FormFactor Inc (FORM) 2019 Q1 法說會逐字稿

Thank you, and welcome, everyone, to FormFactor's First Quarter 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.

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 condition; 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 section of our website and at www.sec.gov and in our press release issued today. Forward-looking statements are made as of today, May 1, 2019, and we assume no obligation to update them.

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

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 3 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 systems 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 4 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 results, 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 a 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 requirements 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 that 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 their 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 its mature 14-nanometer node, while at the same time increasing activity consistent with the expected timeline required for its 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.

As the world's leading foundry, we continue to broaden our footprint with wins on multiple designs from multiple fabulous design houses, serving both mobile and the high-performance computing applications. In RF, we are currently experiencing a midyear increase in RF front-end driven demand as BAW and 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-focused products. During this time, we are advancing our roadmap and qualifying technologies that enable high parallelism, low-cost wafer test at 175 degrees Celsius, helping it address the 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 provide some degree of smoothing to our DRAM probe card shipment timing and volumes.

Our engineering systems business provided a big highlight for 2019 to date, with first quarter deliveries of multiple high ASP systems for both MicroLED and cryogenic temperature testing. Both of these applications, like silicon photonics and advanced 5- 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-efficient 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 and 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 that 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 that growth and execute further share 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 EPS and $110 million of free cash flow.

Shai, over to you.

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. Systems 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 earnings releases, we expect our systems segment gross margin to be at the 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 mainly to annual benefits reset, which typically affect us -- 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 noncash 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 was $0.4 million lower than in Q4, and stock-based compensation was $0.1 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 a valuation 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 communicated.

Our cash tax rate is expected to remain at the 5% to 8% of pretax 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 fully 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 by approximately $0.03 at the midpoint of the outlook. A reconciliation of our GAAP to non-GAAP Q2 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 Craig Ellis with B. Riley FBR.

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. As 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, but was there anything in particular that stood out in that business versus your expectations for the quarter?

I think in Foundry & Logic, obviously, as you know, a 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 result in what's overall a pretty weak DRAM spending environment.

And just following up on that other point. If we look at updates from DRAM manufacturers over the last month or so, it does seem like all are sticking with 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 should 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.

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 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 new designs in DRAM, in node shrinks in DRAM as each of the 3 major customers try and innovate and compete with each other in maybe what's a more challenging end market for them than it was in the middle part of 2018.

And I'll ask one for Shai and 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 margin. So I take it that's 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 there's a meaningful change quarter-on-quarter. Is that just the first quarter systems dynamic shifting the other way? Or what would cause such a meaningful decrease when volume seems to be helping the business?

Yes. Thanks, Craig. So yes, mix has 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 evidenced by systems margin eating 54%, high end of the range. We previously said, right, we talked about 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 factories with a little better revenue. And so this impacted 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.

And our next question comes from Brian Chin with Stifel.

Nice job to the team and thanks for letting us ask a few questions. My first question is, looking at the midpoint of your 2Q revenue guide, it's slightly up from the revenue level you did achieve 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?

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' publicized need to have product on the shelves at the end of the year. So as we've said, that's a midyear 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 2 different markets. In 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've 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 reduced in Q1 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.

Okay. That's really helpful. Following up on 2 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, certainly earlier than they might typically in a sort of a down cycle from a pricing standpoint for them. I'm curious if you've seen any effect on your revenue stream thus far. And whether you think that could have some impact. Certainly counterbalanced against the robust design activity. But some impacts on your business moving into second half in terms of the DRAM market?

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 the manifestation of advanced packaging in memory which is HBM. And we see all of our leading customers now pushing towards that direction. Obviously, a trend that's 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 to because, obviously, they already have the tooling and probe cards they need to test the peak wafer 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.

Okay. That's helpful. It also makes some sense. And one quick last one. 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, that customer on a recent call did talk about maybe seeing slightly better units in terms of CPU units for them by the end of the year, and they also talked about a faster follow-on ramp for their server CPU chips on that 10-nanometer process sometime next year. And so earlier the 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 continuing to remain robust and more sustainable into 2020?

Yes. Well, I think, in general, any customer getting more aggressive with design transitions and node transitions is 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 on to 14-nanometer, which has been a pretty successful mature node for them, drives quite a bit of business. Obviously, we're very excited to see 10-nanometer continuing to progress. And the more designs that make it onto that new node drive volume for our customers 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 Instructions) Our next question comes from Christian Schwab with Craig-Hallum.

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 kind of the puts and takes as you see it that would allow you to get there?

Sure. So if we just revisit some of the fundamental assumptions of the target model to get us to $650 million at the top line and $1.50 of non-GAAP earnings per share, there's 2 pieces to it. Obviously, as 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, they were probably a hair under, $1.5 billion. And so 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 most 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 3 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 at 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 and share gain area for us over the last couple of years.

I think mobile data, as we talk about on the call, we're seeing some signs of life in the RF BAW and SAW filter business. And obviously, 5G is a very exciting opportunity for us. We need that to accelerate and get some share gains there. And then, we need to return to some of the growth in the automotive segment. We're laying the groundwork, like the example I gave for high-temperature test. But those 3 things sort of have to hit on all 3 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.

