U.S. Markets open in 5 hrs 27 mins

Edited Transcript of FORM earnings conference call or presentation 5-Feb-20 9:30pm GMT

Q4 2019 FormFactor Inc Earnings Call

LIVERMORE Feb 11, 2020 (Thomson StreetEvents) -- Edited Transcript of FormFactor Inc earnings conference call or presentation Wednesday, February 5, 2020 at 9:30:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Jason Cohen

FormFactor, Inc. - VP, General Counsel & Secretary

* Michael D. Slessor

FormFactor, Inc. - CEO & Director

* Shai Shahar

FormFactor, Inc. - CFO

================================================================================

Conference Call Participants

================================================================================

* Brian Edward Chin

Stifel, Nicolaus & Company, Incorporated, Research Division - Associate

* Christian David Schwab

Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst

* Craig Andrew Ellis

B. Riley FBR, Inc., Research Division - Senior MD & Director of Research

* David Duley

Steelhead Securities LLC - Managing Principal

* Thomas Robert Diffely

D.A. Davidson & Co., Research Division - MD & Senior Research Analyst

* Tianyan Goellner

Sidoti & Company, LLC - Analyst

* Yu Shi

Needham & Company, LLC, Research Division - Associate

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Thank you, and welcome, everyone, to FormFactor's Fourth Quarter 2019 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, FormFactor, Inc. - VP, General Counsel & Secretary [2]

--------------------------------------------------------------------------------

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, foreign exchange rates, business momentum, business seasonality, the anticipated demand for products, customer requirements, our future ability to produce and sell products, the development of future products and technologies and the assumptions upon which such statements are based. These statements are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from those expressed during this call. Information on risk factors and uncertainties is contained in our most recent filing on Form 10-K with the SEC for the fiscal year ended 2018 and our other SEC filings, which are available on the SEC's website at www.sec.gov and in our press release issued today. Forward-looking statements are made as of today, February 5, 2020, and we assume no obligation to update them.

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

--------------------------------------------------------------------------------

Michael D. Slessor, FormFactor, Inc. - CEO & Director [3]

--------------------------------------------------------------------------------

Thanks, Jason, and thank you, everyone, for joining us today. FormFactor delivered record revenue and profitability in the fourth quarter, with financial performance surpassing the high end of the outlook range we revised upwards on December 11.

The strong performance closed an exceptional 2019, in which we posted 11% top line growth against the semiconductor capital equipment market that shrunk by double digits. Our results again illustrate the robustness of FormFactor's broadly diversified leadership positions in attractive consumables, in R&D-driven markets, in semiconductor test and measurement. As we move through the early part of 2020, many of the same drivers of our 2019 results are contributing to a strong first quarter outlook.

As we noted in December, our fourth quarter benefited from rapidly accelerating demand for Foundry and Logic probe cards, layered on top of steady demand for our other products. The Foundry and Logic strength was notable in its spread, coming from both 10- and 14-nanometer microprocessor designs as well as an assortment of 5- and 7-nanometer designs ramping at each of the 2 leading edge foundries. We also began volume shipments of probe cards to test millimeter-wave RF devices, which are planned to be a key component in the RF front ends of 5G handset launches anticipated later this year.

On the memory front, we ended 2019 with sequential growth in DRAM probe card revenues, building on the decade high revenues posted in the third quarter. At the risk of repetition, our 2019 DRAM results offer an excellent example of how FormFactor's demand drivers differ from capital equipment. Probe card demand is not generated primarily from baseline capacity additions, but instead from both customer node transitions and new design releases.

Consequently, FormFactor benefits as each of the major DRAM manufacturers execute node migrations, such as transitions to the 1Y and 1Z nanometer nodes as well as from architectural and product advances, such as DDR5 in both server and mobile implementations.

Turning briefly to our team. We welcome Sheri Rhodes to our Board of Directors during the fourth quarter. As Chief Information Officer of Workday, Sheri adds significant IT and cybersecurity experience. Concurrent with Sheri's appointment, Mike Zellner retired from our Board, and I'd like to publicly thank Mike for his insight and guidance over 8 years of service to FormFactor.

I'd also like to recognize the world-class performance of our operational team. They've done an outstanding job leveraging our market-leading scale to add labor and tool capacity on extremely short-cycle times. This enabled us to not only capitalize on the strong demand I've discussed, but also to ramp and operate in a relatively efficient way to deliver solid gross margins and strong operating profit leverage, demonstrating one of the key attributes of our target financial model.

Turning now to the current quarter. We continue to experience robust demand for Foundry and Logic probe cards, extending the same basic themes that drove the fourth quarter. Accordingly, we continue to use the capacity we added in the quarter albeit at nominally lower utilization levels. We do expect a sequential reduction in DRAM probe card demand in the first quarter. The major DRAM manufacturers are producing wafers on their new designs, digesting and utilizing the large volumes of probe cards we delivered to them during the second half of 2019.

But that said, with the general strengthening of the DRAM pricing environment and robust new design pipelines from DRAM manufacturers to take advantage of new nodes like 1Z nanometer and new architectures like DDR5, we expect long-term DRAM probe card demand to remain solid.

