FormFactor Inc (FORM) 2006 Q2 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the second-quarter 2006 FormFactor earnings conference call. My name is Colby, and I will be your coordinator for today. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

I would now like to introduce the host for today's call, Ms. Annie Leschin, Investor Relations. Please proceed, ma'am.

Good afternoon and thank you for joining FormFactor's second-quarter 2006 earnings conference call. With me today on today's call are Joe Bronson, President; Igor Khandros, CEO; and Ron Foster, Chief Financial Officer. Joe will provide a summary of our second-quarter performance and then review our market segments and recent announcements and provide an update on our corporate priorities. Ron will then take us through the financials in more detail and provide guidance.

I would like to take a moment to mention that during the third quarter of 2006, the Company will be presenting at the Citigroup Conference on September 6. As more details become available and other events occur, we'll make additional announcements. Before I hand the call over to Joe, I would like to review our Safe Harbor statement.

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 plan. 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 architectures, technologies and products; the extent to which chip manufacturers modify announced capital equipment expenditures and device roadmaps; and the Company's ability to efficiently execute on its capacity plan.

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 statement or update the reasons actual results could differ materially from those anticipated in forward-looking statements.

Finally, a breakdown of revenues and bookings by market and geography and a GAAP to non-GAAP reconciling income statement is available on our website. In conjunction with Ron's statement, a schedule that reconciles our GAAP financial guidance and certain non-GAAP financial guidance with respect to FAS 123R stock compensation expensing will also be available on our website.

I'd now like to turn the call over to Joe Bronson.

Welcome everyone and thanks for joining us today. FormFactor delivered another record quarter as revenue, bookings, production and profitability all reached historical highs. Second-quarter demand for our advanced probe cards continued at a very high rate with all of the industry major drivers intact, including the transition to smaller nodes, need for higher parallelism and the growth in capacity as second-tier manufacturers made the move to 300 millimeter. Revenues grew 14% sequentially at 92.4 million. Gross margins showed substantial improvement, reaching 53.7%. And operating profitability also increased, achieving our long-term model at 25.6%.

We increased factory capacity and began to realize production efficiencies. We believe our state-of-the-art MEMS manufacturing facility is now a significant competitive differentiator as the challenges of developing advanced technology and having to keep pace with volume orders by major semiconductor manufacturers face any company that attempts to enter the advanced probe card market.

Our strong second quarter led to extremely robust first-half growth of 68%, which was driven by strength in multiple markets including increased bit and design growth, particular strength in DRAM as customers simultaneously accelerated purchases for both consumer and DDR2 products. Demand for our known good die products also grew notably in the quarter, especially HFTAP, as more customers are implementing high-speed testing on the wafer instead of line package test.

Key market events we believe will drive our future business are the launch of Vista and the increase in graphics memory applications in PCs, game consoles and PDAs. Our product development efforts made good progress this quarter as we continued to expand our R&D efforts and build out our infrastructure to support the rapidly-growing market and ensure that we meet the specific requirements of different market segments to maintain our market leadership position. 2006 is on track to be a record year as we plan to introduce seven new products, including four new spring technologies and two completely new architectures.

We made a key new product announcement this quarter, including our Harmony one-touchdown, 300 millimeter Flash product in June. We also made progress in fine-pitch logic, shipping our new architecture to an early adopter during the quarter.

Growth in DRAM continues in the quarter due to the ongoing transition to advanced nodes to 90 and 80 nanometer, the conversion to DDR2 and continuing build-out of 300-millimeter factories. Our position with GDRAM customers remain very strong as we expanded our presence with advanced industry-leading customers and penetrated new ones. We're currently experiencing a significant increase in design activity as key customers prepare for new Vista-driven designs and node transitions. We believe that 70 nanometer will be the major node activity in Q4 and beyond; although, technology transitions vary significantly by customer.

Orders continued strong in mobile RAM as customers begin their next tooling cycle in Q3 and RAM production for consumer and mobile markets in preparation for the holiday season. With the proliferation of consumer devices, such as 3G phones and PDAs, the need for KGD in this segment is also growing as it becomes more and more important to cost effectively test die that are assembled into expensive multi-chip packages.

