FormFactor Inc (FORM) 2005 Q2 法說會逐字稿

Good day everyone and welcome to the FormFactor second-quarter 2005 earnings conference call. Today's call is being recorded. At this time for opening remarks and introductions, I'd like to turn the call over to Annie Leschin.

Thank you. Good afternoon and thank you for joining FormFactor's second-quarter 2005 earnings conference call. With me on today's call are Igor Khandros, Chief Executive Officer; Joe Bronson, President and Ron Foster, Chief Financial officer. Joe will provide a summary of our second quarter performance and then review the status of the marketplace, the update on the new factory transition, highlight new product announcements and review our corporate priorities. Ron will then go through our financials in more detail and provide guidance.

Please note that the details of the Company's revenues and bookings by market segment, as well as the regional breakdown of its revenues, can be found in the investor section of FormFactor's web site at www.FormFactor.com.

I would like to take a moment to mention that during the third quarter of 2005, the Company will be presenting at the following conference -- Pacific Crest 2005 Technology Forum in Vail, Colorado on August 8. As other events occur, we will make additional announcements.

Finally before I hand the call over to Joe, I will review our Safe Harbor. During the course of this conference call, we may make projections within the meaning of the federal securities laws, including statements regarding FormFactor's growth and financial performance as well as our strategic and operational plans. These forward-looking statements are based on current information and expectations are inherently subject to change.

Actual results may differ materially and adversely to those in our forward-looking statements due to various factors including but not limited to the rate at which customers adopt the Company's newly released architecture; the technologies of the product; the extent to which chip manufactures modify announced capital equipment expenditures and device roadmaps and the Company's ability to efficiently complete the transition into its new manufacturing facility.

Please refer to the Company's recent filings on Form 10-K and 10-Q for more detailed discussions of the relevant risks and uncertainties. FormFactor undertakes no obligation to review or update any forward-looking statements or update the reasons. Actual results could differ materially from those anticipated in the forward-looking statement. I would now like to turn the call over to Joe Bronson.

Thanks, Annie. Welcome everyone and thanks for joining us today. During the second quarter, demand for our products continued to be robust with significant strength in design activity, advanced nodes, 300 millimeter capacity buys and a continuing shift to consumer applications for Flash and mobile RAM. In aggregate, these factors translate into increased demand for FormFactor products.

Our customers reacted to market changes and ordered additional probe cards as a production methodology of adjusting their test capacity quickly and at lower cost. Every change in a customer's chip design requires a probe card change. Internally, we continue to focus our efforts on transitioning to our new factory while striving to meet our customers' delivery needs for products which are getting increasingly more complex.

As we mentioned in last quarter's call, the name of the game for the next couple quarters is execution. Execution is supplying our customers with on-time deliveries, meeting advanced technology requirements, implementing new production designs and qualifying and shipping production from our new factory.

With that said, we achieved record revenues in bookings for the quarter at 52.3 million in revenue and 58 million in bookings. The expected challenges in the new factory transition and increased demand for products with higher complexity distressed our manufacturing capability which translated into design challenges and some factory inefficiencies. Gross margins were within the expected range at 41.6 and fully diluted GAAP PPS came in at $0.12.

Overall, we were pleased with the Company's performance and we continue to focus on putting in place the infrastructure, systems and processes to support a much larger enterprise. I would like to give your an update of the status of the new factory. During the quarter, we were on track with our production schedule, having produced about 15% of our total capacity from the site. As we move to the final stages of readying our new facility for volume production, the majority of our current revenue is still coming from the old factory. Our first priority continues to be meeting our customers' needs and as such, we will adjust production as necessary between the old and the new factories to meet that demand. We continue to move machines and people to the new facility and transfer existing process technology. The new factory is now capable of completing 100% of all probe card assembly and test operations.

We must also complete proven and certain qualification and debugging of new equipment. Customer qualifications in the new site are mostly complete and the site is qualified for revenue production as we shipped our first revenue probe cards during the quarter. Revenue production probe cards are now shipping from the new site.