In the microprocessor space, probe card demand for 14-nanometer designs continues to sustain at high levels, even as 10-nanometer designs ramp simultaneously in significant volume. As Moore's Law slows, this extended node overlap is another example of the breadth and diversity of FormFactor's demand drivers. As a reminder, probe cards are consumable specific to each new chip design, and so we benefit both from 10-nanometer node transition and the release of new designs on the existing 14-nanometer node.

In the foundry space, we are experiencing strong demand for both a major 5-nanometer mobile applications processor design and multiple 7-nanometer mobile and high-performance compute designs. This continues to be a space where FormFactor's differentiated MEMS probe technology provides significant cost of ownership and performance advantages. This is especially pronounced in advanced packaging applications with high interconnect densities and challenging electrical test performance requirements.

With their adoption of new die-level advanced packaging strategies like chiplets and heterogeneous integration, our top customers are telling us that their test requirements are expected to get even more challenging. This complexity, paired with FormFactor's market and technology leadership, give us an exciting opportunity to provide further value in enabling our customers' leading edge innovation road maps.

Our engineering systems business again produced steady results, serving R&D in development applications for a variety of electrical and optical devices, including next-generation CMOS FinFET structures, silicon carbide power devices and VCSEL optoelectronic sensors.

The addition during the fourth quarter of FRT's leadership position in optical multi-sensor surface metrology opens up an incremental $150 million of addressable market, primarily in advanced packaging and MEMS applications. We have begun to selectively inject FRT's leading technologies and products into the worldwide FormFactor footprint, leveraging our long-standing partnerships with the top fabless, foundry, logic and memory customers. These early efforts are encouraging, and we expect to further accelerate FRT's growth and contribution in the year ahead.

We are closely monitoring the coronavirus situation. And like many of our peers have taken significant preventative measures, including travel restrictions, with our primary concern being the health and well-being of FormFactor employees, customers and partners. With China recently contributing approximately 20% of FormFactor's total revenue, potential demand impact could be substantial. And we have attempted to reflect this in our first quarter outlook. However, the rapidly evolving nature of the situation makes this impact impossible to accurately quantify at this time.

Finally, with average lead times of less than a quarter, our visibility remains limited as always, but we are encouraged by the continued strength of our diversified consumables and R&D-driven demand profile. This strength was clearly demonstrated in 2019 overall and in the fourth quarter specifically, where we posted multiple records in a lukewarm semiconductor capital spending environment.

Although it is only a single quarter, our fourth quarter results validate our target financial model, showing FormFactor has the ability to deliver $1.25 of non-GAAP EPS and $110 million of free cash flow on an annualized top line of $650 million.

Shai, over to you.

--------------------------------------------------------------------------------

Shai Shahar, FormFactor, Inc. - CFO [4]

--------------------------------------------------------------------------------

Thank you, Mike, and good afternoon. As you saw in our press release and as Mike noted, our fourth quarter revenue exceeded our updated outlook range, and our gross margin was at the high end of our outlook range. The combination of these factors, coupled with low effective tax rate in Q4, resulted in EPS that was significantly above the high end of our updated outlook range.

FormFactor's fourth quarter revenues were $178.6 million, a 27% sequential and year-over-year increase. This record quarterly revenues contributed to total fiscal 2019 revenue of $590 million, an 11.3% increase compared to 2018.

Probe card segment revenues were a quarterly record high of $153.2 million, an increase of $36.7 million or 31.5% from Q3 2019. Systems segment revenue were $25.5 million in Q4, an increase of $1.3 million or 5.4% from Q3 2019. FRT revenue included in Q4 came in about $1 million higher than our preliminary estimate of $2 million to $3 million.

Within the probe card segment, in line with the robust incremental demand we discussed in our December 11 press release, Foundry and Logic revenue increased 53.7% from Q3 to $105.1 million and was 59% of total company revenue in Q4, up from 49% in the third quarter.

DRAM revenues were $42.9 million in Q4, an increase of $3.5 million from the third quarter and over 24% of total quarterly revenue as compared to 28% in the third quarter. Building on the strength demonstrated over the past 2 years, this was our highest quarterly revenue from DRAM since Q1 2008.

Flash revenues of $5.2 million in Q4 were $3.4 million lower than in the third quarter and were 2.9% of total revenue in Q4, down from 6% in Q3.

GAAP gross margin for the fourth quarter of 2019 was $74.3 million or 41.6% of revenues, 230 basis points higher than the 39.3% GAAP gross margin in Q3.

Cost of revenues included $7.4 million of GAAP to non-GAAP reconciling items, which we outlined in our press release issued today and in the reconciliation table available on the Investor Relations section of our website. The increase of $1.6 million in the non-GAAP reconciling items in Q4 as compared to Q3 is a result of the acquisition of FRT during the fourth quarter.

On a non-GAAP basis, gross margin for the fourth quarter was $81.7 million or 45.7% of revenues, 220 basis points higher than the 43.5% non-GAAP gross margin in Q3 and came in at the high end of our outlook range. Our probe card segment gross margin was 45.4% in the fourth quarter, an increase of 410 basis points compared to 41.3% in Q3. The increase from Q3 was a result of higher volume and lower manufacturing variances, partially offset by higher performance-based compensation.