Graphics memory demand has also become a new significant driver of our DRAM business. DRAM will continue to be a strong growth driver for FormFactor's business for the second half of 2006. We see compelling market trends that will propel the industry forward for the next several years, in particular, the diversification of end-user applications including PCs, consumer and game consoles. The most significant driver of DRAM revenue will be Microsoft's introduction of its Vista PC, which should provide substantial growth for our DRAM segment in 2007. We believe the new Vista PCs will eventually require a nine-fold increase in memory, including a greater than 2x increase in main memory and new graphics memory. Another application is game consoles, where we anticipate an eight times increase in memory requirements with the Xbox 360, including expanded main memory and separate graphics memory as well. Finally, with the advent of 3G mobile phones, we believe that these devices will require 1 gigabit of memory by 2008 to accommodate an application multi-chip package, which includes mobile RAM and a communication multi-chip package.

Flash revenue showed particular strength in the second quarter due to continuing strength in NOR and shipments of large NAND orders received in Q1 for our [NF150] product. We continue to service the vast majority of the NOR market as technological demands of NOR are increasingly requiring FormFactor solutions. We see NOR as a growing market for FormFactor due to growing contribution of the KGD business in NOR.

We expect the next major growth driver of our NAND business to come from our newly-announced 300-millimeter Harmony one-touchdown wafer probe solution, which we introduced in June. This product will redefine productivity for Flash testing as our Harmony architecture enables high uptime, faster setup and rapid repair. It is based on the new NAND-specific spring technology designed for short cycle time and low maintenance. Our development of this product continued this quarter as we shipped our first one-touchdown, 300-millimeter Harmony NAND product.

We also had major design wins in NAND Flash for 200-millimeter, one-touchdown testing for which we expect volume orders in the fourth quarter. We believe that our solution, once released, will be a compelling, industry-leading product and provide significant value-added propositions to customers in a similar way that we demonstrated in the DRAM market. Our ability to manufacture custom probe cards in volume and keep pace with customer roadmaps will reinforce our industry leadership and allow us to successfully compete in the NAND Flash market and other one-touchdown, 300 millimeter markets, such as DRAM and wafer-level burn-in, where we've already begun development of derivative Harmony 300-millimeter products.

Our memory product portfolio is being fueled by an increasingly diverse set of applications in PC and consumer device markets. We're making deliberate strategic decisions to introduce new products with leading technology adopters, who are engaging with our advanced solutions. As we highlighted at our Analyst Day, we plan to introduce a variety of new products and system solutions that will drive our memory business over the next year.

In logic, flip chip, NPUs and chipsets have driven our logic business, and we continue to broaden our customer base in this market. We've developed a product roadmap to address the larger portion of the logic market, the fine-pitch segment, with a new multi-DUT product for wire bond devices. We achieved a significant milestone this quarter, having shipped our first fine-pitch logic probe card to an early adopter customer for evaluation. Based upon our demonstrated technology and successful early adopter engagement, we anticipate volume shipments and significant contribution to revenues in 2007, which will significantly expand our addressable market. We also had major design wins in our existing flip-chip market, including one for our BR175 multi-DUT product with a major chipset customer, a gaming engine win and some major wins from existing customers. We expect growth from this segment in gaming and graphics customers throughout the year.

Demand for known good die continued strong this quarter. KGD remains FormFactor's most significant opportunity over the next several years as the demand and complexity of consumer applications, such as 3G phones increases. We believe this market will be larger than the NAND Flash opportunity by the end of 2007. Customers can no longer afford the expense associated with any failure in multi-chip or stack packages, which are now required by a growing number of applications.

As devices require more advanced packaging technologies, they also require more advanced burn-in and wafer-level final testing to offset the higher cost of failure. FormFactor's the only provider of a complete suite of cost-effective solutions for short burn-in and high-speed testing, which together make up KGD testing. Our customers reinforced the importance of our KGD products this quarter, driven largely by a substantial increase in high frequency-tested probe, which along with burn-in comprise the components of KGD testing. One customer converted all of its entire test process, all of its sort cards to HFTAP cards during the quarter in order to make KGD-based system and package and provide the most comprehensive testing for its products. We expect this trend to continue as we have design wins with a few other customers who are preparing to do the same. We look for the adoption of our HFTAP and KGD products to increase and grow throughout the year.

We continue to ramp our factory to make ongoing productivity and efficiency improvements and to grow our capacity to stay ahead of market demand. We improved our on-time delivery and reduced lead-times to customers in the quarter, which are the most important competitive advantages to place our leading technology products into these markets as customers' product cycles shorten. We continue to leverage our learning, improve our wafer fabrication, increase yields and improve our performance.

