FormFactor Inc

NASDAQ:FORM

Earnings Call Transcript 2020-Q2

[Operator]

Thank you and welcome, everyone, to FormFactor's Second 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 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 benefits of acquisitions and investments; the impacts of the COVID-19 pandemic; the impacts of regulatory changes; the anticipated demand for products; our future ability to produce and sell products; the development of future products and technologies; and the assumptions upon which these 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 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, July 30, 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, and thank you, everyone, for joining us today.

FormFactor delivered second quarter results that were a near carbon copy of our first quarter, again validating our target financial model. These results are a testament to the dedication, resilience and commitment of our worldwide team, and I'd like to start our call by recognizing and thanking our 2,000-plus employees for their contributions to this impressive performance.

Although the top-level financial results are similar, the underlying path to achieving the second quarter was very different than the first quarter. During the second quarter, we experienced no significant shutdowns or disruptions in our internal operations and external supply chain, allowing us to steadily increase factory output in a safety-focused and socially distanced manufacturing environment. This enabled us to exceed the outlook we provided on May 6 and deliver revenue of $158 million, only $3 million less than the first quarter.

In our Foundry & Logic probe card business, we again experienced strong demand from multiple customers that continues into the current quarter. This demand strength is coming from several end-market drivers, including acceleration of 5G handset pilot production as well as continued work-from-home infrastructure spending. Our large microprocessor customer continues to ramp new designs and increase capacity for both client and server chips on both the 14- and 10-nanometer nodes. Despite our recent announcement of delays in eventual 7-nanometer production, we are currently engaged with this customer in significant 7-nanometer R&D activity and are excited about helping enable the adoption of advanced packaging technologies that are planned to be a prominent part of this node. 7-nanometer production was not planned in the near future. And in the interim, we expect new designs to continue to release on the 10-nanometer node. As a reminder, probe cards are consumable that is specific to each new chip design, and so demand is generated from not just node transitions, but also from the release of new chip designs on existing nodes. Regardless of the manufacturing strategy this customer employs, we expect to support their probe card demand wherever they choose to produce 7-nanometer products.

We also continue to grow our business at the world's largest foundry and are now shipping several major designs in significant volume for each of mobile, high-performance compute and RF applications. This increasing activity demonstrates that FormFactor's differentiated technologies provide compelling performance and cost advantages for wafer test on advanced logic nodes. As more of this customer's designs and wafer starts start to move to 10-nanometer and below, we expect to experience a corresponding increase in our business with them.

In addition, we also expect to grow with their adoption of advanced packaging since advanced packaging increases both test intensity, which expands the number of probe cards required per wafer out; and test complexity, which widens FormFactor's competitive advantage. Whether it's HBM stacking by DRAM customers or dye disaggregation techniques by microprocessor and foundry customers, advanced packaging is an important long-term growth driver of FormFactor's business.

Commenting briefly on our third quarter outlook. While we anticipate continued strength with major foundry and logic customers, we also expect strengthening in DRAM as key customers begin to ramp new server and mobile designs on the one-Y and one-Z nanometer nodes. This DRAM cyclicality is inherent to that market and is expected, but because of the strength of our other businesses, primarily foundry and logic probe cards, this DRAM volatility has not had a significant impact on our recent financial results and is an excellent example of the power of FormFactor's diversification strategy.

Turning to 2 other important points in today's announcement. Since mid-March, we have been limited by capacity and output and not by customer demand for our products. To capitalize on this strong demand, which we view as a secular long-term trend, we are utilizing our strong balance sheet to invest in FormFactor's future growth. In the second quarter, we purchased a new 90,000 square foot building on our Livermore campus, which will enable us to significantly increase our probe card manufacturing capacity. We expect to gradually increase capacity starting in the first half of 2021 as we complete commissioning and begin tool move-in and qualification.

In addition, we earlier today announced the acquisition of the probe card assets of Advantest Corporation. This $35 million acquisition brings several key enabling subcomponent technologies that reinforce FormFactor's technology leadership. It also adds an emerging NAND Flash probe card architecture that is currently qualified at one of the world's leading memory manufacturers, providing us the potential to be a more strategic supplier in mainstream NAND Flash wafer test. Both this acquisition and our facility expansion position FormFactor for continued industry leadership.