Our Q4 systems segment gross margin was 48% as compared to 53.9% in the third quarter. The decrease of 580 basis points was driven mainly by less favorable product mix. As we said previously, we expect our systems segment gross margin to range between the high-40s to low-50s.

Our GAAP operating expenses were $50.6 million for the fourth quarter, $4.6 million higher than in the third quarter. The fourth quarter operating expenses included $6.8 million of GAAP to non-GAAP reconciling items, slightly lower than the $7 million of reconciling items in Q3.

Non-GAAP operating expenses for the fourth quarter were $43.8 million or 24.5% of revenues compared to $39 million or 27.7% of revenues in Q3. The increase of $4.8 million is mainly due to higher performance-based compensation and the inclusion of FRT operating expenses.

Company noncash expenses for the fourth quarter included $7.4 million for the amortization of intangible assets, $6.1 million for stock-based compensation, amortization of inventory step-up of $0.5 million and depreciation of $4.5 million. Amortization of intangible assets was $1.3 million higher than in Q3 as a result of the acquisition of FRT. Stock-based compensation was $0.4 million lower than in Q3 due to the timing of annual grants.

GAAP net income for the fourth quarter was $18.6 million or $0.24 per fully diluted share compared to GAAP net income of $8.3 million or $0.11 per fully diluted share in Q3.

The non-GAAP effective tax rate for the fourth quarter of 2019 was 17.3%, 650 basis points lower than 23.8% in Q3 due to a significant increase in U.S.-based income, which is taxed at a lower rate versus [foreign-based] income. Non-GAAP annual effective tax rate for 2019 was 22%, slightly below our previously communicated estimated range for the year of 23% to 25% -- 26%.

Fourth quarter non-GAAP net income was $32 million or $0.41 per fully diluted share compared to $17.3 million or $0.22 per fully diluted share in Q3.

Moving on to the balance sheet and cash flows. We generated $31.6 million of free cash flow in the fourth quarter compared to $25.6 million in Q3, taking our total cash and investments to $224 million at the end of the quarter. The increase in free cash flow in the fourth quarter as compared to the third quarter was mainly a result of higher revenue and profitability.

We spent $11.5 million on principal and interest payments on our term loan during the quarter, and the loan balance was reduced to $35 million. This loan will be fully repaid by the beginning of Q3 2020. We funded the FRT acquisition with a new 3-year EUR 21 million denominated loan, utilizing the low euro-based interest rates to optimize our cost of capital.

At quarter end, our total cash balance exceeded the debt balance by $166 million, an increase of $10.4 million. While paying down these term loans remains our first priority for using cash, M&A is an important part of our strategy, and we intend to continue to deploy capital to acquire leadership positions that expand our served markets, as we did with the acquisition of FRT.

We invested $6.6 million in capital expenditures during the fourth quarter of 2019, bringing our annual investments to $20.8 million, slightly above our estimated capital spending plan of $16 million to $20 million for the year.

Before turning to our 2020 first quarter outlook, I would like to elaborate on our 2020 non-GAAP effective tax rate. The 2 biggest drivers impacting our effective tax rates are the mix of the U.S. and foreign taxable income and the foreign-derived intangible income deduction, which rewards exports for U.S. corporations. In general, the higher our U.S.-based taxable income, the lower the effective tax rate is. Accordingly, we estimate our overall non-GAAP effective tax rate for fiscal 2020 to be in the range of 15% to 20%. As a reminder, our cash tax rate is expected to remain at the 6% to 8% of non-GAAP pretax income until we fully utilize our remaining U.S.-based NOLs and R&D credits.

Turning to the first quarter of 2020 non-GAAP outlook. As Mike mentioned, we expect the strong year-end demand for Foundry and Logic probe cards to continue, layered on top of continued solid demand for our other products. These factors result in our Q1 revenue outlook in the range of $160 million to $172 million, and non-GAAP gross margins to be in the range of 43% to 46%.

Non-GAAP earnings per fully diluted share for Q1 is expected to be in the range of $0.27 to $0.35. A reconciliation of our GAAP to non-GAAP Q1 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. Operator?

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) Our first question comes from Quinn Bolton from Needham & Company.

--------------------------------------------------------------------------------

Yu Shi, Needham & Company, LLC, Research Division - Associate [2]

--------------------------------------------------------------------------------

This is Charles Shi on behalf of Quinn Bolton. I have a question on the capacity expansion part. So if we look at the Q4, your probe card is already running at about $600 million per year and very close to your $650 million target model. And I think you are -- in the last quarter, you spent $6.6 million in CapEx, a little bit higher than the original $16 million to $20 million plan. So my question is, when I think about next year, right, with the context of what you expect about the demand coming up and what -- how should we think about your capacity expansion and associated CapEx?

