FormFactor Inc

NASDAQ:FORM

Earnings Call Transcript 2021-Q2

[Operator]

Thank you, and welcome, everyone to FormFactor's Second Quarter 2021 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, Vice President and General Counsel]

Thank you. Today, the company will be discussing GAAP P&L results and some important non-GAAP results intended to supplement your understanding of the company's financials. Reconciliations of GAAP to non-GAAP measures and other 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 regarding projections of financial and business performance, future macroeconomic conditions, the benefits of acquisitions and investments in capacity and in new technologies, the impacts of COVID-19 pandemic, the impact 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 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 2020 and in 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 28, 2021, and we assume no obligation to update them.

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

[Mike Slessor, President and Chief Executive Officer]

Thanks Jason. And thank you everyone for joining us today. FormFactor delivered solid results in the second quarter, achieving the second highest revenue in company history. We delivered gross margins comparable to the first quarter, exceeding our outlook range through a combination of factors that were more positive than anticipated on our April 28 earnings call. These together with continued operating expense control and share repurchases, resulted in non-GAAP earnings per share at the high end of our outlook range. Solid demand for FormFactor’s diversified set of market-leading, semiconductor tested measurement products is continuing in the current quarter and we are executing on our planned investments to increase capacity for our products.

Several factors added to our second quarter gross margins. First, overall product mix was more favorable than originally anticipated with Systems segment revenues reaching all-time record levels at near 50% gross margins. In probe cards, DRAM was as expected a significant portion of revenue nearly matching the decade high level of fourth quarter 2019. DRAM probe cards are generally lower margin products and a substantial portion of our second quarter DRAM revenue was concentrated in one specific design with an unfavorable cost profile.

In response, our operations and engineering team focused on yield improvement for this design and delivered better-than-expected manufacturing costs, which improved gross margins significantly above the initial shipments for this design. Our second quarter results provide a reminder, the shifts in FormFactor’s tech mix can have a significant impact on gross margins both quarter-to-quarter and with lead times typically less than a quarter, even into quarter. Shai will provide more details on our gross margin results and outlook later.

We continue to advance our environmental, social, and governance or ESG initiatives during the quarter. Our successful efforts to aggressively reclaim and recycle our rhodium waste, reduced our environmental footprint while also producing a financial benefit as our higher recycling credits favorably impacted gross margins by partially offsetting higher input costs. On the governance front, we welcome Jorge Titinger to our Board of Directors, adding a director with significant industry and executive experience, who's also well-recognized for his passionate commitment to diversity and inclusion.

Jorge is the most recent of three new directors have joined our board over the last two years. FormFactor’s Board of Directors has become an ethnic and gender diverse team of accomplished individuals with world-class expertise in areas from cybersecurity to organizational development, in addition to the requisite experience in semiconductors.

Our ESG initiatives, including our progress against quantitative goals are discussed in the corporate citizenship section of our website. Turning now to segment and market level details. In foundry and logic probe cards, the expected sequential decline in revenues materialize, even so, the top two foundries and the largest IDM remain 10% customers and client PC, data center and mobile designs each contributed significantly to the top line.

In the third quarter, we expect to see the typical seasonal reduction in mobile application processor demand, partially offset by an increase in microprocessor demand and continued strong growth by the RF applications. Foundry and logic customers, including all three of our second quarter 10% customers are making significant wafer fab equipment investments in 2021. As capacity comes online later this year and into early next year, we expect to see increased demand for leading-edge foundry and logic probe cards.

Along with these capacity additions, our customers are adding innovative advanced packaging architectures like EMIB, Foveros and 3D fabric to the road maps to help offset the slowing of front-end driven Moore's law. As we've discussed in the past, these chiplet or tile-based integration schemes drive both higher test intensity, which expands the number of probe cards required per wafer out and test complexity, which widens FormFactor’s competitive advantage. With lead times of less than a quarter, short-term visibility remains challenge as always, with the combination of significant customer capacity investments paired with the adoption of advanced packaging provide longer-term secular demand drivers for FormFactor’s probe card products.

To ensure we're prepared to meet this increased probe card demand. As I mentioned earlier, we're continuing to execute our plan capacity increases with our new 100,000 square foot manufacturing center in Livermore on track to produce initial customer shipment in this year's fourth quarter. Consistent with the flexible manufacturing strategies, it has allowed us to quickly and efficiently capitalize on customer demand across our served markets. This facility will be capable of producing probe cards for foundry and logic, DRAM and flash.

The actual initial capacity addition will be modest because we plan to progressively add tools and labor to match customer demand. We're excited about the capability and flexibility this new footprint will provide, removing a growth constraint that we have operated under for the past 18 months and helping us to achieve $850 million revenue of our target financial model. Third quarter demand for DRAM probe cards continues to be strong. Although, we do expect a slight sequential reduction from higher second quarter levels.