Our strong cash flow is funding the expansion of our existing Livermore operations and helping to fund our global expansion efforts. Our strategy of a global distributed model is underway as we are finalizing plans for the expansion of assembly and test operations in Asia. We plan to build out our back-end manufacturing, engineering, applications and customer service and support closer to our customers and help leverage the introduction of our new products in NAND Flash, fine-pitch logic and advanced DRAM.

FormFactor's investment in its extensive patent portfolio and other intellectual property is at the core of the Company's innovative culture. We will continue to make substantial investments in R&D and protect those investments in our IP patent portfolio. IP is a core asset and competitive advantage for FormFactor, and we are committed to aggressively defending that asset from companies that we may believe are infringing our intellectual property. We're currently pursuing patent infringement actions against Phicom in both Korea and in the United States. As we disclosed previously on June 15, the Korea patent court upheld the validity of all the claims of one of the patents, which was predictably appealed by Phicom. We are continuing to pursue our claims vigorously, including in the United States where these patent infringement actions are currently in the pretrial discovery phase.

In addition, MJC has filed actions in the Korean intellectual property office, Tyco, that seeked to invalidate two of our issued Korea patents. In that proceeding, Tyco has ruled on one of the patents, upholding the validity of all of the claims against it. MJC has appealed that decision to the Korean patent court. Although these rulings and litigation proceedings will have no immediate business impact, we believe the favorable rulings clearly reinforce the strength of our intellectual property position.

Looking ahead, the advanced market will continue to drive the industry with MEMS leading the way. We believe that industry drivers, such as Vista, increase cell phone functionality. And the need for KGD will provide momentum from which several of the advanced probe card manufacturers will benefit. We expect a significant impact of these drivers on industry growth to offset any competitive threats to FormFactor's leadership, which coupled with our volume, manufacturing, efficiency gains, unmatched R&D, strong IP portfolio and the ability to redefine markets and probing systems know-how will keep us at the forefront of the industry. We continue to believe that there are many opportunities not yet served by FormFactor, which we plan to address utilizing several new advanced technologies.

We were very pleased with the Company's performance this quarter. We believe FormFactor continues to solidify its position as the market leader, and the market trends increasingly play to our strength. We believe we are well-positioned to capture a significant portion of the large opportunity ahead. I would like to thank our employees for their hard work and dedication in making this the most successful quarter in FormFactor's history.

Now, I'd like to turn the call over to Ron Foster, our CFO, who will provide more detail on our quarter and give our guidance for the third quarter of 2006.

Revenues once again hit record levels this quarter, climbing for the sixth consecutive quarter, reaching $92.4 million. This represents an increase of 11.1 million or 14% over the first quarter and 40.1 million or 77% versus Q2 of 2005. Sales grew in all regions, significantly in North America and Asia. North American revenue achieved a historic high with growth in both DRAM and Flash. Within Asia, Taiwan continued to grow sequentially to the highest level ever, aided by our new direct sales, service and support operations there.

DRAM revenues grew 2% sequentially. DDR2 revenues increased sharply as manufacturers continue to transition from DDR. Mobile RAM revenues were again strong in the quarter, although down from the high levels of Q1. Graphics memory shipments set a record. We expect continued strength in mobile RAM and graphics going forward.

Flash revenues increased 151% versus the last quarter as both NAND and NOR showed large increases. Pending volume introduction of our new Harmony one-touchdown product family, we had a few key Flash customers place significant orders this quarter and in Q1 for our NF150 product in order to support their tooling cycles. Currently, we have significant design activity going on with new and existing Flash customers that will generate revenue growth in the fourth quarter and beyond. Although Q3 is experiencing healthy design momentum, Flash revenue will likely be down from the second quarter. Meaningful revenue growth will come in the fourth quarter and beyond as we move our one-touchdown product into volume shipments.

Logic revenue was down 9% from the first quarter but up 66% from the second quarter of 2005 as we increased our logic customer base from a year ago. Though logic revenue declined in the quarter due to less demand from flip-chip applications, we expect growth from this market to gaming and graphics customers throughout the year.

Known good die continues to be a growth engine for the Company. Wafer-level burn-in revenues grew 13% in the quarter and HFTAP grew 47% sequentially. Total KGD revenue -- that is wafer-level burn-in plus HFTAP -- was approximately $10.9 million in the quarter, up from 9 million in the first quarter. This amount does not include sort cards that are used by some of our customers in KGD applications. The breakdown of revenues by market and geography is available on our website.