--------------------------------------------------------------------------------

Shai Shahar, FormFactor, Inc. - CFO [3]

--------------------------------------------------------------------------------

Sure. Thanks for the question, Charles. So our capacity is a function of both flexible labor and some CapEx addition. We added mostly flexible capacity in Q4. And as you heard in the prepared remarks, Q4 CapEx, and as you noted was $6.6 million, slightly higher than in the previous quarter, and that brought our total CapEx to $21 million for the year. The higher level of investment is in line with our higher revenue and they added capacity, and we expect to invest in a similar level during Q1.

--------------------------------------------------------------------------------

Yu Shi, Needham & Company, LLC, Research Division - Associate [4]

--------------------------------------------------------------------------------

Okay, okay. And regarding the -- I think, Mike, you mentioned, I mean, 1 month ago at the Needham Growth Conference that you handled that, like the surged demand, like what we saw in the last quarter. You have to do with less efficient -- I mean less the efficient way, like leveraging. I mean how -- using higher utilization, paying a little bit higher of the labor. How should we think about that? I mean going into 2020, do you expect a similar situation to repeat? Or whether we should think about it differently?

--------------------------------------------------------------------------------

Michael D. Slessor, FormFactor, Inc. - CEO & Director [5]

--------------------------------------------------------------------------------

Yes. Well, I think the comments I made at the conference earlier this year, we're associated with -- any time you ramp up capacity that quickly, you're obviously bringing on new labor that needs to be trained. It's not at the peak efficiency, it's going to be over the long run. And we're also retaining the flexibility to bring this capacity back down. So paying temp wages, quite a bit of overtime, so that we're not substantially adding to our fixed cost in the event the demand moderates a little bit.

So when I look at this, we're still in the first quarter, probably not operating at peak efficiency levels. And now it's consistent with the -- if you noted our gross margin outlook range, even at relatively high revenue levels, the top end of that range is 46%. So still operating with some efficiencies, but we -- inefficiency, sorry, but we believe those to be a reasonable trade for the flexibility that's going to give us as we move forward through 2020.

--------------------------------------------------------------------------------

Operator [6]

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Craig Andrew Ellis, B. Riley FBR, Inc., Research Division - Senior MD & Director of Research [7]

--------------------------------------------------------------------------------

And congratulations on the strength in the quarter and in the outlook. Mike, I wanted to go back and just reconcile what I thought was a point in the announcement when the company raised the fourth quarter guidance with our outlook. I think at the time, the company's view was that it was being opportunistic around a number of opportunities. And certainly, there was very good execution there. But with the calendar first quarter's guidance down 7% at the midpoint, it seems like there might be some decent sustainability to what we're seeing. So perhaps you can speak to that point, maybe just talk about some of the gives and takes as you look at the first quarter. What's more opportunistic? What might be more sustainable?

--------------------------------------------------------------------------------

Michael D. Slessor, FormFactor, Inc. - CEO & Director [8]

--------------------------------------------------------------------------------

Yes. So a good observation, Craig. And goes back maybe a little bit to the point about retaining flexibility. I'll remind everyone that we operate with very short lead times and limited visibility in this business well inside a quarter where most of our business has to turn in the quarter. So flexibility and agility, both to the upside and the downside are important in our operating model.

When I compare how we currently view the first quarter to the fourth quarter results, as we said in the prepared remarks, Foundry and Logic continues to be very strong, both in the microprocessor part of the business as well as the foundry part of the business, by and large, around the same advanced node -- overlapping advanced node themes that we had at work in the fourth quarter. So those are probably the positive side of the ledger.

We did also note that we expect a sequential decrease in DRAM probe card demand first quarter compared to the fourth quarter. But we really think that's mostly due to digestion. If you put this into context, in the last half of 2019, we operated at record high shipment levels for DRAM probe cards. Certainly, some of that is due to the trends we've talked about like advanced packaging and increased test intensity, but I think it's reasonable to expect that there does need to be a little bit of digestion as our customers use those probe cards, and as they move through the middle part of the year, probably refresh their new design road maps and return to more normalized levels.

So in terms of puts and takes, I think Foundry and Logic continues to be strong. We'll see how that last through 2020. DRAM in a bit of a digestion phase. Everything else kind of steady as she goes, but that gives us a relatively strong view for the first quarter of 2020.

--------------------------------------------------------------------------------

Craig Andrew Ellis, B. Riley FBR, Inc., Research Division - Senior MD & Director of Research [9]

--------------------------------------------------------------------------------

That's helpful. I appreciate that. And then I'll just give a follow-up to Shai. Can you talk about operating expense? Clearly, very well controlled despite the big revenue increase in the fourth quarter. How should we think about the arc of operating expense as we look through 2020? Are there particular initiatives or programs to be aware of in that line item?

--------------------------------------------------------------------------------

Shai Shahar, FormFactor, Inc. - CFO [10]

--------------------------------------------------------------------------------

Sure. I think the 2 main changes, if we look at 2020 OpEx versus 2019 is first addition of FRT, right? We acquired the company in Q4, and in 2020, we're going to have them for the full year. They're adding about $1.5 million of OpEx per quarter. And if you think about, let's call it, structural annual increases in OpEx related to salary raises, benefit costs, which increased year-over-year. And so if you look at the ranges for 2020, we're probably talking about $42 million to $45 million of OpEx per quarter with the first quarter being at the high end of that range because of the annual benefits reset.

