FormFactor Inc (FORM) 2018 Q2 法說會逐字稿

Thank you, and welcome everyone to FormFactor's Second Quarter 2018 Earnings Conference Call.

On today's call, our Chief Executive Officer, Mike Slessor; and Chief Financial Officer, Shai Shahar.

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

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 security 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 2017 and 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, August 1, 2018, and we assume no obligation to update them.

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

Thanks, Jason, and thank you, everyone, for joining us today. The second quarter of 2018, again, demonstrated the resilience of FormFactor's position as a diversified leader in electrical test and measurement.

As expected, we grew off the lows of the first quarter, delivering increased revenues across each of our major businesses. We benefited from a product mix biased towards FormFactor's differentiated high-end products, driven primarily by growth in advanced packaging applications. Coupled with solid executions by our operations teams, this favorable mix produced gross margins near the levels of our target financial model and with good expense control, produced earnings per share above the high-end of our outlook range. Because many of these factors continue in the third quarter, we expect third quarter revenue and profitability performance to be comparable to the second quarter.

As many of you are aware, there have now been 2 major delays announced in our customers node transitions: the delay of the 10-nanometer node of our largest customer, and more recently, the news that one of our major DRAM probe card customers is delaying its 1Y nanometer node. Obviously, these events caused short-term volatility in our demand profile, and with the DRAM delay now compounding our largest customer's 10-nanometer delay, we think it is unlikely that 2018 will be a growth year.

Beyond this short-term volatility, however, we continue to demonstrate the longer-term value and utility of our products and technologies. For example, as our largest customer releases new designs on their mature 14-nanometer node, they require new fleets of probe cards to test these new designs.

As we've described in the past, since probe cards are consumable, with a specific to each customer IC design, each of these new designs drive demand for new probe cards. This reinvigorated 14-nanometer activity was one of the contributors to our second quarter sequential revenue increase, and we expect this demand to steadily strengthen as we move through the year. We are also ready to capitalize on the further incremental demand driven by the 10-nanometer ramp, an event which is now expected in 2019.

In our DRAM probe card business with one customer's delayed 1Y nanometer transition, we're expecting to see a similar effect as designs that were originally planned for the 1Y node are being migrated back to the 1X node. This will have a short-term impact in probe card demand while those shifts occur, but in a very similar way to the Foundry and Logic case, we expect probe card demand to materialize for new designs on the 1X nanometer node.

In addition, this difficulty in scaling will continue to constrain this supply growth, which is likely to help maintain the current robust DRAM pricing and capacity balance.

As the Moore's Law node transitions become more challenging and unpredictable, the industry is increasingly relying on advanced packaging to innovate and progress. Advanced packaging continues to be a key driver for FormFactor's probe card business. And in these applications, our MEMS probe technology is one of a handful of viable options to meet high-density and stringent electrical performance requirements.

As we shared with you on the last call, VLSIresearch's annual survey of probe card suppliers again reported FormFactor as the market share leader in advanced probe cards with more than twice the revenue of the next largest supplier. That overall market leadership is reflected in a similar position as the top supplier of probe cards using MEMS technology. This leadership is a direct result of significant multi-decade R&D investments we have made in inventing, developing and continually refining our unique MEMS capability.

We plan to continue to devote a significant fraction of our R&D and manufacturing investments to advancing this key-enabling technology as we provide customers with increasing performance in value, which will further expand our competitive advantage.

Two great examples of our differentiated MEMS technologies enabling advanced packaging applications are evident in our second quarter results.

First, in Foundry and Logic, we ship products to the world's largest foundry at levels comparable to our record first quarter shipments. In 2018, the majority of our business with this customer supports a 7-nanometer mobile applications processor project that relies on integrated fan-out packaging. We are pleased to report that we have now also shipped qualification units to this foundry for additional fabless customers and designs as we work to broaden and grow this important opportunity.

