Analyst Day 2020

Aug 18, 2020

Ladies and gentlemen, thank you for standing by and welcome to the FormFactor Virtual Analyst Day Conference Call. At this time all participants are in a listen only mode. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Mr. Mike Slessor. Please go ahead. Good afternoon, and welcome to FormFactor's Virtual Analyst Day. We're very pleased you've joined us to discuss our strategy and new target financial model. Turning to slide 2, Please note that this presentation and discussion will include forward looking statements which are subject to known and unknown risks and uncertainties. You're encouraged to read the full cautionary statement in this presentation, which is available on our website. Okay. With that out of the way, let's turn to a road map for our time together. I'll review the reasons to consider form factor as an investment, some of which are unique in the public Semiconductor Universe. We'll look at the growth drivers in our served markets and how our leadership position in these attractive markets paired with share gains from our differentiated strategy and disciplined execution will drive continued revenue growth and earnings leverage. This growth in leverage underpins our new target financial model, which delivers $2 of non GAAP earnings per share on $850,000,000 of revenue, Chai will then take you through the model in detail. And after that, we'll take your questions. Moving to Slide 5. There are several important facts about form factor on this page, but I'd like to focus on the corners. In the upper left, you can see form factors trailing 12 month revenue is $640,000,000, essentially at our previous target model. The majority of this revenue comes from the leaders in the semiconductor industry whose names you see in the lower right corner as recent 10% customers. They comprise a diverse group of industry leaders, spanning IDMs and foundries across logic, memory, and specialty chips like RF. We spend a lot of time and resources working very closely with these customers, along with the spectrum of fabless customers, ensuring we meet their near term production needs as well as understand their next generation test and measurement challenges. This close dialogue helps shape our capacity investments in R And D spend so that we stay closely synchronized with the customers at the forefront of our industry. Turning to Slide 6. As we've executed our growth strategy, we've demonstrated strong financial performance that positions form factor as an attractive investment. Moving left to right, We own leadership positions in attractive growing markets that today reached $2,000,000,000 with market share almost double our nearest competitor. As we'll discuss, these markets have unique consumable and R and D driven demand attributes that are responsible for attractive growth with less cyclicality than semiconductor capital equipment. Not only do we benefit from the ongoing secular intensification of semiconductor content, we actively participated powerful trends, including 5g And Data Center Investment. At the same time, we also benefit directly from seeking to counteract the slowing of Moore's Law. Powered by the largest R and D spend in our served markets, We are a technology leader with differentiated products, and our customers rely on our proven capabilities from R&D through production. From the lab to the fab. Through targeted reinvestments and disciplined execution, we have consistently grown revenue and generated significant shareholder value. And finally, our organic growth has been and will continue to be complemented by a systematic successful acquisition and integration strategy. Now on to slide 7. Over the past three and a half years, form factor has grown revenue and expanded our market leadership. We've invested in R&D for competitive advantage, while also applying our scale and focus on operational excellence to expand our non GAAP gross margin. We've created leverage on our operating expense structure, and non GAAP earnings per share and free cash flow have grown steadily. Which has enabled both internal growth investments and external acquisitions. Briefly on Slide 8, We've consistently outperformed relevant market benchmarks as we've grown both organically and through acquisition. As you can see on slide 9, we're proud to have been recognized by our customers as a best supplier for 7 consecutive years. This validation signals the strength of our relationships and the critical role we play in their supply chains. Customer satisfaction is foundational to form factors culture, and as I highlighted earlier, our fundamental strategy is to be tightly partnered with later in this presentation. Slide 10 shows the importance of these customer relationships in driving a virtuous cycle of competitive advantage and market share gains. Beginning at the upper left, our engineering systems and probe card teams engage early with customers. To discover their next generation challenges, giving us a front row seat to understand new architectures, technologies, and chip designs being keeping us on the cutting edge. Our technology leadership is then fueled by highly productive and disciplined R and D programs with an technology and market leading probe card and engineering system products with world class cycle times and quality, which our customers depend on to ramp their next technology nodes and new chip designs. The profitable revenue derived from these products is then reinvested in R&D and customer support starting the cycle anew. Turning to Slide 11, we operate between the capital equipment oriented front end, populated by companies like Lam and KLA, and the back end with companies like Besi and ASM Pacific. And we essentially straddle the front end wafer fabs in the back end assembly houses. Our scale technology leadership and customer intimacy has enabled us to consistently grow faster than the 6% market growth for advanced probe cards, and 3% growth for engineering systems you see here. Our businesses are driven by our customers' technology and product development, by new chip designs, technology node migrations, and new R and D originated innovation. Probe cards, our largest business, are a consumable that is specific to each new chip design, and demand is generated from not just node transitions, but also the release of new chip designs on existing nodes. As a result, our revenue is less cyclical than equipment companies serving the front and back end of the semiconductor ecosystem. Slide 12 shows how both we and our customers benefit from form factor early engagement in product and technology development cycles. Our ability to engage industry leaders from the lab to the fab across all of foundry, logic, memory, and specialty applications is unique in the test and measurement space. Is one of the primary reasons for the strength of our customer relationships. Customers come to us to solve their problems. And this lab to fab engagement model means faster time to market for us both. Turning to Slide 13, form factor benefits from 2 big trends in the semiconductor industry today. On the left, you can see that there's a key supplier to the leaders in the industry, the