We expect to experience some learning curve and other inefficiencies near-term, but our focus will continue to be meeting our customers' delivery requirements and ensuring that all process and equipment qualifications are stable before production is fully ramped.

On an ongoing basis, we're working diligently to reduce lead times and total cycle times by making infrastructure investments in the form of highly skilled labor and changes in production line processes. We've begun to see the fruits of our labor in our pipeline of recently announced new products which are addressing the advanced requirements of our customers in the sub-790 nanometer area. We expect these efforts to be reflected in the increased customer activity.

We continue to improve and advance our proprietary manufacturing processes which allow us to continuously introduce larger active area and finer geometry products and improve manufacturing yields.

Against the generally negative outlook for semiconductor capital equipment, FormFactor's demand remains strong. Our unique, resilient business model and leading technology positions us as mission-critical to our customers. Thus, we can benefit during the peaks as well as the trials of the semiconductor cycle. Our products simply reduce the cost of test, provide required capacity and process design bandwidth to enable our customers' production on their test floor day in and day out.

As I indicated, our business continued to be robust with record bookings and revenue achieved in the second quarter. We believe that our overall addressable market is growing faster than industry predictions for the probe card market and we continue to expand our share of this market as confirmed by third-party market research. We are setting the standard for the highest level of technology provided for the semiconductor test industry. Virtually all memory market segments showed strong Q2 orders with our Flash business increasing over 100% sequentially.

Our logic bookings were down sequentially, reflecting the flip-chip requirements of our largest microprocessor customer. We continued to see strength across our markets during the second quarter, particularly Flash, mobile RAM and logic. As we highlighted last quarter, the diversification of the DRAM market into consumer electronics-related areas will continue to benefit FormFactor. Mobile RAM was exceptionally strong in Q2 with revenues and bookings climbing substantially. With a combination of increased sales of portable consumer electronics such as 3G phones, the price premiums that mobile RAM commands and the entrance of major DRAM players to this market, we expect mobile RAM to remain an area of growth going forward.

In addition, low-power requirements, test times and the benefits of determining known good die (ph) before packaging plays strongly to our core capabilities in this consumer market segment.

The first of our three major areas of opportunity is the architectural transitions, such as DVR 2. DVR 2 had a slower quarter due to customer-specific tooling cycles. We also saw customers shift capacity to mobile RAM, Flash and DDR from which we also benefited. Although our DDR2 revenue declined sequentially, the transition to DDR2 continues and we believe the opportunity has simply shifted to the second half of '05. As the market leader in this segment, we expect to be the main beneficiary of the continued DDR2 tooling cycle.

Technology transitions are the second of the three areas of opportunity to drive FormFactor's business at different points in the product cycle. Each time a technological transition occurs, companies most retool their manufacturing facilities. The vast majority of our DRAM revenue, 96%, now comes from 110 nanometer or below products. With the next transition well underway, nearly 60% of our Q2 DRAM revenue was derived from 90 nanometer or below and Q2 shipments from 90 nanometer designs grew 27% sequentially.

The next technology evolution to below 90 nanometer is currently underway. We already have sub-70 nanometer designs in-house. There are initial indications that some customers may make an interim step from 90 nanometer to 80 nanometer as was done from 110 to 100. This development would be beneficial to FormFactor as any technological transition will require new sets of probe cards and represent a completely new tooling cycle.

Another pillar that supports FormFactor's business at different points in the tooling cycle is capacity expansion. The buildout of 300 millimeter facilities by major memory manufacturers continued in DRAM and Flash as even those with traditionally lower CapEx have joined the trend. Most are on schedule to be completed by late 2005, early 2006. FormFactor is already benefiting as some test equipment has already been ordered and our 300 millimeter shipments and bookings continue to grow in the quarter, overtaking 200 millimeter. As the market continues to make this transition, we expect to benefit from the buildout for the foreseeable future.

