FormFactor Inc (FORM) 2004 Q2 法說會逐字稿

Good day everyone and welcome to the FormFactor second-quarter 2004 earnings conference call. This call is being webcast live on the investor relations page of FormFactor's website at www.formfactor.com. (OPERATOR INSTRUCTIONS) As a reminder, today's conference is being recorded. And now I would like to turn the conference over to Ms. Erica Mannion, Investor Relations for FormFactor. Please go ahead, ma'am.

Good afternoon everyone and thank you for joining us for FormFactor's 2004 second-quarter earnings conference call.

Shortly after market close today the Company put out a press release announcing its second-quarter and financial results. If you did not receive a copy of the press release, you can obtain one from the investor section of FormFactor's website at www.formfactor.com.

You may listen to an audio replay of this conference call by dialing 888-203-1112 and entering reservation number 754133. Also, a webcast replay will be available in approximately 2 hours on the investor section of the Company's website.

With me today is Igor Khandros, President and Chief Executive Officer, and Jens Meyerhoff, Chief Operating Officer and Chief Financial Officer. Igor Khandros will begin with an overview of the Company's achievements and progress during the second quarter of 2004. Jens Meyerhoff will provide you with details of the second-quarter financial results and financial guidance for the third quarter of 2004. We will then open the call up for questions.

The Company has allocated approximately 1 hour for today's call. During the Q&A period, as a courtesy to those individuals seeking to ask questions, we ask that participants limit themselves to one question and one follow-up.

Please note that details about revenues and bookings by market segment, as well as a regional breakdown of our revenues, can be obtained from the investor's section of FormFactor's website at www.formfactor.com. This information will remain available until July 27, 2004 at 9 PM Pacific Daylight Time.

During the third quarter of 2004 the Company will be presenting at the following conferences -- Pacific Crest Technology Forum in Vail, Colorado; and Banc of America Annual Investment Conference in San Francisco.

Now I would like to make a brief statement regarding forward-looking remarks that you may hear today on the call.

During the course of this call the Company will make projections or other comments that are forward-looking statements within the meaning of the Federal Securities Laws. These statements include a number of risks and uncertainties. In addition, statements regarding design wins and bookings should not be read as predictions or projections of future performance. These statements are based on current information and expectations that are inherently subject to change and involve a number of risks and uncertainties.

We caution you that actual events or results may differ materially from those in any forward-looking statements due to various factors, including but not limited to -- the demand for certain semiconductor devices; the rate at which semiconductor manufacturers make the transition to 110 and 90 nm technology nodes; the rate at which semiconductor manufacturers expand their 300 mm wafer manufacturing capacity; the performance and market acceptance of the Company's new products or technologies; the implementation of volume production of the Company's new products; the Company's ability to efficiently build-out and move into its new manufacturing facility; changes in semiconductor manufacturers' test strategies, equipment or processes; and the Company's relationships with customers and companies that manufacture semiconductor test equipment.

Additional information concerning factors that could cause actual events or results to differ materially from those in any forward-looking statement is contained in the Company's Form 10-Q for the period ending March 27, 2004 filed with the Securities and Exchange Commission, in subsequent SEC filings made by the Company, and in the Safe Harbor language in the earnings release sent out today. Copies of filings made by the Company with the SEC are available at the investor section of the Company's website.

The Company assumes no obligation to update any statement made during today's call or to revise any forward-looking statements or to update the reasons actual results could differ materially from those anticipated in forward-looking statements.

It is now my pleasure to introduce Igor Khandros, President and CEO of FormFactor. Igor?

Thank you Erica. Thank you for joining FormFactor's second-quarter 2004 earnings call.

The second quarter of 2004 continued the strength in our core markets. Our revenues were up 16 percent sequentially and 95 percent year-over-year. Our net income rose 32 percent sequentially to 6.8 million.

During the second quarter of 2004 we witnessed the continued strong momentum for high-parallelism Flash memory test products continued from the first quarter. The adoption of high-parallelism Flash for both NAND and NOR architecture is well underway with FormFactor's wafer (indiscernible) cards enabling the rollout of new high-parallelism tests and platform. The new customer wins during 2003 in the Flash memory market are now manifesting themselves in a significant product ramp.

Flash revenues increased from 4.2 million in the first quarter to 10.8 million in the second quarter of 2004. The sharp rise in demand for high-parallelism Flash wafer probe cards resulted in Flash memory bookings of 15.2 million, a 65.2 percent increase over Q1.