--------------------------------------------------------------------------------

Operator [11]

--------------------------------------------------------------------------------

Our next question comes from Brian Chin from Stifel.

--------------------------------------------------------------------------------

Brian Edward Chin, Stifel, Nicolaus & Company, Incorporated, Research Division - Associate [12]

--------------------------------------------------------------------------------

Congratulations on the execution this past quarter and year. Maybe to hone in first, again, this is kind of going back to some of the epicenter of the strength that you've seen in Q4 and into Q1 here. But honing in on sort of your largest customer, they're driving a very high level of spend in Q4. Can you talk about your visibility on the sustainability of this run rate moving across the year, and that's taking into consideration comments maybe that have been made in recent public forums about what they're trying to do in terms of getting supply out and maybe get in front of that to some degree?

--------------------------------------------------------------------------------

Michael D. Slessor, FormFactor, Inc. - CEO & Director [13]

--------------------------------------------------------------------------------

Yes. I think it's a great observation, Brian. And it's part of the reason, again, why we want to retain some flexibility and agility. I think, as anybody who operates in the semiconductor supply chain knows today things are very dynamic. Our fourth quarter showed the ability to really respond to the upside and execute well in capturing the demand. We see, with our largest customer and some of the other customers in Foundry and Logic, that strength continuing into the first quarter. But it does seem like there's a general consensus that Foundry and Logic spending and investment is probably first half weighted in 2020.

Having said that, the constituents of the strength with our largest customer continue to be this -- sort of the result of Moore's Law slowing, driving overlapping activity on both the 14-nanometer and 10-nanometer node. 10-nanometer being a new node that's ramping with relatively high-test intensity also plays into the strength of demand for FormFactor's products at the present time. But I think it's one of those situations where the usual caveats associated with visibility definitely apply here. A general consensus that maybe the overall spending will moderate as we move into the second half, resulting in a first half weighted piece. So I think Foundry and Logic pretty strong at this point. We'll continue to execute, capture the demand as we can and take advantage of the opportunities as they present themselves.

--------------------------------------------------------------------------------

Brian Edward Chin, Stifel, Nicolaus & Company, Incorporated, Research Division - Associate [14]

--------------------------------------------------------------------------------

Okay. Got it. That's helpful. So if I heard correctly, maybe some more revenue concentration in first half relative to second for you guys, some moderation in second half, if I'm not -- if I'm hearing you correctly. And then...

--------------------------------------------------------------------------------

Michael D. Slessor, FormFactor, Inc. - CEO & Director [15]

--------------------------------------------------------------------------------

I think that's a -- yes, I think that's a fair working assumption that has pretty big error bars around it, right? I think everybody's visibility is awfully limited at this point, not just us.

--------------------------------------------------------------------------------

Brian Edward Chin, Stifel, Nicolaus & Company, Incorporated, Research Division - Associate [16]

--------------------------------------------------------------------------------

Okay. Yes. And maybe going to something that, again, is difficult to sort of get a read out on. But Mike, you did mention how there is some contemplation in your guidance for the March quarter relative to the coronavirus, albeit difficult to quantify sort of the ranges around that. But just to be more clear, is that sort of reflected in the width of your revenue range or more kind of where you put a midpoint on that revenue guide? Or anything else you can kind of provide there would be -- anything that you're seeing from the supply chain disruption standpoint would be helpful.

--------------------------------------------------------------------------------

Shai Shahar, FormFactor, Inc. - CFO [17]

--------------------------------------------------------------------------------

Sure. Brian, I'll take that. And I will answer 2 parts, I would say. I will talk about the demand impact and also about the operational and supply chain impact. So when it comes to the demand, as you heard in the prepared remarks, because of the additional uncertainty and difficulty to accurately quantify the impact of the coronavirus at this time, we have lowered our range more than it would otherwise would have been, but we also widened our revenue outlook range. It's now $12 million. If you look at previous quarter, it was $8 million. And we assigned a higher risk to certain transactions. We took into consideration our backlog, what we shipped already to China and others. We closely continue to monitor the situation.

And to your specific question, we believe our outlook is adequately reflecting the current situation. We built it into the range. That's on the demand side. When it comes to the operational and the supply chain impact, we have significant footprint in China for over a decade now, but very minor manufacturing. And we believe there will be no significant impact on our operations and our supply chain when it comes to the coronavirus.

--------------------------------------------------------------------------------

Brian Edward Chin, Stifel, Nicolaus & Company, Incorporated, Research Division - Associate [18]

--------------------------------------------------------------------------------

Okay. That's helpful. Maybe one last question. From a capital allocation standpoint, clearly, you're putting up a lot of free cash, and it's clear the bias is with an eye towards M&A as you alluded to in the prepared remarks. Is there any update in terms of -- to the extent you can talk about in terms of timing and/or the characteristics the company is looking for in terms of any potential deal?