Bookings achieved record levels again in the second quarter, reaching 96.5 million, up 1% over the first quarter and 66% over the same period last year. Sequential increases occurred in DRAM and logic, and all markets increased year-over-year. Geographically, order growth was the strongest in Japan.

DRAM bookings increased 8% over the first quarter. Mobile RAM again set a bookings record as momentum in consumer markets continues to go. Flash bookings declined by 24% compared to the strong first quarter. Logic bookings increased by 1% from the first quarter and 95% from the prior year. KGD bookings continued to rise, up 25% for the second consecutive quarter as both HFTAP and wafer-level burn-in grew sequentially. We are especially pleased with the rapid HFTAP adoption we are experiencing with customers migrating high-speed test to the wafer.

Backlog entering the quarter was in the normal range of six to eight weeks. As with last quarter, I will cover some non-GAAP numbers to supplement understanding of our GAAP financials. A schedule is available on the investor portion of our website that provides the GAAP to non-GAAP reconciliations.

GAAP gross margin for the quarter was 52.7% and 53.7% on a non-GAAP basis, which compares to 50.2% and 50.8% respectively in Q1. Our focus on improving our manufacturing processes over the past several quarters paid dividends in the second quarter, resulting in factory productivity, yields and on-time delivery improvements that enabled the revenue growth. These factory improvements and the resulting revenue increase generated significant labor and material efficiencies that drove higher gross margin in Q2.

All processes are running now in the new factory, with current revenue capacity of greater than 100 million per quarter. We're still operating some equipment in the old facility as new equipment arrives and the factory layout is modified. We're steadily expanding our capacity to about 125 million per quarter when completed in early 2007.

Operating expenses for the quarter were 29.6 million on a GAAP basis and 26.2 million non-GAAP, up from 25.5 million and 22.2 million respectively in Q1. As a percent of revenue, operating expenses were 32% on a GAAP basis as FAS 123R option expenses added 3.4 million or 3.7%. On a non-GAAP basis, operating expenses for the second quarter were 28.4%., which compares to our 27.3% last quarter.

R&D expenses excluding FAS 123R option expenses increased by 1.9 million over Q1 to 11.4% of revenues due primarily to the increased investment in the development of our Harmony architecture, fine-pitch logic and other key development projects. SG&A expenses excluding FAS 123R increased 2.3 million to 15.4 million or 16.6% of revenues as the Company continues to invest in service centers and infrastructure to support growth.

Non-GAAP stock option expense for Q2 related to APB 25 cheap stock was $328,000. On a GAAP basis, operating income for the second quarter was 19.1 million or 20.7% of revenue compared to 15.3 million and 18.8% for Q1. On a non-GAAP basis, operating income for Q2 was 23.4 million or 25.3% of revenue compared to 19.2 million and 23.6% of revenue in Q1. We outperformed our non-GAAP target of 23.5 to 24.5%, and we achieved our long-term model target of 25%.

Interest and other income for the quarter increased to 4.2 million from 1.5 million in the preceding quarter. The increase was attributable to higher interest rates, better foreign currency performance due to an improved hedging program and investment return on the 182 million in proceeds from the March equity offering. The yield on our cash investments in the quarter was approximately 4%.

Litigation and compliance expenses for the quarter were 1.5 million compared to 1.7 million in Q1. We continue to take actions to protect our intellectual property in Korea, Taiwan and the US as a part of our long-term strategy.

The tax rate for Q2 was 34.6% compared to 35.9% in the first quarter. An improved mix of foreign income provided the rate improvement. The tax rate for the remainder of the year is projected to be 35%. Net income for the quarter was a record at 15.3 million or $0.32 per fully diluted share on a GAAP basis and 18.1 million or $0.38 per fully diluted share on a non-GAAP basis. This compares favorably to 10.8 million or $0.25 per fully diluted share on a GAAP basis and 13.2 million or $0.30 on a non-GAAP basis in the first quarter and 5 million or $0.12 per fully diluted share in the same period of 2005. The equity offering of 5 million shares, executed in March, had a dilutive effect in the quarter of $0.01 EPS.