Another positive trend has been a growing rise in demand for Mobile RAM products. The increasing testing requirements for low-power modes of these Mobile DRAM devices leads to an increase of test time per bid (ph), and proportionally increased demand for our product units. Mobile RAMs also drive the initial adoption by the DRAM industry of wafer level final tests (ph). As the demand for fully tested unpackaged die, or known good die, is increasing as DRAM devices continue their push into digital consumer applications as a part in stacked packages. As a result, Mobile RAM bookings increased to 6.4 million in the second quarter, up from 4.2 million in the first quarter. Year-to-date FormFactor's Mobile RAM business has grown to 12 -- 13 fold to 12.6 million for the first half of 2004 versus the first half of 2003. We're excited about this trend, as it will continue to drive demand for our recently introduced S200 technology product, as well as wafer-level burn-in products for reliability testing.

In addition, our DRAM customers continue to execute on their major transitions of 110 nm technology, 512 Mb density, 300 mm capacity ramps, and DDR 2 in the second quarter of 2004. During this quarter we saw the following developments in our business -- 110 nm shipments decreased 9 percent sequentially over Q1; 110 nm related DRAM revenues accounted for 64 percent of our DRAM revenues in Q2 compared to 67 percent in Q1. We believe the 110 nm tooling cycle is now mature, which has been our guidance in prior calls. However, we are beginning to see not only first engineering designs at the 90 nm node, but also see some of our customers migrating to 100 nm sub-node.

DRAM revenues for sub-110 nm designs increased to 1.2 million in the second quarter, up from 389,000. More importantly, we saw a sharp rise in sub-10 nm bookings from 783,000 in the first quarter to 3.7 million in the second quarter of 2004.

512 Mb designs accounted for 7.3 million of our revenues during the second quarter, down from 9.7 million in the first quarter.

During the second quarter we saw the mix shift back to 256 Mb devices, which accounted for 12.2 million of our revenues in the second quarter, up from 9.7 million in the first quarter. This mix shift is extending into the third quarter, as indicated by 16 percent sequential increase in 256 Mb bookings during Q2.

The uncertainty in density mix facing DRAM manufacturers continues to create a favorable demand situation for us as the industry tools multiple density possibilities.

The bring-up of a new 300 mm wafer capacity is continuing and remains an important growth driver for us. 300 mm shipments during the second quarter of 2004 increased to 10.5 million and accounted for 38 percent of our DRAM product shipments, up from 34 percent in the first quarter of 2004.

DDR2 wafer product card shipments stayed essentially flat at 4.6 million compared to 4.8 million during the first quarter of 2004. After the very strong surge in our DDR2 bookings during the first quarter we saw a sequential decline in our DDR2 bookings. Bookings for DDR2 accounted for 4.7 in the second quarter, down from 8.1 million in the first quarter of 2004.

Consistent with our reports in prior calls, we expect this transition to gain momentum through the second half of 2004 as it relates to FormFactor's business. As we look at our current design pipeline, we see a significant increase in the design activity for DDR2 as the next wave of customers readies for this device ramp. But clearly the bulk of DDR2 tooling transition cycle is still ahead of us. Similar to my earlier comment on density transitions, a prolonged (indiscernible) of multiple architectures leads to the favorable increase in the number of designs as customers must prepare to cover potential transition scenarios.

Flipchip logic based revenue increased slightly to 4.2 million from 3.9 million sequentially. Flipchip bookings declined slightly from 4.6 million in Q1 to 4.3 million in Q2.

We moderated our intake of flipchip orders as under the current strong demand conditions our focus has been on fulfilling customer demand in situations where FormFactor is absolutely mission critical to our customers.

Looking back at the first half of 2004, we witnessed a clear growth trend for applications of our products for testing of consumer electronics bound (ph) semiconductors. Advances in technology and function integration have enabled an explosion of feature-rich species of consumer products. Power and small form factor are the two main challenges in mobile consumer electronics. High-density, low-power Mobile RAM and Flash memory chips are the main memory mass (ph) storage for these computing devices. On top of their contribution to the overall DRAM bid (ph) growth, the mobile RAMs require additional testing times related to their low-power features, driving an increase of (indiscernible) test time per memory bit, resulting in an increase in the relative required number of probe cards.

Flash devices are tested extensively at wafer sort as well. As a result, more than one-third of the total FormFactor bookings and revenue in the first half of 2004 came from products used in testing of consumer electronic chips.

Our growth in consumer electronic device testing is an important vehicle for diversification of our business among end-user markets with varying seasonalities and trends. Additionally, due to the small FormFactor constraints, chip stacking has become the device integration method of choice in mobile electronic devices. And the stacking of multiple chips in one package requires a known good die, driving the increasing trend for wafer-level final testing and wafer-level burn-ins for mobile RAM and for some Flash devices.