Finally, having achieved our target financial model for 3 consecutive quarters, we plan to unveil a new target model on an August 18 analyst update call. In reviewing the path to our new model, we will discuss growth drivers including 5G and advanced packaging that are driving faster than industry growth in our $2 billion of served markets. Our leadership position in these attractive markets, paired with our differentiated strategy and disciplined execution, will drive continued growth and share gains, enabling us to achieve our next target model.

Shai, over to you.

[Shai Shahar, executive]

Thank you, Mike, and good afternoon.

As you saw in our press release, our second quarter revenue was within the revised outlook range we announced on July 1. These are impressive results especially in light of the impact of COVID-19, which required the gradual reopening of our California facilities during Q2 following a temporary shutdown during the last 2 weeks of March. These results show FormFactor's agility and ability to deliver to our customers while safeguarding employees and supporting our supply chain partners. There are also compelling evidence of our ability to perform at our long-term target financial model across nearly all lines of our P&L.

FormFactor's second quarter results were similar to the first quarter. Revenues were $158 million, a 1.8% sequential decrease from our Q1 revenues and a 14% year-over-year increase. Probe card segment revenues were $134 million in the second quarter, a decrease of $1 million or less than 1% from Q1. Systems segment revenues were $24 million in Q2, a decrease of $2 million or 8% from the first quarter driven mainly by lower sales to universities and institutions that were impacted by COVID-19. Within the probe card segment, robust demand for foundry and logic continued, with revenues increased 3% from Q1 to $109 million, comprising 69% of total company revenue in Q2, up from 66% in the first quarter. DRAM revenues were $19 million in Q2, a decrease of $6 million from the first quarter and were 12% of total quarterly revenues as compared to 15% in the first quarter. DRAM demand continued to be down in large part due to customers absorbing purchases made in several 2019 high-revenue quarters. Flash revenues of $5.4 million in Q2 were $1.1 million higher than in the first quarter and were 3.4% of total revenue in Q2, slightly higher than the 2.7% in Q1. We continue to expect Flash revenue to be lumpy from quarter-to-quarter.

GAAP gross margin for the second quarter was $66 million or 41.9% of revenues, same as in Q1. Cost of revenues included $6.1 million of GAAP to non-GAAP reconciling items, which we outlined in the 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 second quarter was $72 million or 45.8% of revenues, 30 basis points lower than the 46.1% non-GAAP gross margin in Q1 mainly as a result of slightly lower revenue and lower Systems segment gross margin partially offset by higher probe card segment gross margin. Our probe card segment gross margin was 46% in the second quarter, an increase of 90 basis points compared to 45.1% in Q1. The increase from Q1 was mainly a result of more favorable product mix. Our Q2 Systems segment gross margin was 44.6% as compared to 51.2% in the first quarter. The decrease of 660 basis points was driven mainly by lower sales, unfavorable product mix and higher warranty and E&O costs. We expect our Systems segment gross margin to return to the range of high 40s to low 50s that we've said previously is the norm.

Our GAAP operating expenses were $43.7 million for the second quarter, $5.3 million lower than in the first quarter. The decrease in second quarter GAAP to non-GAAP reconciling items from $6.2 million in Q1 to $2.6 million in Q2 is mainly due to a $3.7 million benefit from contingent consideration adjustment we recorded in the quarter.

Non-GAAP operating expenses for the second quarter were $41.1 million or 26% of revenue compared to $42.7 million or 26.6% of revenues in Q1. The decrease of $1.6 million is mainly due to lower travel expenses and lower performance-based compensation.

Company noncash expenses for the second quarter included $6.5 million for the amortization of intangible assets, $5.6 million for stock-based compensation and depreciation of $4.7 million. Amortization of intangibles was $0.8 million lower than in Q1 due to certain intangible assets reaching full amortization.

GAAP net income for the second quarter was $20.5 million or $0.26 per fully diluted share compared to GAAP net income of $15.9 million or $0.20 per fully diluted share in Q1. The non-GAAP effective tax rate for the second quarter of 2020 was 17.4%, similar to the 17.6% in Q1 and within the range of 15% to 20% estimated rate for the year, as we communicated in our previous earnings calls. As a reminder, our cash tax rate is expected to remain at 6% to 8% of non-GAAP pretax income until we fully utilize our remaining U.S.-based NOLs and R&D credits. Second quarter non-GAAP net income was $26 million or $0.33 per fully diluted share, same as in Q1.