New design activity continues at high levels across all DRAM customers with remarkable breadth across multiple nodes for DDR4 and DDR5 designs in both mobile and PC server application. As a reminder, probe cards are a consumable that is specific to each new chip design. And so demand is generated from not just node migrations, but also the release of ship designs on existing nodes as architectures.

As also noted earlier, our engineering systems business delivered record revenues with contributions from the acquired FRT and HPD businesses augment the steady legacy station business. FRT tools provide unique metrology capabilities that enable advanced packaging applications. And we're currently capitalizing on strong demand for FRT’s high performance, multi-sensor 300-millimeter optical metrology tool, especially among leading foundry customers.

Advanced packaging is a key driver for all of our businesses, as our customers begin to adopt chiplet style integration strategies to generate new test and measurement requirements. Our capability to quickly, accurately and non-destructively measure and control critical dimensions, film thicknesses, and surface topologies on chiplet to chiplet interfaces is key to improving and maintaining assembly yields. HPD’s business targeted longer-term growth by enabling quantum computing applications also had good momentum in the quarter. Together with Northrop Grumman, a key customer partner in the quantum computing field, we announced a fully automated cryogenic wafer probe system, which will accelerate the development of superconducting compute applications.

Let me close by noting that with a continued solid demand outlook and good execution on both short and long-term gross margin and capacity expansion on the path towards the target financial model, we unveiled last year that delivers $2 of non-GAAP earnings per share on $850 million of revenue. Test and measurement is becoming a more important and strategic place in the semiconductor industry, driven by powerful trends, including 5G, advanced packaging and memory content growth.

Our leadership position in these attractive markets paired with our differentiated strategy and disciplined execution to drive continued growth in share gains, as we progressed towards our target model.

Shai, over to you.

[Shai Shahar, Chief Financial Officer]

Thank you, Mike; and good afternoon. As you saw in our press release, second quarter revenues and non-GAAP EPS were at the high end of our outlook range, solid revenue reaching the second highest ever in company history and non-GAAP gross margin exceeded the high end of our outlook range. FormFactor’s second quarter revenues were $188 million, a 1% sequential increase from Q1, and an increase of 19% year-over-year.

Probe Card segment revenues were $154 million in the second quarter, a decrease of $5.2 million or 3.3% from Q1. The decrease was driven by lower Foundry and Logic and Flash revenues, partially offset by an increase in DRAM revenues. Systems segment revenues were $35 million in Q2, an increase of $6.7 million or 24% from the first quarter, mainly as a result of higher sales of optical metrology and thermal systems driven by advanced packaging and automotive application.

Within the Probe Card segment, foundry and logic revenues decreased by $10 million from Q1 to $104 million in the second quarter, comprising 55% of total company revenues as compared to 61% in the first quarter. DRAM revenues were $42 million in Q2, a significant increase of $8 million or 24% from the first quarter, and 22% of both our quarterly revenues as compared to 18% of revenue in the first quarter. Building on the strength demonstrated over the past year, this was our second highest quarterly revenue from DRAM since Q1 2008.

Flash revenues of $8 million in Q2 or $3.7 million lower than in the first quarter and were 4% of total revenues in Q2, down from 6% in Q1. As we said in the past, we expect Flash revenues to be lumpy from quarter-to-quarter. GAAP gross margin for the second quarter was 40.6% of revenues, as compared to 41.1% in Q1. Cost of revenues included $7.2 million of GAAP to non-GAAP reconciliations, which we outlined in our press release issued today and the reconciliation table available in the investor relations section of our website.

On a non-GAAP basis, gross margin for the second quarter was 44.4%, slightly above the high end of our outlook range and 60 basis points lower than the 45% non-GAAP gross margin in Q1, the decrease on the first quarter was mainly due to less favorable mix with lower foundry on logic and higher DRAM revenues. Mike briefly discussed some of the reasons gross margin in Q2 was above the high end of our outlook range. They included more favorable product mix, better yields on a new ramping design and improved utilization and absorption. In addition, precious metals usage was more efficient, as we took measures to reduce the impact of higher material prices and are able to reclaim and recycle more road units.

Our Probe Card segment gross margin was 43.3% in the second quarter, a decrease of 90 basis points compared to 44.2% in Q1. The decrease is mainly due to the change in mix between foundry and logic and DRAM revenues I just mentioned. Our Q2 systems segment gross margin was 49.2%, essentially flat with Q1. As we said previously, we expect our systems segment gross margin to range between high-40s to low-50s.