Now to the balance sheet. Cash and marketable securities were 433 million in the second quarter, up 31 million from the first quarter. Operating activities generated 34 million of cash in Q2 compared to 7.5 million generated from operating activities in Q1. Revenue linearity, working capital management and reduced incentive payments in Q2 resulted in the increased cash flow from operating activities. During the second quarter, we spent 8.9 million in capital expenditures compared to 9.7 million in the first quarter. The majority was utilized on factory and global service center capacity expansions.

DSO continued low at 46 days in the second quarter similar to the first quarter. The accounts receivable balance actually declined $5 million from the end of the first quarter, helped in part by improved factory linearity. Net inventories increased by 3 million during the quarter to 24.1 million. Inventory turns declined from 9.3 to 8.6 quarter-to-quarter. More linear shipments in the quarter contributed to a higher inventory balance and with [NFGI] at the end of the quarter.

Headcount increased to 1,013 from 928 in the first quarter as product development, customer support and other infrastructure headcount investments exceeded manufacturing headcount growth.

With this, let me give you our guidance for the third quarter of 2006. Revenue, which grew at the heated pace of 68% in the first half compared to the same period last year, is expected to moderate to around a still robust 50% growth rate in the third quarter. So we expect revenues for the third quarter to be 93 to 95 million.

GAAP operating income is projected to be in the range of 20% to 21%, including about 5 points of incremental FAS 123R stock comp expense. Excluding FAS 123R, non-GAAP operating income guidance is 25 to 26%.

Now that we have achieved our target model range of 25% operating income excluding FAS 123R, we expect to operate in the 53 to 55% gross margin range going forward. We intend to continue investing significantly in R&D as well as in needed SG&A infrastructure to support our long-term growth prospects. Consequently, we expect operating income to vary in a range around 25%.

We target GAAP earnings per share of $0.32 to $0.33 per fully diluted share. FAS 123R expenses will have an additional $0.06 EPS impact related to stock-based comp in the GAAP results. This would translate to non-GAAP EPS guidance of $0.38 to $0.39 for the third quarter.

Now, let's open the call for questions. Operator?

(Operator Instructions). Mark Bachman, Pacific Crest Securities.

I was wondering if you discussed the DDR2 end market right now. Specifically, I'd like you to at least address two things. What is your estimated market share here and which one of your competitors offers the most competitive product in DDR2?

This is Igor. The end market in DDR2, that's now the main memory in PCs. So PC is driving DDR2. Of course, when Vista will be introduced, that will drive additional DDR2 demand. You're likely to see next year ramp of 1 gigabit architecture, and the real ramp is likely to be on whatever is the most advanced technology node that a given manufacturer will manage to exhibit. And it's likely to be 70 nanometers for a majority of them.

As far as our market share, our market share is pretty high in DDR2. It traditionally has been that way. In terms of competition, we see competition mainly today from needle probe cards. And also, we see some companies with MEMS-based technology and notably Phicom in Korea. We believe that some Japanese companies are beginning to try to do that including MJC.

Jim Covello, Goldman Sachs.

Congratulations on the good results. Could you help us to quantify and prioritize the growth drivers for the second half of 2006 and 2007? And when I say quantify, whatever the growth -- take growth and break down the percentage that each of the products is going to drive. NAND, I know you said that would be down in Q3, up in Q4 -- the known good die suite, incremental DRAM. I think that would be real helpful.

Thanks for the compliment. The DRAM is going to continue to be strong. As we mentioned, we're seeing graphics memory is becoming strong. And for us, NAND is a growth story for the second half, particularly it will start to ramp in the fourth quarter. So the level of business is pretty good, and there's a lot of opportunities that we're seeing.

This movement to Vista is also very important as they start to develop Vista-ready PCs, even though full adoption will be next year. But there's a lot of hardware coming down. As well as KGD applications will continue to grow. So I think that there's a whole bunch of drivers there for us for the second half.

If I could ask one quick follow-up -- the Hynix situation, obviously, there was a situation where your competitor couldn't provide the 256 DUT cards to Hynix and that's going to create an incremental opportunity for you. When does that opportunity show up on the P&L? Then I guess most importantly, how sustainable is it? Do you think that when Phicom gets their product back that that is revenue that will shift back to Phicom, or do you think that's something that could be more sustainable? In other words, is the Phicom slipup creating a more sustainable opportunity for you at a customer which has historically used one of your competitors?

