FormFactor Inc

NASDAQ:FORM

Earnings Call Transcript 2020-Q1

[Operator]

Thank you, and welcome everyone to FormFactor's First Quarter 2020 Earnings Conference Call. On today's call are 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.

[Jason Cohen, executive]

Thank you.

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

Today's discussion contains forward-looking statements within the meaning of the federal securities laws. Examples of such forward-looking statements include those with respect to the projections of financial and business performance, future macroeconomic conditions, the impacts of the COVID-19 pandemic, the impacts of regulatory changes, 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 2019 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, May 6, 2020, and we assume no obligation to update them. Also, as an aside, since this is an entirely remote earnings call for us, please bear with us on any audio delays or issues.

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

[Mike Slessor, executive]

Thanks, Jason. Thank you, everyone, for joining us today.

Before discussing our results and outlook, I want to recognize and thank peers and employees for their effort, dedication and [ perseverance ] during the COVID-19 pandemic. Our global

[Audio Gap]

quickly reacted to a variety of government directives that [ then ] shifted focus to replan manufacturing operations to restart our California and [indiscernible] factories, all in closely with our customers. Our key products were prioritized and quickly delivered. Their performance demonstrates agility and resilience, and I'm extremely proud of our team.

This first quarter had 2 distinct [indiscernible], a strong first weeks, followed by 2 weeks where our ability to produce and ship products was substantially reduced. You'll recall that we [indiscernible] first quarter outlook range on [indiscernible] following Bayer [indiscernible] shelter-in-place orders and the temporary shutdown of our Livermore and [indiscernible] sites, including all manufacturing operations.

Subsequent to Oregon and California statewide orders also [indiscernible] our Beaverton and Carlsbad [indiscernible], but through the [indiscernible] for essential infrastructure business and development of a set of [indiscernible] of on-site employee procedures. We restarted our production at each site in the final days of the quarter.

We'll review details of the first quarter results, but it's noteworthy that the avalanche of unexpected [indiscernible], FormFactor delivered results [indiscernible] clearly validate our targeted financial model. Reviewing [ our ] quarter on an annualized basis, we delivered $643 million of revenue and 46% gross margin, with $1.32 of non-GAAP earnings per share and $110 million of free cash flow. Take it together with our fourth quarter, these results demonstrate achievement of our target financial model, and we plan to update our model later this year when overall conditions have settled.

Our first quarter revenue contained a strong mix of foundry and logic probe cards, consistent with the commentary we provided on our February 5 earnings call. This demand was broad-based, spanning both 10- and 14-nanometer microprocessor designs, multiple foundry 5- and 7-nanometer mobile and high-performance compute designs, along with a variety of 5G-enabling RF filter and antenna devices.

DRAM probe card revenue was down in the first quarter [indiscernible] during an expected digestion period [indiscernible] [ full ] sequential quarters of record [indiscernible]. We are currently working closely with each of the new DRAM manufacturers on new [indiscernible] mobile and designs on both the wall [indiscernible] and 1Z nanometer nodes. These designs are expected [indiscernible] in volume in the second half of 2020.

Our engineering systems delivered steady results in what is seasonally weakest quarter [indiscernible]. Customers continue to engage FormFactor to solve toughest electrical and [indiscernible] and measurement challenges in R&D. As an example, we delivered our ultra-low noise 300-meter automated system to a leading foundry to help them [indiscernible] 3-nanometer development, build improvement.

FormFactor's results demonstrate the resilience [indiscernible] diversified leadership position, probe cards and engineering service. That leadership again documented in VLSIresearch's annual survey of the probe card market, where FormFactor's 13% annual growth in 2019, outpaced 9% market growth in the same period. This market growth is in sharp contrast to 2019's decline in semiconductor capital equipment spending and provides an additional proof point of the consumable nature of probe card demand. As a reminder, probe cards are a consumable that is specific to each new chip design. And so demand is generated from both node transitions and the release of new chip designs on existing nodes.

FormFactor's market share gains to 32% of the advanced probe card market are driven by themes we've discussed before. Namely the increase in test complexity associated with advanced packaging schemes like chiplets and heterogeneous integration. The high interconnect densities and challenging electrical test performance requirements in advanced packaging applications continues to be a space where FormFactor's differentiated MEMS probe technology provides significant cost of ownership and performance advantages.

In view of the continued uncertainty regarding COVID-19 restrictions in the region where FormFactor and our suppliers operate, we are not providing a formal outlook range this quarter and we'll instead provide insight into near-term demand [indiscernible] and supply constraints.