Second, in DRAM, the continued growth in wafers starts at High Bandwidth Memory or HBM, contributed to revenue growth at our largest DRAM customer from already strong first quarter levels. This advanced packaging application requires FormFactor's technologies to match the unique electrical and thermomechanical test requirements of these stacked die structures. And we are excited about growing this business as HBM volumes increase.

I'd like to say a few words about the gains of our Flash probe card revenues to double-digit levels. We continue to view this as an opportunistic business for FormFactor. And we do not rank it as a growth factor in the same class as our line-of-sight opportunities in advanced packaging, mobile data and automotive. However, the multiyear expansion of our Flash probe card business is indicative of a gradual move towards more demanding test requirements, mostly associated with the densities and complexities of high layer count 3D NAND devices. Given our relatively limited exposure to the broad NAND Flash market, we continue to expect volatility in this business but are encouraged by the gradual long-term growth trend we've delivered so far.

Turning to our Engineering Systems business. The Systems segment, again, produced strong results in the second quarter, gradually improving on all financial metrics. In addition to this business's significant financial contribution, it also provides important visibility and engagement in supporting next-generation applications and devices.

To that end, in the second quarter, we won a selection for a complete pilot production system at one of the leading developers of micro LED display technologies, which will add to our worldwide installed base in this exciting future application. In this case, we are providing a complete turnkey probing system that includes the material handling capabilities of our BlueRay prober, carefully matched with a specially developed advanced probe card and tester interface that together meet the challenging and unique combination of mechanical, electrical and optical requirements in this application.

In the quarter, we also released the SUMMIT200 and Tesla 200 engineering probe stations, which bring the productivity and time-to-results benefits of automation to our flexible and accurate 200-millimeter platform in both RF and high-power applications. With its unique combination of high-power and high-temperature automated test capability, the Tesla 200 is an example of our investments to support our line-of-sight automotive growth opportunity, and we are receiving positive feedback from our initial customers.

Before turning the call over to Shai, let me state that we remain committed to achieving our hard target financial model and expect we will achieve this performance on a run-rate basis late next year. As the leader in our served markets, we will benefit from continued industry growth over that time frame, but we also require some resolution of the current node transition issues at our major customers. Provided these occur, we're excited about delivering $650 million of revenue and $1.50 non-GAAP earnings per share.

With that, I'll hand the call over to Shai for further details on our second quarter results and to provide insight into FormFactor's third quarter financial outlook.

Thank you, Mike, and good afternoon. As you saw from our press release and heard from Mike's comments, our top line results for Q2 were above the midpoint of our outlook and significantly above the Q1 low, and our gross margin exceeded the high end of our outlook range. These results, coupled with continued good operating cost control, allowed us to deliver non-GAAP EPS above the high end of our outlook range.

FormFactor's revenues for the second quarter of 2018 were $135.5 million, up 14.6% from the first quarter of 2018. Probe card segment revenues of $111.6 million increased by $16.7 million or 17.6% compared to Q1. And Systems segment revenues of $23.9 million increased by $0.6 million or 2.4% compared to Q1.

Within the probe card segment, Foundry and Logic revenues of $62.1 million increased by 6.3% compared to the -- our first quarter. The increase was mainly attributable to the high revenue from our largest customer as expected and relates to additional 14-nanometer designs.

During the second quarter, we continued to see significant shipments to the world's largest foundry, which utilizes our technology in advanced packaging applications for leading-edge nodes.

Foundry and Logic revenues were 46% of total company revenue in the second quarter, down from 49% in the first quarter. While Foundry and Logic revenue increased in absolute dollars, the decrease in the percentage of total revenue was mainly due to the strong memory revenue in Q2.

DRAM revenues were $38.1 million in Q2, up $7.8 million or 26% sequentially. We continue to experience sustained DRAM demand as our customers released new designs for data center and mobile applications. DRAM revenues were 28% of total operating revenues in the second quarter, a slight increase from the 26% in the first quarter.

