0.9 million relates maybe to annual benefit reset which typically affects our OpEx at the first half of each year. As well as higher R&D investments partially offset by lower SG&A expenses.

Company non-cash expenses for the first quarter included $7.1 million for the amortization of intangible assets, $5.3 million for stock-based compensation, and depreciation of $4 million. Amortization of intangible assets were $0.4 million lower than in Q4 and stock based compensation was $0.5 million lower than in the fourth quarter. GAAP net income for the first quarter was $5.5 million or $0.07 per fully diluted share compared to net income of $85.1 million or $1.13 per fully diluted share in Q4. As discussed in our previous earnings call, GAAP net income for Q4 included a noncash deferred tax benefit related to evaluation allowance release of $75.8 million. The non-GAAP effective tax rate for the first quarter of 2019 was 24. 4% in line with our previously communicated estimate of 25% for the year.

I would like to remind you that beginning the first quarter of 2019 we recorded noncash deferred tax expenses in addition to the 6% current tax expenses. As we said in our previous earnings call we will not be excluding the effects of these noncash charges from the non-GAAP outlook and earnings that we communicate. Our cash tax rate is expected to remain at the 5% to 8% of pre-tax income until we fully utilize the remaining $200 million of U.S.-based NOLs. First quarter non-GAAP net income was $15.2 million or $0.20 per diluted share compared to $23.5 million or $0.31 per fully diluted share in Q4.

Moving on to the balance sheet and cash flows. We generated $14.9 million of free cash flow in the first quarter compared to $15.8 million in Q4, taking our total cash and investments to $160 million at the end of the quarter. We paid $7.8 million on principal and interest payments on our term loan during the quarter. Our total cash balance exceeded the balance of our debt by $102 million at quarter end, an increase of $18 million. We invested $6 million in capital expenditures during the first quarter of 2019 as part of our annual capital spending plan of $16 million to $20 million.

Turning to the second quarter non-GAAP outlook. We expect Q2 revenues to be in the range of $131 million to $139 million. Although revenue is expected to be higher than in Q1 at the midpoint of our outlook range, product mix is expected to be less favorable. These factors partially offset by continuous expense control and good operational execution lead us to estimate a non-GAAP gross margin for Q2 in the range of 41% to 44%. Non-GAAP earnings per fully diluted share assuming the effective rate of 25% which includes the noncash deferred tax expenses I described is expected to be in the range of $0.15 to $0.21. The inclusion of these noncash deferred tax expenses reduces our Q2 outlook for non-GAAP diluted EPS.

Questions and Answers:

Operator

(Operator Instructions) Our first question comes from Craig Ellis with B. Riley FBR. Your line is now open.

Craig EllisB. Riley FBR — Analyst

Thanks for taking the question and congratulations on executing well on what’s been a tough economic and spending environment in the quarter. Mike, I’ll just start with a question for you if I look at the details of the business it looks like the Foundry and Logic business did noticeably better than we were expecting. So congratulations overall on the revenue performance on that front. Was there anything particular that stood out in that business versus your expectations for the quarter?

Mike SlessorPresident and Chief Executive Officer

I think in Foundry and Logic obviously as you know are pretty volatile spending environment. But I think it goes back to one of the things we were trying to communicate on the call is our market share and presence across the leaders in the industry, but also many other customers really helped give us a diversified revenue stream in the first quarter as it has at various times in the past. We’re always going to have quarter-to-quarter mix shifts among key projects and key customers. But I think the first quarter is a pretty good example where we had several of those kind of come together for us and helped the overall results. I think we can say the same thing about DRAM. Our presence across the leading DRAM customers led to a relatively strong DRAM results in what’s overall a pretty weak DRAM spending environment.

Craig EllisB. Riley FBR — Analyst

And just following up on that other point. If we look at updates from DRAM manufacturers over the last month or two it does seem like all are sticking that technology transition commitments. So does that provide a backdrop where the DRAM business despite some customer specific volatility through the year can hang in at current levels, Mike, or are there things that you see as you look to the year that would cause the business to deviate meaningfully one way or the other? It seems that at least with the largest manufacturer there is a market share gain opportunity that’s coming up maybe not this year but perhaps next year?