Moving on to the balance sheet and cash flows. As you would expect, we are especially focused on cash flow management at this time. Cash flows from operations were $43 million in the second quarter as compared to $39 million in Q1. As Mike mentioned, during the quarter, we had completed the acquisition of a building in our Livermore campus for a total of $24 million, of which $19 million were paid in Q2 and $5 million were paid in the previous quarter. We partially financed this building purchase with an $18 million 15-year real estate loan. This acquisition reduced Q2 free cash flow generation to $19 million compared to $28 million in Q1 and brings our free cash flow over the trailing 12 months to $103 million or $127 million excluding the acquisition of the building.

Our total cash and investments were $264 million at the end of the quarter. Almost 90% of these are in the U.S. We maintained substantial liquidity, and our capital structure is healthy and solid as we use our cash balance, combined with taking advantage of the current low interest rates to optimize our cost of capital.

Here are some more details on our current debt. As of the end of Q2, we had 3 term loans on our balance sheet totaling $50 million. The first loan related to the acquisition of Cascade Microtech in 2016 had a balance of $12.5 million in the end of Q2 and was fully repaid earlier in Q3. The second loan is a 3-year EUR 21 million-denominated loan we took to fund the FRT acquisition in Q4 2019. The remaining balance of this loan as of the end of the second quarter was $17.5 million -- EUR 17.5 million. The third loan is the new $18 million real estate loan I mentioned earlier. This loan bears an effective fixed interest rate of 2.75%, taking into consideration an interest rate swap we put in place.

At quarter end, our total cash balance exceeded the debt balance by $214 million, an increase of $16 million. We continue to invest in capital expenditures and M&A as important parts of our strategy.

We invested $24.7 million in capital expenditures during the second quarter compared to $12 million in Q1. The increase in CapEx in the first half of 2020 as compared to our 2019 run rate is chiefly the result of the $24 million used to acquire the new Livermore building and additional capacity expansion initiatives as part of our multiyear plan to support our anticipated medium- to long-term demand. The acquisition of the building and needed investment as well as ongoing CapEx is expected to bring our capital expenditure in 2020 to $50 million to $60 million. We will elaborate on our 2020-and-beyond CapEx plan and an updated long-term financial model as part of our webcast strategy update for the investment community, which we plan to hold on August 18. We will provide more details closer to the event.

Turning to the third quarter non-GAAP outlook. As we and our suppliers gain additional experience operating in the safety-focused and socially distanced manufacturing environment, we are again able to provide outlook ranges for the current quarter. As Mike mentioned, we expect DRAM revenue to strengthen in the third quarter, layered on top of continued solid demand for our other products. These factors result in Q3 revenue outlook in the range of $170 million to $182 million. I'll repeat that, $170 million to $182 million. The anticipated increase in DRAM revenue is expected to result in a less favorable product mix. Accordingly, non-GAAP gross margins outlook for Q3 is in the range of 44% to 47%, and non-GAAP earnings per fully diluted share for Q3 is expected to be between $0.30 and $0.38.

The acquisition of the probe card assets of Advantest is not expected to have a significant impact on our Q3 results. A reconciliation of our GAAP to non-GAAP Q3 outlook is available on the Investor Relations section of our website and in the press release issued today.

With that, let's open the call to questions. We ask that when you asked 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 Craig Ellis with B. Riley FBR.

[Craig Ellis, analyst]

Congratulations on the nice execution team. I'll start with a question for Mike. Mike, I think in your prepared remarks, you indicated that you expected DRAM revenues to improve in the third quarter. I was interested in understanding the magnitude of improvement that the company is seeing. Would we expect DRAM to get back to what I think some of us would have thought would be a normalized range around $30 million or maybe not quite that robustly as you start the back half of the year?

[Mike Slessor, executive]

Yes. Thanks for the question, Craig. So just to calibrate everyone, recall, going back to the fourth quarter of 2019, we had an 11-year high on DRAM revenues. We then expected some digestion here in the first part of 2020, which we've indeed seen. But as we move into the third quarter, seeing some real strengthening of the Q2 lows in DRAM, probably that in round numbers that $30 million annualized -- or $30 million normalized level is a decent expectation for the third quarter. Obviously, this continues to be a terms business and so there's some uncertainty associated with that. But as all of the major DRAM manufacturers sort of begin design releases for both mobile and server on one-Y and one-Z nodes, we're seeing quite a bit of increased activity as they begin to ramp those designs in the third quarter. So I think that normalized $30 million level a good estimate from where we sit in the quarter right now.