Flash revenues of $11.4 million were $5.2 million higher than in the first quarter. We continue to see stronger demand for our technology due to stringent test requirements for high layer count 3D NAND. Approximately $7 million of the Flash revenue in Q2 were from NAND Flash applications.

GAAP gross margin for the second quarter of 2018 was $56.2 million or 41.5% of revenues, up 3.3% compared to 38.2% in the first quarter of 2018. Similar to Q1, Q2 cost of revenue included $6 million of GAAP to non-GAAP reconciling items, which we outlined in the reconciliation table available on the Investor Relations section of our website and in our press release issued today.

On a non-GAAP basis, gross margin for the second quarter was $62.2 million or 44.9% of revenues, up 2.6% from the 43.3% in the first quarter and as I mentioned, above our outlook range. The increase was primarily due to a favorable product mix; a significant increase in revenue; better factory utilization; and excellent operational execution during the second quarter.

Our probe card segment gross margin was 45.3% in the second quarter, a significant increase of 3.2% compared to Q1 due to the factors mentioned before.

Our Systems segment gross margin continue to improve and was 48.6% in the second quarter, 0.9% higher than Q1, on slightly higher revenue. As discussed in previous calls, we expect the Systems business gross margin to continue to improve towards the target level of high 40s, low 50s, excluding potential impact of FX.

Our GAAP operating expenses were $44.9 million for the second quarter, $3.4 million higher than the first quarter. The second quarter operating expenses include $5.3 million of GAAP to non-GAAP reconciling items.

Non-GAAP operating expenses for the second quarter, including ERP implementation costs, were $39.6 million or 29% of revenues, up $3 million compared to Q1. The increase is mainly due to employee-related costs, including higher performance-based compensation and benefits. We also made some R&D investments in the second quarter to further expand our differentiated competitive advantage.

As a reminder, beginning the first quarter of 2018, we view ERP integration and implementation expenses as routine. And accordingly, these costs are not excluded from our non-GAAP operating expenses. ERP integration and implementation expenses were approximately $1 million and $1.1 million in Q1 and Q2, respectively. And we expect similar quarterly expense levels during the remainder of 2018.

Company non-cash expenses for the second quarter included $7.2 million for amortization of intangible assets, $4.1 million for stock-based compensation and depreciation of $3.4 million, all at similar levels to the first quarter.

The non-GAAP effective tax rate for the second quarter was 7.5% compared to 5.3% for the first quarter. We entered 2018 with over $240 million of remaining U.S.-based NOLs. As such, we expect to have a non-GAAP effective tax rate of 5% to 8%, while we utilize our U.S. NOLs. The increase in the effective tax rate in the second quarter and the increase in the range from 4% to 6% previously communicated are due to higher percentage of profit in foreign tax jurisdictions versus the U.S.

GAAP net income was $9.1 million or $0.12 per share or fully diluted share for the second quarter compared to net income of $2.1 million or $0.03 per fully diluted share in Q1. Second quarter non-GAAP net income was $20.4 million or $0.27 per fully diluted share compared to $12.7 million or $0.17 per fully diluted share in Q1.

Moving on to the balance sheet and cash flows. We generated $16.8 million of free cash flow in the second quarter, significantly higher than the $6.3 million generated in Q1, taking our total cash to $144 million at the end of the quarter. The $10.5 million increase in free cash flows in Q2 as compared to Q1 is mainly the results of higher Q2 revenue.

We spent $13.3 million on principal and interest payments on our term loan during the quarter, including $5 million of prepayment. Our total cash balance exceeded the balance of our debt by $59 million at quarter end. In line with our annual capital spending plan of $16 million to $20 million, we invested $4.7 million on capital expenditures during Q2.