As I mentioned, quarter results were limited by manufacturing capacity constraints through shutdowns and by a lack of customer demand. At present, [indiscernible] 5 factory operations [indiscernible] and social distancing requirement, the capacity constraint situation continues, and we expect [ to ] persist at least through the second quarter.

We continue to experience robust and [indiscernible] for foundry and logic probe card with steady demand for memory cards and engineering systems, extending the same basic theme for the first quarter. We've maintained close and transparent communication with our customers, starting with our factory shutdown through the restart in [indiscernible] the limited production phase to ensure we are focused on [ adhering ] to their highest priority products and designs. Operations team continues to systematically resolve both internal supplier constraints, steadily increasing throughput and capacity to best keep customer production and design release schedules.

Our present view of the various output constraints limit second quarter factory output to approximately 10% below the overall first quarter output. Although our visibility is even more limited than usual, demand for FormFactor's design-specific consumables and R&D-driven products would be expected to produce sequential growth in the second quarter if not for these output constraints.

Shai, over to you.

[Shai Shahar, executive]

Thank you, Mike, and good afternoon.

FormFactor's first quarter revenues were $161 million, a 10% sequential decrease from our Q4 '19 record high revenue and a 22% year-over-year increase. These are impressive results, especially in light of the impacts of COVID-19, which included a temporary shutdown of our California factories for the last 2 weeks of the quarter. These results are a testament of our team's focus on the agility necessary to deliver for our customers while safeguarding employees and supporting our supply chain partners during a period of unprecedented challenges. As Mike noted, there are also compelling evidence of our ability to perform at our long-term target financial model levels across nearly all lines of our P&L in a very challenging environment.

Probe card segment revenues were $135 million in the first quarter, a decrease of $19 million or 12% from Q4 2019.

Systems segment revenues were $26 million in Q1, an increase of $0.6 million or 2% from Q4 2019, with strong sales of our advanced 300-millimeter systems.

Within the probe card segment, robust demand for foundry and logic continued, with revenue increased 1% from Q4 million to $106 million, comprising 66% of total company revenue in Q1, up from 59% in the fourth quarter.

DRAM revenues were $25 million in Q1, a decrease of $18 million from the fourth quarter and were 15% of total quarterly revenue as compared to 24% in the fourth quarter. DRAM demand was down in large part due to customers absorbing purchases made in several recent peak revenue quarters.

Flash revenues of $4.3 million in Q1 were $1 million lower than in the fourth quarter and were 2.7% of total revenue in Q1, similar to the 2.9% in Q4. We continue to expect flash revenue to be lumpy from quarter-to-quarter.

GAAP gross margin for the first quarter of 2020 was $67 million or 41.9% of revenues, 30 basis points higher than the 41.6% GAAP gross margin in Q4. Cost of revenues included $6.7 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. We had $0.8 million of reconciling items in the fourth quarter related to the acquisition of FRT that did not reoccur in Q1.

On a non-GAAP basis, gross margin for the first quarter was $74 million or 46.1% of revenues, 40 basis points higher than the 45.7% non-GAAP gross margin in Q4, mainly as a result of higher Systems segment gross margin.

Our probe card segment gross margin was 45.1% in the first quarter, a small decrease of 30 basis points compared to 45.4% in Q4. The decrease from Q4 was a result of lower volume, partially offset by more favorable product mix and lower performance-based compensation.

Our Q1 Systems segment gross margin was 51.2% as compared to 48% in the fourth quarter. The increase of 320 basis points was driven mainly by a more favorable product mix. As we have said previously, we expect our Systems segment gross margin to range between the high 40s to low 50s.

Our GAAP operating expenses were $49 million for the first quarter, $1.6 million lower than in the fourth quarter. The decrease in first quarter GAAP to non-GAAP reconciling items from $6.8 million in Q4 to $6.2 million in Q1 is mainly due to lower stock-based compensation. Non-GAAP operating expenses for the first quarter were $43 million or 26.6% of revenues compared to $44 million or 24.5% of revenues in Q4. The decrease of $1 million is mainly due to lower performance-based compensation and lower travel expenses, partially offset by the impact of the typical beginning of the year benefits reset.

Company noncash expenses for the first quarter included $7.3 million for the amortization of intangible assets, $5.6 million for stock-based compensation and depreciation of $4.6 million. Stock-based compensation was $0.5 million lower than in Q4 due to the timing of annual grants.

GAAP net income for the first quarter was $16 million or $0.20 per fully diluted share compared to GAAP net income of $19 million or $0.24 per fully diluted share in Q4.