Mike SlessorPresident and Chief Executive Officer

Yes. I think a good question, Craig. And I’ll start it by reminding everyone that with lead times inside of a quarter our visibility is pretty limited. But a couple of indicators that leave us pretty optimistic on our DRAM probe card business certainly as we move through the second quarter and things can get a little foggy as we move to the second half. But if I look at design activity, new design activity driven by both those node transitions and the move of some significant customer products to some of these new nodes, we see a pretty healthy backlog of new designs continuing to move through. And so that leaves us optimistic certainly that there is going to be continued investment in a new designs in DRAM, in node shrinks in DRAM as each of the three major customers try and innovate and compete with each other in maybe what’s more a challenging end market for them than it was in the middle part of 2018.

Craig EllisB. Riley FBR — Analyst

And the last one for Shai then I’ll hop back in the queue. Shai just on the gross margin commentary for the quarter you called out the favorable end of the systems mix for gross margins. So I take that some percentage of the upside that we saw versus our expectation, but were there other positive variances? And then as we look at the guidance for the second quarter it seems like that there’s a meaningful change quarter-on-quarter. Is that just first quarter systems dynamic shifting the other way? Or what would cause such a meaningful decrease when volume seems to be helping the business?

Shai ShaharChief Financial Officer

Thanks, Craig. So mix is by far the biggest impact on our gross margin. And it was evident in Q1. We shipped some high margin systems during the quarter. And it was evident by systems margin reaching 54%. High-end of the range we previously said Mike talked about the high-40s, low-50s, so 54% is the high end of that range. And there were some other small factors better warranty, better quality of our products and utilization of the factory was a little better revenue. So this impact Q1. Looking into Q2, revenue at the midpoint are higher than in Q1 that has a small impact. But again the biggest impact is mix. We don’t expect the systems business to repeat this high gross margin because of the mix of products they are about to ship in the second quarter.

Operator

And our next question comes from Brian Chin with Stifel. Your line is now open.

Brian ChinStifel — Analyst

Hi, good afternoon. Nice job to the team and thanks for letting us ask a few questions. My first question is look at the midpoint of your 2Q revenue guide, it’s slightly up from the revenue level you did achieved in Q1. Just curious what is your expected trend in terms of the SOC logic as well as the memory segments in terms of the outlook?

Mike SlessorPresident and Chief Executive Officer

Yes. I think — so several different moving parts. Foundry and Logic, we expect to be a little bit stronger again with my usual caveat that we’re still booking business that we need to turn in the quarter. Some different dynamics there. Obviously the 10 nanometer ramp that we’ve all been awaiting is beginning some activity consistent with our largest customers publicize need to have product on the shelves at the end of the year. So as we’ve said that’s a mid-year event. We’re beginning to see the leading edge of that event. But it sort of bridges Q2 and Q3. So some of the upside there probably in Foundry and Logic. I think in memory it’s the — we see memory in the middle of the year as really the tale of two different markets. And the answer to Craig’s question I described how pleased we are with DRAM overall shipment activity, but also design activity which is obviously a leading indicator of future shipment activity.

So we feel like DRAM probably pretty steady going Q1 to Q2. I think NAND Flash probably a bigger question mark for us. Now obviously a much smaller part of our business. But as we described before we operate pretty opportunistically in this segment and we don’t see a lot of business there in Q2. And you saw it reduce in Q1 as well. So I think Foundry and Logic probably up a little, DRAM steady as she goes and Flash maybe detracting a little bit. We see engineering systems being roughly constant, maybe a little bit of growth.

Brian ChinStifel — Analyst

Okay. That’s really helpful. Thanks, Mike. Following up on two things. First in terms of DRAM I think we have seen sort of concrete evidence that they have maybe reduced utilization rates, reduced wafer inputs certainty earlier than they like typically in a sort of a down cycle from a pricing standpoint for them. I am curious if you’ve seen any effect on your revenue stream thus far? And whether you think that could have some impact certainly counterbalance against the robust design activity? But some impacts on your business moving into second half in terms of the DRAM market?

