Welcome everyone to FormFactor's third quarter 2018 earnings conference call. On today's call, our 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.
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 2017, 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, October 31, 2018. We assume no obligation to update them. With that, we will now turn the call over to FormFactor CEO, Mike Slessor.
Thanks, Jason, and thank you, everyone, for joining us today. As we anticipated during last quarter's conference call, FormFactor delivered third quarter results comparable to our second quarter on the top and bottom lines. The expected gross margin reduction due to product mix was mostly offset by good operating expense control, enabling us to deliver non-GAAP earnings per share at the high end of our outlook. As you saw from our press release earlier today, we expect a modest sequential increase in fourth quarter revenue. Given the volatile industry backdrop in a quarter that is often seasonally weak, these healthy results and outlook are a direct demonstration of our leadership across attractive served markets in advanced probe cards and engineering systems. A primary driver of our financial performance is the structural demand for FormFactor's products and technologies.
As we've described in the past, probe cards are a consumable that is specific to each and every new IC design. As a result, we benefit from both node transitions and the release of new designs on existing mature nodes. With the stalling of Moore's Law, our opportunities on mature nodes are especially important, providing demand even when new nodes are delayed, an event we saw twice with major customers this year. Our third quarter results offer a strong example of this demand for probe cards on existing nodes, as our largest customer released several new designs on their 14 nanometer node, which is now nearly five years old. This new design activity resulted in third quarter volumes that returned to the levels we delivered in the first half of 2017, and in the current quarter, we expect this strong 14 nanometer activity to continue.
We also benefit from node transitions, of course. We expect to generate demand as our largest customer transitions to 10 nanometer production, an event which we continue to expect in 2019. More immediately, we are currently benefiting from other customers' node transitions in foundry and logic, with our fourth quarter outlook supported by initial seven nanometer production volume at the world's leading foundry. As we've discussed in the past, the cornerstone of this expanding relationship is FormFactor's proprietary MEMS-based probe technology and the differentiated advantages it provides, especially in advanced packaging applications like integrated fan-out. We will continue our R&D investment in MEMS probe leadership to further differentiate and increase our share as more silicon is integrated using advanced packaging. Turning to memory. Amidst the high degree of noise around customer investment plans, the third quarter saw sustained volumes of probe cards for both DRAM and flash applications.
The three major DRAM manufacturers continue to exhibit slightly different node transition and design release cadences, helping to stabilize and smooth overall probe card demand from quarter to quarter. In addition, our opportunistic flash strategy continued to pay dividends as we won several high-end designs where FormFactor's MEMS technology has a substantial performance and quality advantage over our competitors. Another exciting component of FormFactor's opportunity set is the broadening of our served application space through our engineering systems products. As we've described previously, this business allows us to engage with customers in early development of the devices and technologies that will power tomorrow's electronics industry. Increasingly, these products are in the form of optoelectronic as the industry innovates in sensors, displays, and other devices that rely on a combination of electrons and photons.
Our team and products have been supporting development and initial production of such innovative devices as VCSELs, microLED displays, and silicon photonics. In the silicon photonics application, we have partnered with instrumentation leader Keysight to produce a turnkey integrated system that dramatically reduces the time to data for our customers, accelerating their time to market and increasing their profitability. Although still an emerging application, we are excited by the recent momentum in silicon photonics, as evidenced by the expansion of our installed base in the quarter to more than 10 systems. Consistent with the well-recognized weakening of customer investment in both DRAM and NAND flash, we expect memory probe card demand to reduce in the fourth quarter. As a reminder, our lead times are approximately half a quarter, our visibility beyond that is limited, especially in the current environment.
We continue to manage our business with the knowledge that we operate in a cyclical industry, relying on our broad and diversified opportunity set to generate demand, while maintaining a disciplined and flexible approach to our cost structure. The second half of 2018 offers some nice proof points of these. In particular, the fourth quarter strength in foundry and logic is expected to offset weaker memory demand, and paired with the operating expense control demonstrated in the third quarter, is combining to deliver solid profitability and cash flow. In summary, we remain excited about our markets and our position in the industry and are committed to achieving our target financial model. As the share leader in our served markets, we are not immune to short-term industry demand volatility, but we are demonstrating an ability to weather this volatility.