Turning to the third quarter non-GAAP outlook. We expect Q3 to be similar to Q2, and therefore, we expect revenues in Q3 to be in the range of $130 million to $138 million. Consistent with Q3 revenue being comparable to Q2, third quarter volumes and factory utilization are expected to be similar to the second quarter, tempered slightly by less favorable product mix. As such, we currently expect third quarter non-GAAP gross margins to be in the range of 42% to 45%. We expect to realize non-GAAP earnings per fully diluted share in the range of $0.20 to $0.26.

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 to questions. Operator?

(Operator Instructions) Our first question comes from Patrick Ho with Stifel.

This is Brian calling in for Patrick. Maybe first question for Mike, Q3 revenue guidance is pretty constant Q-on-Q. Tell us how the end-market mix is expected to vary, though, Q3 relative to Q2?

Yes. I think -- so the way we characterized it, Brian, was being comparable, and it's interesting not just at the highest level for the overall company revenue do we view things to be comparable, but as we work our way through the different market mix and even customer mix, things are pretty similar as we go from Q2 to Q3. There are some puts and takes in our different emerging businesses. Obviously, we have said some of these things are going to be volatile, like our engagement with the world-leading foundry. But overall, I would say, not just the top line, but the different product and customer mix is pretty similar as we move Q2 to Q3.

Okay. That's helpful. Also, moving on to your major advance Logic customer. I'm kind of curious, relative to the prior watermark year -- prior high watermark year in 2017, should 10-nanometer begin to kick out into volume production next year, how would you expect the revenue contribution in 2019 to trend relative to the prior high watermark year in 2019? Should we expect -- would you expect it to be up at this point in time? Or any other sort of color you could provide would be helpful.

Yes, well, I think the comparisons -- as we work our way through node transitions and supporting our largest customer's activity, I think one of the interesting things that I want to highlight before we talk about too far in the future is we are experiencing some nice incremental design activity in probe card business associated with then continuing to innovate at the 14-nanometer node. So we did see an increase as we move from Q1 to Q2. The forecast we have for Q3, again, largely concentrated in 14-nanometer, continues to support that growth through the year.

If we look back to 2017, which was, I believe, a little bit over $140 million with that customer, I think to repeat that or exceed that, we're going to need a very strong 10-nanometer ramp in combination with the sustaining 14-nanometer activity. And there's quite a few different moving parts, I'm getting all of those things moving together again. But certainly, if those conditions exist, if we get these node transition issues resolved with both our largest Foundry and Logic customer and one of our larger DRAM customers, we're pretty confident we can touch on the high watermarks of those 2 customers again in 2019.

Got it. That's helpful color. And just curious, just to add on to that, based on prior experiences, would you feel that the ramp would be sort of a gradual or maybe kind of a sharp -- even though you can't be precise on timing, perhaps in 2019, would it be more gradual or kind of a sharp pick-up?

No. I think it's challenging to go back with historical experience because some of these node transitions are getting so challenging from our customers that they don't really follow the historical patterns. If we do go back to the historical patterns, they've typically been pretty sharp. And if you look at, for example, our revenue with our largest customer, in 2017, it ramps up pretty quickly as 10-nanometer intensified before they tapped the brakes on that ramp. And I think that's probably a reasonable trajectory, something like over a 2-quarter time frame to imagine the revenue trajectory is going to be when 10-nanometer actually ramps.

Okay, very helpful. Maybe one more question on the Flash business. I understand that there are opportunistic things that you can capitalize [and] it become a pretty material number in this quarter. Kind of curious, what do you think the normalized level is? How we should think about margin profile in that business? And maybe even if you can kind of flush it out and characterize what drove the incremental in the quarter?

Yes, no, it's a great question because $11-odd million, it is becoming a material and significant piece of the -- at least the second quarter business. I will reiterate that we do view it as volatile because the fundamental thing driving this is us serving opportunities really at the very high end of 3D NAND, high layer counts, where there's high densities, where customers really do need FormFactor's MEMS technology to be able to probe and test these chips. And in the second quarter, there was more of that business to be had. I think, from a profitability standpoint, if you look at our overall gross margins, even with that heavy Flash concentration, you can see things were pretty healthy. And I think it goes to, yes, we're treating this as an opportunistic business, but the requirements do demand FormFactor's MEMS technology, and as a result, we're being compensated for delivering that kind of technology into these high-end 3D NAND applications.