As we predicted heading into the quarter, our Flash revenues grew significantly, up nearly 60% sequentially as customers' requirements for higher parallelism increased. Unlike last quarter, nor (ph) Flash contributed the majority of our flash revenue. Demand also grew largely due to new design wins and the continuing acceptance of our newly announced NF150S product. The overall market for Flash remains strong as the increase in consumer applications, such as digital still cameras, 3G phones, MP3 players and USB Flash drives propels the segment. It is our belief that customers continue to select our products due to their high-performance, superior reliability, resulting in increased yields and decreased cost of test.

As we highlighted last quarter, a key part of our strategy is to broaden our product line beyond DRAM. Thus, the logic market was a key area of focus during the quarter. We made great strides this quarter with a nearly 50% uptick in our logic revenue. We also announced our leading-edge Blade Runner 175 multi (indiscernible) product for the logic segment this quarter which dramatically increases system on a chip flip-chip test throughput and lowers the cost of test. Confirming the superior value, we have also announced another milestone, having shipped our 500th Blade Runner 175 single and multitude DUT products, confirming the superior value the product delivers by strong customer acceptance in this market.

In Q2, we have achieved a number of significant design wins with our Blade Runner Single and multi-DUT products, making important inroads into games and graphics applications. We expect to see strength in our logic business during the second half of '05.

The consumer market is driving wafer sales and system and packaged applications and as a result, more customers are optimizing their back end to meet the new required level of validation on the wafer. FormFactor's wafer-level burn-in and HF Tab (ph) products are critical to achieve these requirements. Wafer-level burn-in represents the first leg in this demand. We expect to continue growth of wafer-level burn-in probe cards to continue into the second half followed by HF Tab products which will increase when the performance requirements surpass the capabilities of our standard products and demand the use of our high-speed electrical probing.

As announced in the press release this morning, we will be significantly increasing our presence in Taiwan by opening a new sales service and design center. From this center, we will now be selling FormFactor products directly to the Taiwanese market. This is a part of FormFactor becoming a global company with significant investment to support our customers in our local markets. Spirox (ph), who has been handling our distribution in Taiwan, will now focus exclusively on selling our products in China and Singapore.

As we look ahead to the second half of '05, our main goals continue to be effectively managing the new factory transition in order to expand our capacity, focus on operational execution, expand our product portfolio and improve the timely delivery of new products to customers. Our recently announced Harmony architecture and multi-DUT products will be important to maintaining and extending our leadership as we work to deliver lower cost of testing across all of our markets.

Overall, I believe the outlook for FormFactor is strong as market demand for our products continues across all segments as evidenced by our strong bookings and design backlog.

We are also excited by our penetration and new product potential in logic. Our priority remains ramping our capacity so we can deliver the industry-leading products and meet our customers' requirements.

Finally, as announced earlier in the week, Hans Mierhoff (ph), Chief Operating Officer, decided to leave the Company. We want to thank Hans for his dedicated efforts to FormFactor and wish him well on his future endeavors. I would also like to thank our employees for their hard work and dedication in making this a successful quarter. I'm now going to turn the call over to Ron Foster, our CFO, who will provide second quarter results analysis and our guidance for the third quarter. Ron?

Thanks, Joe. Now we'd like to highlight the financials for the quarter and provide a few more details.

Revenues for the quarter were 52.3 million, an increase of 1.4 million or 3% over the first quarter and an increase of 9.2 million, or 21% compared to the same period last year. From a geographic perspective, we saw strength across most regions, especially North America and Japan. As Joe mentioned, DRAM revenues were down 7% from the first quarter.

Although there are quarter-to-quarter fluctuations, we continue to see solid demand for both DDR and DDR2 probe cards. As mentioned last quarter, some customers are moving to 90 nanometer DDR before making the full transition to DDR2. Each of these moves result in more probe card sales for FormFactor.

Meanwhile, Flash revenue climbed 58% versus the first quarter as the Nor (ph) market returned and we continue to penetrate the Nan (ph) market. Revenues from wafer-level burn-in products also grew moderately in the quarter, up 8% sequentially. A breakdown of revenues by market segment and geography is available on the Web site.

Second-quarter bookings grew to record levels of 58 million, up 14% over Q1 and 13% over the same period last year. Orders were the strongest in Japan and North America. Bookings rose in every segment except logic, which as Joe mentioned, was primarily a timing issues and the logic bookings declined 20% from Q1. We expect our bookings business to be strong in the second half of '05.