This is Igor. We are getting design wins -- additional design wins in DRAM as DRAMs go to higher densities and higher parallelism. These are not normally opportunistic kind of design wins -- or design wins because somebody couldn't provide something. When we get in, we get in due to compelling advantages of our products, due to our better understanding of systems. In some cases, as you know, we help customers actually. We enable them to do testing in that parallelism, and some of that includes our intellectual property.

So I would not characterize it as just short-term opportunistic gains that won't impact the mix because somebody couldn't do something. It's a result of a lot of work. It's a result of superior products, and it's the result of our applications expertise.

As you know, we normally don't comment on specific companies. But we are getting to be more and more competitive. The factor is coming. It is more efficient. It translates to better cycle times and lead-times. We are adding talent, and the talent we are adding are people who understand how to enable customers to reduce cost of debt. So those are the reasons that we're winning the business.

I also wanted to add to your previous question. That is, we will continue to grow the second half, and it will spill over into 2007 both in our core markets because of the macro reasons and Joe eloquently here mentioned the Vista will drive we believe a step function kind of demand in memory because Vista has many qualities to it. Memory content will go up. We're talking about significant multiples in terms of memory content when you have real systems showing up in 2007, towards the middle of 2007. Memory speed will go up. And because the DDR speed will go up, this is where our products do very well. You can start expecting to see some binning. For example, on the same wafer, you'll make lower speed parts and higher speed parts. Of course, higher speed parts sell for more money.

FormFactor probe cards have superior signal fidelity. It will help our customers to bin out high-speed parts. You will see Vista driving transition to 70 nanometer because that's pretty much the cost-effective way to supply 1 gigabit DRAM that everybody is in consensus will be the basis for Vista ramp next year. Also, you'll have new designs on existing technologies towards 1 gig from 512 megabit DRAMs. You will have hybrid drives introduced in Vista. Those hybrid drives will contain some Flash memory, and the Flash memory is likely to be different from what goes for example into storage cards. That's likely to be lower density. You'll have -- basically, hybrid drives will be both the same way as you see hard drives in your computers today. Plus, there will be NAND Flash in it to the tune of 256 to 512 megabytes and maybe going to 1 gigabyte. What will happen is, you are likely to see shrinks of existing legacy designs and more advanced technologies, which is going to drive that business.

Of course, the big story also about Vista is ramp in graphics. It will have huge demands for graphics chips, and graphics is a sweet spot of FormFactor business. Graphics chips normally a very high pin count. They have finer pitches. And this is where FormFactor often is mission critical to customers. We believe that around Vista, you made need -- you may see the faster demand for DDR3 transition that will start next year. So I'm kind of tired of listing all these things. But in a nutshell, Vista will drive quite a bit of business.

Then also in the second half and towards the end of the second half, you will see FormFactor new products kicking in. These are products that are now with early adopters. Some of these products are already getting reorders. Some of these products, we're looking for first article orders this quarter, which means reorders and ramp in Q4. And so the confluence of this demand, driven by Vista, driven by 3G phones, driven by games and FormFactor new products coming in that will allow us we believe to take market share in Flash, to take market share in logic. That pretty much will drive our growth in the second half and into 2007.

Timothy Arcuri, Citigroup.

A couple of things. First of all, Joe, can you comment on what your current product lead-times are and whether or not they've changed in the past quarter? And then as a follow-up, Ron talked about a $100 million revenue capacity today. Given that you're guiding to roughly 95ish, you're kind of pushing up against that. Is that uncomfortable?

In the first -- the lead-times are coming down as the factory gets more mature. I would say we've cut lead-time by 30 to 40%, so we're quoting better times for reorders and also for first article designs. With respect to capacity, we talk about having -- we have 100 million in capacity today, but we have the capability to stretch that a little bit if we needed to. And certainly, we could stretch it higher. We're continuing with our -- the capacity plan that we've talked about to get to 125 million fairly early in '07. So, we think we're pretty well matched up. And with the productivity gains we make, we feel pretty comfortable about our near-term capacity situation.

What are the lead-times right now, Joe?

It depends on the customer. Basically across the board, the customers were reducing them. It would be -- like I said between 30 and 40% per customer.

This is Ron. Just to elaborate a little bit on that capacity -- as I commented, we're actually greater than 100 million in capacity currently in terms of our factory and we are moving stepwise increments in terms of our capacity as we modify the layout of our factory floor and receive bottleneck equipment sets into the factories. So you can think about it as we are above 100 million per quarter currently, and we are moving steadily towards the 125 in early '07. Of course beyond that, we're working on our plans for back end distribution in Asia, as Joe commented, to expand our capacity beyond that in '07 and onward.