Our next question comes from Craig Ellis of B. Riley FBR.

Shai, I just wanted to go back to your commentary as you were talking about the gross margin guidance. I was with you on flat sales and flat utilization, but then you said gross margins would be essentially down by about 240 basis points quarter-on-quarter. So as we think about flat revenues and utilization but gross margin moving off of the prior quarter level, is it just that the operational execution was so stellar in the prior quarter, or are there intra-segment or intra-customer dynamics? What is it that's causing there to be a material variation in gross margins when other factors look fairly similar?

Thanks. It's a great question. And we saw strength across the board of our product mix during the second quarter, which was the main driver for the higher gross margin in the second quarter. We started with advanced packaging in both Foundry and Logic but also in HBM activity under the DRAM memory segment -- market. So that was the biggest piece that contributed to the higher gross margin. Going forward, we forecasted it to be -- and of course, the higher revenue as a total dollar also contributed. Going forward, we mentioned that we expect a different, less favorable product mix in Q3, which contributed to -- which will contribute to the update Q3 range of 42% to 45%. So we are very glad with execution in Q2. Many things were moving in our favor. Q3 should be similar, comparable, as we describe it. 42% to 45% is a good range for Q3.

Would you expect a decrease in both the systems and the probe card gross margins? Or is it more of one versus the other?

I think systems, we expect it to continue to improve, stay at similar levels. We're now at 48.6. Our goal is to be at a low -- high 40s, low 50s. We continue to see improvement. So I expect it to be in a similar level, and the change will come mostly from the probe cards business because of the change in the mix.

Okay. That's helpful. And then the next question I had. Mike, appreciating that FORM has looked at NAND as an opportunistic business historically and still has that view but with the market coming towards FORM. Can you be a little bit more specific on where you're seeing the opportunities? Is it really as manufacturers try and go in volume at 96 layer? Or are you seeing success at 64 and 72 or even at levels below that? Any color there would be helpful.

No. Craig, it's really the high end of that layer count range. And it goes down to sort of the pretty simple advancements and requirements as densities go up. In some cases, the probing gets more challenging. Pads on the die get smaller. In some cases, the die themselves get smaller. And that's where customers really need our MEMS technology to probe these smaller pads and do it in a cost-effective and electrically accurate way. Thematically, it's really the same thing that caused us to be adopted last year at the world's largest foundry for integrated fan-out applications. In a similar story, associated with HBM, where the densities are going up and people really need the scalability of FormFactor's MEMS technology to be able to probe and test in a cost-effective way.

That's helpful. And then the last question. I appreciate the longer-term color regarding being able to get to target model run rate levels in the second half of next year. As you look ahead, can you just list the 3 or 4 things that really give you confidence that, that path is within reach for FormFactor?

Sure. Thanks, Craig. So as we look at the target model that produces $650 million in revenue and $1.50 of non-GAAP earnings per share, a few things that we need to get there but things where we demonstrated or can rely on some pretty significant momentum. I mean, the first one, as a market share leader in about $1.5 billion of served market, we need that market to continue to grow. But I think all the signals that we see are that the semiconductor market and the probe card consumables and systems markets are pretty healthy and continuing to grow on that trajectory. So we're pretty confident there. In our Analyst Day last year, we articulated the line of sight growth opportunities that really bridge and drive our revenue growth inside that market: advanced packaging, mobile data and automotive. And without going through the details of each of them, I think we've shown pretty good progress in each of them. Advanced packaging clearly highlights where we're well ahead of where we thought we'd be in capturing that opportunity. And I think that gives us confidence that we can execute on all 3 of these line of sight opportunities but advanced packaging, in particular, carrying a lot of momentum, as we described in the prepared remarks. The one that's maybe a little bit more uncertain is the node transitions. And as I described, I think it was Brian's question, there are certainly some puts and takes associated with our largest customers' 10-nanometer transition, timing uncertainties there. The different DRAM node transitions and design changes that we need to support that revenue base, we need those things to happen as well. But all indications are that those things are going to begin to resolve themselves here as we move through 2019. And that's why we're confident in trying to convey that confidence to people that we'll exit 2019 on a run rate that's consistent with our target financial model.