Our strength in Flash was apparent as bookings rose 113% sequentially due to a very strong Nor increase, though Nan grew was well. DRAM bookings increased moderately, up 7% from Q1, driven largely by an increase in mobile RAM.

Our turns ratio based on customer demand was 49% for the quarter, below last quarter's 53%. Q2 bookings, which were especially strong in the last month of the quarter, resulted in lower turns than our normal expected range of 50 to 55%. Backlog grew substantially on the strong bookings, somewhat above our standard six to eight weeks.

GAAP gross margins for the second quarter were 41.6%, including all of the factory startup costs, down from 43.4% in the first quarter and 52.9% in the second quarter of 2004.

As we proceeded with the transition to the new site during Q2 and into Q3, we have elected to scale up key equipment sets and manufacturing expertise ahead of volume needs in order to reduce transition risk and be in a better position for the next stage of volume growth. We also accelerated the introduction of certain new product technologies that are generating earlier than anticipated interest from our customers. The effect of these changes is somewhat higher term -- higher near-term costs in manufacturing and more leverage to move to higher revenue levels in the next several quarters.

Second quarter startup costs were 4.7 million, $365,000 over the first quarter. Gross margins net of new factory startup costs were 50.7%, down from 52% in the first quarter. Now based on our conversation with analysts and investors, it appears that the theoretical new factory transition model on our website has caused more confusion than clarity. As such going forward, we feel it would be more helpful to update you periodically on our progress rather than continue to republish the model. That being said, we're confident that we will achieve the long-term business model targets, including our new factory once the transition is complete and the factory is loaded. Thus, we continue to predict sustainable gross margins in the 53 to 55% range. We now expect to continue some level of factory transition into the fourth quarter to meet customer requirements.

Operating expenses for the quarter were 15.5 million, about flat with Q1. Legal and compliance costs were 1.6 million as we continued with our ongoing litigation of Sarbanes-Oxley compliance work. Operating expenses, excluding stock-based compensation of $750,000 as a percentage of revenue, were 28.5% in the quarter, down from 29.2% in the first quarter. SG&A expenditures increased slightly in absolute dollars.

Operating income for the quarter came in at 6.3 million or 12% of revenue, in-line with guidance, down 400,000 or 6% versus the first quarter. Interest and other income and expense for the quarter was $868,000, reflecting an average yield of greater than 2% on primarily tax-exempt investments.

The fiscal 2005 tax rate was revised downward to 32.5% as increased tax-exempt interest income, higher pretax income forecasts and greater utilization of export tax credits improved the rate from the previous 35%. The Q2 tax rate was reduced to 29% to bring the first half tax expense in line with the revised projection.

Net income for the quarter was 5 million, or $0.12 per diluted share versus 4.9 million, or $0.12 per fully diluted share during the first quarter and 6.8 million or $0.17 per fully diluted share during the same period of 2004. Earnings per share in the first and second quarters of 2005 included a decrease of $0.07 and $0.08 per share, respectively, for new factory startup costs.

Cash and marketable securities were $195.5 million in the second quarter, up 3.8 million from the last quarter. DSO's were 46 days during the second quarter versus 44 days in the first quarter as a higher proportion of Q2 shipments occurred in the last month. Net inventories increased by $2.4 million during the quarter to 12.8 million as incremental material was purchased for some customer deliveries that were not shipped in the quarter.

Cash flow generated from operations during the second quarter was 11.8 million, an increase of 13.7 million compared to the first quarter and a 3.7 million increase over the same quarter of 2004.

During the second quarter, we spent 9.5 million in capital expenditures on a cash basis, up from 2.6 million in the first quarter. The majority was spent on equipment for the new factory. 1.4 million was received from issuance of stock associated with the exercise of employee stock options, down from 3.1 million in the first quarter.

Headcount continued to increase, reaching 704, up from 616 in the first quarter. More than two-thirds of the headcount increase related to incremental manufacturing resources.