Mike SlessorPresident and Chief Executive Officer

Yes. I think we see a much larger effect from this move to some new designs and new architectures. One that we talked about in the past that continues to be pretty strong is manifestation of advanced packaging in memory which is HBM. And we see all of our leading customers now pushing toward that direction. Obviously a trend that is good for us. I think when they ramp down wafer starts on existing nodes and existing designs that’s probably something we don’t have a lot of visibility too, because obviously they already have the tooling and probe cards they need to test the peak way for loads. And so our business typically again is driven by these transitions to new nodes or new designs on existing nodes and that activity continues to be pretty robust even as older nodes and old designs ramp down.

Brian ChinStifel — Analyst

Okay. That’s helpful. It also makes some sense. Maybe one quick last one. Going — doubling back in terms of the 10 nanometer CPU ramp that you’re participating in and driving demand here Q2 into Q3. I think that customer on a recent call did talk about may be seeing slightly better units in terms of CP units for them by the end of the year. And they also talk about a faster fall on ramp where there are server CPU chips on that 10 nanometer process sometime next year. So earlier than follow-on in terms of the server versus the client CPU ramp. It sounds like a positive. Can you talk maybe through what that speaks to in terms of revenues continue to remain robust and more sustainable into 2020?

Mike SlessorPresident and Chief Executive Officer

Yes. Well I think in general any customer getting more aggressive with design translations and node transitions going to help drive our business. So any of that kind of innovation whether it’s the move to a new node or the move as we saw with that customer over the past couple of years continuing to move designs onto 14 nanometer, which has been a pretty successful mature node for them. It drives quite a bit of business. Obviously we are very excited to see a 10 nanometer continuing to progress and the more designs that make it onto that new node drive volume for our customer and then eventually us. We’re looking forward to that. So I think generally the trends you described would be a positive for us.

Operator

[Operator Instructions] Our next question comes from Christian Schwab of Craig-Hallum. Your line is now open.

Christian SchwabCraig-Hallum Capital — Analyst

Mike can you walk us through what type of trends and business conditions would be needed in 2020 or 2021 for us to attain your target model and get to earnings of $1.25? Can you give us the kind of puts and takes as you see it that would allow you to get there?

Mike SlessorPresident and Chief Executive Officer

Sure. So if we just revisit some of the fundamental assumptions of our target model to get us to $650 million at the top line and $1. 50 non-GAAP earnings per share. There is two pieces to it. Obviously if somebody who leads in market share we need our served markets to grow. And when we put that model together the underlying assumption was our served markets had to grow to something like $1.7 billion $1. 75 billion a year. Last year there were probably a here under $1. five billion. So if that gives you some sense of the market growth that’s required. I think if we look at the probe card market it’s expected to contract as no semiconductor supply markets are here in ’19. So there would need to be a pretty good step up in 2020. But the underlying assumption there is the $1.7 million, $1. 75 billion of served market. Those are markets we serve today and markets that we’re executing in. The other element we talked about was some of the growth associated with three opportunities. One being advanced packaging, two being mobile data, three being automotive.

I think advanced packaging I think we’re ahead of where we said we’d be from an incremental share gain perspective whether you look the high bandwidth memory example I talked about before, largest customer talking about chiplets, some of the other examples like integrated fan-out, advanced packaging has been a nice growth in share gain area for us over the last couple of years.

Mobile data, as we talked about on the call we’re seeing some signs of life in the RF (inaudible) filter business and obviously 5G is a very exciting opportunity for us. We need that to accelerate get some share gains there. And then we need to return to some of the growth in the automotive segment. We are laying the groundwork like the example I gave for high-temperature test. But those three things sort of have to hit on all three cylinders and we need the overall market growth for us to get there. So whether that’s 2020 or 2021, those are the basic ingredients for us to get to the target model.

Christian SchwabCraig-Hallum Capital — Analyst

Great. And then my last question if I may, it has to do with potential M&A after successfully putting in Cascade Microtech into the company and leveraging some of those opportunities because setting up your lab-to-fab strategy. Is there any areas out there that you think or technologies or if could you just give us an update on how you’re thinking, I guess about M&A, obviously you’re not going to name a company, but thank you.