Our next question comes from Edwin Mok with Needham & Company.

First question, [to follow up] with the line of question on the 10-nanometer and your largest customer. I think on the quarter, you talk about targeting the holiday season of 2019 for products to hit the shelf. Based on a prior experience, if that's the ramp-up time that [they] expect, when do you expect your demand to start ramp? Is it 2Q, 1Q or 3Q? Just if you could give a rough idea on that.

Yes. And consistent with what I talked about before, some of the historical data points on ramp timing and ramp duration are maybe not so reliable to rely on in the current situation. But I would expect if that end market product timing is going to be the case, that we'd be somewhere in mid-2019 in beginning to support the initial parts of the ramp in probe cards to test the wafers that are going to end up in the channel to feed the holiday season. I realize there's a lot of ifs there. And to be honest, there's a lot of ifs [in] all of the different market signals associated with the 10-nanometer ramp. But again, with the assumption that end products are going to hit in late 2019, 2019 holiday season, I'd expect us to be seeing the demand sort of mid-year 2019.

Okay. That's helpful. On the Flash, the $11.4 million revenue you see this quarter, are you more in the same level of revenue in third quarter? I just want to get a rough idea. You talked about this being mobile. How do you expect it to normalize in the coming quarter?

Yes. With the reminder of the caveat that we're running on average lead times that are approximately half a quarter, so we're operating with a significant element today of turnables in our third quarter forecast, we do expect to see the Flash mix be comparable in Q3 to that which we delivered in Q2, the sort of $11 million and change. And that's true sort of across the different businesses. We see a similar mix profile. Some of the customer-specific designs are not so favorable from a cost perspective for us, and that's why we're guiding gross margin down a little bit from the 46% we saw in the second quarter. But at the highest levels at the markets we report, Flash, DRAM, Foundry and Logic and systems, I'd expect to see a pretty similar breakdown of revenues across that mix.

Okay, great. At the largest foundry customer, you mentioned on the prepared remarks that you started to ship a number of sample probe cards for newer designs, right? And we've also heard a lot of new design around the 7-nanometer node. I'm just curious, is there a way to kind of think about opportunity there? I understand you are consolidating market share over competitor there. Can you give us some color in terms of where you stand in the market share and if there's a way you can kind of think -- help us think about opportunity there, not even -- maybe not this year but more like '19 or even beyond? Any color would be helpful.

Yes. And I think the opportunity there, again, consistent with us progressing towards our target financial model, is a substantial one. And it's primarily driven by advanced packaging where those customers -- where the fabless customers in that foundry really need FormFactor's MEMS technology. I think we've made good progress. We've grown share here in the first half of '18 over that which we achieved in '17. And wanted to highlight for you what we view as a really significant development in that we have now provided qualification units for more than just a large mobile application processor project. We're now branching out and diversifying that business a little bit. The timing of that turning into material revenue and really sizing the opportunity is a little bit challenging for us to size right now. But I would say, longer term, and it's probably even past 2020, as that customer migrates more of their wafer starts to advanced nodes and advanced packages, the opportunity for our technology grows. We sort of -- the available market, the served market for us at that foundry grows. And when we reach a steady state in that, again, it's probably post-2020, but we view that as an opportunity comparable to the size of our largest customer, significant number of wafer starts, high test intensity and large design mix, all good factors for us. And we view it as a significant long-term opportunity on the way to our target financial model.