With this, let me give you the guidance for the third quarter of 2005. We experienced demand across a broad range of product areas and our outlook for Q3 remains strong. We expect revenues for the third quarter to be 54 million to 59 million. GAAP operating income is expected to be approximately 11 to 14%, including 5 to 6% of new factory startup costs.

As previously mentioned, this guidance reflects somewhat higher costs related to accelerated purchases of equipment and manufacturing resources to position for future growth and to reduce transition risk. We expect stock-based compensation of $800,000 for the third quarter.

This guidance does not include any cost of a pending separation agreement which will be communicated subsequently in an SEC filing. This guidance does include a few hundred thousand dollars of startup costs related to our Taiwan expansion. We expect incremental revenues associated with the direct sales in Taiwan to begin in the first quarter of 2005.

We target GAAP earnings per share of $0.12 to $0.14 per fully diluted share, including new factory startup costs of about 3 million, or about $0.05 per share. With that, let's open the call for questions. Operator?

(Operator Instructions) Jim Covello, Goldman Sachs.

Good afternoon guys, thanks so much. Quick question -- can you give a little bit of incremental granularity on what it is we're talking about when we're talking about increased costs now to ensure a smoother transition to the new facility? Can we get a little more granular on that? Thanks.

Jim, the costs that we're including in factory startup, I think we can categorize them as customer qualification costs, as equipment qualification costs, classes characterization cost, cost of training, employees and what I would call redundant capacity. And I think the thing that we're trying to ensure is that this factory comes up and comes up well.

So we have added more redundant capacity than was originally envisioned in the startup for various types of applications in our wafer fab and some of the other what I would consider to be very important manufacturing processes. What will happen is that these costs, some of these costs will go away, but as equipment becomes qualified, it will then be translated into an operating cost and then that will become part of the operations of the Company. So that is going to drop over time, but we have added more cost in the short-term to deal with this situation.

Bill Lu, Piper Jaffray.

Hi there. Just a clarification here. If I look at your guidance for the second quarter, is that still capacity constrained, or is that the real demand -- for the third quarter, I'm sorry?

I would characterize it as still capacity constrained.

Peter Wright, CIBC World Markets.

I have a couple of questions. First one on the Asian distributor agreement, I was wondering if you could help us understand the impact that this might have to margin selling direct as opposed through a distributor in Taiwan. And I guess there is some concern that that might create an inventory build, but it seems fairly illogical to me that that would be the situation if you're still capacity-constrained, you'd be able to move that capacity elsewhere. If you could just explain through what dynamic that is playing in the market in Taiwan, that would be great, then I have one follow-up.

Yes Peter, this is Ron. In terms of the Asian distribution arrangement, we are now going direct as we mentioned. So what that means is we will be incurring some incremental costs. I mentioned that there is some amount that is actually in the Q3 guidance as we're ramping up the capabilities to distribute directly in Taiwan. And then in the fourth quarter, we would expect to see some incremental revenue related with the direct selling associated with that business activity.

So structurally, we will have revenue up and costs up some as well. That would show both on the revenue line and on -- more on the operating expense line.

I meant more on the longer-term -- is it a favorable impact to margins?

I would expect there to be a favorable impact.

Great. And then on the inventory side?

On the inventory, if you're talking about our production inventory, we ship directly to customers today. So that would not change inventory at all.

Stuart Muter, RBC Capital Markets.

Thank you, good afternoon. A couple of questions. One, in terms of logic where you're gaining traction, could you talk a little bit about what kind of logic products you're gaining traction with? And second on the DDR2 transition, could you talk a little bit about what you guys believe has caused that transition to come a little bit slower than generally expected? Thanks.

This is Igor. On logic, we did have significant design wins during Q2, and those were in the game-related and graphics-related applications. And as both Joe and Ron mentioned, we do anticipate to see positive impact on our logic revenue in the second half.

On the DDR2, it does look like this parity for DDR2 is moving from Q3 to Q4. That's what I think consensus is evolving in the industry. For us, we are seeing very, very strong demand and the fact that a large portion of DDR2 transition is still ahead of us. It is a very positive, I think, thing for FormFactor, which means that there is positive demand ahead of us.