The non-GAAP effective tax rate for the first quarter of 2020 was 17.6%, similar to 17.3% in Q4 and within the range of 15% to 20% estimated rate for the year, as we communicated in our previous earnings call. As a reminder, our cash tax rate is expected to remain at the 6% to 8% of non-GAAP pretax income until we fully utilize our remaining U.S.-based NOLs and R&D credits.

First quarter non-GAAP net income was $26 million or $0.33 per fully diluted share compared to $32 million or $0.41 per fully diluted share in Q4.

Moving on to the balance sheet and cash flows.

As you would expect, we are especially focused on cash flow management at this time. We generated $28 million of free cash flow in the first quarter compared to $32 million in Q4. This brings our free cash flow over the trailing 12 months to $110 million and takes our total cash and investments to $243 million at the end of the quarter. Almost 9% of these cash and investment balances are in the U.S. The sequential decrease in free cash flows in the first quarter was mainly a result of lower revenue and profitability and an increase in investment in capital expenditures.

We have 2 term loans on our balance sheet, totaling $45 million. The first loan related to the acquisition of Cascade Microtech in 2016 had a remaining balance of $24 million at quarter end, and it is expected to be fully repaid by the end of June 2020. The second loan is a 3-year, EUR 21 million denominated loan we took to fund the FRT acquisition in Q4 2019, utilizing low euro-based interest rate to optimize our cost of capital. The remaining balance of this loan as of the end of the first quarter was EUR 19.3 million. We spent $13.4 million on principal and interest payments on these 2 term loans during the quarter.

At quarter end, our total cash balance exceeded the debt balance by $198 million, an increase of $32 million. While paying down these term loans remain our first priority for using cash, we continue to invest in R&D and capital expenditures that support our organic growth as part of our multiyear plan. M&A also continues to be an important part of our strategy, and we intend to continue to investigate opportunities to deploy capital and acquire leadership positions that expand our served markets as we did with the acquisition of FRT last year.

We invested $12 million in capital expenditures during the first quarter of 2020 compared to $6.6 million in Q4. The increase in CapEx in the first quarter is part of our multiyear plan to support the demand for our products that we anticipate over the medium to long term. We will continue to be very disciplined in our spending as part of aligning our expenses with customer demand while rationing capital that is not directly related to additional capacity or technology development.

Our liquidity position and capital structure are solid. And together with our disciplined approach to spending and our flexible cost structure, we retain significant resilience to weather an economic downturn.

In light of our recent results and to better align our target financial model with growth in the markets we serve, we plan to hold a webcast strategy update for the investment community later this year at which we will update our long-term model. We will provide more details closer to the event.

Turning to our Q2 outlook. Although we are not providing a formal outlook given the continued uncertainties related to COVID-19, I can share some things for you to consider when thinking about our second quarter financial performance.

We are continuing to experience capacity limitations with adjustments to factory operations that implement social distancing and other safety measures. While demand appears to remain strong, we are output constrained. Capacity challenges will negatively impact our revenue and gross margin in Q2. As Mike noted, absent these capacity constraints, we would have expected sequential growth in Q2. Based on our current assessment of capacity constraints, we expect Q2 revenue will be lower than Q1 by approximately 10%. This estimate is subject to considerable uncertainty, of course, with the evolving COVID-19 classes and its broader potential impacts. Given the uncertainties, we are not providing an outlook range for gross margin or EPS for the second quarter.

With that, let's open the call to questions. We ask that when you ask your question, please indicate if you direct your question to Mike or to me since, as you can imagine, we are not in the same room. Operator?

[Operator]

[Operator Instructions] Our first question comes from the line of Tom Diffely with D.A. Davidson.

[Thomas Diffely, analyst]

Yes. So Mike, I'm curious, when you talk about the constraints for manufacturing, is that purely just manufacturing capacity issues? Or are you having supply chain issues as well in getting the parts and pieces?

[Mike Slessor, executive]

Yes. Good question, Tom. And before I address that particular one, I understand the fidelity of my prepared remarks wasn't great. So for all the participants, we've distributed the written script for you as well. So apologies there, but hopefully, we get better information transfer here.

Your question -- really, the answer to your question is both. There continue to be constraints, both internal to FormFactor as well as through our supply chain. There -- as you can imagine, our supply chain is global in nature, and so different government directives have had impact with different suppliers in different regions at different times, starting with China early in the quarter. Our operations team has done a great job of resolving those conflicts revolving those constraints as well as continuing to add capacity to the internal FormFactor operations in our California and Oregon factories as we continue to grow experience operating in these social distancing measures.