things that drive the industry drive us. And we benefit from the persistent increase in semiconductor complexity and consumption. Our engineering systems are used characterize and debug new technologies, architectures, and chip designs in applications as varied as power semiconductors for automotive, through optoelectronic silicon photonics, switches in data centers. Once these technologies reach production, Our Advanced probe cards, which again, are a device specific consumable, are used in volume testing and yield improvement. As a result, our business is driven by trends like infrastructure and enterprise spending to power the cloud and support the world's dramatic increase in data use and storage. And we have our F expertise and testing experience that makes us the preferred supplier for demanding 5G and automotive applications. On the right, the industry's innovation trajectory is increasingly challenged by the slowing of Moore's Law. As successively smaller nodes no longer provide the cost reductions or performance advantages they once did. Advanced packaging techniques provide an exciting new cost and performance road map that helps overcome this challenge, which I'll discuss more in a moment. Moving to Slide 14. As I mentioned, form factors probe card business is a design driven consumables business. And the continuing expansion and diversification of semiconductor applications increases customer spending on probe cards. We manufacture probe cards specific to each customer chip design. For that reason, more customer products and shorter product life cycles drive higher volume for our products. And as product life cycles continue to accelerate, our ability to help customers reduce their time to market is of critical value to them and whether in general mobility applications or in connecting the internet of things. We're well positioned for success here. Because the RF requirements of 5 g are technically demanding. FormFactor has the expertise and R and D resources to keep pace with customers developing applications, the dependability that they rely on and the close working partnerships that have been developed over many projects. You pull these together. You see how form factor's already strong competitive advantage is amplified by industry trends like 5 g. Turning to Slide 15, Going 1 level deeper. Data center spending is projected to increase at near double digit rates to support cloud infrastructure, the explosion in data, and at least in the short term, working from home. At the same time, Semiconductor Content continues to increase in personal mobility and automotive applications, each of which are good examples of the broad based increases in semiconductor content, across the global economy. Moving to Slide 16. The 2nd growth driver for form factor is advanced packaging. This is what the industry is now relying on to offset As you see in the chart on the left, no shrinks no longer provide the cost benefits they did in earlier generations. There's widespread recognition that advanced packaging can improve both performance and cost. On our most recent conference call, We estimated that approximately half of the world's largest foundry sub 10 nanometer node chips use some sort of sophisticated advanced packaging. In order to continue to innovate and build sophisticated functionality into their products, customers are using these techniques which include dye disaggregation, heterogeneous integration, and dye stacking to bring different pieces of silicone together, into a single integrated product. Although we are not a packaging company, the good news for form factor is that probe cards are essential in enabling advanced packaging applications. Chip manufacturers use probe cards to make sure bad die are not integrated into an otherwise good package. Advanced or otherwise. As the quad chart shows, if die yields are high and the packaging cost is low, there is no law in need to test. It's economically sensible to just scrap the bad dye at final QA. But if the chip manufacturing process has low yields, and the packaging cost is high, the benefit of testing is substantial to avoid incorporating bad dye into the otherwise good package. This is exactly the situation we have in the various advanced packaging schemes. And as a result, as advanced packaging becomes the norm we are seeing substantial increases in test intensity. On top of that, the technologies required to test these devices are extremely complex and sophisticated. Some images of part of a probe card are shown at the right. The dimensions of these probes are comparable to a human hair, They carry power at an amp of current and signals at tens of gigahertz, while lasting millions of contact cycles. And these images show a very small portion of the overall unit as a typical probe card contains tens of 1000 if not hundreds of thousands of these probes. You can see that technically speaking, we are performing micro assembly at a vast scale, relying on the proprietary MEMS technologies in which we've invested 100 of 1,000,000 of dollars over the company's 30 year history. Moving to Slide 18, with these growth drivers and competitive advantages in mind, let me introduce form factor's new target financial model. Turning to Slide 19 and moving from left to right. FormFactor's leadership makes us a core player in the broad secular global growth of semiconductor content and adoption. Later on top of that, our sophisticated technology and customer relationships with the industry leaders and we are well positioned to benefit from the implementation of advanced packaging and adoption of 5 g and myriad applications. Fueled by this growth from our leadership position in expanding served markets, we will generate $200,000,000 of incremental annual revenue, taking our target revenue to $850,000,000 by 2023. Turning to Slide 20. The overall probe card market is projected to grow at a 5% annual rate and the differentiated advanced probe card market where we lead with nearly double the market because of our proprietary technologies, strong at a rate exceeding 8% annually. We've done this consistently in the past, most recently in 2019 where our 13% probe card revenue growth outpaced 8% market growth. Moving to Slide 21, While not growing as rapidly as the advanced probe card market, engineering systems are less cyclical than most capital equipment markets. And because we're working with customers to solve their next generation measurement challenges in the lab, engineering systems strengthens the customer intimacy and applications knowledge I mentioned earlier. By leveraging our large installed base, proprietary measurement solutions, and the technical breadth of our portfolio, we anticipate we will grow faster than the market overall, achieving annual compound growth of more than 5% With that, let me introduce our new revenue target on page 22. The model reflects form factors continued evolution with increasing diversification and scale, leading to expanding share of our addressed markets, and substantial revenue growth. We anticipate, as I mentioned, the form factor will outgrow our attractive served markets through focused reinvestment in R&D, capacity, and