As a reminder, as we continued to make progress toward achieving our target financial model gross margin of 47%, we expect that margins will fluctuate from quarter-to-quarter, mainly as a result of changes in product mix. Our GAAP operating expenses were $56 million for the second quarter, $2 million higher than in the first quarter. Non-GAAP operating expenses for the second quarter were $48 million or 25.7% of revenues compared to $46 million or 24.9% of revenues in Q1. The increase of $2 million quarter-over-quarter was mainly due to increase in labor cost related to higher headcount and annual salary raises, partially offset by lower performance based compensation.

Company non-cash expenses for the second quarter included $6.6 million for stock-based compensation, $7.1 billion for the amortization of acquisition related amounts and depreciation of $6.6 million. Second quarter stock-based compensation was $0.5 million lower than Q1, due to timing of grants. And depreciation was $0.4 million higher, due to additional assets placed in service. Non-GAAP operating income for the second quarter was $35.2 million, $2.4 million lower than the first quarter.

GAAP net income for the second quarter was $17.9 million or $0.23 per fully diluted share, compared to $19.6 million or $0.25 per fully diluted share in Q1. The non-GAAP effective tax rate for the second quarter was 18.7%, approximately the same as in Q1, and within our anticipated non-GAAP effective tax rate for fiscal 2021 of 15% to 20%. As a reminder, our annual cash tax rate is expected to remain at 6% to 8% of non-GAAP pre-tax income until we fully utilize our remaining US-based R&D credits. Second quarter non-GAAP net income was $28.4 million or $0.36 per fully diluted share, compared to $30.8 million or $0.38 per fully diluted share in Q1.

Moving to the balance sheet and cash flows. We generated $16 million of free cash flow in the second quarter, compared to $19 million in Q1. And we had total cash and investments of $260 million at the end of the quarter. The second quarter sequential decrease in free cash flow reflects an increase in capital expenditures and changes in working capital, on which the largest portion is higher inventories related to timing of manufacturing and product shipments. As of the end of the second quarter, we had two term loans remaining on our balance sheet, totaling $29.5 million. We invested $18 million in capital expenditures during the second quarter, compared to $13.5 million in Q1, this brings our year-to-date CapEx to $31.5 million and chiefly relates to the capacity expansion in our Livermore manufacturing center.

We continue to expect a significant investment in capacity in 2021, and with half of the year behind us, we are lowering the range for forecasted cash topics for the year to be $70 million to $90 million from the $80 million to $100 million previously communicated. As a reminder, we expect CapEx to return 3.5% to 4% of revenues in our target financial medal, after we conclude these capacity expenses. At quarter end, our total cash and investments balance exceeded the debt balance by $230 million, a decrease of $10 million from Q1 quarter end. We had strong cash flow from operations in Q2 offset by cash usage for capital expenditures and $18.2 million is used for share repurchases.

During the second quarter, we purchased 484,000 shares, this brings our year-to-date share repurchases total grew by 0.8% of our outstanding shares, offsetting approximately one year worth of dilution from stock-based compensation. At quarter end $26 million remained available for future repurchases, and there are $50 million share repurchase plan.

Turing to third quarter non-GAAP outlook. As Mike mentioned, we expect a generally strong demand to continue, with sequentially higher systems demand also by moderate decreases in probe cards, resulting in overall similar revenues to Q2 at the midpoint of our outlook range. This factor result in a Q3 revenue outlook in the range of $182 million to $194 million, non-GAAP gross margins for the third quarter is expected to be in the range of 43% to 46%. For the midpoint of these outfit ranges, we expect Q3 operating expenses to be higher than Q2 by $1 million to $2 million, mainly due to the increased investment in R&D and higher travel expenses as things start to get back to normal.

Accordingly non-GAAP earnings per fully diluted share for Q3 is expected to be between $0.31 and $0.39. A reconciliation of our GAAP to non-GAAP Q3 outlook is available on the investor relations section of our website and in our press release issued today.

With that, let's open the call for questions. Operator?

[Operator]

Thank you, sir. [Operator Instructions] Your first question is from the line of Craig Ellis from B. Riley Securities. Your line is now open.

[Craig Ellis, B. Riley Securities]

Thanks for taking the question, and congratulations on the good gross margin execution in the quarter. Mike and Shai, I just wanted to start there and understand what's embedded in the outlook for the third quarter, because I think three months ago, we expected that in 2Q we could see around 150 basis points of mix related headwinds, maybe a 100 basis points of rhodium-related headwinds. Clearly, the team executed very well on the utilization side and got back some of the rhodium as well. But as we look to the third quarter, which looks flattish, what's inside that flattish guide with gives and takes on the mix and the rhodium issues? And for that efficiency gain that was achieved in manufacturing, is that something that rolls forward or is that more of a one-time benefit?