[Thomas Diffely, analyst]

Okay. Great. And then you talked about demand being strong, but is there a relative strength between the logic and memory sides of your business from a demand point of view?

[Mike Slessor, executive]

Yes. In the prepared remarks, we tried to detail it for you. Really continued strength in foundry and logic. First quarter DRAM revenues were relatively weak coming off a very strong 2019 where we had several sequential record quarters. Our customers are digesting those record shipments. And at the same time, we're seeing very strong activity in foundry and logic, both in the microprocessor space, the foundry space and the RF space. I think this is a good example of FormFactor's overall diversification strategy playing out pretty nicely. When some of our segments are weak, others are strong. And we managed to find a way to be able to balance our overall manufacturing capacity to deliver into each of them and deliver relatively stable results as each of these segment demands go up and down.

[Thomas Diffely, analyst]

Okay. And then finally for Shai. When -- you're not giving gross margin guidance, I understand. But when you look at the additional cost brought on by COVID-19, is there some way to quantify what the near-term impact will be?

[Shai Shahar, executive]

So I think when we think about gross margin, we need to think about what are the main drivers there, right? And it's true that we do add some additional costs related to COVID-19 like additional cleaning and stuff. But I think that most impact gross margin are, as in previous quarters, first of all, product mix. This change from quarter-to-quarter, and this will continue to have the biggest impact. And then the second item will be volume. As you noticed in Q1 versus Q4, Q4 -- Q1 volume was lower than Q4 and it did have some impact, that offset -- that was offset by product mix in a way. And of course, operational excellence, right? Our team are doing excellent job in executing even in these challenging times. So I know I didn't quantify exactly for you, but these are the main things that impact the gross margin and will continue to impact in Q2.

[Operator]

Our next question comes from the line of Tianyan Goellner with Sidoti.

[Tianyan Goellner, analyst]

First, question just for Shai, on the OpEx. And I remember you gave the guidance probably last quarter in the range of $42 million to $45 million per quarter. I know we don't give a formal guidance now, but I'm just wondering, will this still be a reasonable range for us to look into the 2020?

[Shai Shahar, executive]

Yes. That's a great question. As you saw in Q1, OpEx went down $1 million. This is although we added a full quarter of FRT versus only like 2.5 months in Q4. And we had the annual benefit reset in Q1. That also impacts Q1 and usually Q2. And that's -- the main reason for that decrease is less travel, which is, of course, in this environment has an impact. And the performance-based compensation, a portion of our expenses is tied directly to our performance and move up and down with it. So that's why you saw a decrease in Q2.

If I'm thinking about the rest of the year, I think about the same trends, right? We continue to control these expenses. A portion of it will be impacted by performance-based. I suspect in Q2, we're still going to see less travel. And I think we're going to see R&D impacted as well a little bit because some projects just cannot be done from home, right? You have to be in the lab to perform that work. And so Q1 is a good estimate, but it includes lower annual benefits -- sorry, higher annual benefits and lower performance-based compensation as compared to previous quarters. And this factor will continue to impact the next quarters.

[Tianyan Goellner, analyst]

Okay. And then a follow-up would be for Mike. Mike, when we look at foundry and logic, it's really high, very high. And on the other hand, DRAM is lower. As I know, you mentioned the customers are digesting the previous purchase. I'm just wondering, how should we really think about for 2020? Will the foundry and the logic will still be at a similar level? And when will the DRAM go back to the higher level due to kind of a node transition and new technologies?

[Mike Slessor, executive]

Let me start with DRAM. I think one of the interesting things right now is we're very actively engaged with the major DRAM manufacturers on new design adds. Designs are expected to [indiscernible] in [ second ] half of the year according to current cash schedules. So I think we're in a period where we're preparing for the next ramp of DRAM. We look forward to the [ second ] half of the year. Obviously, there's obvious tremendous caveats around macroeconomic conditions and the memory [ market ], but that's the way we currently [ think ].

I think foundry, the strength right now, all of the issues we're getting against our customers are that, that strength is going to [indiscernible]. It's fairly broad-based in processors, 5G mobility and high-performance [indiscernible]. And indications we're getting from our customers are that we should be prepared for this foundry and logic demand continue to be robust of the balance of 2020. Again, obviously, there's caveats associated with macroeconomic impact of COVID-19. For now, that's the way we see things.

[Operator]

Our next question comes from the line of Craig Ellis with B. Riley.