customer support to amplify our leadership. And while this model excludes any inorganic growth, we will continue to utilize our free cash flow generation to fuel M and A. Expanding our addressable markets with leadership positions in attractive adjacent areas within semiconductor test and measurement. I hope you're as excited about form factors growth prospects as we are. Let me now hand it off to Shay, who will take through our Targa Financial model and capital allocation strategy in more detail. Thank you, Mike, and good afternoon. Mike has just shown you, our 4 factors growth drivers will enable us to grow faster than our addressable markets. Now let me take you through what that means for FormFactor's new target model. Turning to Slide 24. You will recall we introduced our current target model in June 2017, $650,000,000 in revenue, and non GAAP earnings per share of $1.25. We have now operated this level for 3 consecutive quarters, and we achieved this target in the timeframe we originally indicated. Building on that momentum, we are today introducing 4 factors new long term target model. It is underpinned by the steady increase in demand for our products, driven by 5g And Advanced Packaging, among other drivers that we see in our markets. We are targeting $850,000,000 in revenue. As we have discussed today, we believe this $200,000,000 increase is attainable through organic growth and any acquisitions we complete will be incremental to it. 50 basis points expansion of our non GAAP gross margin, rising to 47% compared with the 44.5 percent recorded in our last full fiscal year ended December 2019. Non GAAP OpEx is expected to be 25% of revenue. And together with the higher non GAAP gross margin, We anticipate the growth in our non GAAP operating margin from 17.3% in 2019 to 22%, an increase of 4 70 basis points. Our target model anticipates a non GAAP effective tax rate in the range of 15 to 20%, consistent with our recent outlook. For simplicity, we have 17%. We continue to expect our cash tax rate to be in the high single digits as we utilize our net operating losses and R and D credits, which we have another 2 to 3 years to fully utilize. Our new model targets $2 in non GAAP earnings per share, representing a CAGR of nearly 18% if attained by the end of 2023. Note that our share count assumes 2% dilution annually for employee incentives. Finally, our model projects annual free cash flow growing to $160,000,000 from $102,000,000 in 20.19. The increase in our cash flow generation is enabled by our more than 40% increase in revenue and increased profitability. Moving to Slide 25. Revenue growth will be the primary driver of shareholder value creation. Mike shared our market opportunities and how we will leverage our industry leadership to grow faster than our addressed markets. In order to generate approximately $200,000,000 of incremental revenue. FormFactor will benefit from the substantial operating leverage enabled by our scale, driving gross margin higher. Our disciplined operating structure is a significant asset. In our response to COVID-nineteen, for example, we demonstrated form factors agility with a high variable cost component that enables us to pull levers to meet varying revenue levels. We are rigorous in our cost controls in how we add headcount, for example, and we'll continue to operate with this nimble mindset. We also focus on optimizing working capital, such as by controlling inventory and minimizing the cash conversion cycle. We have successfully grown free cash flow, a record we are proud of and that we expect will continue. As we noted in our last earnings call, we are using some of this free cash flow in 2020 to add capacity to respond to the increase in demand. As Mike mentioned, we have invested in R&D for competitive advantage. We will continue to focus on profitable growth investing in growing our revenue and margins. Our capital allocation strategy supports these value creating actions shareholders benefit from our productive R and D activities, which are financed by our industry leading scale. We increase capacity in a disciplined way as you saw last month, with the announcement of the acquisition of a new living room facility. We do not require an additional facility beyond this, to hit our $850,000,000 revenue target, and we have ample funds to finance our operations. Finally, we are prudent and successful in how we deployed capital for inorganic growth. We are patient and deliberate acquirers and seek opportunities that expand our addressable markets and bring us key technologies. Our criteria includes assets that complement our businesses organic growth profiles, diversify our revenues, and our accretive to our earnings. While we do have substantial dry powder and borrowing capacity, we will absolutely adhere to our patient and selective approach. At the current time, with attractive opportunities to finance profitable organic growth, and potential acquisitions that meet our requirements, we do not believe significant share buybacks are an optimal use of shareholders' funds. As you can see on slide 26, with increased revenue, form factor has generated increased profitability. Our non GAAP gross margin increased 170 basis points from 2017 through June 2020. And with the increase in target model revenue, $850,000,000, we anticipate non GAAP gross margin will expand further to 47%. The chief factors in our non GAAP gross margin expansion will be increased operating efficiency and factory utilization. We scrutinize every line that contributes to gross margin, supply chain, labor, overhead, each element of cost of goods sold. And we will continue our focus on achieving operational excellence to get the benefits of our scale and utilize our physical plans. Slide 27 demonstrate that this form factor has grown. Our focus on cost has enabled us to consistently reduce operating expenses as a percentage of revenue. Even when we grow scale, by leveraging our efficient operations. In our target model, total operating expenses is expected to be 25 percent of revenue. R and D, at 13% of revenue and target model, powers form factors, depreciating technologies, and early customer engagement. We are a technology leader in R&D as part of our DNA. Consequently, our expenditures have been highly productive. Although our R and D budget has been largely stable as a percentage of revenue, it has grown, of course, as our sales have expanded. And is the largest in our served markets. We are concentrating in minimizing SG and A expenses, targeting 12% of revenue and are very disciplined in controlling head office and other costs. Several information technology projects, some of which started as early as 2018, will tail off next year, and the benefits will be substantial, as you can see, by the declining percentage of SG and A compared to revenue shown on this slide. As illustrated on Slide 28, we anticipate that form factors growth in revenue and continued discipline expenses control will increase our operating margin substantially, with a projected increase of approximately 500 basis points from the end of 2019, to 22% at our target model. Moving to Slide 29. After several years of