[Craig Ellis, analyst]

Great. And then if I could, one more on your prepared remarks. You mentioned advanced packaging a little bit more than I recall the last few calls in reference to things that you're doing with leading-edge foundry and logic customers. The question is, with that as 1 of the 3 areas of strategic TAM expansion focus, are you starting to see an acceleration in activity with your customers there? And how should we think about the rate of growth in that part of the business going forward relative to what you've seen in the past?

[Mike Slessor, executive]

Yes. I mean in general, advanced packaging is, for us, a long-term multiyear secular trend. That really increases the opportunity for FormFactor. It increases test intensity and increases test complexity, obviously, both trends good for us. I'd characterize the activity is still very early innings. We're seeing more in the foundry and logic space. Recall that a lot of advanced packaging activity that we've benefited from previously has been in the DRAM space with high-bandwidth memory, or HBM. We certainly have seen things like fan-out and some die stacking in the foundry and logic space. But as I said in the prepared remarks, the 7-nanometer node, 5-nanometer node in foundry and logic are going to prominently feature some of these advanced packaging techniques for a variety of integration schemes. I'd still characterize it as being mostly early R&D and pilot production in the foundry and logic space with the arguable exception of fan-out. But this is an exciting opportunity for FormFactor moving forward that are really going to drive the growth as customers combine both Moore's Law advances with the integration and performance advantages associated with advanced packaging.

[Craig Ellis, analyst]

That's helpful. And then if I could just ask Shai a question on gross margin. And congratulations to the team for a revenue guidance range that implies that record revenues are possible in the quarter. Shai, the question is on the 44% to 47% range. I think we typically just think about mix as being the primary determinant. But with manufacturing being impacted by changes that are related to COVID, how should we think about the puts and takes that determine the lower end of the range versus the higher end of the range?

[Shai Shahar, executive]

Sure. So the main element that impacts gross margin continue to be mixed. And as I said in the prepared remarks, since we expect DRAM to increase in Q3 and DRAM has a lower margin than foundry and logic, so as a percentage of the total revenue, DRAM is going to have a bigger share, which means it drags the gross margin down a little bit. And that's why the range is 44% to 47%, even though we see an increase in revenue.

[Operator]

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

[Brian Chin, analyst]

Nice job on the quarter. Maybe first question. As Flash has been sort of the ancillary market for the company and so my question, I guess, is what, if any -- what is any manufacturing capacity is transferring over? Why is Advantest willing to exit the market? And what gives you confidence that you can reenter this TAM at an acceptably high-margin level? Also, do you expect any incremental sales from the acquisition in 3Q? And is it immediately accretive?

[Mike Slessor, executive]

Yes. So, Brian, it's Mike. I'll take that one. I think focused on this acquisition, one of the very exciting pieces about it for us is the elements of technology. There's a couple of key enabling subcomponent technologies that Advantest had invested in over the years, both in terms of the MEMS technology, which, as you know, is a key enabler for making the individual probes; as well as the interconnect technology that then connects those probes up through the printed circuit board to the tester. So one of the more exciting parts for it is the general technology which we feel is applicable across many of our served markets and product lines in the future.

The current revenue, which was about $7 million in 2019, expected to grow a little bit in 2020, is primarily associated with Flash. They've got a decent cost structure on this emerging product, but it was going to take some significant investments to really scale that, things like the design automation that FormFactor really has, the worldwide support infrastructure that FormFactor factor already has. And so we work with Advantest to put together a business model for looking how we would help grow this business, and the acquisition seem to make sense.

To set expectations, it's going to take us an assessment period to figure out what exactly those investments are, what Flash market share we can gain, but there is an exciting opportunity there to grow off the single-digit millions that, that Teradyne did last year. So we'll keep you updated as we go through that assessment. But I think overall, when I look at the technology portfolio we've acquired, some pretty exciting additions to the form factor road map.

[Brian Chin, analyst]

Okay. Interesting. So some IP synergies even beyond Flash, but of memory, maybe that's like a $200 million, $250 million kind of TAM just for Flash in itself.