Our engagement in early customer innovation and R&D through our engineering systems business, transitioning into production volumes with our consumables probe card business, is a powerful model that sets the stage for continued leadership, driven by growth in advanced packaging, mobile data, and automotive applications. With that, I'll hand the call over to Shai for further details on our third quarter and to provide insight into FormFactor's fourth quarter financial outlook.
Thank you, Mike, and good afternoon. As you saw from our press release and heard from Mike's comments, our third quarter results were comparable to our second quarter. FormFactor's revenues for the third quarter of 2018 were $135 million, basically flat with the second quarter. Probe card segment revenues of $111.6 million and systems segment revenues of $23.4 million were both comparable to the Q2 levels. Within the probe card segment, we also saw very similar revenue levels in each of the markets we serve. Foundry and logic revenues of $61.2 million decreased less than 2% compared to our second quarter and were 45% of total company revenues in the third quarter, slightly down from 46% in Q2. DRAM revenues were $37.4 million in Q3, down $0.7 million, or 1.8% sequentially.
In both Q2 and Q3, we experienced sustained DRAM demand as our customers released new designs for data center and mobile application. DRAM revenues were 28% of total company revenues in the third quarter, consistent with the second quarter. Flash revenues of $13 million were $1.6 million higher than in the second quarter, a 14% increase. We continued to see stronger demand for our technology due to stringent test requirements for high layer count 3D NAND. We are being opportunistic and capitalizing on winning additional flash designs where we have a technology advantage. Approximately $8 million of the flash revenues in Q3 were from NAND flash applications. Looking ahead, we believe flash will be a single-digit percentage of our revenue in the mid- and long term.
GAAP gross margin for the third quarter of 2018 was $53 million or 39.2% of revenues, down 2.3% compared to 41.5% in the second quarter. Similar to Q2, Q3 cost of revenues included $6 million of GAAP to non-GAAP reconciling items, which we outline in the reconciliation table available on the investor relations section of our website and in our press release issued today. On a non-GAAP basis, gross margin for the third quarter was $58.9 million or 43.7% of revenues, down 2.2% from the 45.9% in the second quarter and slightly above the midpoint of our outlook range. As a reminder, product and customer mix, including mix within the different markets we serve, have the biggest impact on our gross margin, and the decrease in Q3 was primarily due to a less favorable product mix in the third quarter as compared to the second quarter.
Our probe card segment gross margin was 42.7% in the third quarter, a decrease of 2.6% compared to Q2 due to the product mix factor I mentioned before. Our Q3 systems segment gross margin was very similar to Q2 at 48.1%, 0.5% lower than Q2 on slightly lower revenues. Our GAAP operating expenses were $43.6 million for the third quarter, $1.3 million lower than the second quarter. The third quarter operating expenses included $6.1 million of GAAP to non-GAAP reconciling items. Non-GAAP operating expenses for the third quarter were $37.5 million or 28% of revenue, down $2.1 million compared to Q2. The decrease is mainly due to employee-related costs, including lower performance-based compensation and benefits and disciplined spending. Non-cash expenses for the third quarter included $7.5 million for the amortization of intangible assets, $4.5 million for stock-based compensation, and depreciation of $3.6 million.
Amortization of intangibles and stock-based compensation were both slightly higher than in the second quarter due to timing of annual stock grants and updates to the amortization schedule. The non-GAAP effective tax rate for the third quarter was 7.1%, similar to the 7.5% for the second quarter. We entered 2018 with over $240 million of remaining U.S.-based NOLs. As such, we continue to expect to have a non-GAAP effective tax rate of 5% to 8% while we utilize our U.S. NOLs. GAAP net income was $7.7 million, or $0.10 per fully diluted share for the third quarter, compared to net income of $9.1 million, or $0.12 per fully diluted share in Q2. Third quarter non-GAAP net income was $19.6 million, or $0.26 per fully diluted share, compared to $20.4 million or $0.27 per fully diluted share in Q2. Moving on to the balance sheet and cash flows.