[Craig Ellis, analyst]

Congratulations on your execution in a challenging environment. The first question I wanted to ask is really just a clarification. Maybe I'll direct this to Shai. Shai, as we look at the revenue level that was reported versus the initial guidance, the variance being due to shelter-in-place issues impacting manufacturing, how did that impact revenues on an end market basis? Was it more concentrated in one area or the other? Or was it about equally distributed on a percent basis across DRAM, foundry and logic and et cetera?

[Shai Shahar, executive]

Sure. So first of all, the factories that were impacted were mainly in California and then later in Beaverton. And so the factories in Germany were not impacted. So the impact on the Systems business was not that big. So most of the impact or almost basically all of it came from the probes card business. And within that market, our factories in California, Livermore, San Jose, Carlsbad, they serve all these markets. I don't know if we can take this couple of weeks that the factory was shut down and try to extrapolate on what was exactly the impact on each one of these. So the factory is also feeding each other.

[Craig Ellis, analyst]

Got it. Okay. So then it would be tough to piece apart for the second quarter impact given the 10% impact to supply. Let me move on and ask Mike a question. So Mike, it seems like one of the things that's happening is that there is some supply constraint in the system, and I don't know if that's occurring beyond FormFactor. But can you just help us understand what's going on at the customer level? Are customers just finding way to operate with less probe card supply in the near term? Or is there some share shift either way? What's going on downstream from you at the customer level given that we have fewer probe cards available in the first half of the year than what we were thinking a couple of months ago?

[Mike Slessor, executive]

Yes. And I think that's a good overall observation, Craig. In the -- if you look at the major probe card supplier to FormFactor and our competitors, we're all sitting in regions that have been some [ way ] affected by this pandemic and government responses. So there is a concern on overall probe card supply. I would say that it's been a very active discussions with our customers. And [indiscernible] with other pieces of supply chain as well. So there's a pretty active prioritization activity that's ongoing, continues to this day, shifting design priority and moving things up and down [ that ] priority to make sure we're [ doing ] the best job we can of supporting them. And it's my view that, that's going on throughout the industry, both in probe cards and in capital equipment.

[Craig Ellis, analyst]

That's helpful. And then lastly, if I could. Shai, can I just come back to you? Since our view on the second quarter is impacted by some near-term supply constraints, what do you need to see from the operational teams, and more broadly, to be comfortable that output can be back at optimal levels exiting 2Q? If you could just give us a short list of 2 or 3 things, that would be real helpful.

[Shai Shahar, executive]

So we are now impacted by government orders. We have some capacity constraints, mainly related to social distancing. And we're also putting some measures in place to make sure our employees are safe. We are getting better and better at it. We are shifting tools around the fab and the rest of the factories to make some room for social distancing and increase capacity. So it's an ongoing process. We're getting better at it. And I expect the output to improve. But there's still a lot of uncertainties, right? And we are still -- even though we are still halfway through the quarter, our lead times, if you remember, are relatively short and the different government guidelines change and evolve. And we're also working very hard with our supply chain partners to make sure we secure what we need to continue to produce, and we make great progress there as well.

[Operator]

Our next question comes from the line of Krish Sankar with Cowen and Company.

[Sreekrishnan Sankarnarayanan, analyst]

Mike, you had like really strong revenues from China. I was trying to figure out, can you just try to segment it between domestic and multinational and between logic, foundry and DRAM?

[Mike Slessor, executive]

Sure. And to [indiscernible] people recently, for the past several quarters, China revenue has been about [ 20% ] of the total company. As Chris notes, that's for mix of multinationals that operate in [indiscernible] who are our major customers [ and ] logistics. So that mix is back and forth according to the spending cycles. So I'm not sure I won't try and segment it. Foundry does the same thing. Although recently, obviously, with the memory [indiscernible] has been quite strong from a [ memory ] perspective, again, from the multinationals and the demand. So [indiscernible] and the rest of the world, a pretty good blend between all segments, although recently, the memory has been quite strong.

[Sreekrishnan Sankarnarayanan, analyst]

Got it. All right. Fair enough, Mike. And then as a follow-up. I understand your supply constrained. Your typical lead times are probably like half a quarter or so. Are you -- with the supply constraints, are you seeing lead times stretch out? And if supply does come back to normal in -- by end of Q2, should we see a snap back in Q3 because of pent-up demand?

[Mike Slessor, executive]

Yes. So -- in lead times, obviously, the second quarter [indiscernible] a little bit, if only because of lowered overall capacity that we have and our competitors have. So in general, probe card lead time have extended here in the quarter. I think it's a realistic assumption to think things are going to immediately snap back. I think we're operating under the assumption the loosening of restrictions is going to be a little more manageable. And we will continue really to [ operate ] with some measure of social distancing in our factories, which obviously reduces our overall throughput, even as we add capacity through CapEx and long-term measures to try and address this demand. So I don't view it as a snapback. We're going to gradually build capacity to meet this demand as we go through Q2 and into Q3.