[Mike Slessor, executive]

That's right. And I think our primary focus here is to understand those technology synergies early. You're right. The overall Flash TAM is something like $250 million, where we hold relatively small share. This will probably help like gain share there. But again, some of the technology elements are very exciting for the broader FormFactor market space, not just in Flash.

[Brian Chin, analyst]

Okay. Great. Great. And maybe turning back to logic for a moment, in the past, delays in your MDU customers' technology road map has increased the volatility of your revenue and really, for that matter, the entire supply chain. You did provide some puts and takes in your prepared remarks. And it sounds like demand remains solid in the 3Q. But presently, I know this is kind of hard math maybe to put you on the spot with here, but when you tally up sort of the increased 10-nanometer activity, the increased incremental advanced packaging opportunity and maybe minus a pushout of 7-nanometer, in calendar '21, do you think this could be somewhat of a push from a revenue perspective? Any sorts of thoughts incrementally would be helpful.

[Mike Slessor, executive]

Yes. It's certainly an interesting question because, as you note, there are a lot of puts and takes. A couple of things that have really driven this business to strong levels in recent quarters and even recent years, we've had this overlap of the 14-nanometer and the 10-nanometer node with this customer continuing to aggressively release designs on both of these nodes. We've also had what feels like a pretty fundamental increase in wafer test intensity, trying to drive more test content to the wafer level closer to the fab that obviously drives up the overall wafer test and probe card spend. And that's a theme we've seen across the foundry and logic space, but this customer in particular.

7-nanometer in '21, I think for us, by and large, remained a development activity. So in '21, probably not too much of a tailwind. But I do think, as we look to longer term, these elements of node overlap, probably some reduction in the test intensity as yields go up and the node strategy stabilizes a little bit. I don't know whether there is a push, but I do think reasonably comparable levels are not a bad expectation, at least as far as we can see through the rest of '20 into '21. I'll give you the usual caveat that with a turns business where lead times are well within a quarter, our visibility remains very limited. But some of those trends we talked about as the puts and takes remain mostly intact, I think, as we go through the longer-term future.

[Operator]

And our next question comes from the line of Amanda Scarnati with Citi.

[Amanda Scarnati, analyst]

Mike, just going back to sort of the Intel conversation, and you touched upon this a little bit in your prepared remarks. But if Intel were to switch over to sort of an outsourced manufacturing position for 7-nanometer or beyond, how do you think that, that would impact your business? Or do you think it's sticky enough, what you do with Intel that it would have limited impact on it?

[Mike Slessor, executive]

Well, I think it's sort of an interesting data point on our fundamental customer strategy, right? Look back to FormFactor several years ago, we really didn't have a very strong foundry business. In fact, I think it's characterized -- fair to characterize it as pretty weak. We made it a strategic initiative to become a key supplier of the world-leading foundry so that if any of these shifts in manufacturing strategies from any of our customers, whether they be microprocessor, IDMs, fab-light customers, fully fabless customers, those events and shifts, we want those to be agnostic to us. So I think it's still early in sort of everybody figuring out what the impact of potential manufacturing strategies are for our largest customer. We really feel like we have our bases covered now that we're significant share and a key qualified supplier for the advanced nodes at the world-leading foundry.

[Amanda Scarnati, analyst]

And then just on the capacity constraints, can you expand a little bit more on the impact that, that had within the quarter and if it's leading to any sort of significant backlog going into the September quarter and when you expect that new capacity to be able to come online?

[Mike Slessor, executive]

Yes. And maybe we'll deal with the second part of the question first. So as we told people in the past, inside our existing footprint, we're by and large capacity constrained, right? We've produced a high of near $180 million in revenue in Q4 '19 as we worked through the first half of 2020 with different shutdowns and then social distancing, obviously, reduced revenue levels. The second quarter, we were fortunate to not have any significant shutdowns, but we got off to a pretty slow start, too, right? We were just re-ramping and bringing people in and learning how to manufacture in this environment, as were some of our suppliers. I think exiting the quarter, it's hard to use the word normal in this environment, but I'd say operationally, where we're by and large back to normal and, on a run rate basis, operating at essentially the outputs, the throughputs, the cycle times that we want to with a couple of exceptions here and there.