Mike SlessorPresident and Chief Executive Officer

Yes. No, I can give you some update and remind you of the general things. So what we said is that M&A will continue to be a part of the strategy. As you know the Cascade Microtech deal was a very good combination for both companies. And we hope to do the same kind of thing again. But we want to use our capital to buy leadership positions in new pieces of served markets. We don’t think there’s a lot of shareholder value and trying to roll up our existing served markets. So then you get into a question of the adjacencies. Certainly anything in and around electrical test and measurement, instrumentation, arguably metrology. We’re looking in areas that are resonant with our business where we can really get good leverage out of our sales force, out of our fixed cost sort of our G&A, and then look to long-term revenue synergies and product synergies as we have in the Cascade Microtech deal to drive an interesting compelling roadmap, we in places like advanced packaging that are becoming a new part of the overall industry roadmap.

Operator

Our next question comes from David Dooley with Steelhead Securities. Your line is now open.

David DooleySteelhead Securities — Analyst

Thanks for taking my question. I was wondering as far as your largest foundry customer goes, they’ve certainly been talking about a big recovery in their business in the second half of the year. I think it’s up like 30% or 35% versus the first half of the year. If they’re able to achieve that kind of first half — second half performance over the first half and lot of that’s ramping 7-nanometers. How would that impact your business?

Mike SlessorPresident and Chief Executive Officer

A good question. So If we think about any customer, a lot of what we’re delivering today and probably even in the latter part of last year, it is four designs that are going to be ramping in the middle part of the year sort of six months after we deliver probe cards. So to some extent on that narrative part of our strength with that customer in Q4 was the 2 million probe cards they’re going to be using to produce sort of Q2, Q3, maybe even Q4 revenue. I think the exciting part of it for us is the extension with that customer into multiple new fabulous customers and multiple new designs not just in the mobile space but in the high-performance compute space. So as we’ve talked about before business with that customer has been pretty concentrated with a single fabulous customer in a mobile application processor, obviously driven by integrated fan-out packaging, but we see that opportunity now expanding to other customers and other end applications beyond mobile. And so as we look to the second half I think if the foundry business is going to get that strong and if people are adoption that both 7 nanometer, 7 nanometer-plus in advanced packaging I think there’s some opportunity for us there.

David DooleySteelhead Securities — Analyst

So it’d be more associated not the overall revenue growth half-over-half but more the 7 nanometer ramp?

Mike SlessorPresident and Chief Executive Officer

I think so. We’re really exposed there on advanced notes. 10, seven and below.

David DooleySteelhead Securities — Analyst

Okay. Great. And then I just wanted your perspective on 5G. I understand the bond soft filters and the antennas and a lot of the RF parts are going to be discreetly packaged in advanced packages. I am just wondering what your perspective is? Is that the right way to think about it that’s 5G is going to be much more advanced packaging-intensive for some of the front-end RF parts?

Mike SlessorPresident and Chief Executive Officer

Yes. I think the jury is still out on a lot on this. It’s still from our perspective pretty early days on 5G. We are shipping probe cards, multiple units of probe cards for different designs inside the 5G semiconductor ecosystem. But a lot of these people are sampling and still very sorting out what their architectures and chipsets and therefore packaging strategies are going to be. I think there is an interesting opportunity as people build RF modules to take advantage of some of the RF or some of the advanced packaging and it’s spectacular RF performance. But I don’t know that that’s really been fixed on most customers road map yet. So certainly an opportunity for us and one that we’re helping enable in early development. If we get there with 5G that would be a fantastic opportunity for FormFactor.

David DooleySteelhead Securities — Analyst

Maybe let me ask you in a slightly different way. If a lot of these antenna parts and front end phone parts in the 5G phones are packaged in advanced packaging. Isn’t that going to be better for you because your advanced packaging is more cap, pro and test intensive?