[Operator]

Our next question comes from the line of Quinn Bolton with Needham.

[Quinn Bolton, analyst]

Just trying to follow-up on that last question. As you build out capacity, is any of that clean room capacity which may be more capital intensive? Or are you experiencing spacing issues in the clean room?

[Mike Slessor, executive]

Yes, Quinn. Certainly, some of the things we've confronted and begun to resolve are spacing issues and footprint issues in the variety of clean rooms we operate, whether they be our MEMS fab or the assembly area. So we are deploying cash on increasing our [indiscernible] and making sure [indiscernible] mentioned that we're spacing things out to the best possible ability [ that ] people are separated from each other. Lots of work by the ops team and optimize in some existing footprint and find [ where ] we get additional space to the clean room areas, which is [indiscernible] are capital intensive.

[Quinn Bolton, analyst]

And do you think you have to find additional space for clean room? How long does it take to sort of install and equip that additional clean room space? I mean is that something you can do in a quarter's time? Or does that typically take multiple quarters?

[Mike Slessor, executive]

It sort of depends on the magnitude. We've [ managed ] at least up till [indiscernible] to take existing lab inside our footprint, and that does require some capital investment. But as we've discussed with you in the past, we're getting pretty close to breaking our overall capacity limitations. And as we look forward to sharing a new target model and a longer-term strategy, that will be part of the overall discussion.

[Quinn Bolton, analyst]

Got it. Got it. And then Mike, it seems you guys significantly [ upsided ] Q4 and back around the end of the year. You sort of thought that, that strength was perishable, and you were able to capture that demand. It certainly looks like the demand environment has remained pretty robust, albeit you're output constrained in the near term. Can you talk about -- does it feel like the demand environment has now fundamentally improved? Or do you think that some of the factors that drove the upside late last year and then Q1, do they just continue but they're still temporary in nature? For instance, your largest CPU customer running 2 nodes at fairly high volumes. I mean is that now more sustainable? Or do you still think it's sort of temporary in nature?

[Mike Slessor, executive]

Well, I think some of these trends do appear to be a little more sustainable than we might have thought in the fourth quarter. The fact -- you look at what we delivered in Q1, even missing, in good part, the last part of the quarter. I think there are some trends associated with advanced packaging with 5G that are driving fundamentally more spend in test, and preferentially, as you saw on the VLSIresearch results, market share gains for FormFactor and the leaders in the industry, because there's only a few people who can really serve these advanced nodes and these -- the requirements associated with things like testing chiplets, testing the high frequencies of a 5G front end. These are some pretty stringent requirements. As that momentum continue, these things are a little more nimble than we might have thought back in before.

[Quinn Bolton, analyst]

And I guess sort of a final question. Just that foundry strength, I think historically, you've seen concentration in the foundry business. Is part of that sustainable demand really reflective of you gaining additional customers outside your kind of -- your lead foundry end customer?

[Mike Slessor, executive]

Yes. It's a [ really ] important point. We've talked about our [ foundry ] business becoming more diversified over time. Several years ago

[Audio Gap]

by applications, lots of mobile, but lots of performance compute now as well and multiple fabless customers across a variety of designs, still much less lumpy, much less concentrated. And that continues to be one of the long-term growth opportunities for FormFactor is continued

[Audio Gap]

[Operator]

Ladies and gentlemen, please stand by.

[Shai Shahar, executive]

Hi, everybody. Can you please stay on the line while we try to fix this difficulties?

[Mike Slessor, executive]

Yes. Slessor is back. Apologies again.

[Shai Shahar, executive]

Okay. Shai is back. Can you hear me?

[Mike Slessor, executive]

Yes.

[Operator]

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

[Christian Schwab, analyst]

Great. Mike, I just want to make sure that we're not -- that Q2's revenue due to capacity constraint isn't lost revenue. Is that something you would expect to recoup maybe as soon as Q3 depending upon social distancing and kind of movement controls? Is that fair?

[Mike Slessor, executive]

Well, I think there is some level of demand that will continue into the third quarter. There are some longer-term initiatives and projects where key customers are increasing capacity and really investing in capacity around some of these key designs and initiatives. Some of the 5G investment is probably one of them. So I think there is some element with lead time extensions that we talked about earlier in the call where you are going to see some of this demand spill over into Q3.