FormFactor booked 7.2 million in products related to wafer level final testing and burn-ins in the first half of 2004. We believe we're seeing an encouraging beginning of the longer-term trend of incremental migration of final package test to wafer level test -- the trend, which potentially increases significantly our served markets; a trend which is a strong potential engine of growth for our company for many years to come.

During the last quarter we made additional significant commitments to the long-term growth of FormFactor. We made a decision to create a separate R&D line to accelerate our innovation and to widen the scope of the new technology and product innovation. This R&D line will allow for better return on ideas, as new ideas and inventions will be evaluated without any conflict with existing production priorities.

FormFactor also decided to create a separate research group in addition to our engineering and development groups. This research group will focus on advanced technology and product innovation.

I will now hand the call over to Jens Meyerhoff, our COO and our current Chief Financial Officer, for a more detailed review of our operations and second quarter financial results.

Thank you Igor and good afternoon.

Before I review the results of another very strong quarter with you, I would like to briefly explain an accounting adjustment made to our deferred stock-based compensation expense.

As indicated in today's press release, FormFactor has changed the amortization schedule of its deferred stock-based compensation recorded in fiscal 2001 through the first quarter of 2004.

During our IPO in June of 2003, we recorded a total of $14.3 million in deferred stock-based compensation, commonly referred to as a chip stock charge (ph). The change relates to a limited number of our pre-IPO stock option grants, which we refer to as refresh options. The refresh options were designed as a tack on grant to employees' existing option vesting schedule with the purpose to ensure a consistent option compensation profile following full vesting of the original higher grant.

In connection with our IPO, we, in consultation with our independent auditors, determined to amortize $8.3 million of deferred stock based compensation relating to these refresh grants over the respective 12 months vesting period of each individual grant. During the second quarter of 2004 our independent auditors indicated that we should amortize deferred stock-based compensation relating to these refresh grants from the date of grant through the vesting period, rather than through the vesting period alone.

At the recommendation of our audit committee we discussed this highly technical matter with the Office of the Chief Accountant at the SEC and have confirmed that the $8.3 million of deferred stock-based compensation related to refresh grants should be amortized from the grant date through the final day of vesting rather than through the respective 12 month vesting period.

I would like to emphasize that the total amount of deferred stock-based compensation initially recorded remains unchanged, while the expense recognition increases in the years 2001 through 2004 and decreases in the years 2005 through 2007.

The effect of this non-cash adjustment to net income is as follows -- for fiscal 2001 net income declines by $205,000 or 1 cent per fully diluted share; for 2002 net income declines by $1 million or 3 cents per fully diluted share; for fiscal 2003 net income declines by $1 million or 3 cents per fully diluted share; and for the first quarter of 2004 net income declines by $73,000 with no EPS impact.

The income for 2004 projected is a decline of -- or an increase in stock based compensation of $430,000. Going forward, the impact assuming the current effective tax rate on net income will be favorable to the prior amortization method. Stock-based compensation tax affected will decline in 2005 by $793,000, in 2006 by 1.4 million, and in 2007 by $293,000.

We are required to reset our earnings and have filed today an amended 10-K for fiscal 2003, an amended 10-Q for the first quarter of 2004 reflecting the revised amortization schedule for deferred stock-based compensation. We have also published comparative schedules detailing the effect on our website.

Please note that the following review of our second-quarter financial performance reflects the changes I just discussed.

Revenues for the second quarter were $43.2 million, an increase of $6 million or 16 percent over the first quarter of 2004 and an increase of $21.1 million or 95 percent compared to the same period of last year.

Geographically we saw a slight shift in demand toward Asia-Pacific, especially Taiwan and Korea. However, Europe also showed demand strength. Revenue increased in all regions except Japan where we had seen strong demand growth in prior quarters.

We achieved record bookings of 51.2 million. We are encouraged by the continued strength in our second quarter bookings, especially in light of the stronger than projected bookings we realized in the first quarter. The ramp of our key Flash customers manifested itself in bookings of $15.2 million in the market segment, indicating continued strong market share gains.

Our unconstrained turns ratio declined from 50 percent in the first quarter to 35 percent in the second quarter as a logical response to the strong order surge during the first quarter and the continued order momentum experienced in the second quarter. Most orders booked during the second quarter converted to shippable backlog for the third and fourth quarter. This gives us higher visibility than we usually have at the beginning of a new quarter.

We're pleased with the incremental capacity ramp of $6 million in products shipped, the strongest experience in the Company's history. Our clear focus on capacity expansion and critical manufacturing areas and continuous yield improvement gave upside to our quarter.