[Shai Shahar, Chief Financial Officer]

Yes. Great. So when we look at Q3, the midpoint of our outlook range, gross margin is expected to be similar to Q2. And we see a higher systems revenue in Q3, which as you know are revenue – gross margin for systems revenue is higher, so this – but we also see some offsets in the probes card business, which impact the gross margin. But we still have the design that we're talking about, we still have it in Q3, the one with unfavorable costs. And although we are getting better at it with improved yields and more certainty, it still has some impact on Q3 as well. So if you take all of these together, these are the main factors. We saw rhodium prices ease up starting in May, although they still fluctuates. So taking all these together, basically we're talking about flat gross margin quarter-over-quarter with flat revenue at the midpoint of the ranges.

[Craig Ellis, B. Riley Securities]

Okay. And then with the point on revenue of those trial, I'll use that as a segue into a revenue related question. So nice to see 3% to 10% customers in the quarter with healthy activity from TSMC and Samsung, the question is more on Intel, it's been awhile since Intel was down closer to the mid-teens percentage of mix, of course, if these revenue levels that's still a very material amount of sales. But the question is, as you look at that opportunity and with the backdrop of their recent packaging and process, webcast showing annual product cycles over the next four or five years, how do we think about the path back to kind of a normalized mid-20s to mid-30s percent of sales for that customer? How quickly could that happen and what are the risks that we would actually stay here closer to the mid-teens for some protracted period?

[Mike Slessor, President and Chief Executive Officer]

Yes, Craig; it’s Mike, I’ll take that. So prior to the second quarter here, we had several orders where that customer was around and above $50 million or a $200 million annual run rate, which we said, we expected was kind of an elevated run rate due to a variety of factors. So in Q2, the pendulum probably swung a little bit hard in the other direction. We do embedded in our Q3 outlook, used some sequential strengthening with that customer my comments about microprocessor strengthening in the quarter. But as you point out longer-term, there is some really exciting things going on with that customer.

You have a long-term relationship, decades long, where we've been a key supplier to them with strong market share, and both their strategic initiatives in entering the foundry business, as well as their adoption of advanced packaging technologies that they highlighted earlier this week are really exciting opportunities for us, that I do think allow us a path back to kind of this $200 million run rate. Now it's going to take a while to get there, right, they're not entering the foundry business in a material way tomorrow, but we've got such a solid foundation with this customer and a nice competitive position with the technologies that we have with their strategic initiatives do offer us a longer-term path back to that $200 million annual run rate level. Even as we work our way a little bit closer to there in the back half of the year.

[Craig Ellis, B. Riley Securities]

That's really helpful. And maybe just to follow-up on that, Mike, it's been a couple of quarters since we had three customers that were 10% customers. Do you expect that as we look ahead to the third quarter that you would have an equal number of 10% customers, or do you think that it looks ultimately more like Q1 where there was a couple

[Mike Slessor, President and Chief Executive Officer]

Craig as you know, our strategy really is to be partnered with the leaders in the industry and try and drive significant market share with those leaders. So we over the long-term tend to have 5%, 10% customers. And by and large, we expect each of those customers to kind of move off and on the 10% list in any given quarter, some of them are quite close to the 10% threshold. In the third quarter, as I noted, we do expect some seasonal weakness that we've seen in the past few years associated with the mobile application processor business, just the ramp of those designs and the concentration of those designs at the world leading foundry, we'd expect that to softening Q3. But at the same time, we're making good progress in expanding that business to a more fabulous customers, more designed, moving into high performance compute, but mobile is such a big part of that, you could see that customer not be a 10% customer in Q3.

[Craig Ellis, B. Riley Securities]

Yes. That's very helpful guys. Really appreciate the help. Thank you.

[Mike Slessor, President and Chief Executive Officer]

Okay. Thanks, Craig.

[Operator]

We have our next question from the line of Brian Chin from Stifel. And kindly limit yourself with one question and one follow-up. Your line is open.

[Brian Chin, Stifel]

Okay, we'll do. Hi, thanks for letting us ask a couple of questions. Maybe first, just to follow-up on that last one. Mike, I think you're talking about sort of the traditionally softer 3Q from foundry. I guess, applying that similar logic will 4Q typically be seasonally stronger for you? And I guess, do you think that, is that part of the rationale in terms of having some of the new capacity online?

[Mike Slessor, President and Chief Executive Officer]

So we have seen for the past couple of years, the fourth quarter to be very strong from a seasonal perspective in the foundry and logic business. If you go back and look both 2019 and 2020 our fourth quarters very strong foundry and logic business driven by the foundries and mobile applications. I have to temper that with the usual caveats that we're sitting here at the end of July, and that's a long way out compared to our lead times. So the historical pattern, certainly we would expect to see that strength, but we don't have anything like a forecast or a backlog yet emerging that would support that.

As you note though, each of those customers is building significant capacity through their WFE skins. And so whether it's a 4Q event or a first quarter – second quarter 2022 event, this is part of the reason why we're continuing to invest pretty heavily in our Livermore manufacturing center and in other areas around the world to increase our capacity.