Now that obviously cannot last indefinitely. And we want to make sure that we're doing everything we can to add capacity to serve the element that could be perishable demand. And so trying to add capacity, continue to reduce our lead times, and even in a socially distance manufacturing environment, get us back to the output levels we were at in the fourth quarter and in portions of the first quarter.

[Christian Schwab, analyst]

Great. And then another question for you. We're hearing a lot of more positive chatter about the micro LED markets than maybe we would have say at 90 to 180 days ago. Are you seeing any positive movement on your side in that market yet?

[Mike Slessor, executive]

That's an application in a market where we've been very engaged with some of the leading developers of the technology. If you recall, we started talking about it a few years ago in serving -- basically serving it with our systems business. We continue to see activity there. But as with most of our systems business, I don't know that we're really going to see a lot of volume production business from that. We're exposed to -- some of it in the probe card business, and we are seeing initial activity there. But for example, you're not going to see the ramp of it from us like you might from some of the assembly equipment providers in the space who will undergo significant growth when it really ramps. So continued steady good evolution, but more in enabling the R&D and next-generation of it.

[Christian Schwab, analyst]

Okay. Great. And then lastly, not to potentially spoil the new target model. But since our market share is so close to our target model, is that -- were you surprised that your ability to get to 32% market share exiting 2019? And any color you could share with us regarding future aspirations?

[Mike Slessor, executive]

Yes. Well, I think their market share, we do expect that there's continued gains to be made in our served markets. Obviously, you end up saturating at some point given the industry's need for multiple suppliers and to keep things balanced. So we do think there are still share gains to be had from the overall 32% level. Maybe looking at it a different way. This is one of the reasons why we're so focused on deploying the cash we generate from our leadership positions to buy companies like FRT who lead in growth areas that extend our served addressable market. So I think there are continued share gains to be had as we continue to execute, and things like advanced packaging in the 5G drive preferential share gains for us. But I also think it's one of the reasons why M&A is such an important part of our overall strategy.

[Operator]

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

[Brian Chin, analyst]

Nice execution. And Mike, I think we need to upgrade you to 5G. I guess my first question here. In terms of maybe shipment linearity, can you give us a sense sort of what that looked like in Q1 and also how to think about it in Q2? And so I didn't quite catch this, but it did sound like you were shut down for most of the final 2 weeks of the first quarter, yet you still achieved the low end of your original guidance range, which I know you retracted. But essentially, it sounds like you would have exceeded that range. You had the -- those measures not taking place.

[Shai Shahar, executive]

So I'll take that, Brian, and good to hear from you. I think it's -- it will not be accurate to extrapolate 11 weeks of a strong, over 13 weeks of full quarter and assume linearity. That's not how our business has been operating. There were several quarters that the first month or the second month was stronger than the third month and vice versa. So I wouldn't take our results divided by 11 and multiply by 13 and assume we would have -- be out of the range. I think it will be -- we would have been at the high end of our preliminary outlook range, as we stated and you confirmed. Going into the second quarter, we started our -- restarted the factories in the beginning of the quarter. As you can imagine, we started slow, putting new measures in place, increasing capacity slowly. So even in Q2, again, I wouldn't look at linearity and try to understand how the quarter will look like.

[Brian Chin, analyst]

Okay. That's fair enough. I appreciate that color, Shai. Staying with supply here for another question. In terms of that 10% lower output in Q2, is this pegged to an underlying assumption for shelter-in-place measures being lifted in the associated and affected region? Is this a swing factor? Or does graduating the higher output have more to do with the sort of creative efficiencies and maybe perhaps mix that you've referenced?

[Mike Slessor, executive]

Yes, Brian. It's Mike again. It's more of the latter. We are not expecting sort of the -- I think somebody used a snapback analogy. We're not expecting or assuming in the outlook we provided that we're going to be free of social distancing measures in our factories or on site or visiting customers anytime in the second quarter. That may be an overly pessimistic or conservative view, but it's the one we're taking now just to make sure we're able to make a realistic commitments to our customers and then be able to deliver on those commitments.

So if we do find a situation where government restrictions are completely lifted, and equally importantly, we feel confident and our employees feel confident in the lifting of those restrictions, then I think there probably is some upside baked into this. But the assumptions we're working with right now is that we're essentially under the same restrictions for the balance of the second quarter and able to gradually improve things inside that set of restrictions and mandates.