stable CapEx, generally around $20,000,000 per year and ranging between 3.2% and 3.8% of revenue, we anticipate CapEx in 2020 will increase to between $50,000,000 to $60,000,000. This increase includes the $24,000,000 already spent as we discussed last month. To acquire the building to expand our Livermore campus and another approximately $20,000,000 for outfitting costs, including building another clean room. The estimate for 2020 also includes an expansion of our Germany facility and other customary CapEx for new tools. As discussed, this capital outlay sets us up with ample capacity to achieve our target model. Once this bump is behind us, we anticipate that our CapEx will return in 2021 and beyond to our customary 3.5 to 4 percent of revenue. Turning to Slide 30. Our target model exclude Inogonic growth. But that said, We see and continue to actively explore opportunities to grow through smart acquisitions as we have done in the past. FormFactor has a track record of making successful acquisitions that expand our served markets. In addition to the acquisition priorities you see here, Our well established process focuses on how an acquisition will leverage from factors, infrastructure, and key capabilities to achieve both revenue and operational synergies. The acquisition of Cascade Microtech in 2016 is a great example. After it was integrated into our Salesforce, Engineering Systems revenue grew 17% in the year after acquisition. Our Salesforce was selling to the same customers, and by combining the companies, we could now offer comprehensive solutions and services. Another example is our acquisition of FRT in late 2019. FRT will subscale and needed marketing capabilities to expand further. Becoming part of form factor provided FRT with access to our sales and tech team in Taiwan and cutting edge customers throughout Asia, including the world's largest foundry, saving need to build infrastructure that could cost 1,000,000 of dollars. Our latest acquisition of the probe card assets from Adventist last month is a third example. This acquisition brings several key enabling sub component technologies that reinforce form factors technology leadership. It also adds an emerging non flash probe card architecture that is currently qualified at 1 of the world's leading memory manufacturers, providing us the potential to be a more strategic supplier in mainstream non flash wafer test. Let me close my part on Slide 31, by observing that form factor has a highly resilient business model. As we saw most recently during the second quarter, phone factors flexible cost structure added resilience during a period of uncertainty and operating challenges. Helping produce solid financial results. At the same time, form factor possesses a strong balance sheet with a total net cash balance of nearly $215,000,000 at the end of Q2. Our company has strong cash flows from operations, and we have a track record of managing debt effectively. That wraps up my section of representation. Now let me turn back to Mike for closing remarks. After which, we'll take your questions. Thanks, Shai. To summarize on Slide 33, We shared with you why form factor is a unique and compelling investment in the Semiconductor ecosystem. The attributes you see here have driven recent revenue and earnings growth and will be central to achieving our new Targa financial model, which produces $2 of non GAAP earnings per share on $850,000,000 of revenue. With that, Let's questions. Your first question will come from the line of Brian Chin of Stifel. Please go ahead. Hi, good afternoon. Thanks very much for the presentation. And also thanks for letting us ask a few questions. Maybe first question here, again, great detail, walking across sort of your outlook. $850,000,000 revenue target implies sort of a 8% to 9% CAGR over the 3 year horizon. And I guess I was curious if in relation to this, you think the incremental contributions from logicfoundry DRAM and non volatile memory will be proportional? In terms of that growth over the horizon? Or do you see a bias to one segment or another? Thanks for the question, Brian. It's Mike. I'll take that. I think an interesting question. And as those of you who follow us closely know, we usually provide A little more granular detail on some of the submarkets between our two segments of probe cards and engineering systems. And in fact, inside those markets, when you think about what's driving Advanced packaging and the innovation in our customer base, I think it's not too hard to make the connection that we expect to see the biggest growth in our foundry and logic probe card segment. If you look at some of our major customers, whether they're IDMs, the foundries or the fabless customers, there's a heavy dose of Dydus aggregation, heterogeneous integration and these other advanced packaging techniques in their roadmap. Certainly be some of that memory, but it's a very prominent feature in the foundry and logic roadmaps of our customers. And therefore, we expect to see kind of an outsized contribution to our foundry and logic probe card business in the path from here to the 850,000,000. Great. That's helpful. Maybe piggybacking off of that, thinking about the Advanced Packaging market and that rate of adoption. If you think about the contour over the ensuing several years, terms of commercialization of some of these new advanced packaging technologies and processes that you've referenced, do you think this will be sort of a linear ramp or adoption curve or more likely, do we get a ramp say 12 months or 18 months in? Trace, what you're thinking there is, Mike? And also What sort of lead time do you need in order to stage out capacity in the appropriate timeframe? Yes. So on Advanced Packaging, we're still in pretty early innings of overall industry adoption. Obviously, you've heard several of our major customers talked about their roadmaps and their strategies from a product standpoint using different advanced packaging techniques. And a lot of those production or limited production on 1 or 2 advanced processors. I think from a mainstream perspective, you're probably looking at something like that wells to 18 months out or maybe even a little further for widespread many customer adoption of these, advanced packaging techniques. And so in terms of staging things out, we certainly see contributions now. But the exciting part Packaging continues to be the long term industry trend towards driving more and more innovation onto these advanced packaging techniques, which drive up test intensity and drive up test complexity, both obviously beneficial for form factor? Okay, great. That's helpful. Maybe the sneak went in for Shai as well. Looking at that target model again over the 3 horizon, know is that SG and A run rate seems to be kind of similar ish to where you're going to be here in 3Q of this year. I'm just wondering if you could be maybe even more descriptive as you sort of reallocate some of that, those expenses more towards the increase in R and D. How you expect to extract that amount of leverage on the SG and A? Sure. So our SG and A organization is pretty effective. Right? Pretty, we use shared services in the