So if we look longer term, we're not pushing much of a backlog -- significant backlog into Q3. It's more the normal demand profile. But that's what's motivated us to go purchase an extra shell for building, start to outfit it, spend the CapEx to slowly build capacity so that we don't find ourselves constrained. We're obviously quite bullish about some of these trends like 5G and advanced packaging. And we want to have, at the very least, the optionality to have the capacity in place to go capitalize on those opportunities and grow our revenue.

[Amanda Scarnati, analyst]

Great. And then the last question for Shai, just on the operating expenses. How quickly does that sort of ramp back up? And this might be something that you're going to talk about at the Analyst Day in a couple of weeks, but if the revenue came down or the OpEx came down quite a bit this quarter on sort of one-off charges potentially, when does that kind of revert back? And should we see a step-up as we kind of go through the back half of the year?

[Shai Shahar, executive]

Yes. I think it's a good observation. And if you look at our outlook for Q3 and you do the math from the gross margin down to the EPS, you will notice that we expect higher OpEx in Q3, probably in the range of $46 million to $48 million versus the $41 million in Q2. And these increases can contribute to a few things. First of all, we have the acquisition that we announced today, they are adding to our OpEx. With the higher revenue and performance in Q3, we expect higher performance-based compensation. We also had our annual salary raise in the beginning of the quarter -- quite in the beginning of the quarter. Travel is expected to pick up in Q3 after almost completely shut down in Q2. Some of our R&D teams are, in addition to working remotely are going back to the office or to the labs, so we expect to see some ramp-up of R&D projects and materials. And we also have a significant investment in information technology, mainly hardening security but also related to our ERP consolidation project, which we have talked about before.

So some of these elements are onetime in nature, like the IT investment. Some are variable structurally, like the performance-based compensation. And some have a more permanent nature, like the salary raises. And as you noted, we'll get into more details of rest of the year, longer term, et cetera, in the analyst update we're going to do later in August.

[Operator]

Our next question is from David Duley with Steelhead Securities.

[David Duley, analyst]

Mike, this is probably for you. As far as test intensity goes, I think Teradyne made a big deal on their most recent conference call about increased test intensity across the board, not only with the APU chip, but with many other parts. I was just wondering what you're seeing as far as test intensity goes. And does the increased tester intensity translate directly to probe card intensity as well, plus or minus? Or how should we think about that?

[Mike Slessor, executive]

Yes. So I'll amplify what you just said. Obviously, given that we're the interface between the ATE equipment built by Teradyne and Advantest and the customer chips on the wafer, there is a pretty direct correlation between the test intensity they see and the volume of required probe cards. There's a variety of things driving this. 5G is a really good example. When you look at the complexity of testing some of these 5G chips, the frequencies involved, the brand-new yield fallout modes that are involved, the use of advanced nodes, which by themselves are probably not yielding where customers would like them to be, you end up having a variety of factors that are driving the need for more and more test.

The other nice thing obviously about testing at the wafer-level for our customers is to get the answer faster. They avoid putting more manufacturing time, more dollars into a chip that's not going to yield once it gets to the final package date or in the advanced package with some other chips. So I think there's some fundamental advantages to driving test intensity up at the wafer level.

We, along with people like Teradyne and Advantest, through our performance, are able to enable more of that, but some of it's just driven by the complexity of the silicon that's running through new applications like 5G and advanced packaging.

[David Duley, analyst]

And along those same lines, do you think when you think of the overall growth rate of the probe card market, would these trends help increase the overall growth rate? And do you have an idea about the incremental growth caused by the move to advanced packaging?

[Mike Slessor, executive]

Yes. There are many things driving the advanced probe card growth rate. And certainly, what we've seen historically and what various forecasts either by us or by various market prognosticators indicated is that the advanced probe card market is growing faster than the semiconductor market overall primarily for those reasons, right? Test complexity, advanced packaging, really driving more and more test, especially at the wafer level, which means more probe cards. This is going to be a fairly prominent topic at our August 18 call. We're going to take a step back and look at our served markets again with everyone. And you'll see that some of these drivers that are upping both complexity and intensity are producing above-market growth rates for the high end of advanced probe cards, where we lead.

[David Duley, analyst]

Okay. Final one for me, and I'll pass it on to someone else. Can you take a guess as to as far as sub-10-nanometer processes coming out of the foundries? What percentage of parts do you think are going into a true advanced package at this point?