We continue to make good hiring progress with 21 new manufacturing employees hired during the second quarter. But more importantly, the implementation of a worldwide training program aided by our service centers overseas provided us with an acceleration in our capacity ramp in critical manufacturing areas. Our current site team remains highly focused on continued execution of our capacity plans.

The build-out of our new factory is progressing on schedule. The factory has converted to cleanroom protocol and first equipment sets have been delivered and are being installed. We have begun to work closely with our customers on qualification plans while installing and qualifying equipment and processes.

Gross margins for the second quarter were 52.9 percent, up from 51 percent in the first quarter and up from 47.4 percent in the second quarter of 2003. The increase in gross margin during the second quarter came from increased revenues and significant manufacturing efficiencies achieved during the second quarter.

During the quarter we incurred $481,000 of nonrecurring expenses related to the new site bring-up. Excluding such expenses, we achieved an incremental gross margin performance of 67 percent during the second quarter, an indication of very strong gains in operational efficiencies and leverage.

Operating expenses were $11.9 million in the second quarter of 2004, up from 10.8 million in the first quarter of 2004. The increase is a result of increased personnel expenses and R&D, as well as increased SG&A spending for personnel related expenses and sales commissions driven by the increase in bookings and revenue.

Operating expenses excluding stock-based compensation as a percent of sales were 26 percent in the first quarter, a decline from 28 percent in the first quarter of 2004, as a result of higher revenues.

Operating income for the second quarter was 25.3 percent or $10.9 million, an increase of $2.7 million over the first quarter of 2004 and an increase of $9.4 million over the second quarter of 2003. Operating income for the second quarter included $721,000 for the revised amortization of deferred stock-based compensation.

Interest income for the quarter was $572,000, reflecting an average yield of 1.4 percent for primarily tax-exempt commercial paper.

Other income and expense was impacted unfavorably by losses from foreign currency exchange of $204,000 or $123,000 after taxes during the second quarter.

The tax rate for the second quarter was 39.8 percent, up from 38.5 percent in the first quarter of 2004 and up from 38.4 percent in the second quarter of 2003.

Net income for the quarter was 6.8 million or 17 cents per fully diluted share compared to 5.1 million or 13 cents per fully diluted share during Q1 of 2004 and $1 million or 3 cents per pro forma fully diluted share during the same period of 2003.

Please refer to our press release on the investor section of our website for a detailed presentation of our share count reflecting the recent follow-on offering, the IPO, and the conversation (ph) of our preferred stock and the reconciliation of the pro forma presentation to GAAP.

Cash and marketable securities decreased by $7.1 million during the second quarter as a result of the increased capital spending at our new production facility.

Cash flow from operations during the second quarter of 2004 was $8 million compared to a cash usage of $739,000 in the first quarter of 2004 and cash flow of $4.3 million during the same quarter of 2003.

We spent $15.2 million in capital expenditures during the second quarter against depreciation and amortization of 1.4 million, and received $727,000 from the issuance of stock driven by employee stock option exercises.

Our DSO increased to 60 days during the second quarter of 2004 compared to 52 days in the first quarter of 2004.

Net inventory increased by $861,000 during the second quarter as a result of the increase in demand and continued ramp of production.

Our guidance for the third quarter of 2004. We expect continued revenue growth for the third quarter. We target revenues of 48 to $50 million for the third quarter of 2004. We expect operating income in the range of 23 to 25 percent. We expect stock based compensation of $800,000 for the third quarter. And we expect to incur approximately 1 to $1.2 million of nonrecurring expenses relating to the new factory bring-up. We expect to incur approximately $250,000 of legal expenses in current litigation. We target earnings per share of 18 cents per fully diluted share.

With that, we will open now the call for questions. Operator?

(OPERATOR INSTRUCTIONS) Jim Covello, Goldman Sachs.

A question on the DRAM bookings and the Flash ramp. Obviously we saw a decline in the DRAM bookings; would we expect that to ramp back up in the second half of 2004? And then where are we in the Flash ramp? You've shown terrific traction in the Flash ramp, and can we expect that to continue or should we expect that to flatten out from here? Thanks.

Let me answer those two questions.

On the bookings side, as we indicated for DRAM, the significant tooling events we are seeing ahead of us are the DDR2 conversion obviously, which we expect to gain momentum in the second half and should drive demand. And as Igor mentioned in his remarks, we have a very strong design pipeline that gives us visibility into that. We also continue to see strength on the Mobile RAM, so I believe that's going to continue to drive business in the second half as well. So I think the outlook for DRAM remains consistent with what we talked about in prior quarters with continued strength through 2004.