[Brian Chin, analyst]

Got it. That's helpful. And then shifting to demand. Maybe for DRAM specifically, do you see the DRAM industry migrating support away from mobile towards supporting more PC server wafers? So what is the net effect or product, I guess, of your revenue outlook for this segment if that's the case? And I guess talking about the designs that you referenced in DRAM. Are they more pin to no transitions, more have to do about the migration of wafers, maybe the PC server, stronger markets or things like GDDR6? Anything you could be descriptive on would be helpful.

[Mike Slessor, executive]

Sure. I think like most people who operate in the design specific space, we have seen a tactical shift by the DRAM manufacturers of wafer starts from mobile to server in particular, but also PC DRAM. That obviously has generated a little bit of incremental demand for some of the PC server designs that we serve, but probably a zero-sum game against the mobile designs that were originally planned. When I talked about the heavy design activity right now that will feed second half 2020 volume design, that's spread out pretty evenly between graphics, mobile and PC server. So I think in the short term, certainly, our customers adapted pretty quickly to go serve the non-mobile demand. But the longer-term design road maps haven't changed much, I don't think, looking forward to the second part of the year.

[Operator]

We have a follow-up question from the line of Craig Ellis with B. Riley.

[Craig Ellis, analyst]

Yes. Mike, I wanted to cycle back on a topical issue on this call. So just reflecting on some of the key themes here versus 3 months ago. Obviously, shelter-in-place in the crisis is one, but that's not the question. It seems like one of the things that's really starting to happen with the business is 5G is starting to become a more meaningful incremental driver to probe card demand and customer engagement for you now than it was say 3 or 6 months ago. So one, is that true? And two, if it is, can you provide us some color with how you see 5G as an incremental driver playing out over the business as we look through the back half of this year and 2021?

[Mike Slessor, executive]

Yes. So I think 5G for FormFactor certainly is creating some momentum not just around our RF probe card business. But more broadly, when you think about a 5G handset, and as a reminder, FormFactor's exposure really is to the handset side of the business because of the large number of units there and not so much the infrastructure side. When you look at the content increases, not just in the RF front end driven by 5G, but more DRAM, more NAND, a more complex display, clearly, a more complex applications processor, the overall move to 5G on the handset manufacturers' road maps is driving a real growth opportunity for FormFactor. When we look at it, we feel like we're relatively well positioned in -- with both the RF fabless people customers as well as the digital portion of it, and of course, the memory portion of it.

So I think your observation that 5G is becoming a bigger part of our overall business and driving a more substantial position for FormFactor in the overall supply chain, probably a fair observation. Now the timing of these 5G handset launches, I think, is pretty up in the air at this point. We've seen some handset manufacturers push some initial ones out. I think there's still some uncertainty. But over the longer term, there's no question this is a very strong positive tailwind for FormFactor business.

[Craig Ellis, analyst]

And that's helpful. Then the follow-up question was in reference to a comment made around DLSI. They had to report that identified market share, and congrats to Form for its strong performance there. But I think they also had a forecast for industry growth that was somewhere around 6% to 7.5% on a compound basis over the next 3 to 4 years. So with FormFactor having executed some very interesting tuck-in deals recently, transformative deals a few years ago, is it reasonable to think that if the company can maintain its execution on inorganic growth, that at least mid- to high single-digit growth would be possible for the company? Or are there things that you're seeing in your served markets that would argue for growth that would be a discount to that?

[Mike Slessor, executive]

Well, I think, overall, the growth you mentioned about our served market in the probe card space is really a function of some of the themes we've talked about in the past where probe cards are a design-specific consumable. And so as customers change designs, whether it be a node change or a move from DDR4 -- DDR4 to DDR5, these are things that drive probe card demand. And I think that's why you're seeing this high single-digit long-term growth. It's quite a bit more stable than semiconductor capital equipment spending.

As we look at FormFactor strategy, it has both capitalizing on that organic growth of the market in which we lead, but also the inorganic piece in markets where we want to serve that really are nicely adjacent to the overall probe card and engineering systems market. So I think it's reasonable to expect we'll continue to execute organically against this market growth and amplifying our leadership position, but also then taking the cash we generate there and acquiring leadership positions in new pieces of served market to keep the growth going.

[Operator]

I'm showing no further questions in the queue. I would now like to hand the call back over to Mike Slessor for closing remarks.

[Mike Slessor, executive]

Thank you, again, everyone, for joining us today. Apologies for some of the technical difficulties. If we need to follow-up with you and schedule something to make sure that we get your questions answered, please reach out to Stan and our IR department to do that. Thanks again, and stay safe.

[Operator]

Ladies and gentlemen, this concludes today's conference. Thank you for your participation. You may now disconnect. Everyone, have a wonderful day.