acquisitions that we did, we have, we benefited from synergies on both mainly sales, but also SG And A. We have some ERP or IT information technology projects that we started in 2018. That we expect to roll off next year. And then we're going to see some benefits from 1st, not investing more on that on this project, but also seeing benefits from all of the company or almost the entire company being on one system. These benefits can be from SG And A, but also for purchasing power and things like that. That's why in addition to the increase in revenue, we see the leverage from the SG and A. Thanks so much. Appreciate it. Your next question will come from the line of Quinn Bolton of Needham. Please go ahead. Hey guys, thanks for the presentation and the nice job on the new model. Just wanted to maybe start with, sort of a question on TSMC. I know that they still have some manufacturing capabilities internal and so they buy more kits or components from you rather than full blown probe cards. Just wondering to the extent that TSMC continues to sort of gain share in the Advanced Manufacturing segment and probe card. Has that been sort of factored into your guidance or and maybe a related question. Can you give us some sense, what an advanced probe card sold to one of your other customers might be? How much of a discount you would get in the sale of those components to TSMC. And then I've got a couple of model follow ups. Sure. So I'll start with sort of the relationship in the foundry base and how we've moved that forward. As a reminder, several years ago, we essentially had no market share there. Made it a real company objective and goal to start to become a key part of their supply chain. I think we've done a good job on the progression towards that. The business model, depending on their customer and the application varies quite a bit. There are elements of subcomponent sales. There are also elements of complete probe card sales. And we've obviously factored that mix with some certain assumptions into the overall model. But I think the key dynamic associated with our foundry business is continued growth. Right, is we see more and more fabless customers moving to advanced nodes at the foundries, the world's largest foundry in some of the others. We see stronger demand for form factors products, both on the engineering system side for debug, but probably more importantly, as I said in the response to an earlier question, On the foundry and logic probe card side, there's some significant growth as that complexity increases in going to the more advanced nodes. And in particular, the advanced packaging that drives test intensity and test complexity. So, Kevin, on the modeling questions. How should we be thinking about the addition and the build out of the new facility, the new clean room Obviously, you're not going to fill it day 1 in terms of revenue. And so does that carry some higher fixed costs that might be an actual drag on gross margin as that facility first comes online, or can you manage the expenses of that facility to sort of to time it with the revenue through that facility? And then the second modeling question is, what are you assuming on either interest income or share count? Because I guess when I do a rough calculation on the $2 of EPS. It doesn't look it looks like you're using about 80,000,000 shares outstanding is roughly where the current share count is today. And I think, Shai, you mentioned there's no intended use of cash in the near term to buy back stock. And so flat shares 3 years from now seems like it seems like you would have some creep in the share count just through equity compensation programs. So Thank you. Sure. I'll start with the end actually on interest income or expense, nothing significant given the fact that currently our loan position is not significant. The impact on the model of interest income or expenses is not is not huge. When it comes to share count, I did mention in my prepared remarks that we assume 2% dilution annual. This is for employee incentives. So that's how we get from the 70 something, some 75, 76 share count median. Shares we have today to around the $80,000,000 that you referred to. When it comes to capacity, your first question, So we believe or we plan to see output from the new facility in Livermore in the beginning of 2021. And it's not going to be full capacity day 1. If you think about the different components of capacity, The first one is the physical footprint, the building. So that's one we acquired. Now we are building the tool, building the cleanroom, populating and populating it, and that's what we're going to do, we're going to do gradually. And to respond to the demand. It's a gradual process. The 3rd component is labeled and this is something that we've historically and we plan to do going forward as well. We plan to monitor very carefully. We are very, very flexible and agile when it comes to controlling labor whether by adding, over time, if it's temporary or adding more permanent capacity, if required, So we're going to see, these 3 components build over time together with the increase in the demand. And all these factors are built into the model into the $850,000,000 of revenue that we get gradually going to get and into the extension of the gross margin to 47 that. And I think I answered your question, but let me know if you need more information. Our next question will come from the line of Todd Diffely of D. A. Davidson. Please go ahead. Yes, good afternoon, and thanks for all the detail today. So, Mike, I hate to complain about your growth because it is really nice over the next few years, but if you look at the Advanced probe card market and you look at the data center business going up 50% and 5G just starting, Advanced Packaging just starting It seems like the Advanced probe card market projection of only 6% growth is a little small. I'm just kind of curious if you could talk to how that Advanced Propeller market is growing slower than it served markets? Well, I think when you look at the Advanced Pro Market, it cuts pretty wide swath through the semiconductor industry. Certainly data center and 5G and elements like that, are driving it, but there's a lot of other applications as well. Obviously, things like automotive microcontrollers some of the RF components in there, we might not expect to grow quite as rapidly. And so you've got an overall mix I think it's still growing faster than the overall, semiconductor end market, but you're right. There are sub segments that are driving much faster growth. That's kind of why we highlighted 5G and advanced packaging because overall, we expect those elements to drive much stronger sub segment growth than the 6% CAGR for the overall advanced probe card market. So, you know, some puts and takes inside the whole thing. Obviously, advanced probe cards includes all of memory and foundry and logic. Some of the things that we've tried to point out that I think you're pointing out, some exciting prospects, especially in the foundry and logic space for growth? Okay. I guess that makes sense. I know that you highlighted logic and foundry as the bigger growth component, but are you still expecting