We generated $13 million of free cash flow in the third quarter, compared to $16.8 million in Q2, taking our total cash to $143 million at the end of the quarter. The $3.8 million decrease in free cash flow in Q3 as compared to Q2, is primarily due to an increase in inventory to meet Q4 customer demand. We spent $13.2 million on principal and interest payments on our term loan during the quarter, including $5 million of prepayments. Going forward, we expect to repay the term loan principal based on the original amortization schedule. Our total cash balance exceeded the balance of our debt by $71 million at quarter end, an increase of $12 million. In line with our annual capital spending plan of $16 million-$20 million, we invested $3.8 million in capital expenditures during Q3.
Turning to the fourth quarter non-GAAP outlook, we expect Q4 revenue to be in the range of $132 million-$140 million, and non-GAAP gross margins to be in the range of 42%-45%. non-GAAP earnings per fully diluted share is expected to be in the range of $0.23-$0.29. A reconciliation of our GAAP to non-GAAP Q4 outlook is available on the investor relations section of our website and in our press release issued today. With that, let's open the call to questions. Operator.
Ladies and gentlemen, if you have a question at this time, please press the star, then the number one key on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Our first question comes from the line of Craig Ellis from B. Riley FBR. Your line is open.
Thank you for taking the question, and congratulations on the steady results in what was a very dynamic environment in the third quarter. Mike, I wanted to go back to your points on the foundry and logic business and just see if I could dig into some of the details that we have coming up. Nice to see a strong performance from your U.S. customer. The question is, since they have been public in August with their three-year roadmap with a late 2018, a late 2019, and 2020 14, and 10 transition, what does that mean for that part of foundry logic? Does it mean it should be steady from levels we are seeing in the back half of the year, or is there an opportunity to grow that part of that business?
Thanks for the question, Craig. Obviously, with that customer, it has been a very volatile year, starting with the 10 nanometer delay at the beginning of the year. As you have seen, we are pretty pleased with the growth of that business as they have transitioned some products into 14 nanometer and generated probe card demand on these new designs. I think, as you say, the cadence is going forward of continued 14 nanometer designs and then transitioning much of the wafer start volume to 10 nanometer is something that the customer has been fairly transparent publicly about their plans in 2019. We continue to stay very close from a planning perspective with them to make sure we are prepared to make that transition in lockstep with them. There may be some upside associated with a 10 nanometer transition. As we have discussed in the past, typically, new transitions have higher test intensities.
Given that the bulk of our volume right now is on 14 nanometer, there is some potential upside to 10 nanometer. I want to caution people that it's also not purely additive. It's not going to be 10 nanometer on top of 14 nanometer. There will largely be a substitution factor there with maybe a little more test intensity.
Got it. That's helpful. Switching gears to Taiwan Foundry, that's been a nice growth story for you. It sounds like there's good seven-nanometer traction. That customer seems to have a growing customer base itself. Can you talk about the potential for that business as you look out over the next three to four quarters to provide growth, and what are the prospects that business can provide a solid year-on-year growth in 2019 versus 2018?
You're absolutely right. That is one of the nice growth stories in our business in 2018. I think there's two components to it. First of all, our opportunity in serving this foundry is really associated with 10 nanometer, 7 nanometer, and below, with a very strong growth vector around advanced packaging, in particular, integrated fan-out. As we see more of that foundry's wafer starts and more fabless customer designs moving to those nodes and the advanced packaging technologies, that grows the opportunity for us. We've said in the past, we expect long-term, this opportunity to be comparable to the business we have with our largest customer, and nothing we've seen so far has changed our view on that.
We continue to make good progress towards it. I think you'll see us having gained share in 2018 over 2017 with that customer, growing the business. We expect and are planning to do the same thing in 2019 as we grow towards, again, the magnitude of business we have with our largest customer.