Mike SlessorPresident and Chief Executive Officer

It is. It’s more probe and test insensitive just as high-bandwidth memory was in DRAM just as integrated fan-out was in logic. The point I was trying to make is I think the jury is still out on whether a lot of advanced packaging is going to be employed for some of those modules. Not to dampen everybody’s enthusiasm but it’s still feels awfully early days in 5G to us.

David DooleySteelhead Securities — Analyst

Final question from me. You had one big customer, largest foundry customer kind of leading the way in advanced packaging with our integrated fan-out. But you’re starting to read a lot about other customers such as Intel and their programs in this area. I am just wondering do you expect more of your large customers to ramp some sort of advanced packaging programs in the next year or so?

Mike SlessorPresident and Chief Executive Officer

I don’t think there’s any question that they will. If you look at the way the industry overall and therefore the major customers are dealing with this loan growth Moore’s law, I mean it’s clear that advanced packaging offers another way to innovate to get to the performance, the footprint and the cost attribute that they’ve always got from just shrinking transistors. Obviously shrinking transistors is no longer quite as easy and cost-effective as it used to be. So advanced packaging weather it be integrated fan-out, whether it be the full application whether it be HBM are all things that leading customers are adopting in the next year. And our great drivers of FormFactor business as we’ve talked about in the past.

Operator

Our next question comes from Tom Diffely with D.A. Davidson. Your line is now open.

Tom Diffely — D.A. Davidson — Analyst

Good afternoon. This is Frank up for Tom. I guess I’ll turn on the logic side. What is currently the mix between the 14 nanometer and 10 nanometer nodes right now. Are they the same?

Mike SlessorPresident and Chief Executive Officer

No, I think in any given time period it’s fluctuated pretty significantly. I think it’s a fair statement to say that 14 nanometer and 10 nanometer are coexisting and will coexist for a long time. In any given period the mix shifts one way or the other but they are both significant parts of our business at present and we expect them to both be significant pieces going forward.

Tom Diffely — D.A. Davidson — Analyst

And so I guess picking back up for that. So when the 10 nanometer is launched and how it appears — how long do you expect the 14 nanometer to stay or do you expect new designs of that node?

Mike SlessorPresident and Chief Executive Officer

Yes. I mean I think if we look at any of our major customers narratives. Some of these what would’ve been thought of this trailing edge and almost obsolete nodes in the past are going to stick around for a long long time. Whether it’s 28 nanometer in the foundry space or 14 nanometer in the CPU space, there is some very useful designs that are going to be placed on those nodes and continue to drive volume for both our customers and us. So I’d expect 14 nanometer to be around for an awfully long time, almost independent of how fast 10 nanometer ramps at this stage of the game.

Tom Diffely — D.A. Davidson — Analyst

Okay. And then jumping to RF. What are your expectations for the demand as I guess for the year? And then your expectations changed during the quarter?

Mike SlessorPresident and Chief Executive Officer

Look as he said in the prepared remarks we are seeing some mid year strength in RF. Now that’s not an unusual time to see that strength because if you think about the typical cadence of handsets hitting the market, the filter manufacturers and antenna and power amplifier manufacturers really need to be ramping right above now. It’s been such a lumpy market for the last couple of years that our visibility is not great. Certainly we are seeing some strength here now and are excited about the longer term prospects of the RF business given the 5G elements that we just talked about.

Tom Diffely — D.A. Davidson — Analyst

All right. And then lastly I saw some nice mix related gross margin benefit from engineering systems in the quarter. I know this is like a sort of (inaudible). But can you talk a little bit about the long-term opportunities and what are the biggest drivers there in the future?

Mike SlessorPresident and Chief Executive Officer

Yes, engineering systems remember is a business where we are engaging with customers, in some cases universities, in some cases labs on the very early end of development. And so there’s no one application that drives that business. It’s a narrative of different applications where people are having to do brand new kinds of tests and brand new kinds of characterizations. So if I run down sort of the list of applications, obviously this time around we talked about some cryogenic test systems. Testing temperatures ranging from 77 kelvin or liquid nitrogen all the way to liquid helium and below, those are enabling a whole bunch of new applications, but that doesn’t mean we’re going to get a whole bunch of cryogenic production test business.