[Mike Slessor, executive]

Well, some of that's a bit of a nomenclature question too because advanced packaging means different things to different people. We've tried to be a little bit more conservative in our definitions. So things like fan-out, things like HBM, not regular flip chip, we view the former is advanced packages, so something like fan-out.

My guess is we're somewhere around 50% of the overall wafer outs at the advanced nodes are, again, integrated with some of these -- some flavor of advanced package like that. Obviously, you look at our key customers, they're pushing more and more of the technology burden at 7 and then 5 and below that onto some of these advanced packages. So we would expect that attach rate to increase over time.

[Operator]

And our next question is from the line of Tom Diffely with D.A. Davidson.

[Thomas Diffely, analyst]

Okay. So I guess, carrying on the capital intensity question, when you see a second- or third-generation chip on the same node, say, 10-nanometers, are you actually seeing a decrease in test intensity at this point? Or is it still at fairly high levels?

[Mike Slessor, executive]

Certainly, our experience has been it's still at fairly high levels. You would expect a decrease over time as the fundamental yield of the node increases. The first designs out on the node typically are relatively low yielding, and so we're going to require more tests just to get a given number of good die-out but also to debug and reduce those failure modes. But we've seen test intensity hold up pretty well as we've gone through, for example, the 10-nanometer node because each new design has its own subtleties associated with its yield failure nodes. So over multiple years, a node like 14-nanometer, which is now, I don't know, 7, 8 years old, certainly, the test intensity was much higher at the start of the node than it is now. But in general, at some of these advanced nodes, we do see the intensity diminishing but not diminishing in a really significant way, kind of holding in.

[Thomas Diffely, analyst]

Okay. So Mike, when you look back at the delay of the 10-nanometer ramp initially a few years ago that caused a couple of quarters of pain for you. Was that just driven because it was a last-minute delay and there weren't other designs at 14-nanometers to take its place and there was just a waiting period? Or is there something more to it that caused the big dip in business for you?

[Mike Slessor, executive]

Yes. And Tom, I think you're talking about sort of the early part of 2018, if I recall. That was really problematic because of the last-minute nature of it, sort of designs that were planned for the 10-nanometer node. Once the 10-nanometer node was delayed, it had to be respun on the 14-nanometer node. And that caused between a 1- and 2-quarter delay in our business as that reshuffling of our customer road map took place.

I think if you look at the current 7-nanometer situation obviously, we were not on the verge of 7-nanometer production here, and so quite a bit different situation than 10-nanometer, which were -- where we experienced the change right on the verge of the planned production ramp of that node.

[Thomas Diffely, analyst]

Okay. That's helpful. And then finally, when you look at the ramp that you've seen on the foundry business with more fabless customers going to the little edge, I guess I'm surprised we haven't seen that foundry become a 10% customer yet. Maybe just a quick update on how that ramp is going for you.

[Mike Slessor, executive]

Yes. I guess I'd qualitatively characterize it as we've been within striking distance of a 10% level over the past couple of quarters. So this is a significant business for us that continues to grow. Obviously, at these kind of levels, like aggregate revenue levels for the company, the bar gets higher to become a 10% customer as we continue to diversify the business and win the business around. So I guess I'd say stay tuned. Given where this business is and the concentration of this business and how it's growing on multiple designs for multiple applications, I would expect to see it in the 10% list in the relatively near future.

[Operator]

And our next question comes from the line of Robert Mertens with Cowen.

[Robert Mertens, analyst]

This is Rob Mertens asking on behalf of Krish Sankar. Maybe first question for you, Mike, and then I have one follow-up. Just to expand on the earlier capacity question, when thinking about supply constraints earlier in the year and as capacity has come back online, do you see this as common throughout the whole industry? And then do you think there's an opportunity once you start building out capacity in the future, that form could take some share gains from any supply-constrained competitors?

[Mike Slessor, executive]

Yes. I think all of us -- I'll speak about sort of the market segments we operate in. But I think most suppliers in these segments had to deal with some sort of disruption and reduced capacity in the first half of 2020, came at different times around the world and in different ways. But I think I'd characterize our served markets as all being capacity constrained right now. Things like advanced probe cards and engineering systems are not easy to build, and so there's only a handful of suppliers, including FormFactor that can really produce into those spaces. We've made the decision to make some investments to both add capacity over the longer term. Clearly, a 90,000 square foot building is going to offer a significant manufacturing capacity increase, but we're also not going to do it all at once. We're going to be fairly gradual about how we outfit this building and the number of tools we add to it to make sure that we keep our supply and demand in reasonable balance. But over the long term, some of the secular growth trends we've talked about, we're pretty bullish that the advanced probe card market is going to continue to deliver market growth outside the semiconductor industry. And we want to have sort of the flexibility and optionality to be adding capacity inside a larger footprint and go win that demand.