I think what is causing it is that it's supply-demand in DRAM is such that customers now are seeing pretty good pricing on DDR and some customers are taking advantage of it. And what customers are doing to do that, they are buying full suites of probe cards to cover each option. And they are doing it with DDR1, DDR2 and they're doing it in some cases switching production from DDR to Flash or back. And that also has been and we expect to be a very positive factor in driving our business growth because people just carry more suites of probe card again to cover each potential option.

So those are basically the reasons. There are some customers as Ron mentioned chose to ramp on 90 nanometer DDR1, which is something they know and then go to DDR2 and maybe that had impact with supply. But that would be inconsistent with very strong (ph) pricing on DDR. So I think it's just supply-demand for different architectures.

Murali Abburi, J.P. Morgan.

Thanks for taking my call. If I look at your revenue opportunities going forward in kind of three buckets -- Nan, Flash, wafer (indiscernible) burn-in and logic -- could you rank for us which of those three represent the biggest growth opportunities over the next maybe year or so?

I think all of them represent growth opportunities for us, and I think, as you have seen in the first two quarters of this year, wafer-level burn-in has been growing for us and we see that trend to continue. What customers are doing is as they are implementing (indiscernible) die flows where they are forced to do all testing on the wafer for some applications, such as (indiscernible) systems in a package; they are finding additional advantages from doing more and more testing on the wafer for faster cycles of learning, better feedback into front-end end that a management of supply chain downstream. And that is, will continue to drive wafer-level burn-in, probe card demand and later, high-frequency probe card demand that may not even be related to normal (ph) die testing. So we see this as an important opportunity.

Logic is beginning to take advantage from multi-DUT testing. FormFactor entered memory business because our compelling value proposition was to increase testing parallelism. And we are seeing that exciting trend now in logic where customers do have test to (ph) platforms to conduct testing of many logic devices in parallel. And we just announced BR 175 (ph) new product, that is multi-DUT, and we see that driving our business. And we see Nan Flash in the future also being a positive market for us. Our behavior in the market right now is very much driven by constrained supply and us directing this supply towards applications where we are mission-critical to customers.

Mark Bachman, Pacific Crest Securities.

Hi, Joe. With regard to the new factory, did I hear you correctly that you said that you can now produce 100% of a probe-card order out of your new facility?

No, we are -- what I said in the script is that we are assembly and test 100% is all out of the new facility. We still have wafer lines in both facilities. We have a new wafer lines in the new and the old in the old, and then there are certain pieces of equipment that are going to be too risky to move from the old to the new. So we're going to keep those there and we're ordering new equipment for the new. It's that kind of situation.

So if you take all of the, what we would call the value-added of production, we believe by the end of the quarter, we will be close to the 75% level out of the new factory.

Mehdi Hosseini, FBR.

Yes, Joe, I have a couple of questions. First, this is the second quarter in a row that we are seeing unexpected cost associated with ramp of the new facility. Help us understand what gives you confidence that this unexpected cost that is putting pressure on gross margin are behind us and as we execute forward, we should see a better acceleration in gross margin.

My second question has to do with mobile RAM. Would you be able to offer us the mix of mobile RAM as total DRAM so we could better understand opportunities there? And third more of a housekeeping, if you could provide CapEx expectation for the second half? Thank you.

Igor will take the second one and Ron will take the last one.

I would not characterize these costs as unexpected at all. I think it is extremely critical for this company to get this transition right, because if we get it wrong or it becomes a real problem, it adds very, very serious consequences in our customer base. So we have decided that the first thing -- the customer comes first and we have to solve -- gets the cards to the customers on time. The only thing the customer has is time and if we miss our deliveries, our timely deliveries, we're not only penalized the present, but we will penalize the future.

This is also a very -- it's hard to characterize. This is not like building tools where you just put material -- you get materials for suppliers and put them together. There are a significant processes going on. I'm not saying that we're unique in that, but we do have a wafer fab which is actually running pretty well, but we have a lot of process steps and everyone of these cards is a custom design. So we have to be extremely diligent about redundancy and ensuring that the new factory comes up according to snuff. We have so many new products coming out that the other thing that has changed is the mix of large areas arrays from say last year to this year is almost doubled, not quite doubled. But it has increased the complexity.