With respect to Flash, I think what's very encouraging here is that we're seeing very strong traction on high-parallelism Flash in both NAND and NOR. And as you know, that continues to show a very strong bit growth. So here pure capacity continued to drive business. But for us it is really primarily market share gain as we are converting lower-parallelism business with a rollout of high-parallelism tester platform to our core business.

So I think as you look forward for Flash, I think we will continue to see strength, but the strength is going to be driven by individual tooling cycles and you see the bookings that we have see in the second quarter is one of those tooling ways.

That's very helpful, thanks. If I could sneak maybe just one more in. With respect to the semiconductor cycle, can you talk a little bit about the dynamics that are going to drive your business even maybe as unit growth or capacity expansion slows a little bit, if it is going to slow a little bit in the second half of this year and the first part of next year? Thanks.

I'm going to answer this question more broadly of how we participate in the cycle, while at this point in time we have no indications on our end of any weakness in the cycle.

So if you think about it, we do benefit from three significant growth drivers, one being technology transitions, one being capacity expansion, and the other one being any other design change as our architecture transitions, etc. So with that, we believe, and we have proven historically, that we have a lot of resilience in our business model.

An important aspect with respect to capacity to understand this, that while we are leading any cycle from a design and technology point of view, we're trailing capacity with respect to increased wafer starts. So all equipment orders that you see and that you have seen in prior quarters will result in additional wafer starts as we go well into 2005, which will produce transistors and bits that all need be validated and therefore probed.

So from that perspective, we're looking out and we believe that we have a very strong resilience independent of the cycle. And of course we have very significant tooling cycles in front of us as the DDR2 conversion. We talked about already what you see in sub-110 nm bookings which is very encouraging to us and starts to gain traction at some key customers. But also very importantly, the combination of both a continued transition to 300 mm where we have very strong market share and the long-term trend of the migration of final test and reliability test towards the wafer level will continue to fuel growth for FormFactor.

And if I may add, Jim, another trend that we're seeing is that with all these transitions that we're witnessing -- and we mentioned architecture transitions or density transitions -- coexistence of different options does drive surprising richness in customer designs. Customers increasingly differentiate themselves based on designs and we're increasingly becoming a design factory and that there are significant positive impacts in times of indecisions or times of transitions in our business. So all of these factors, in addition to what Jens so comprehensively described, we believe will drive positive trends for us.

That's very helpful. Thanks so much.

Ed White, Lehman Brothers.

Did I read you correctly; did it sound as though you were saying that you had limited the flipchip business primarily because of capacity constraints during the quarter? And if that's true, do you think that will get alleviated at some point with the new building coming online?

I think essentially what you stated reflects what you heard in our initial remarks. And the new factory -- so here you see we're acting very comparably to what we have done in the Flash side. In the Flash side we did limit the intake of low-parallelism business and seeded the market with our product for very strong penetration of high-parallelism product. We’ve continued to focus right now on mission-critical applications.

And with respect to flipchip logic we're looking forward to continued growth there. And the new factory is going to be a key enabler as we bring the new factory up. And as we reported to you in prior quarters, 2005 is the year for broad logic growth in both high-parallelism logic test, as well as known good die logic tests enabled by FormFactor's technology.

And then as a follow-on, as you look at the strong outlook ahead do you think more of that will be driven by Japan? Because as you had mentioned, they had been strong and then a little bit weaker in the last quarter. Do you see them coming back as you look at the rest of the year?

I think you will see growth in logic at customers worldwide. Basically you should list the industry leaders, and those are opportunities for growth in logic. I don't believe you will have necessarily a territory that is a focus for us.

I meant overall. If you look at your overall revenues, do you see more activity in Japan during the quarters ahead or do you think it's going to continue to be concentrated in the rest of Asia?

As you can see, we went through a very, very strong tooling cycle with one significant DRAM customer in Japan. And so that drove very, very accelerated growth. That same customer has probably announced a significant further expansion of the 300 mm facility. We're tightly partnered in that activity. But we're also seeing growth from the new customer wins that we reported in 2003, especially in the Flash memory market. So while I think we just put in the first quarter some explosive growth behind us, we see that Japan will remain a key contributor to our business.

Thank you.

Mark Fitzgerald, Banc of America Securities. Kevin Vassily.

Question. Agilent is introducing a combination Flash and DRAM tester, or what they call a configurable memory tester. Just wondering how you guys would view a successful adoption of that product with regard to its impact on your business.

I would respectfully ask you to probably talk to Agilent about their product as it puts us just in a very difficult position to comment on their product roll-out.