That's helpful. Shai, I'll flip it over to you with two clarifications. One, with respect to gross margin, it seems like gross margin is performing well. You've got certainly volume working more at your favor. Can you give us a sense for just the gross margin gives and takes in the fourth quarter? Sticking with the middle of the income statement, were there any one-time or special items in the meaningful decrease in the third quarter's operating expense, and is that an operating expense level that it is sustainable going forward? Thank you.
Yeah. Thanks for the two questions, I think, Craig. I'll start with gross margin. As I said in my remarks and we said before, mix has the biggest impact on our gross margin. We saw that evident in the difference between Q2 and Q3, gross margin and Q4 gross margin is expected to stay the same level because of these changes of the mix. This has been consistent. No surprises there. When it comes to OpEx, we have communicated before, range of $36 million-$39 million of quarterly OpEx. We are within that range in Q3 and Q4. No special one-time items that we saw. We continue to monitor our OpEx. We remain disciplined, we are keeping our expenses, and that's our plan, to keep our expenses in line with our revenue going forward.
Thanks, gentlemen.
Thanks, Craig.
Your next question comes from the line of Edgar Roesch from Sidoti & Company. Your line is open.
Thanks. I'll add my congrats on a very steady quarter. On that theme, I wanted to ask because your guidance implies you'd have kind of three quarters in a row, right around $135 million, $136 million, if you use the midpoint for Q4. Wanted to ask if the pacing of revenues within the quarter also was pretty evenly distributed, or if you saw any kind of fall off and then acceleration towards the end of the quarter or vice versa? Any color would be appreciated.
Sure. Thanks, Ed. I think I'll start by summarizing that although the top-line results, Q2 to Q3 to our midpoint view of Q4 are very similar, it's sort of this mid-$130s stretching to $136 million in Q4, are very similar to each other. There are an awful lot of moving parts underneath there. In the fourth quarter, in particular, we're expecting to see a substantial shift from memory to foundry and logic. Inside each of the markets we serve, there's quite a bit of variability in between each customer and individual designs and some of the cadences they go through on even a week-to-week basis. The ebbs and flows, both from a mix perspective and from a timing perspective within the quarter, are much more dynamic than the top-line results would lead you to believe.
Okay, I appreciate that. Your business touches a lot of different aspects of the industry here, and I was just wondering if you could provide any kind of color on the issue of tariffs and if you can even offer some general comments on any kind of change in behavior or demand modification that you've borne witness to, maybe not in your own business, but that you would say you've seen as a result of some tariff issue. Thanks.
Your next question comes from the line of.
In particular, the tariff issue for us is pretty squarely focused, as I think it is for most people, on China. We've had a significant footprint in the region for more than a decade, and have been investing fairly heavily in that business as the indigenous Chinese semiconductor industry sort of bootstraps itself up, especially in memory, to full production. Just to benchmark people, it still typically represents less than 10% of our revenue in any given time period. We do view it, as most other suppliers in the space do, as a.
Okay. Then one final question. Engineering systems revenues year-to-date are pretty flat year-over-year. The original intent seemed like that might be an interesting area to consolidate. I was wondering if the viewpoint on that industry is still pretty consistent, and once you get your balance sheet where you want it, maybe could get a little more active on that front.
Yeah. Maybe, Ed, I don't know whether we had some technical difficulties there, I wouldn't mind finishing my thought on the tariffs issue. We have seen.
Oh, sorry. Go ahead
No problem. We have seen a few discussions, mostly with suppliers, where we're importing from the region. I would say limited impact to our customer engagements at this point, but it's something we're monitoring and evaluating pretty closely because, I think we, along with most suppliers operating in the global industry, have a hard time viewing this as being positive. Moving then a priority, we've talked about continuing to de-lever being a use of our capital. We applied essentially all of our free cash flow to de-levering in the 3rd quarter, but we continue to be pretty active in prospecting and building an M&A funnel around the themes of electrical test and measurement in some of these emerging growthier markets. I'd agree with you. I think there are some opportunities there. We're still in the prospecting phase, and debt reduction, de-levering, still remains our top priority.