One last question I have. On DRAM, you mentioned you some HBM design on the second quarter. Is that volume coming down, I guess, offset by other DRAM demand, but that's part of the mix that affect the gross margin in the third quarter?

Well, there's lots of puts and takes on the mix. I would say HBM continues to be relatively strong as we move through the third quarter here. There's some more subtle issues associated with test configurations and different ways customers deploy our technology. Again, reminding you that a probe card is a designed specific consumable. And so the details of that design are pretty important for what our cost structures and ASPs look like. HBM continues to be a pretty strong component of our overall DRAM mix here through the middle part of the year. And we're pretty excited about the continued adoption of that because as we've discussed in the past, it's a real advantage for FormFactor and will draw customers towards our technology.

Our next question comes from Tom Diffely with D.A. Davidson.

Maybe one more question on the Flash side or the non-volatile side. What was the balance of that category? Was it NOR Flash?

It was $7 million out of the $11.6 million was NOR.

NAND.

NAND, sorry.

It was NAND. And so NOR was the remaining?

Yes.

That's correct.

Was there something in the NOR? Because that was a -- that's a pretty big number for NOR too, then. Isn't it?

It is. I think both components grew significantly. Obviously, NAND, if I back up a couple of years, was very, very low for us. But the NOR Flash component has grown as well. We view that as probably a little less volatile than the NAND part of that Flash business. And a lot of it's driven by the end markets in automotive. We see that being part of our overall automotive growth opportunity. Obviously, not all of that NOR goes into the automotive sector, but a good chunk of that growth is being driven by the end market automotive.

Okay. And kind of curious what trends you're seeing on the RF mobile side of the business right now. There's obviously -- the year started out pretty weak for most players but is starting to pick up at this point. Are you seeing much in the way of additional capacity needs for this year?

I think RF -- our RF probe card business -- I'll talk about the RF systems business in a minute. But the RF probe card business I characterize as pretty close to steady state over 2017. We are seeing some design pickup as we enter into the back part of the year, but the fundamental dynamics of handset unit growth essentially being flat and some of the different market share puts and takes among the filter manufacturers, we don't see a lot of year-on-year growth in that business '18 over '17. What we do see is some pretty interesting developments as we start to move towards the initial deployments of 5G. And that's going to drive a lot of performance test requirements that bring things towards FormFactor strength, and we're anticipating some pretty strong growth as that kicks in. On the systems side, obviously, the analysis and engineering work that's going on for a lot of either the new filter designs or the new RF front ends at the higher frequencies of 5G have us pretty well exposed to those trends in working with the customers as they develop their test programs, devices and test methodologies going forward. So I think the production probe business to first order close to flat year-on-year, Tom, but we do see some interesting opportunities as the leading edge of 5G kicks in.

Okay. Great. And then you talked about the broadening of the customer base at the high end. What is the relative opportunity for you having a single large-run product versus, call it, 10 small products if the volume is the same ultimately?

Yes. So if everything else is the same, right, if all other things, wafer starts and all that sort of thing are the same, the opportunity for us is roughly the same, right, between 10 different designs on the same number of wafer starts versus one different design. Now there are inefficiencies in customer production buffers and that sort of thing that will drive a little bit more volume in the more -- in the 10 design scenario. But there's other factors in any specific opportunity that probably are more dominant.

Okay. So really the opportunity for you was just [in] expanding of that customer base for more wafer starts ultimately?

Yes. More wafer starts, more customers, more different probe cards for us to expand our opportunity inside that customer. But fundamentally, you can think of it as their leading edge nodes, 10-nanometer and 7-nanometer, driving the sheer scale of that opportunity for us.

Okay. Great. And then finally, you said that we're counting on the 10-nanometer ramp to happen until next year. Is it a similar view for the 1Y node on the DRAM side?