[Brian Chin, Stifel]

Okay. Thanks. And maybe for my follow-up, maybe to Shai. Just kind of going back to the gross margins, can you just roughly quantify what the drag in 3Q is from first the DRAM mix issue piece of business? Is it something like 100 basis points still, because I would imagine that it's – could probably be non-repeating when you get into 4Q, so maybe it's still there in 3Q, maybe not repeating in 4Q? And then also rhodium prices, who knows where it goes from here, but if it kind of stays at these more lower levels, do you think you could get additional benefit in 4Q relative to what you're seeing in 3Q?

[Shai Shahar, Chief Financial Officer]

Yes. On rhodium prices, I think it's very hard, of course, to model or predict the prices of precious metals. We took benefit in Q2 in purchasing inventory that will be used in Q3 and it’s too early to say, what's going to be the impact on Q4. We have the materials that we need and we’re keeping an eye on it, hopefully it will stay at these lower levels than the peaks are still elevated, if you compare it to previous – last year, but still not that big that we say during the first quarter.

In terms of mix, so I don't go into all these details and drag you to the – here. But, we see systems growing up and we had a better margin, foundry and logic expect to go down a little bit in Q3, DRAM, as Mike mentioned, expect to go down a little bit, but we see improved margins there, because of the things we learned and experience during this quarter’s manufacturing. And flash is expected to go up a little bit as well. So all these moving parts, each one of them has kind of small impact, but overall that's where we end up we as do the same gross margin as in Q2 on similar revenue. On Q4, I think it's too early as I said rhodium prices too soon and all the other factors are still a lot depend on mix, which is still too early for us.

[Brian Chin, Stifel]

Okay. Got it. Thanks.

[Operator]

Next is Krish Sankar from Cowen and Company. Your line is open.

[Stephen Chin, Cowen and Company]

Hi, this is Stephen Chin calling on behalf of Krish. Thanks for taking my questions. First of all, if I may on your revised CapEx range for the full year, I think you mentioned it's currently lowered to $70 million to $90 million for the full year. Is that a reflection of capital efficiency and how you're able to utilize the spending for the capacity maybe this year, or is there any push out in spending, first of all?

[Shai Shahar, Chief Financial Officer]

So we've made significant progress in completing the manufacturing center year-to-date. We expect to start few thing, as Mike mentioned, shipping product in Q4. So we have six months of actually behind us, since these were coming in a little bit below budget, that's why we decided to update the estimate, but there is no significant change to our plans or to our targeted financial model gross margin of 47%. So some of the update is just simply with timing as things push a little bit to early 2022 or to the timing of cash payments for these fixed assets, no significant changes to our plans or to the gross margin target.

[Stephen Chin, Cowen and Company]

Okay. I understand. And one product-related question, just to given how DRAM probe card demand has been fairly strong and it seems like it's going to be gradually heading a little bit into the back half, that's still fairly healthy. A question on the DDR4 versus DDR5 technology, and as mentioned earlier that every design has quite a different probe cards. So as far as DDR4 and DDR5 has – or any of its products kind of getting customer are those potentially shared probe card designs or it would – different technology require different cards there.

[Mike Slessor, President and Chief Executive Officer]

Yes, well, DDR4 or DDR5 mobile server, any change in the chip design drives a change in the probe card. And so something is major is being going from DDR4 to DDR5, almost always changes the layout of the chip and how the customer is going to test it, which means new probe card. That's why, we try and emphasize, so people understand some of the demand drivers of our business that this diversity of designs, not just in DRAM, but in foundry and logic as well being accelerated by advanced packaging, really is an interesting growth driver for us. So when I talk about design activity, we've got a lot of first articles or across 1 alpha, 1 beta, 1Z nodes in DRAM, DDR4, DDR5s in both mobile and server and in each of those is unique and drives a refresh of the probe card fleet.

[Stephen Chin, Cowen and Company]

Great. Thank you so much.

[Mike Slessor, President and Chief Executive Officer]

Yes.

[Operator]

Your next question is from the line of Tom Diffely from D.A. Davidson. Your line is now open.

[Tom Diffely, D.A. Davidson]

Yes. Good afternoon. First question on the systems business that was strong in the quarter and growing in the next quarter. Is that strictly just the addition of some of the acquisitions, or is there something in the core business that is growing faster than seasonal this year?

[Mike Slessor, President and Chief Executive Officer]

Yes, I think when you look at the systems results, you can think about it as a couple of different components as you broke them down. One is the legacy systems business we acquired as part of the Cascade Microtech acquisition in 2016. That business has been pretty steady, if you look at our target financial model and the underlying assumptions, low single-digit percent grower and has been executing to that. So the step up here to the mid to high-30s in revenue really associated with the acquisitions we've made.