Our next question comes from the line of David Duley from Steelhead. Your line is open.
Thanks for taking my question. You mentioned that you've done well with a Taiwan foundry, but when we look at your breakout of results in the quarter geographically, Taiwan is down pretty strong. Could you just elaborate a little bit more on the timing of your business there?
Sure.
As a follow-on, with a lot more people adopting seven nanometers with that foundry than at 10 nanometers, would you expect that business to smooth out or be less first-half loaded?
Yeah. I think the second part of your question hits on the core issue. Our historical, even through the middle part of 2018, engagement with this customer has been pretty focused and concentrated in essentially a handful of application processor projects. Part of what we're trying to convey about the fourth quarter is we see, for the first time, us having a significant fourth quarter contribution from that customer as we broaden the relationship, as we generally gain market share there, but also as the relationship expands and we serve more customers and more designs. We do expect it to start to smooth out as we move through the fourth quarter and into 2019.
Excellent. Did you have 10% customers during the quarter, and what percentages were they?
Yes. This is Shai. We had our largest customer, Intel, at, let me give you the percentage, just a second. At 24% in the quarter, Micron was number 2 this quarter at 12%.
Excellent. The flash revenue that you're capturing now and that you've seen growth in versus last year, I think you mentioned it had to do with higher layer counts. Would you expect your flash revenue to perhaps ramp up with 96-layer flash parts, or is there some correlation between this, or what is the driver to this business to grow further? Thank you.
Yeah. It's a very good question, David, and one that we debate a lot internally. Certainly, our flash business to date, as we've opportunistically gone after designs and parts of the market where we really have a differentiated advantage, have been pretty strongly correlated to higher layer counts. They've also been correlated pretty strongly to higher densities and higher test speeds associated with certain customers and their test strategies. I'm not sure I'd draw a one-to-one correlation between 96-layer flash and FormFactor flash growth. I think it's one of the components that certainly helps us as it drives up complexity in the required performance at the wafer test step where we participate.
I guess one final question from me is along those same lines. It sounds like not only the higher layer counts help, but that these flash parts have higher speeds, so longer test times. My question is: Do you see an increase in test time intensity with these flash parts? Maybe you could share with us what that increase in intensity is. Then just to double-check, in the past, I think you've mentioned that advanced packaging such as InFO are roughly 20% or 25% more test intensive and probe card intensive. I was wondering if that is still the view or if that's the accurate view. Thank you.
Sure. Generally on test intensity and test time increases associated with different things, it's a pretty complicated function of a whole bunch of variables, not the least of which is what the yield of the native die are. I think, the ballpark estimate associated with advanced packaging being 20%, 25% more test intensive than, if you like, a plain silicon die, I think is a reasonable estimate. That's been triangulated by, I think, a couple of other test suppliers as well. 3D NAND's a little bit more complicated because it goes to the yield ramps, the layer counts, and then, of course, the individual architectural decisions that each of the customers are making and their test strategies, where they choose to spend their test dollars, whether it be a wafer test or final test. That one's a little more variable.
It does seem to be more test-intensive as you go up in layers. Certainly, as we see die stacking and advanced packaging moving into some of the regions of non-volatile memory, that offers the opportunity associated with advanced packaging as well.
Thank you.
Thanks, Dave.
Again, ladies and gentlemen, if you have a question at this time, please press the star and then the number one key on your touch tone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Your next question comes from the line of Patrick Ho from Stifel. Your line is open.
Thank you very much, and congrats on the nice quarter and outlook. Mike, maybe as a follow-up to Dave's comments about test intensity on the memory side, if we can look at DRAM for a second. Obviously, the industry is undergoing a lot of node transitions, which helps you on the design phase. Talking to people in the industry, test intensity for DRAM is also becoming higher with the higher speeds and bandwidth and things of that nature. Can you comment on how that potentially can increase, I guess, the market opportunity, especially the near term, as you're going through several node transitions in the industry?