Let me ask it a slightly different way then. Is there anything favorable or unfavorable about a configurable platform, be it something that came from Agilent and someone from like Advantest or Ando? Does that help you, hurt you, neutral, etc.? Because I would imagine if they're successful you would see other people move that way as well.

I think new advanced platforms which are introduced by companies, excellent companies like Agilent or other industry leaders and testers, normally cater to our strength. They normally require very high-parallelism, they have new platforms, from all customers; will try to leverage higher frequency testing in the future. Any new platforms that require advanced probe cards, I believe that’s a positive event for our business.

Maybe I'd add to that. These platforms, while it gives the customer flexibility to switch lines between DRAM and Flash production, and that flexibility requires them to tool on the probe card side for both different design flavors, and that we've seen is definitely a favorable impact to our business.

Thank you.

Mark Bachman, Pacific Crest Securities.

Can you give us an update on the wafer level burning card? I believe that on your last call you stated that you had two beta customers out there and expected meaningful revenues by Q4. Are these plans still on schedule?

I think overall, as we reported in our initial remarks, the transition of full validation of devices at the wafer level is moving strong, particularly in DRAMs, but also in Flash devices. And in DRAMs we're seeing an increased demand for higher reliability application of known good die. So we are continuing to be very positive about continued adoption of burn-in at the wafer level and we're seeing increased interest in that product at other customers.

So you have more than those two beta customers then right now?

I say at this point in time we're discussing this with other customers, but we have not disclosed yet other adopters.

Any new 10 percent customers that you will report in your Q here next month?

I probably don't want to reach too far out here, because the Q is going to come out. Hold on for one second here. So there is probably not a significant enough swing that I would give you. There's some movement here. Maybe, yes, there's some movement here in North America where you see discloseable customers on the memory side and then also with respect to Europe.

Okay. Finally, factory costs. You only expensed about 500,000 this quarter; you were expecting to do about 900. Can you tell us what was going on there? And is kind of the extra 400,000 being rolled into the next quarter?

As a matter-of-fact, I believe that we probably will not have a complete roll-over of that $400,000 as the savings related probably to the timing of some hires in this area. However, as I reported to you, the project remains to be exactly on schedule, which means we utilized our existing workforce to continue to maintain the schedule, and you can take that money to the bank.

Has there been any significant bumps in the road over the last quarter for you with the new facility?

No. So far we're very encouraged with respect to the schedule conformance we have on the new site. As I mentioned to you, if you go into the new site right now you'll see equipment sets there that are being qualified as we speak.

Thank you very much.

Bill Lu, Piper Jaffray.

I had a couple of questions. One is going back to DDR2. We have heard from several sources about delays in Grantsdale, and also some of the PC makers are now rolling out PCs with DDR1 in Grantsdale PCs versus DDR2. These are certainly short-term issues, but are you're expecting DDR2 might be a smaller market than you anticipated previously over the long-term or is it just near-term?

I don't think there's any significant impact on the overall adoption of the DDR2 architecture. It is going to become a key differentiator as the speed of the memory bus increases, enabled by the chip sets that you referenced.

You're correct; there have been reports of some speed bumps. But what we see for our business, what is important is that our customers are tooling for this event because the event in itself is inevitable. And we're seeing I think a lot of customers talking probably around a 15 percent type bit shipment (ph) for DDR2 in the fourth quarter, but you also see reports from customers that they are tooling actually for the opportunity to potentially have higher bit shipments than that.

As I mentioned with respect, since we are part of the tooling cycle of this, is that these fine-tunings in the schedule of the DDR2 rollout as you're describing as little speed bumps really don't impact and haven't impacted our business.

Just to add to that and give you an idea, in the first half about 19 percent of our total DRAM bookings came from DDR2. And even today probably the shipment level, bit shipment is probably in the neighborhood of 5 percent. So we see customers, as Jens mentioned, tooling for this event, and the most encouraging news is that with the strong demand that we're seeing today the DDR2 tolling event is still largely ahead of us.

Thanks.

It is going to be a significant event we believe.

Thank you. That's a very thorough answer. One other question is that it seems like over the last couple of quarters you have been for the most part supply constrained, as you just talked about. You're going after more of the mission-critical applications. As you ramp up your new factory should I expect a different business model going forward, meaning that maybe you go after a broader part of the market and some of these applications that are not so mission-critical, and therefore maybe bigger revenues and lower margins? Or how should I think about that?

I think so far the strategy is we will obviously leverage this new facility. This new facility is the most significant investment ever made within the probe card industry, and we will leverage that facility. The facility will give us operating efficiencies, and therefore over time advance us in gross margins and profitability.