--------------------------------------------------------------------------------

Michael D. Slessor, FormFactor, Inc. - CEO & Director [19]

--------------------------------------------------------------------------------

Sure. I mean as we've said, M&A has been and will continue to be a key part of our strategy. We also have as an equally important part of our strategy, executing in the served markets we have leadership positions in now as you can see in the fourth quarter and first quarter outlook.

On the M&A front, there's 2 pieces to it. One, we're executing a funnel of smaller tuck-in deals, FRT in the fourth quarter, an excellent example or case study of this. Smaller companies may be lacking the channel, the customer relationships and support infrastructure to really take their compelling technologies and drive them to share positions inside what's a pretty risk-averse customer base. So we think we're bringing a lot of value to those kind of companies. FRT, again, being a nice example that we're beginning to make some progress on.

We're also investigating and where possible trying to execute and pursue deals of scale. A good example of that would have been the Cascade Microtech deal we did back in 2016, that really adds significant revenue, cost synergy and fundamental strategic value to the company, changing the character of our EPS. As you might imagine, those are a little more challenging to get done. Part of the reason why we're executing on a tuck-in funnel, but we're not giving up hope on being able to continue to do deals of scale that expand our served market and put the cash we're generating to work for shareholder.

--------------------------------------------------------------------------------

Operator [20]

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Thomas Robert Diffely, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [21]

--------------------------------------------------------------------------------

So Mike, I wanted to ask a little bit about the 14-nanometer business that you're seeing. Obviously, it's a fairly mature node at this point. And the fact that it's still a robust driver for you, does that change your long-term view of capital intensity for testing and -- or tester intensity and how these nodes could be bigger and longer lasting than you previously thought?

--------------------------------------------------------------------------------

Michael D. Slessor, FormFactor, Inc. - CEO & Director [22]

--------------------------------------------------------------------------------

Yes. I think a good observation, Tom. I mean the 14-nanometer node at our largest customers been around for, I think, pushing 7 or 8 years by now from the first probe cards we shipped. And obviously, at some point, especially as 10-nanometer really reaches entitlement yields and maturity, we'd expect 14-nanometer activity to tail off. Having said that, I probably made that comment 3 years ago. So its longevity and robustness over time has been, obviously, a very pleasant surprise for our demand drivers.

The test intensity for a node that mature does go down over time. The yields go up. Customers work hard to test less and make sure they're really being most efficient with their intensity of spend on capital. But there's -- any time because of the way wafer test works and probe cards work, any time they release a new design, even on these mature nodes, it creates incremental demand for us. And that's part of what you're seeing not just in the 14-nanometer microprocessor space but when we talk about opportunities like automotive, those are back up at 28-nanometer and even 45-nanometer in some cases, but as customers release new designs, they need new probe cards driving demand for us.

--------------------------------------------------------------------------------

Thomas Robert Diffely, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [23]

--------------------------------------------------------------------------------

Okay. And then maybe just quickly touch on what you're seeing as far as the broadening of your customer base in the foundry side. I think it sounds like that was going to be a big opportunity over the next few years at the leading-edge nodes.

--------------------------------------------------------------------------------

Michael D. Slessor, FormFactor, Inc. - CEO & Director [24]

--------------------------------------------------------------------------------

Yes. And I think a lot of that's still in front of us. We're pleased to be able to report and -- this was in our prepared remarks, that our business at the largest foundry is beginning to diversify, it's still really concentrated on the advanced nodes, primarily today a big applications processor project at 5-nanometer and then a couple of other projects at 7-nanometer. But the interesting part is the 7-nanometer projects are both mobile and high-performance compute and begin to diversify and broaden us out of just having that 1 application processor project every year. Obviously, a big effort for us. We think this customer can grow into the scale and scope of the contribution, our largest customer currently makes. It's still going to take us several years to do that as more wafer starts, move to these advanced nodes where we're relevant and have a competitive advantage and as we continue to grow our stature as a supplier to this customer.

--------------------------------------------------------------------------------

Thomas Robert Diffely, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [25]

--------------------------------------------------------------------------------

Okay. Great. And then, Shai, looking at the coronavirus, the lowering and widening of the range, was that a specific sector that you serve? Was it DRAM, logic, foundry? Or was it just a general taking a haircut across all Chinese or Chinese-related customers?

--------------------------------------------------------------------------------

Shai Shahar, FormFactor, Inc. - CFO [26]

--------------------------------------------------------------------------------

I would say it's specific to China, but it's general over the markets we serve.

--------------------------------------------------------------------------------

Thomas Robert Diffely, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [27]

--------------------------------------------------------------------------------

Okay. And then finally, when you look at the OpEx, I was surprised when you talked about the increase in the quarter, you did mention increased head count as a driver of that. Is that just not as meaningful as the 2 items you mentioned?

--------------------------------------------------------------------------------

Shai Shahar, FormFactor, Inc. - CFO [28]

--------------------------------------------------------------------------------

So some of the -- or some or even most of the increase in head count went to COGS, right? That's the direct labor, the flexible capacity we talked about. And for 2020, the increase I talked about answering a great question was some more investments in R&D, some head count, but mostly the inclusion of FRT and structural annual increases.