Yeah. Similar theme to the last question, as you noted, Patrick. I think DRAM, because of the node transitions that all the major customers are going through, we do see generally the test intensity going up there. Anytime there's a move to a new node, higher densities, and higher speeds, this does demand increased test intensity to make sure customers are resolving their yield challenges and ramping effectively. That's part of FormFactor's value proposition for them. I think the other thing I'd like to highlight, though, in DRAM is a theme that you've seen in our DRAM business in 2018, and that's high-bandwidth memory, which is one of these advanced packaging applications.
Each of those die, as we've discussed in the past, that goes into the stacked die HBM or high-bandwidth memory package, requires significantly higher test intensity, essentially to make sure that it doesn't kill its neighbors in this stack. That's one of the other big drivers associated with test intensity in DRAM, is the innovation associated with advanced packaging like HBM, driving the need to ensure maybe not quite known good die, but pretty close to known good die.
Great. That's helpful. Maybe going to the engineering systems business for a bit. There's, I guess, multiple applications and multiple products which you have, whether it's on wafer or advanced packaging. Is any one of those segments, I guess, outperforming in the near term? Are you seeing more advanced packaging applications more so than the others, or is it pretty balanced?
I think overall, what we're seeing is something I tried to convey in the prepared remarks. A lot of our engineering systems business, both the interaction with customers and the development and shipment of systems, is really starting to shift towards photonics applications. Whether they be sensors like VCSEL or CMOS image sensors, some of the stuff we're doing with next-generation displays like microLED, we're seeing that be a fairly strong segment, both from an activity perspective but also from a business perspective. It's starting to impact our results in a pretty significant way, which is why we tried to draw attention to it, in particular, the silicon photonics example, driving an installed base now of more than 10 systems, which for an engineering business, is a significant footprint worldwide.
Great. Final question maybe for Shai in terms of the free cash flow and CapEx needs. Given that we're a couple of years from the Cascade Microtech deal, as your free cash continues to grow, I guess, where are some of the priorities? Is there a need to increase CapEx as some of your product and markets grow? Where are we looking at putting that cash to use?
Specifically about CapEx, our plans in the last couple of years and going forward will be to invest between $16 million-$20 million a year on capital expenditures. I see ourselves staying in that range next year as well. Regarding capital, how we deploy our cash, we said before, our first priority is to deleverage our balance sheet and repay the loan. We've been prepaying our loan in the last few quarters. Q3 of 2018 will be the last quarter we're going to do advanced prepayments on the loan. Going forward, we are going back to the original amortization schedule. Moving into our second priority, which is to expand our SAM through an M&A, as Mike discussed before, we believe it can create more value to our shareholders.
Great. Thank you.
Your next question comes from the line of Christian Schwab from Craig-Hallum. Your line is open.
Hi, this is Tyler on for Christian. Congrats on the quarter, and thanks for letting me ask a couple of questions. First, your largest customer moving to 10 nanometer, as you spoke about, their timeline has been pretty well transparent. I was just wondering if you could remind us what the timeline for your business in relation to that customer's 10 nanometer products.
Sure. Thanks, Tyler. Well, as we've said about this node transition and the transition to 10 nanometer, historical comparisons have led us astray a couple of times. If I do rely on some of the historical node transitions we've been through as a four-generation supplier with this customer, typically, I'd expect us to lead their broad market launch of products by a quarter or two, maybe three. We see this, to put it a different way, as long as they stay on track with the late 2019 production release they've talked about publicly, we see this probably being a mid-2019 event where you'll start to see significant activity for us. Now, that's true more generally throughout much of our customer base. There are some projects in RF that have shorter cycle times or lead times between probe card delivery and customer shipment.
By and large, you'll see us, our business, leading our customer product releases by a quarter or two, sometimes three.