growth in the memory segment as well? We are. We do expect memory probe cards, both DRAM and NAND, to grow from a market perspective over that timeframe. Obviously, those are markets that tend to be a little bit more cost constrained than, than foundry and logic probe cards as we've seen historically. But obviously, we have a very strong incumbent position in DRAM. Continue to be opportunistic in NAND. As we work our way forward on the integration of the advantest probe card assets, maybe there's some optionality there. Again, the markets memory probe card markets, both DRAM and NAND, we would not expect to grow as fast as the foundry and logic markets. And as a consequence, we would not expect our foundry we would not expect our memory probe card revenue to grow as fast as our foundry and logic probe card revenue. Okay. And you don't need a significant contribution from your emerging NAND business to get to the 850 model? No, we've been pretty conservative about the assumption there. Obviously, it's early days. As a reminder, NAND probe cards, about a $250,000,000 annual spend by our mers, although there's significant geographical sub segmentation in there. There is some potential certainly for us to increase our NAND flash share position. But we haven't, we haven't assumed anything big in the path from here to 850 associated with NAND flash market share gains. Okay, great. And then finally, Shai, when you look at the gross margin expansion to 47% over time, it sounds like that just is indicative of overhead absorption and some cost controls. It doesn't require a more attractive mix of product or a move to higher product higher margin products? That's correct. So the most part, given the revenue profile, The mix might change a little bit because we expect higher growth on the probe cards business unit versus segment versus the engineering system business. But since that the portion of the engineering system business is not as big, we're going to expect it to significant impact on the margin. Now remember historically, mix can change from quarter to quarter and things can fluctuate until we get to the model. But overall, no significant impact mix of mix. Okay. Thanks for the details and appreciate your time today. Thanks John. Thank you, Tom. Your next question will come from the line of Craig Ellis of B. Ripley FBR. Please go ahead. Yes, it's a tricky one B. Riley FBR. Thanks so much for taking the question guys. And I appreciate all the information. But Mike, I wanted to start, with you on my first question. And it's less of a modeling question and more of a follow-up. On some of the technology and R and D breadth capabilities that you talked about. As we look at the $200,000,000 of incremental revenue that the company targets, over the next few years. How much of that is targeted with technology that's in the market today versus technology that might be in R&D that you intend to bring to market over the next 1, 2 or 3 years. Well, so it's an interesting question, Craig, and a difficult one to attribute hard numbers too, because I'll go back to the fact that probe cards are a device specific consumable. So we're constantly doing customization and some degree of R and every time we get a new design from our customers. And that's a significant amount of work. So to some extent, stuff we're going to ship in the fourth quarter has some dose of R And D in it. But if I think about this a longer term view of R and D and major programs and innovation moving forward. As we get into the out years of the model and talk about some of the very high density and high speed associated with the advanced packaging applications, those are things that are really in R&D right now. We've shipped a few to our key customer partners for beta testing, but those are things that really are still in front of us. And part of the reason why we're excited about the competitive advantage opportunity that Advanced Packaging offers is that it's really difficult to do and bringing our R and D resources and customer relationships to bear on the problem, we think is going to offer some significant competitive advantage. That makes sense. The follow-up question, first part of it, I'll give to you and then the second part, I'll follow-up with Shai. As we look at the free cash flow part of the target model, it seems like over the target model period, the business could generate over $400,000,000 in free cash flow. So, one, can you give us, an update on how you think the FRT acquisition is going, what should our expectations be on the revenue generation side with Advan test and just give us a sense for your comfort small tuck ins versus mid to large size deals? Yes. I'll actually start with the last part of the question. Yes. I'll start with the last part of the question first, Craig, because I think we remain very interested in large scale transformative deals, right? Obviously, both Cascade Microtech and MicroProbe going back in our history fall into that category. And we believe that there's going to be continued consolidation and benefits of continued scale and diversification in the industry. Having said that, right, at least 2020 is proving to be pretty challenging in trying to push forward and execute on any deals of scale for a bunch of obvious logistical reason. So in the interim, we're focused on some of the tuck in deals. Two examples you mentioned, FRT that we did last year to get us into optical metrology and an inspection for advanced packaging. And then last month's position of these Viantes probe card assets. Maybe starting with FRT, you can imagine this fits pretty well with our stated M and A strategy of buying leadership positions in attractive pieces of served market that we don't access today. We're trying to expand our SAM, and continue to diversify our business, which has stood us well over the past several years. FRT is doing pretty well. It's not growing as aggressively as it has been over the past couple of years. Some of that certainly is related to the special circumstances associated with 2020, things like difficulty of installing tools and R and D program push outs and things like that. But that's an area in a business where we continue to be very optimistic about the long term prospects for serving that niche. Advantests from a revenue growth perspective, the acquisition of those assets, as we mentioned on our last earnings call, some really exciting technology in that business that had been invested in over the years, but is applicable not just of the NAND Flash offering, that business has, but more broadly across our DRAM and foundry and logic roadmaps. And so I think we're still, as I said before, beginning integration and execution to grow the revenue. We've been relatively conservative about the explicit contribution we think revenue growth will make to the $850,000,000 model. It obviously gives us some optionality to be more active in the mainstream NAND flash market. Got it. Got it. And maybe just a follow-up to Shai given, given the amount of free cash flow of the business should be generating over a multi year period. Just help us understand how we should think about the business's capital structure. There