But the way we're going to continue to gauge end (ph) customers is by selling the product that significantly adds value, and not necessarily to try to compete head-on with, for example, a needle card. And as I mentioned, for example, we see a significant opportunity in logic for both high-parallelism tests of devices, as well as for known good die applications, especially in the foundry fabless constellation. And that is where very, very significant supply chain problems can be solved; where significant reduction in package costs can be achieved. And that's where we will apply our advanced technology and product in a total cost of ownership model.

Thank you.

Peter Wright, CIBC World Markets.

Congratulations on a good quarter. My first question for you, Jens, is looking at your new facility, I guess it's fair to assume that you are running at north of 100 percent utilization. I was hoping that you could quantify somehow the magnitude of the capacity ramp that we can expect from where you are now to where we might see you at the end of the year. And specifically what I'm looking at is the bookings, which have significantly outpaced your revenue level for the last two years; if maybe you could provide us with a backlog number as well. And then I have one follow-up.

I think the backlog number, I believe I’ve supplied all of our bookings and revenue numbers, so maybe you just do the math on that one. It is going to be a quick one for you I think. For the time being right now what we see in backlog is that we're well filled with respect to the outlook we have given you for the third quarter.

So with respect to capacity, so you see that we're solving problems as we continue to drive additional incremental capacity out of the existing site. So we do have a clear capacity plan in place for the remainder of the year, and it will be in the fourth quarter, as reported previously, where we will see first incremental revenue contribution of the new factory.

The new factory in itself is providing 2.5 times the clean room space that we have here at the existing site. So as toolsets get installed and as the line gets brought up, we will see a significant step function in capacity subject to how we man power the line as we go into 2005. And that will obviously be subject to the business climate. But it sets up a significant step function for us with respect to capacity and also operating efficiency.

I'm assuming on the backlog response that I can assume 0 cancellations, specifically in light of maybe lighter 110 DRAM demand than what we'd been expecting over the past 3 months?

I think so. Let me maybe throw a quick comment in. 110 nm is pretty much mainstream. So we have reached maturity, and that's very consistent I think with what I guided to in the first quarter with respect to the status of the tooling cycle. What's exciting is that we saw over $3 million in bookings of sub-110 nm. So here you see actually fairly quickly customers moving to nodes below 110 in memory.

And you had a second question, and I missed that.

Was there any noticeable cancellations in the quarter?

Cancellations? No, we have not seen any significant cancellations. As a matter-of-fact, we have actually never seen cancellations in our business really at any material event because we've got -- as you know, we're building a custom product. And that custom product is tied into a fairly stringent cancellation policy issued by the Company.

My second question is on the expansion of your R&D line. And I was wondering if strategically that's being positioned to expand your service revenue, and if you could comment maybe on your strategy there in light of your recent press announcement in conjunction with Credence. What is the current strategy on remaining vendor neutral versus supplying your customers with best-of-breed technology?

As far as R&D line goes, this is an important decision for us that sets aside a separate facility. And what we measure in our Company is we have a process called invention to market share. And we're very focused on reducing time from idea and invention to gaining market share. And we're creating -- in conjunction with that we're creating a research group, and we're building world-class mems (ph) capabilities that will ensure our leadership we believe for decades. We're building advanced electrical capabilities and product capabilities. So all of that will be fueled by this R&D line, and what we expect to see is an increased amount of innovation and reduced time from innovations to market share.

As far as our position with respect to new tester platforms, we, as you know, support all significant tester platforms. We build a fully custom product which on one side will interface with any tester platform, and on the other side of course interfaces with every custom customer design. We do not presume to pass our judgment on what is best-of-breed. That's up to customers really to decide what fits them better.

Thank you very much.

Tim Schultz (ph), Morgan Stanley.

Just two questions, if I may; the first with regard to your expansion. Could you just give us a sense as to how many open racks (ph) you still have for headcount additions and what your headcount was at the end of the quarter? And then I have a follow-up.

We never thought of this call as a tool for hiring processes.

The headcount at the end of the quarter was 477.

And so at this point in time I think I'm going to answer the second question. If you look at total open racks since we're going through a regular process of organizational review and development, we usually float actually a sizable amount of racks as a company. But at this point in time I think the key hires we're focusing on you're talking probably between 50 and 60 key hires.

And the second question was talking about the new facility coming online at the end of the year. You also mentioned that you are getting improved visibility on your revenues. So can you just give us a sense as to where we should expect capacity utilization to be out at the end of '04 going into '05?

I think I probably would like to address this when we go through our third-quarter earnings call and we have a little bit better visibility on that.

Fair enough. Thanks.

Stephen Rawlston (ph), Glen Capital Management (ph).