I think that's a good question and one that we're obviously trying to stay very close to. I'm not sure I have any significant data to add to what's been sort of disclosed over the last couple of weeks, except to say that probe cards typically trail the capital equipment installs, the process equipment installs by something like a quarter to 2 quarters. So as you see the process to a manufacturer starting to install and ramp up on 1Y, expect to see us 1 to 2 quarters later.

So I assume at this point you've done some pilot line 1Y work, and it's just [that] you're talking about volume now?

We have. And one of the more interesting things that's happened in our pilot line 1Y work is that through the multi-year reengagement with this large customer, we think we're in a pretty solid competitive position for 1Y. So we're a little bit disappointed that it's not ramping aggressively because we think there's going to be some additional market share gains for us when that customer transitions from 1X to 1Y.

Just sets up a good 2019.

(Operator Instructions) Our next question comes from Edgar Roesch with Sidoti & Company.

A quick one for Shai to lead off. Inventories ticked up a little bit in the past 2 quarters. Is that some timing issues? Or are there some more expensive raw materials playing a factor in there? Could you speak to that a bit?

Sure. Mostly the reason for the increase in inventory in the last couple of quarters was in anticipation of the increase in revenue we saw in Q2. All right. We need to start purchasing things and build some inventory ahead of the -- to this ramp-up. If we talk about Q3 outlook being comparable to Q2, then I do expect revenue levels to go down a little bit with the -- in the third quarter.

Inventory levels.

Inventory, I'm sorry, inventory levels go down in the third quarter.

All right. Appreciate that. And then, Mike, really nice color on the long-term financial plan and where we stand relative to that. If we look back and just take stock of Q1 a little bit, is it fair to say that the expectation of shipping the 10-nanometer and then -- and that sort of being delayed seemingly last minute was really a disruptor? And could maybe a normalized Q1 sort of split the difference between your 1 18 that you reported and what you have for the second quarter?

Yes. I'm not sure I entirely understand the question, Ed. But certainly, Q1 represents what we view as the low in our current operating model and the current industry situation and really was indicative of one particular customer not ramping the 10-nanometer node and really not in a position to start migrating designs to the 14-nanometer node. Here in the second quarter and through the third quarter, we see business with that customer strengthening because there's pretty robust design activity on 14-nanometer. Even as 10-nanometer sits on hold, we expect that as we exit the year, we'll be back at nominally that $100 million annual run rate or $25 million a quarter business with that customer, really just in supporting the 14-nanometer design activity.

Okay. Appreciate that. And then one last one. Just -- a lot of my questions have been asked already, but a major supplier of testers recently spoke about parallel testing in the mobility device arena. Having reached some practical limits for a few years now and leveled out, and I was just kind of wondering if you could speak a little bit about where parallelism is still playing a part in your business. I know RF was one where you're hoping to produce some gains for your customers. If you have any thoughts on that to share, that'd be great.

Yes. And I think it's very, very device- and application-specific. I would say I agree with the notion that in high-end mobile, the applications processor, parallelism probably has reached some natural limits. And although those are exciting opportunities, flashy businesses, there's also a whole bunch more probe card demand where parallelism increases continue to be the fundamental value driver and haven't reached any limits. RF was one of them. We're working with -- there's this pause in the RF filter market. We're working with several customers to try and advance their parallelism. So if things pick back up associated with presumably the 5G ramp, we've brought to them a higher level of efficiency, improve their cost of tests and of course, get compensated for that. So that's one area. The other area I'd like to highlight is DRAM continues to increase parallelism. As node shrinks, die sizes get smaller and there's more die per wafer. And so we're now shipping cards that are close to 3,000 die tested in parallel in testing a single wafer. So I would expect that trend to continue in DRAM so that overall cost of test is continued to be driven down.

I'm not showing any further questions at this time. I would now like to turn the call back over to Mike Slessor for closing remarks.

Right. Thank you all for joining us today, and we'll talk to you at conferences throughout the summer or on our Q3 earnings call. Thanks, again.

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