--------------------------------------------------------------------------------

Operator [29]

--------------------------------------------------------------------------------

Our next question comes from David Duley from Steelhead Security.

--------------------------------------------------------------------------------

David Duley, Steelhead Securities LLC - Managing Principal [30]

--------------------------------------------------------------------------------

And congratulations on nice results. Just a couple macro questions here. Regarding the virus, there's at least, I think, 2 memory fabs in Wuhan or right in the epicenter of the virus. Are you able to get product into there? Are you able to ship stuff in and out of the area at this point?

--------------------------------------------------------------------------------

Michael D. Slessor, FormFactor, Inc. - CEO & Director [31]

--------------------------------------------------------------------------------

Well, there's a couple of things going on in very -- right now. Obviously, the team in China and most of the country has been on Lunar New Year holiday and kind of still is on and extended at least work at home holiday through what we understand to be next Monday.

With the Wuhan-based customers, in particular, I'll remind you that they are primarily flash producers, and as you might remember and can see from our results, we're not a big player in flash. We do, do reasonably well at the high end of the flash memory market. But we don't have a lot of revenue concentration in that segment or as you might imagine with those customers in particular. So we haven't had to exercise particular shipments in and out of that region because obviously, we just don't have a lot of backlog in their mainstream flash production.

--------------------------------------------------------------------------------

David Duley, Steelhead Securities LLC - Managing Principal [32]

--------------------------------------------------------------------------------

Okay. Excellent. And as far as, again, on the guidance range for the current quarter, a lot of companies that I've talked to have talked about just kind of extending the Lunar New Year by another week beyond what they would normally see or 2 weeks and that's how they came up with their lower revenue projections. Is that essentially the logic behind your lower revenue projection, 1 less week of production in the quarter? Or maybe just a little bit more color on that?

--------------------------------------------------------------------------------

Shai Shahar, FormFactor, Inc. - CFO [33]

--------------------------------------------------------------------------------

No. Not necessarily because we don't have significant production in China. It's mostly general impact of business overall, more uncertainty, more unknown at this point than specific manufacturing risk.

--------------------------------------------------------------------------------

David Duley, Steelhead Securities LLC - Managing Principal [34]

--------------------------------------------------------------------------------

Okay. And then final question from me is, TSMC has been talking a lot about at the advanced nodes, not just at 5 and 7 nanometers, but maybe include the node before that, that they're seeing a higher percentage of parts moving to advanced packaging or an advanced package type package. I'm wondering what you're seeing in the industry at this point? Are you seeing a higher percentage of parts move into the advanced packaging realm?

--------------------------------------------------------------------------------

Michael D. Slessor, FormFactor, Inc. - CEO & Director [35]

--------------------------------------------------------------------------------

I think the simple answer is yes. We obviously don't have perfect visibility into all the parts in the industry because our business does tend to be concentrated more, at least in the Foundry and Logic side, mostly around flip chip and advanced packages. But clearly, with the growth we've shown in Foundry and Logic and as we've described before, the competitive differentiation we have in testing parts that are packaged with advanced packages, there almost must be an increased adoption of this.

I still think there's a significant amount of it in front of us. As I talked about in the prepared remarks, the road map reviews we have between our exec team, our R&D team and our key customers, more and more of those discussions are pointed towards the requirements associated with advanced packages, whether they be chiplets or fan-out or HBM in memory. And those are driving a set of test requirements that are very, very difficult to meet. FormFactor is probably one of a handful of suppliers who can meet them and keep pace with these really aggressive road maps.

And so we're probably seeing some of that contribution today. But I feel like this is one of the big, longer-term secular opportunities for us as the industry moves forward of not just a front-end driven innovation road map, but using advanced packaging to create the products that are going to differentiate them in the marketplace.

--------------------------------------------------------------------------------

David Duley, Steelhead Securities LLC - Managing Principal [36]

--------------------------------------------------------------------------------

Final question from me. I just had one more, I want to slip in is, do you expect to grow in calendar 2020?

--------------------------------------------------------------------------------

Michael D. Slessor, FormFactor, Inc. - CEO & Director [37]

--------------------------------------------------------------------------------

A good question and one that we're debating. I think given the comments I made before in response to one of the earlier questions on sort of the house view -- well, the general view, maybe not the house view, the general industry view being maybe that Foundry and Logic spending is first half weighted. I think you're going to need DRAM to continue its recovery and move forward into a more aggressive growth posture in the second half of the year, and I think we'll need 5G to accelerate. But if we see some of those things happen, I don't think it's unreasonable that we could see 2020 be growth year.

The usual caveats associated with less than one quarter visibility don't allow us to make a definitive statement, but there's some ingredients that if they move our way and the industry's way in general, I think we're in pretty good shape to capitalize on it and deliver a growth year.

--------------------------------------------------------------------------------

Operator [38]

--------------------------------------------------------------------------------

(Operator Instructions) Our next question comes from Christian Schwab from Craig-Hallum Capital Group.