A couple of questions. First of all, can you talk a little bit more about your plans as you have been able to squeeze some capacity out of your existing factory; how you're going to shift over to the new factory, duplicate processes and then move to the new factory independently, just update us on your thinking there?

Certainly. Remember in the last call I talked a little bit about this so I'm glad to give you an update. We fundamentally have established two teams -- one engineering team that's supported now also by technicians as we start to do our unit processing for the new factory; then of course we have our core team, that deals with the production in the existing factory. So the two organizations on that perspective are clearly divided headcount wise. So we're trying to avoid double duty in these areas. And each team hires individually its resources. So that allows you from a manpower point of view at this stage independent operation. While we're running product at our existing site we have an independent team qualifying the toolsets, bringing up the toolset and then fingerprinting, qualifying the process at the new site.

And then as we go to customer qualification and we're starting to ramp individual customers, we are right now set up in a four shift structure which allows us a certain level of modularity with respect to the manpower where we can start to move individual teams with respect to different shifts over into the new facility in order to ramp the capacity.

The toolsets are fully redundant. So part of the capital expansion is that we have fully redundant toolsets that allows a dual operation at both facilities.

Did that answer your question?

Mostly. Can you talk -- as you’ve been able to squeeze more efficiency also in the face of more demand from your current facility, in terms of the timing of the movement of certain processes and production to the new facility I think what you're saying is you're on your plan, even though you're actually shipping more product than you might have thought previously.

That is correct. Overall with respect to the new site bring-up, I think we are right on plan, yes.

With respect to the additional capacity we're delivering out of the new site, one thing is this training program I referred to which related to we did hire people starting in the first quarter in one key area -- that area and skill are very specific to FormFactor. And we actually developed and deployed a worldwide concerted training effort for that skill set that allowed us to pretty much solve the bottleneck in that area to move forward. And in addition to that, we're gaining efficiencies as we move forward also from yield improvement efforts.

That answers that question. Igor, could you talk a little bit about the new R&D arm that you spoke a little bit about and talk about what your quantifiable objectives are over the next one to two years are for that group?

So I think one to two years would be really too much of a granularity for me to comment on. Basically what it will do is it will fuel both existing businesses and it will fuel our future efforts to bring out new product lines. And so that is what research group will do, which is independent from the development group and engineering groups which are within the COO (ph) organization.

What will enable this group and will also enable the existing organization is the R&D line where now you can have an idea or you could have a modification to a process and you can go and execute on trying it out and bring it to fruition without any conflict with production facility. Or if you would like to try different methods, you do not need to go back to change the process in the production facility. So this is very, very key to our future. And it pretty much is put together and designed to fuel our growth for many, many years to come, including the next two years. So having this capability and putting online new manufacturing facility next year, those are two strategic moves that we're making to grow our business in the future.

Will that report to you? And how many people do you plan on having in that group?

We're beginning to build that group. The group will report into the CTO who reports directly to me, yes.

Thank you.

Jim Covello.

Just a couple quick modeling questions. I believe the 18 cent EPS guidance that you gave includes extraordinary items, is that right?

Yes, that as in prior quarters is a GAAP number.

Right. Thank you. And then some guidance on the tax rate going forward?

So you see right now we're running for the year the provision has stayed at the 39.3 percent tax rate.

So we should just use that for modeling purposes going forward?

Yes.

Okay, and then final question. Some guidance on the extraordinary items going forward. Should we expect about that 1.4, 1.5 million level for a couple of quarters?

I think we have a slide on that in our corporate overview, so that has not fundamentally changed. We're guiding you to 1.2, but we still expect to hit a run rate up probably 1.4, 1.5 as we go into the final transitions.

Does that -- the 1.4, 1.5 -- include or exclude the legal expense?

That excludes; that's strictly new site related.

And then the legal expenses, should we assume that that persists for a couple of quarters also?

As you know, these processes take some time so quarter-by-quarter we will update you on this. But yes, it will extend beyond the third quarter.

And then final question. Update on the CFO search?

We kicked off. As we reported to you in last call, we kicked off the search. We went ahead and hired a search firm after a thorough process of evaluating several firms. And we have seen first candidates and we're going through the rigorous process that includes management team members and our Board members. And we will be very much focused to find great success at the end.

It won't be easy. Thanks a lot.

Mark Bachman, Pacific Crest Securities.

All three of my questions were just answered. Thank you.

That would conclude our question and answer session. I would like to turn the conference back to our speakers for any additional or closing comments.

Thank you very much everybody as usually for joining us on this earnings call. We really appreciate your continuing interest in FormFactor and hope to talk to all of you on the next call. Thank you.

Thank you for your participation on today's conference call. You may disconnect at this time.