Great. A second one. On the memory side, the DRAM side, this quarter, your DRAM business was pretty stable. I believe you guys noted due largely to some new devices. I was just wondering, as we go into this next year and memory customers make the transition to this next node, what's the magnitude of that, or what's the expected magnitude of that at the DRAM business versus normal new devices on the current node?
Well, that's also a situation that's been pretty dynamic over 2018 and even over the last couple of years. It used to be, four or five years ago, that our business was purely driven by node transitions. As shrinks have gotten tougher, as node transitions have been drawn out, we've tried to draw people's attention to the fact that we also derive significant demand from new designs on existing nodes. Currently, there's an awful lot of our DRAM revenue that's supporting new designs on existing nodes. I think if we expect some of the node transitions to things like 1Y in the first part of 2019, maybe the first half of 2019, I think those will be events that probably cause a little bit of growth in our DRAM business off the fourth quarter levels.
Again, reminding you that we're seeing a little bit of weakness off the third quarter levels going to fourth quarter in our DRAM probe card demand. If we see those node transitions kick in, I think you could see it come back up to the Q2, Q3 levels.
Great. Thank you. That's all for me.
Thanks.
Your next question comes from the line of Craig Ellis from B. Riley FBR. Your line is open.
Thanks for taking the follow-up question. Mike, I just wanted to cycle back. You've touched a number of times in different comments on the automotive opportunity in mobility and advanced packaging. I just wanted to go back to the $130 million opportunity that you see longer term there. Can you just catch us up on where you think the company is in terms of harvesting some of the growth that exists in those three areas?
Sure. To get everybody on the same page, we've talked about these three components, advanced packaging, mobile data, and automotive, as essentially being the constituent growth drivers that get us to our target model, which delivers $650 million on the top line and $1.50 of non-GAAP earnings per share. As I break down the three of those, I think far and away, the leader from our perspective in executing against those opportunities is advanced packaging. Whether it be HBM in memory, which we've talked about previously and a little bit on this call, or integrated fan-out, which is one of the key drivers for our expanding foundry business at 10 and seven nanometer. Advanced packaging, we're probably two-thirds, three-quarters of the way there to achieving the opportunity that we laid out. We see more headroom beyond that with advanced packaging. This is a very exciting trend for us.
Mobility, with the pullback in handset growth over the past year or so, anybody who follows the industry knows that I think RF components growth has slowed a little bit. I think that's offset going forward, especially here in 2019, by some really exciting 5G projects. We're working now on first silicon with all the leaders in the industry as they build not just the filters, but the modems and some of the 5G unique beam steering silicon that's really going to be part of what gives 5G the inherent advantages. We're still probably early in our achievement of the incremental mobile demand. Automotive, I know there's been customers talking about the weakening of that market, continues to be pretty steady for us.
A business that's not growing as fast as the other two opportunities in advanced packaging and mobile data. We continue to see some solid performance out of that.
That's a real helpful summary. Shai, maybe I can just get your commentary. As we look at the target gross margin level of 46%, how can we think about bridging the gap between where we are today with gross margins around 43.5% up to another 250 basis points to 46%? If we broke that down into three or four buckets, how would we get from where we are now to 46%?
First, I want to remind you that in prior quarter, we reached 45.9%, right? Gross margin. That was a great indicator for us that we can reach that target model. One of the things that will impact improving our gross margin as a target model is, of course, the volume. At $650 million, we can achieve more leverage, and that will contribute to the increase. Mix, as I mentioned before, will continue to have a big impact on our business. Operational execution is also something that we focus a lot on improving yields in our factories.
We think we can also achieve more leverage by cost initiatives that we're taking with our company-wide initiatives, such as ERP integration, that we made a lot of progress this year and we're going to continue to invest in next year, plus specific BU initiatives, cost reductions in specific areas.
Thanks, guys.
Thanks, Craig.
I am showing no further questions at this time. I would now like to turn the conference back to Mike Slessor.
Great. Thank you everyone for joining today, and we'll talk to you again in the quarter.
This concludes today's conference call. You may now disconnect.