First FRT to get us into metrology for advanced packaging back in 2019, that business beginning to accelerate nicely as – especially as the foundry ecosystem adopts our tools to do process control for their advanced packaging lines and the HPD business showing some nice momentum in the early part of characterization, nowhere near production for quantum computing. And so probably the way to think about the systems growth is that the acquisitions are delivering growth on top of the stable legacy systems business.

[Tom Diffely, D.A. Davidson]

Okay, thanks. That's helpful. And then as a follow-up, I'd like to go back to Craig's question. You talked about how deals were better on the DRAM business, and that helped you get back to higher margin level. Are those improvements – yield improvements items that can progress on in the future are those one-time items with a more around that would be great?

[Mike Slessor, President and Chief Executive Officer]

Yes. So remember our DRAM revenue is pretty concentrated in a single design. It's not often we have a high runner that is this large portion of the design. And as we told you on the last earnings call had a pretty unfavorable cost structure on the initial shipments of those designs. So I want to give kudos to our operations and engineering team, they really went to work on improving this yield. Given that these are design specific parts, you know, this probe card and its layout and the yield idiosyncrasies are really associated with this one design, it is kind of isolated to the one design.

However, we have learned some things about designs of this level of complexity in some of the things here that could translate into other designs. So probably think about it as being pretty designed specific. That one design in DRAM is still a large portion of our Q3 DRAM revenue, so helpful there, but I wouldn't sort of say it's a general uplift across all our DRAM designs.

[Tom Diffely, D.A. Davidson]

Okay. Maybe it’s a nice learning in case you have another volume orders.

[Mike Slessor, President and Chief Executive Officer]

Yes. That's right.

[Tom Diffely, D.A. Davidson]

Great. Thank you.

[Mike Slessor, President and Chief Executive Officer]

Thanks, Tom.

[Operator]

Next is Charles Shi from Needham & Company. Your line is now open.

[Charles Shi, Needham & Company]

Thank you for taking my question. Mike and Shai, congrats on the strong recovery of your gross margin. I want to ask a couple of questions around the foundry logic probe card. I think you talked about design, you talked about packaging, but no conversion, no upgrade is still a powerful demand driver. So I want to ask something around a three nanometer really outside of Intel. I wonder what's – I mean, without getting into anything too customer specific, what does your outlet for 3 nanometer probe card, I mean, were in July, 2021, it's probably a year away from production.

But are you seeing any leading indicator like Intel design activities of the 3 nanometer, and is it going to ramp by the end of this year, or do you see more of the ramp at a 3 nanometers on the mobile side or on HPD side? So that's a multifaceted question, but I hope you can give us some color about that.

[Mike Slessor, President and Chief Executive Officer]

Sure. Well, I think Charles, you're absolutely right, one of the demand drivers is node transitions for us because a node transition automatically resulted in new designs, right. If you're going to convert the node, they become new chip designs that both fabless customers and IDMs take advantage of that new node capability to drive new products and new designs. And that means new probe cards.

On 3-nanometer in particular, as you also indicate it's pretty early, some activity but I think probably the exciting part of it is, it's very likely to be one of the nodes where advanced packaging is a really key part of how the node gets deployed. Probably high performance compute tiles will be built on the 3-nanometer node, but then stacked together with other parts of the eventual product that maybe are built on 7-nanometer or even 10-nanometer. So as with leading customers, we're engaged in R&D but it's pretty early and I certainly wouldn't expect to see 3-nanometer be a significant part of our near-term results.

[Charles Shi, Needham & Company]

Got it, got it. So I mean, it’s still around 3-nanometer, I understand you said it's still pretty early, but your leading foundry customer did say that they are seeing the 3-nanometer tape-out being a lot higher than the number of tape-out at 5-nanometer when it was about two years ago. I wonder, what does that mean to your business? Do you sort of expect that you can gain more of the revenue from the 3-nanometer maybe next year? I mean, compared to what you got from 5-nanometer in 2020 or maybe 2019. I'm not sure whether that's a fair comparison or not, but any good color will be great.

[Mike Slessor, President and Chief Executive Officer]

Yes. Well, and I think generally, if you look at some of these node progressions, test intensity is definitely going up. So there's lots of different dynamics at work, but these new nodes, especially when they intersect with the advanced packaging technologies are requiring higher test intensity, which means more testers and more probe cards per wafer. And I think you're seeing that from some of the ATE manufacturers as well. Each of those ATE systems requires multiple probe cards over its life. So excuse me, a pretty good indicator there.

So I do think that the progression for five to three and at other customers from 10 to seven or whatever, we're calling it now are tailwinds for FormFactor’s business because test intensity and test complexity are going up.

[Charles Shi, Needham & Company]

Got it. Thanks Mike. I think I'm limited to two questions. I thank you very much. I'll jump back to the queue.