is still some debt. Should we think that you could further pay down debt or for you intend to keep the debt that you have and accumulate cash until the right acquisition opportunities present themselves? Sure. So I think I had a slide about it. I'll spend a little more. And first priority is to pay down the debt, but now we're down to 1,000,000, which is what we make in a quarter and a half for free cash flow. So I wouldn't be too concerned about that. And certainly, investing in R&D, which is not obvious in these times and followed by expanding our sand, we're doing M and As. These are our priorities. And now we need to remember that we are going through uncertain times this day due to COVID-nineteen, right? Many other companies and peers withdrew their revolvers we don't have a revolver, so we use our existing cash as a cushion. That's going to be some sort of insurance policy to deal with these uncertainties. And with the liquidity requirements of the business. And so at the current time, attractive opportunities to financed profitable organic growth and potential acquisitions that meet our requirements, these are our priorities. And we'll when it comes to additional debt, we'll be opportunistic. And for the acquisition of FRT, we used a debt, a very low interest rate a euro label very low. So we took a loan to finance that. When we acquired the building, we also took a loan because of very low real estate interest rates. For the acquisition of the Adventist Podcast business, we finance it with around cash. So going forward, for more tucking, depends on the circumstances and the location. We can fund it with our free cash flow and existing cash. For something bigger, if it happens, it depends on the size, but we have additional capacity for additional debt if required. That's very helpful. Thanks, guys. Thanks, Chris. Thank you, Quinn. Your next question will come from the line of David Duley of Steelhead Security. Please go ahead. Yes. Thanks for taking my questions. I think you mentioned that about 50% of sub nanometer sub ten nanometer parts are put in an advanced package. In the timeframe of your target model between now and 2023, what percentage do you think will end up at the end of that timeframe? Is it going to be 75% or could you just help us understand how you're thinking about that. Sure. Well, and remember, there's a pretty broad swath across the industry of different people adopting this in different ways. So the 50% estimate we made associated with the world's largest foundry certainly has some error bars on it. I don't perfect resolution into that, but it's a good order of magnitude and estimate. I think, obviously, when you look at customer road now, whether they be in the microprocessor space, in the mobile space, some of the system level integration people are talking about, there's a strong drive towards advanced packaging as an integration technique, both from cost and for performance. So if you look at applications like high performance compute and artificial intelligence, they're almost required to use some sort of advanced packaging. And if you look at the growth rates and adoption rates inside those kinds of applications, I think something like a a 2 thirds to 3 quarters of the end products associated with these advanced nodes, 10 nanometer and below, let's call it, probably a reasonable estimate. There's always going to be monolithic chips that don't require it, but I think as a tool in the toolbox of our customer's product development teams, advanced packaging is going to be a significant tool over the timeframe of the model we're talking here as we get through 2023. Okay. And as a follow-up, what do you think your market share is now of the high end foundrylogic business? And if you grow at the CAGR that you expect, where should we end up in 2023? Yes. I think in the foundry and large PropCard business, as we've talked about in the past, there's significant sub segmentation inside of that. It kind of gets reported as a model market, but there's a lot more action underneath it than that. But I think if you look at the high end, some of the more, demanding applications like RF, 5G both from a processor standpoint and an RF component standpoint, microprocessors, high performance compute more broadly and then, mobile application processors and things like that. I think if you roll all of those things together, we're probably somewhere around high 30s, low 40s in there. And that market really tends to be a 2 supplier market. Us and our major competitor are really the only 2 suppliers of scale that can solve the kind of problems we talked about in the presentation. You go back and just look at Slide 17, did the technology in those pictures of the probes and the overall probe card is pretty difficult to create. And so I think there are some barriers to entry for some of the smaller suppliers in this market. Thank you. Thanks guys. Your next question will come from the line of Krish Sankar of Cowen and Company. Please go ahead. Yes, hi. Thanks for taking my question. And thanks again, Mike and Shai for a very clearly detailed alternative to long term opportunities. My first question is, the $200,000,000 incremental revenue in the long term model, it seems like it's coming from data center mobility and auto. Is there a way to quantify how much is coming from each of those three buckets and how the margin profile for or for each of those 3 categories? And then I had a follow-up. Yes. And if you go back to the last model we put out in our Analyst Day back in 2017. We did try and break things up into the various submarkets. We've not done that this time because there's some blending between them. We think that really these dominant sort of growth drivers associated with, 1st of all, secular semiconductor content increases across out locations, whether they be automotive, data center mobility is one driver. And clearly as a market leader, we're going to benefit from that rising tide. But perhaps the more interesting ones are form factor specific, those of advanced packaging and 5G, and those kind of blend across the different vertical. You can imagine that 5G is going to drive significant data center growth, right? It just transact all of this data at high bandwidth. It certainly plays in mobility in the handsets, but is also likely to enable some of the, either autonomous or assisted automotive applications, that we read so much about. So there's a blending across the different verticals and the different growth drivers for form factor that together kind of come together to produce the $200,000,000 incremental. Difficult to parse out kind of as individual components? Is there a difference in margin profile within those 3? I wouldn't say so. Again, I'll go back to reminding people that our business because probe cards are a device specific consumable. There's tremendous margin diversity across our different served markets and across our different applications. You can have an automotive application that bears very high margin just because of the configuration. Maybe it's a very high parallelism probe card that operates at very high temperature and very low temperature that gives