--------------------------------------------------------------------------------

Christian David Schwab, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [39]

--------------------------------------------------------------------------------

Congratulations on a great quarter. I guess most of my questions have been asked. I just have one quick one. On market share, can you give us an update of where you think you ended the year in market share in foundry, logic and DRAM? And maybe, in particular, in Foundry and Logic, with the multiyear opportunity for share gains is if things grow with the Taiwanese customer?

--------------------------------------------------------------------------------

Michael D. Slessor, FormFactor, Inc. - CEO & Director [40]

--------------------------------------------------------------------------------

Yes. I'm going to have to be a little bit waffly on that because some of the key data we need to really understand that comes out over the next several weeks, both in terms of industry benchmarking reports and some of our competitors reporting publicly.

So having said that, I do believe we made structural share gains in our 2 biggest businesses in probe cards, both DRAM and Foundry and Logic over the year. If you look at DRAM, there were some nice designs in the advanced packaging arena like HBM that we executed pretty well on, and I think led to some share gains.

In Foundry and Logic, if I just look at the fourth quarter results, it does seem reasonable to assume that there must be some implicit share gain in there unless the entire Foundry and Logic space spends at sort of triple the historical rate that they ever have. And so not being too glib about it, we do need to wait for some of the data. But I feel like qualitatively, as we look at our 2019 performance, and in particular, the second half 2019 performance that there are some share gains in there.

--------------------------------------------------------------------------------

Operator [41]

--------------------------------------------------------------------------------

And our last question in the queue comes from Tianyan Goellner from Sidoti.

--------------------------------------------------------------------------------

Tianyan Goellner, Sidoti & Company, LLC - Analyst [42]

--------------------------------------------------------------------------------

Congratulations on the strong quarter and also solid outlook. And Mike, I just have a clarify first, and maybe a follow-up afterwards. So you mentioned about DRAM, probably in the first quarter where you experienced sequential decline because it will be in the digesting phase, and then maybe in the second half, it will resume into growth. I assume you may resume into growth like probably compared to current level.

--------------------------------------------------------------------------------

Michael D. Slessor, FormFactor, Inc. - CEO & Director [43]

--------------------------------------------------------------------------------

Yes. So a fair observation. If you put things into a broader context, the Q3 and Q4 of 2019 were decade high levels for our DRAM probe card revenue. And so I think it's reasonable to expect that there is some digestion that's going to go on here. I don't think there's a structural fundamental change in long-term DRAM probe card spend, and so the levels we delivered in Q3 and Q4 are probably a reasonable expectation for a near-term high watermark. If conditions are right, maybe we get back to there in the second half of 2020.

--------------------------------------------------------------------------------

Tianyan Goellner, Sidoti & Company, LLC - Analyst [44]

--------------------------------------------------------------------------------

Okay. That's clear. So then still follow-up on the DRAM. And how long do you think -- because now we are really at a very high level, as you pointed out, over a decade high, record high level. So how long do you think the DRAM will maintain at the current level, like a few years or at least 1 year?

--------------------------------------------------------------------------------

Michael D. Slessor, FormFactor, Inc. - CEO & Director [45]

--------------------------------------------------------------------------------

Well, again, I think you have to look at these levels probably through a cycle, right? The customers, design releases and node shrinks, ebb and flow as you go through the cycle. And so I think if you look at 2018 DRAM revenue was in the, call it, $135 million range, 2019 closer to $145 million. So stepped up a little bit. I think these are reasonable levels to think about long-term DRAM probe card spend.

One potential component of upside that we talked a little bit about in Q&A is the adoption of advanced packaging. DRAM structures like HBM or high bandwidth memory, as we've explained in the past, driving much higher test intensity. And so that could be something, if we get more and more HBM wafer start, you could see an increase in the overall DRAM probe card spend. But absent that, I think this sort of $130 million, $140 million level is about right from annual DRAM probe card contribution at FormFactor.

--------------------------------------------------------------------------------

Tianyan Goellner, Sidoti & Company, LLC - Analyst [46]

--------------------------------------------------------------------------------

Okay. That's great. And then my last question would be, do you -- can you give any color on what FRT did in the fourth quarter? And any color also in 2020 regarding FRT.

--------------------------------------------------------------------------------

Shai Shahar, FormFactor, Inc. - CFO [47]

--------------------------------------------------------------------------------

Sure. So FRT, initially, we talked about $2 million to $3 million of contribution to Q4. They came in about $1 million better than that. So that's about $4 million in Q4. If we analyze that, we're talking about $16 million for next year or for this year.

--------------------------------------------------------------------------------

Operator [48]

--------------------------------------------------------------------------------

I show no further questions in the queue. At this time, I'd like to turn the call over to Mike Slessor, CEO, for closing remarks.

--------------------------------------------------------------------------------

Michael D. Slessor, FormFactor, Inc. - CEO & Director [49]

--------------------------------------------------------------------------------

All right. Thanks, everyone, for joining us today. We'll keep you updated on our progress as we navigate through the first part of 2020. Have a great day.

--------------------------------------------------------------------------------

Operator [50]

--------------------------------------------------------------------------------

Thank you. Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.