We are also, for example for the major DRAM customers, we brag and talk a lot about these transitions and tooling cycles; we are -- this is very interesting and difficult design work that no one else in the world seems to be able to do. So to use the word unexpected, I would not characterize it that way. I would characterize it as risk mitigation. And I think we're going to do what we think is the right thing to ensure that that happens. And that is going to be more important than one or two margin points down the road. So I will let Igor answer the question on mobile RAM.

So mobile RAM is a fascinating -- it's a pretty good market for us. So this year, it's somewhere in high-double digits as an overall portion of DRAMS, I think I had to go between the project between 8 and 9% and next year, it will get to double-digits probably. And mobile DRAMs are going basically into something like 3G phones, cellphones, PDAs, or similar devices.

Now as it relates to FormFactor business, the impact in our business is a more positive than just say 8% in terms of (indiscernible) 8% of overall business. The reason being that mobile DRAM requires significantly longer test, which means it requires more probe cards for a design or more probe cards per bit (ph) tested.

There are very sensitive refresh cycles that are being tested there for which you need a probe card with high signal integrity. They have more (indiscernible) in some cases for a device, so it drives really complexity and drives electrical demand on probe cards and drives up the number of probe cards.

Additional point here is that many mobile DRAM designs now generate not one but two products for us -- a sort (ph) probe card product (indiscernible). And as I mentioned, you need more of them because of longer test times and it now in many cases drives wafer-level burn-in probe cards. And in the future we believe it has the opportunity to drive three (ph) products for design for FormFactor, which is sort, wafer-level burn-in high and frequency test. And there are testers that are being introduced this year that will be able to support the kind of performance that our probe cards can support.

So in that sense, it is -- there is implification (ph) in terms of impact our on business beyond what this portion of DRAM business is. But that market as a portion of DRAMs will grow.

The interesting point is that DDR3, which is a follow-on architecture after DDR2, and we already have one design in-house for DDR3 -- DDR 3 will have the features of the DDR2 which is low voltage and will have the low-power features of mobile DRAM. So that architecture transition will be very, very good to FormFactor.

Your last question on CapEx. We obviously have been spending capital significantly in the first half on our new factory startup. We don't generally guide CapEx looking forward. That being said, I expect some moderation of the capital expenditures payments as we go out through the year related to that factory startup.

Patrick Ho, Legg Mason.

Thanks a lot. First, just a quick clarification as I was taking notes. What was your GAAP operating income guidance again? And my question maybe for Joe. I think you mentioned in your talk about how stressed the production capabilities were at both facilities, and you mentioned design challenges and manufacturing inefficiencies. Would you say that those are part of the reasons why you're I guess taking on higher cost to make sure that the redundancy is there?

In terms of operating income guidance, I called that out at 11 to 14%. Joe, you want to address the --.

I would be happy to. Patrick, I would say that's a rather complicated question because it involves a mix of things. I think what -- the Company is still growing pretty fast when you look at the bookings and we are now running pretty close to a 240 million run rate on bookings. And hopefully we will get to that chip rate here fairly carefully too sometime.

So when I say stressed, you have -- we have done this factory startup by having a full production factory organization and then a startup factory organization. Now we are to the point where these two functions need to be integrated. So the deployment of engineering the manufacturing resource is as unnecessary now. And the other thing that we have been doing in earnest lately over the last three or four months is really instituting a rigorous quality program, including statistical process control techniques in all of our processes.

We also have a lot of work to do on ERP with Oracle and we have an MES system. So I'm giving you a lot of detail, but the point is, is that there is going to be some inefficiency while you do some of these things. We are trying to do the best we can to get products out the door and improve our cycle times. That's going to alleviate margin pressure, and it's also going to get the factory done right and that is what we're focused on. But there's a lot of things going on here. And people here, it's a 7 by 24 operation and it has been for the last 90 days.