customers a tremendous productivity increase. That bears a very high ASP compared to maybe a different configuration that operates at 1 temperature and test fewer chips. And those things are up to customer test strategies. We serve them all, but that's what drives a lot of the variance in margin mix. And I'd say that that product mix, that margin mix, even inside segment is a much larger variable than across the different verticals or different segments? Got it. Got it. And then, another question I had, and then I had like a very quick follow-up after that. The second question is, you spoke about advanced packaging. It makes a ton of sense. The move to like chiplets, heterogeneous structures or tiles or whatever you want to call that, is there a way to quantify the opportunity from a probe card perspective relative to what traditional packaging or flip chip used to be, is there a way to quantify how much incremental dollar is coming to probe cards because of these advanced structures? Yes. Well, again, kind of goes back a little bit to Tom's question. If you look at the overall advanced probe card market, a 6% CAGR over the model timeframe, clearly there's some elements that are going to be growing faster than the sales percent and some slower. And the things associated with advanced packaging are going to be growing faster. Certainly we expect them to be. You know, I can probably point to some of our, co travelers in the test space. I know several of the tester manufacturers have recently talked to the test intensity associated with advanced packaging and 5G being something like a 2025, maybe the 30% step up. Obviously, if there's 30% more testers being sold, there's going to be 30% more probe cards, to get on to those test systems. And remember, we're a device specific consumable. So when the designs refresh on those testers, we help the customers use them for more and more designs. And so I think something like that, you know, 20%, 25% probably a reasonable expectation for how test intensity increases associated with advanced packaging and the designs that use advanced packaging? That's very helpful, Mike. And then just a very quick follow-up for Shay. If I look at the long term model, it looks like from here to 2023, the incremental gross margin drop through is about 50%. Is that the way to think about it on a linear fashion or do you think it's not, it's more a step function not a linear move on a 50% gross margin drop through? So, I think we should think about the growth margin or step function because of the different components that it has. It's not completely step function, but some elements of it are. I talked about it when I responded to a question that was asked for. If you think about the capacity we added last month, the additional building, the physical capacity, that's a step function, right? That building will bring us it's sufficient for us to achieve our model of 850,000,000. Then the 2nd layer would be the 2 of the growing and the 3rd layer would be the labor, the headcount. So each one of them has a different level of let's call it step function with the building physical capacity has the the biggest step function, let's call it followed by the tools, followed by the label. Your next question will come from the line of Tyler Burmeister of Grayfield. Please go ahead. Hi. Thanks for letting us ask a couple of questions. I appreciate the presentation and all the detail. Most of my questions are largely been answered. So it can maybe be on different tangent, if you could. If you had any comment on the recent commerce department's additional restrictions on Huawei, a couple of days. And it seems like their target market chip makers as an equipment maker. So maybe your exposure to mobility was would have a different impact. So any comments on a potential concern that would be greater? Yes, I'd say the last couple of days really have not changed our overall view and our overall view of the China business and that customer in particular. Maybe as a reminder for everyone, China has been a growing part of our revenue. Through most of last year, it was around 20% of revenue. Has stepped up here in 2020 to closer to 30 percent of revenue, but it's important to understand that the vast majority of that is shipping to the multinational that operate in the region and not companies, associated with the Huawei supply chain. If you, if you then think about our ability, even over the past year or so, given the trade restrictions to do business with some of the local China customers, it's already been fairly significantly restricted. And so if you think about the announcement or clarification that came out in the last couple of days, we don't see any incremental impact associated with that. And as we've been putting together this long term model at $850,000,000, we've been relatively conservative about our assumptions for growth in China. I do think clearly there's headwinds associated with trade, they're unpredictable. And certainly on the trajectory they're on, they're not a positive growth driver for any U. S. Company, form factor or other So we've been pretty conservative on our China assumptions getting to 850. That's great. That's very helpful. And then understanding today with obviously long term focus. But since we have you speaking with you in public, I just wanted to take the opportunity and any update since just a few weeks ago and reported earnings. Any update in the near term or Q3 outlook that you'd like to comment on? No, I think we obviously had an earnings call, couple 3 odd weeks ago. Although this business is a turns business and changes pretty rapidly. I think the fundamental elements that we talked about driving our business for both second quarter results and into the third quarter outlook remain securely in place. I mean, there's significant investment in the foundry and logic space. Obviously, there's some 5G handsets that are launching in the 2nd part of the year are driving significant activity in our customers and significant business for us. And there's continued infrastructure investment by our customers that's driving a good healthy demand for both probe cards and engineering systems. So nothing substantially different over the past couple of weeks or the themes we've talked about on the past couple of earnings calls, but they are central underpinning and providing the foundation for the financial model we've shown you going forward. That's great. Thanks. That's all from me guys. Okay. Thanks, Tony. We have no further questions at this time. I'll now turn the call back over Mr. Slacer. All right. Well, thank you very much for joining us today. We're happy to be able to provide you with a look towards the future after achieving as Shai noted, our previous target financial model of $650,000,000 $1.25 of non GAAP earnings per share in the timeframe that we indicated, we're looking forward to getting to work and executing on this one. And having an Analyst Day again in another couple of years where we refresh the model. Thanks again for joining us and thanks for your interest in form factor. Thank you. And this concludes today's conference call. You may now disconnect. Thank you.