[Robert Mertens, analyst]

Great. And then just one on the DRAM market. Thinking of the current strength over the next few quarters, is the main driver still just the technology transitions? Or have you seen any early signs of capacity growth within the market?

[Mike Slessor, executive]

Yes. I mean probe card demand, remember, is driven by new designs, right, so new chip designs, whether they be on existing nodes or new nodes. So a node transition, and I think there's a fairly decent understanding among the supply chain that there are some node transitions taking place in DRAM right now, that is going to drive probe card demand. I'd say for us, pure capacity tends to be less of a driver. Obviously, if a customer is going to produce more wafers of an existing design, they're probably going to need more probe cards. But where we see the big spikes in demand for DRAM probe cards is on node transitions and new design releases. And that's part of what we're seeing right now that's helping the relative strength in the third quarter.

[Operator]

[Operator Instructions] Our next question comes from the line of Charles Shi with Needham & Company.

[Yu Shi, analyst]

This is Charles Shi on behalf of Quinn Bolton. Not sure this question can be better addressed by Mike or Shai. But if I look at midpoint of your guidance for the third quarter '20, it's about roughly $20 million up sequentially. And if you want us to model like DRAM revenue at roughly $30 million level, that's about $10 million up, so I have to think that the foundry and logic part of the business is probably holding up very well and/or even like grow sequentially by about another $10 million. So I really wonder that whether the strength or even the growth is really coming from the foundry part of the business or directly coming from your largest logic customer.

And on top of that, I think we -- you guys talked about maybe some of the demand on your largest logic customer could be transitory, as we talked in Q4 last year. Are you still thinking about that or you have really changed your view on that? And whether that customer is really going to set the new normal, instead of $30 million, maybe now it's $60 million.

[Mike Slessor, executive]

Charles, it's Mike. I'll take that one. A lot of different elements to that question. Let me see if I can try and distill it. So sequentially, Q2 to Q3, you're right, in big round numbers, at the midpoint, we're up a little less than $20 million. We already discussed, I think it was Craig's question, the DRAM was probably going to be around the $30 million level, which would represent, again, in big round numbers, up about $10 million sequentially. So the Foundry and Logic business as well as some of the other businesses, the Systems business continues to do pretty well, all contributing to some level of sequential increase as we go Q2 to Q3. I think where we see particular strength in that mix really is in the Foundry business. If you think about the seasonality or design release cadence of those businesses, we're coming up on a time when a lot of the fabless customers are aggressively releasing and ramping designs primarily to meet late-year handset release cycles. So lots of activity there. So lots of different puts and takes to get us from Q2 to Q3, but DRAM and then a little stronger in the Foundry business are probably 2 of the big elements.

Returning to the microprocessor business, we touched on this a little bit earlier in the Q&A session, I think. Some of the elements that caused us to be a little bit conservative when we talked about Q4 and the strength of that customer, I think, are probably a little more robust, things like test intensity, this multiple node overlap probably continues for a long time. Even as 7-nanometer gets thrown into the overall factory mix, we would still expect 10-nanometer to be around. So I think there are some elements of it that get us above the sort of previous expectation of $100 million annual run rate. I don't think the run rate we've delivered in the first part of 2020 are sustainable at that level but probably think about it as somewhere in the middle of the $100 million annual run rate and then the run rate we've been operating at in the past couple of quarters.

[Operator]

Thank you. And I'm not showing any further questions, so I'll now turn the call back over to Mr. Slessor for closing remarks.

[Mike Slessor, executive]

Great. Thanks, everyone, for joining us today. We're looking forward to touching days in a little under a month where we're going to provide you with a new model update and, as I said, take a step back and look at some of our markets and the growth opportunities that are driving FormFactor's business towards that next target model. Thanks again for joining us, and stay safe. Bye-bye.

[Operator]

Ladies and gentlemen, this does conclude the program. Thank you for participating. You may now disconnect.