[Mike Slessor, President and Chief Executive Officer]

Thanks Charles.

[Operator]

We have our next question from the line of Christian Schwab from Craig-Hallum Capital. Your line is now open.

[Christian Schwab, Craig-Hallum Capital]

Hey, good quarter, guys. What should we be thinking about the range of quarterly revenue rates for the DRAM business now?

[Mike Slessor, President and Chief Executive Officer]

Yes, I think obviously, we've put together a few quarters here in the mid-30s to high-30s and up around, sorry, I'm getting a lot of feedback or noise. Can you mute, Chris?

[Christian Schwab, Craig-Hallum Capital]

Yes.

[Mike Slessor, President and Chief Executive Officer]

And obviously, this past quarter, the second quarter came awfully close to a 10-year high that we posted in 2019. So I think there's an implicit question, is DRAM probe card – should our DRAM probe card revenues be going up? What we talked about previously is sort of an average, although it's a cyclical business, an average of kind of the mid $30 millions of revenue per quarter. If we continue to see this level of design activity, things again, the advanced packaging theme of working DRAM with things like HBM3, I think it's possible that we could see that average move up to maybe the high 30s, the mid to high 30s.

But historically if you look at DRAM customers, they've done a pretty good job of constraining their overall spend, whether it be on probe cards or equipment, and then driving efficiency to drive their bit growth. So I wouldn't expect a spectacular increase in the spend, but you may see the mean tick up a little bit into the high 30s.

[Christian Schwab, Craig-Hallum Capital]

Great. And then the recovery within Intel, get this back, over time back into the 200 billion range plus and DRAMs kind of in the mid 30s, is there an opportunity for TSM to become a much more material customer on a go-forward basis that they have been kind of over the last six quarters?

[Mike Slessor, President and Chief Executive Officer]

Yes, I think we've talked about it as being something like $100 million annual run rate opportunity. I think the past couple of quarters you've seen them be a little bit short of that, but in that neighborhood. And I think go back to Charles’ question, as they drive their node progressions as more wafers starts occur on the advanced nodes. And in particular, they’re really advanced nodes, like five and three, our addressable market there grows.

Reminding you that we're really only relevant for 10-nanometer and below. And although, that's a big chunk of that foundry's revenue, it's still a pretty moderate chunk of their overall wafer starts, unit wafer starts. And that's one of the things that drive probe card spend. So I think as their business grows as their node migrations, with more wafer starts to these advanced nodes and we continue to work with them on some of the innovation in enabling advanced packaging. I think there is the opportunity for that to grow significantly.

[Christian Schwab, Craig-Hallum Capital]

Great. Thank you.

[Operator]

Next is Amanda Scarnati from Citi. Your line is now open.

[Amanda Scarnati, Citi]

Hi, good afternoon. Question on implications from the DDR5 push out, right. Does that impact how you're looking at overall growth in that DRAM business, right. You mentioned that it could potentially grow to the mid to high 30s at an average basis. But does that have any sort of near-term implications?

[Mike Slessor, President and Chief Executive Officer]

It doesn't seem to have had much of an implication. And I think again, because of the broad diverse designs that our customers are running. Even if certain parts of DDR5 are going to be a little bit slower than anticipated, there's a big chunk of DDR4 designs that are taking up the slack and obviously feel some pretty aggressive, big growth forecast being driven by the combination of the DRAM manufacturers. So I don't think a significant impact associated with DDR5 timing for us.

[Amanda Scarnati, Citi]

And then the other question is a clarification question on the CapEx coming down a little bit, it seems like it's more of a function of better expense management, better cost dynamics and that rather than, reduction in overall CapEx, are we still at a point where you are capacity constrained versus what the demand environment is, or are you in a better place now? And do you have enough room to expand capacity even further as that TSMC business continues to grow?

[Mike Slessor, President and Chief Executive Officer]

I think in some areas, we're a still capacity constraint, right. It really depends on the product mix, we have multiple factories with different dynamics around the world, but in large, at this level of operation, we have seen capacity constraint. And that's why we are putting this capacity expansion in place to answer the growing demand.

[Amanda Scarnati, Citi]

And so the reduction in CapEx is not a function of reducing your overall capacity plans. It's just better costs?

[Shai Shahar, Chief Financial Officer]

No, not at all. It's only really about fine tuning the budget to put that in place at the end of last year. And now we have six months behind us. We have some actual in place, we know better what to expect, what's coming in. Some of it is just push out to the second – to 2022, the beginning of 2022. Some of it just when the cash pay out is going to fall. It is going to fall in 2021 or 2022 but no changes in our line.

[Amanda Scarnati, Citi]

Great. Thank you.

[Operator]

Next question is from the line of David Silver from CLK. Your line is now open.