MicroLED another example like that where we’re selling multiple systems into early development that’s going to help in the long run our probe card business in production but engineering systems business is a collection of all those different applications where we’re engaged with customers in their very early learning and path finding. This quarter obviously we had a mix of those applications and of those systems that was very favorable. We think over a reasonable amount of time over several quarters that that high 40s to low 50s gross margin is the right place to think about our engineering systems and the composite of all the different early applications it serves.

Operator

(Operator Instructions) Our next question comes from Craig Ellis with B. Riley FBR.

Craig EllisB. Riley FBR — Analyst

Thanks for taking the follow up questions. I’ll start with some items that relate to comments thus far. Mike, on the mobile business for RF probes you talked about the near term strength. But my question was a little bit longer-term as we look toward 5G ramping in very small volumes this year but more meaningful next year. What does that mean for the growth rate of the RF business? I think there is a view that filter content could rise by 20% to 30% on a multiyear basis in 5G systems. Is there a coefficient to RF probe growth related to that or how do we think about the structural benefit that you get from 5G?

Mike SlessorPresident and Chief Executive Officer

Yes. I think if we just look at that example. I think almost certainly there will be content growth in 5G. And if you just look at the filters in the front-end — if you look at what happened when people went to 4G and you look at some of the content increases over the past several years, there has been a pretty strong correlation between filter units and our RF probe card revenue. Then move to 5G. In addition, so we do see some unit growth there just driven by the increased number of filter units that are going to be required to manage all the band. I think the other exciting part for 5G is a tougher test problem. The higher frequencies, much much more stringent single noise. So it plays pretty well toward our historic technology strengths. We’re pretty strong through the Cascade Microtech acquisition at RF know how how to design the probe card. So the customers get the test results they want. And so I see this being a little bit like advanced packaging thematically where it becomes a tougher test problem and the amount of testing needs to go up. And so no question 5G and nice opportunity for us. And I think you could expect to see us track pretty closely to RF filter units in the near term.

Craig EllisB. Riley FBR — Analyst

That’s very helpful. And the follow up relates to comments regarding your larger U.S. customers manufacturing and technology strategy to move toward chiplets. It’s certainly early innings in that regard, but does that raise probe card intensity for them and do you have a sense for the impact of that if we do so?

Mike SlessorPresident and Chief Executive Officer

Yes. It is yet another example where customers are adopting advanced packaging to solve a problem that they used to be able to solve using Moore’s Law and transistor strengths. So the notion that now essentially all the leading manufacturers have some level of advanced packaging on the road map whether it be chiplets, high-bandwidth memory, integrated fan-out, I think are really exciting opportunities for us in the larger test community. If we look at some examples from the past, high bandwidth memory is probably the simplest one to look at. Erase tested density significantly because as you can imagine as you stack these chips or chiplets together, you better have pretty high confidence that each of them is going to work so that the collection is not killed by one of the component chips. And so that historically in advanced packaging applications has erased the test intensity. The other thing that happens is customers are pretty aggressive with the design rules on how they package these chips together. And so that makes for a much higher density probe card, something that raise really well to our MEMS technology. We’re able to scale that quite effectively produce quality probe cards and allow them to drive their test cost down. So I think the more major customers we see moving to advanced packaging whether it be HBM, chiplets, integrated fan-out, the better for FormFactor.

Operator

Thank you. And I’m showing no further questions in the queue at this time. I’d like to turn the call back to Mike Slessor for any closing remarks.

Mike SlessorPresident and Chief Executive Officer

Thanks everyone for joining us today and we’ll see you at a variety of conferences as we move through the spring. Have a great day.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude your program and you may all disconnect. Everyone have a great day.

Duration: 48 minutes

Call participants:

Jason CohenGeneral Counsel

Mike SlessorPresident and Chief Executive Officer

Shai ShaharChief Financial Officer

Craig EllisB. Riley FBR — Analyst

Brian ChinStifel — Analyst

Christian SchwabCraig-Hallum Capital — Analyst

David DooleySteelhead Securities — Analyst

Tom Diffely — D.A. Davidson — Analyst

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