Vishal Shah (ph), Lehman Brothers.

Hi. I have a question on your competitive position. Recently, I have heard of some speculation about more aggressive Japanese competition in the DRAM and Flash space. Can you comment on that please? Thank you.

Our belief is that we're gaining market share, our belief is we're amplifying probe card market as we've always done. Our position and belief is that if anything we're gaining in markets where we are very determined to gain.

Our market behavior again is very much right now governed by -- as you can see from the numbers, demand is very strong. So our behavior is to shape into (ph) applications where form factor is absolutely mission-critical, which means where customers rely on us from their facilities. And we also are penetrating new markets and it just drives strong demand.

Our main competition today is still from companies that assemble their probe cards manually, which means even if they make progress for applications where demands are not as difficult as say for DDR2 probe cards or Model (ph) DRAM probe cards, but they may make progress for applications that are less complex. But these technologies will not scale in the future. That's our belief. And as this new manufacturing facility is online and as our product pipeline, which is very full, as it is bearing more and more fruit, you will see us making progress in every market that FormFactor will target.

Doug Reid, Thomas Weisel Partners.

Thanks. There's some evidence out there that yield challenges and Nan Flash, the most advanced geometries, are slowing or will slow the transition to 90 nanometer and 65 nanometer relative to the pace of the previous transitions. So I'm wondering if you're experiencing a related slowdown in Nan design activity that might be offsetting some of the Nan wins you mentioned or the current strength in your Nor (ph) business within flash?

The question really is, our company is beginning to slow if the progress define our nodes (ph) slowing down. What we see, and it started at actually with -- I think either Joe or Ron mentioned it -- from 110 to 90, some companies did take an intermediate note. In those cases, semiconductor equipment business is not impacted significantly, but FormFactor business is impacted significantly.

So when people had demand for 100 nanometer probe cards, we benefited by it. And what we see is the first evidence. It's not yet a widespread phenomenon. But first evidence that companies will take an 80 nanometer stand between 90 and 70 or sub-70. It's happening for some companies and some memory (indiscernible) market segments.

And if that happens, that will have significant positive impact on our business, it will just be another basically tooling cycle for us because it will drive orders of completely distinct probe cards from customers.

And we also have sub-70 nanometer designs in-house. So I would not be looking at one data point to be drawing this conclusion to the recent slowdown in technological progress. I think it's healthy, it's altogether and if anything, you will see people probably taking more intermediate steps to gain cycles of learning.

That's helpful. Thanks.

Timm Schulze-Melander, Morgan Stanley.

Afternoon guys. A couple of questions if I may. Joe, you mentioned that when you guys are putting in place essentially what is a risk-limiting kind of investment here over the near-term, you characterized some stuff as being "too risky to move". Can you maybe just give us a little bit of granularity as to what that would include? And then I have a follow-up.

Simply, we have some critical pieces of equipment that have been there for quite a bit of time and risking having a bad move where they fall out of calibration would disrupt production, and we don't want that. So we're waiting for the new equipment to be delivered directly to the new factory. So kind of it's that simple.

Kevin Vassily, Susquehanna.

A couple of questions. First on lead times, given that strong bookings growth, and should we all infer that lead times have extended, also considering in a manufacturing transition? And then second wedging for Ron. You mentioned something about a cost associated with an upcoming separation agreement that we should see. Could you give us some more detail on that please?

On the lead times, I think it's hard for us to characterize lead. Because of the custom design of the product, we have certain times that are short, and then we have some lead times where a customer is pushing a lot of technology. We may never have done it before, and so you could have a wide variety of lead times.

I would characterize our leadtime situation as probably unchanged from the prior quarter. So that's why we still categorize ourselves as capacity-constrained. I think we will make a lot of progress on leadtimes once we get this factory done because all of the things we're doing around processes are going to bear fruit.

Kevin, this is Ron. Your second question, the separation agreement relates to the departure of our COO.

There are no more questions in queue. I will now turn the call back over.

Thank you operator and thank you all for joining our call and we look forward to seeing you in upcoming conferences and the next earnings call. Goodbye.