[David Silver, CLK]

Yes. Hi, good morning or good afternoon. Sorry, in the VLSI research reports that I scan, your company was mentioned a number of times in their customer satisfaction surveys. And I'd like to maybe just focus on the broadest line, I think the semi equipment group category, but you achieved a very high score overall and in particular, your scores increased kind of across the board versus just one year ago, which I thought was interesting. But could you maybe talk about the strategies or the process improvements, Mike that you would mainly credit for the broad-based improvement in your scores in that survey? And then maybe to take it one step further, I guess, in your experience, how does that customer satisfaction survey results translate into either new customer acquisition or maybe increased business with your existing customer base? Thank you.

[Mike Slessor, President and Chief Executive Officer]

Yes. It's an interesting point. We are – we did make a good showing in this year's VLSI customer satisfaction survey, which is a poll of all of our key customers and are proud of a higher ranking and higher raw scores. Some of the details are interesting. If I recall, we scored very high in technical leadership and customer support and I think those are interesting validation points of our stated customer strategy. We're trying to be very close to the leaders in the industry, as you see from our 10% customers, both in the second quarter and over the last couple of years, want to be partnered with those customers, driving their roadmap and our roadmap forward and deploying what's by far the biggest R&D spend in the space.

So I'm solving their problems and then generating competitive advantage from it. I think rather than maybe being a driver of market share, I think it probably ends up being a reflection of market share. If those customers and all the customers that answer the survey are not happy with you. They're not going to order from you. And so I think that the two go hand-in-hand, and I think both having compelling differentiated products, but also having strong customer satisfaction is central to our strategy and central to the history of market share gains we've executed to.

[David Silver, CLK]

Okay, great. And then maybe just one last question and this is kind of maybe perspective over a longer period of time. So when I look at the breakdown of your revenues by logic and foundry versus DRAM versus flash, et cetera. I mean, there's an element there where you can only sell probe cards for things that your customers desire them for. In other words, you track, I guess, the product development cycles. But I think on the other hand, over a longer period of time, there are different profit or competitive – sustainable competitive dynamics in the individual product lines.

And I'm just wondering over a longer period of time. Do you have kind of a normalized, I don't know, share breakdown between, let's say logic and foundry on the one hand and the memory categories on the other or is it literally the case where you want to align yourselves with the customers and just track the development cycles in the industry. Thank you.

[Mike Slessor, President and Chief Executive Officer]

Yes. Well, if you back up over the very long timeframe, we had some customers where we really didn't have a significant market share position. If I back up 10 years, two of the 10% customers in the second quarter were not really FormFactor customers. And so part of – and this, again, consistent with the strategy I talked about we're working very hard to make sure we have strong combined market share positions at all the leaders in the industry. And so regardless of those development cycles, regardless of where large fabless customers, what foundry they decided to go to. We want to make sure we're in a position that's essentially neutral to that. And as long as we have strong market share with all the leaders in the industry and have good customer SAT scores with them, we think we'll do okay in the long run.

[David Silver, CLK]

Okay. Thank you very much. Appreciate it.

[Mike Slessor, President and Chief Executive Officer]

Thanks.

[Operator]

No further questions at this time. I turn the call back over to Mr. Mike Slessor.

[Mike Slessor, President and Chief Executive Officer]

All right. Thanks very much again for joining us today. And we hope to see you at some of the investor conferences in the second half, and maybe even see you in person. Take care.

[Operator]

I'm sorry. We have our next question from Charles Shi from Needham & Company. Your line is now open.

[Charles Shi, Needham & Company]

Really my apologies, thanks for squeezing me in. So Mike, really just a question around DRAM, I think you might have alluded to this, but I really want to get a clear comment on this. So your DRAM strength going into the second half this year, are you sort of seeing a broadening out in terms of by customer is that because – my understanding is your Q2 possibly a little bit that the first part of the Q3 your demand is primarily driven by one of your DRAM customers. Thanks. That's my last question.

[Mike Slessor, President and Chief Executive Officer]

Yes, that's correct. Although that is not unusual historically, we've seen our DRAM customers be – each have different intensities in different quarters. And so it's not unusual for one of them to be very strong in a given quarter. And then another one be strong in a subsequent forward. Again, go back to the customer strategy. That's one of the reasons why it's important to be a key supplier to all the leaders so that we're able to run our factories at high utilization and be able to make sure that we're on the leading edge of the industry, no matter which one of these DRAM manufacturers is winning market share with their big customers. So not unusual to see customer concentration in any given quarter.

[Charles Shi, Needham & Company]

Thank you, Mike, once again, my apologies for squeezing in the question at the last minute. Thank you.

[Mike Slessor, President and Chief Executive Officer]

No problem.

[Mike Slessor, President and Chief Executive Officer]

Operator?

[Operator]

Thank you, sir. This concludes today's conference call. You may now disconnect.