Great. And then, my last question, if I may, has to do with potential M&A after successfully putting in Cascade Microtech into the company and leveraging some of those opportunities and kind of setting up your lab-to-fab strategy. Is there any areas out there that you think -- or technologies -- or if you could 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.

Yes. No. I can give you some update and remind you of the general things. So what we've 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 market. We don't think there's a lot of shareholder value in 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 at areas that are resonant with our business where we can really get good leverage out of our sales force, out of our fixed cost, out of our G&A. And then look to long-term revenue synergies and products synergies, as we have in the Cascade Microtech deal, to drive an interesting and compelling roadmap in places like advanced packaging that are becoming a new part of the overall industry roadmap.

Our next question comes from David Duley with Steelhead Securities.

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 a lot of that is ramping 7 nanometers. How would that impact your business?

Thanks, David. 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 is for designs that are going to be ramping in the middle part of the year, sort of 6 months after we deliver probe cards. So to some extent on that narrative, part of our strength with that customer in Q4 was the tooling and 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 expansion with that customer into multiple new fabless 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 fabless customer and 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 adopting both 7-nanometer, 7-nanometer-plus in advanced packaging, I think there's some opportunity for us there.

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

I think so. We're really exposed there on advanced nodes. 10, 7 and below.

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

Yes. I think the jury is still out on a lot of 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 this, people are sampling and still really sorting out what their architectures and chipsets and therefore packaging strategies are going to be. I think that 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 its spectacular RF performance. But I don't know that, that's really been fixed on most customers' roadmap 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.

No. Maybe let me ask it 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 the advanced packaging is more capped on a probe and test-intensive?

It is. It's more probe and test-intensive, 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 still feels awfully early days in 5G to us.

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

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 the slowing of Moore's Law, I mean, it's clear that advanced packaging offers another way to innovate to get the performance, the footprint and the cost attributes that they've always gotten from just shrinking transistors. Obviously, shrinking transistors is no longer quite as easy and cost-effective as it used to be. And so advanced packaging, whether it be integrated fan-out, whether it be the [full Bharosa] application, whether it be HBM are all things that leading customers are adopting in the next year and are great drivers of FormFactor's business, as we've talked about in the past.

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

This is Franco for Tom. I guess I'll start on the logic side. What is currently the mix between the 14- and 10-nanometer nodes right now that you're also seeing?

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.

And so I guess piggy-ing back up for that, so when the 10-nanometer is launched then and how [efficient,] how long do you expect the 14-nanometer to stay -- or do you expect new designs with that node?

Yes. I mean I think if you look at any of our major customers' narratives, some of these what would've been thought of as 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's 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.

Okay. And then jumping to RF. What are your expectations for the demand as we progress through the year? And then, did your expectations changed during the quarter?

Look, as I said in the prepared remarks, we are seeing some midyear 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 about now. It's been such a lumpy market for the last couple of years that our visibility is not great. But 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.

All right. Sweet. And then, lastly, I just saw some nice mix-related and gross margin benefit from engineering systems in the quarter. I know this is like a sort of steady grower, but can you talk a little bit about the long-term opportunities and what's the biggest driver there in the future?

Yes. I think engineering systems, remember, is a business where we're 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 myriad of different applications where people are having to do brand-new kinds of tests and brand-new kind of characterization. So if I run down sort of the list of applications, obviously, this time around, we talked about some cryogenic test systems, testing at temperatures ranging from 77 Kelvin or liquid nitrogen, all the way down 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 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 pathfinding. 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.

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

I'll start with some items that relate to comments thus far. Mike, on the mobile business for RF probes, you've talked about the near-term strength, but my question was a little bit longer term as we look towards 5G ramping in very small volume this year but more meaningful next year. What does that mean for the growth rate of the RF business? I think there's 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'll get from 5G?

Yes. I think if we just look at that example, I think almost certainly, there will be content growth in 5G, and if we 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.

The 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 different band. I think the other exciting part for 5G is it's a tougher test problem. The higher frequencies, much, much more stringent single noise. And so it plays pretty well towards our historic technology strengths. We're pretty strong through the Cascade Microtech acquisition at RF, 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, a nice opportunity for us. And I think you could expect to see us track pretty closely to RF filter units in the near term.

That's very helpful. And the follow-up relates to comments regarding your large U.S. customers' manufacturing and technology strategy, the move towards 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 it does so?

Yes. Well, it's 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 shrinks. And so the notion that -- now, essentially all the leading manufacturers have some level of advanced packaging on their roadmap, whether it be chiplets, high-bandwidth memory, integrated fan-out, I think, are really exciting opportunities for us and the larger test community.

If we look at some examples from the past. High-bandwidth memory is probably the simplest one to look at. It raised test intensity 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 raised 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 plays really well to our MEMS technology. We're able to scale that quite effectively, produce quality probe cards that allow them to drive their test costs 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.

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.

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.

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.