Jesse Pichel, Piper Jaffray.

One of your competitors put up some very disappointing numbers today, and I would speculate that affected your stock. I would like to hear your comments on that. And also, by my calculations and some comments there from the DRAM industry, about 50% of DRAM shipments are DDR2 at this point. How should investors think about your market opportunity in DDR2? Is it running ahead of 50% realized or below? I hope that made sense. I mean have you realized you think 50% of your total available market yet in DDR2?

This is Igor Khandros. On the first question, frankly, we are pretty much focused on developing new products and executing in our business. And we still firmly believe that that's the way for us to succeed. So we're not as closely watching what our competitors announce as you do. I guess we'll probably see tomorrow. So maybe later on, you can call us and tell us what happened with competitor.

On the DDR2, DDR2 is a much larger opportunity. It has turned out to be a much larger opportunity for FormFactor than DDR1, probably by a factor of two. We are done with the transition. It's pretty much it's all DDR2. Our bookings for DDR1 are pretty much minuscule, so it's all DDR2 now. But DDR2 has a lot of life in it because Vista will ramp on DDR2. The true transition from DDR2 to DDR3 will probably happen in 2008. So we have another what 1.5 years of quite a bit of revenue that we will realize in DDR2. We also see DDR3 actually as a much larger opportunity than DDR2. So it is actually getting better with this new architecture, and we will know much more about it probably later in the year. But it looks to be probably larger than DDR2 by a factor DDR2 was compared to DDR1.

Just to -- this is Ron -- to scale it just a little bit, our DDR1 revenue opportunity was probably in the range of 180 million total, and DDR2 is probably going to be a 300 to 350 million kind of opportunity to give you an order of magnitude of what Igor is talking about.

How much of that 350 have you realized I guess is what I'm asking?

We're just on the front end of that.

As I said, you'll have 1.5 years -- almost 1.5 years of majority of our year-end revenue being all DDR2. Of course, there I am talking about main memory, right? But what you have now is mobile DRAM and DDR3. Actually, the bit growth rate there are significantly higher by a factor of 2 to 2.5 higher than for main memory. And that's driven by cell phones and that's driven in case of GDDR3 by gaming systems and Vista. So you now have three architectures where basically it was different end-user market, which for us that means diversification.

So roughly speaking, we're probably 20, 25% into that market.

That's encouraging.

Chris Blansett, JPMorgan.

You had a good quarter beating your guidance. I was wondering how much of that was due to reduced lead-times in your factory versus maybe just stronger demand than expected during the quarter.

I would say it would be both. Because we're able to ship the higher levels of demand than we receive.

Can you quantify it? I'm just trying to get an understanding. Was a lot of this due to just very rapid improvement in factory (multiple speakers)?

Don't forget, this is the second quarter we finished the ramp of the factory in the fourth quarter. So this is really the second consecutive quarter. The more employees are trained and learning and the more things and processes that we've put in place -- and we haven't had to do this transition work from the old fab -- you get a lot of leverage from that capability and that's what's happening. That's why we're able to do a much better job. That's why you are seeing the margins go up to what we said they would go up to.

Then in general for the Harmony products, are they at where you want to be for lead-times? How much more reduction do you think you can get in those as that product matures?

The spring architecture for Harmony is designed to be a fast lead-time product. When we talked about this product, this NAND Flash product was developed specifically for NAND Flash. Whereas before, our NF150 product was essentially a DRAM product derivation. So, in order to be competitive, we have to have shorter lead-times. And there are various reduced processing requirements to get this product into the market. So we believe that our lead-times for this product will be short once we start ramping volume.

So, in general, they will be under the average for the overall DRAM products?

We were hoping to get them a little bit shorter because they process -- there's less processing. So they should be shorter than our DRAM product offerings.

Mehdi Hosseini, FBR.

I have a couple of questions. First, the question is for Igor. I think at this point, it's clear the growth driver. But I think what we're struggling with is trying to figure out some metrics that will help us quantify the growth opportunity like with mobile DRAM. Help us understand the increased bit growth is impacting the mobile DRAM business at FormFactor. Is it the density that is doubling that is driving the growth for you in (indiscernible) moderating handset unit growth?

And then also on DDR2, Vista is going to come out sometime early next year, but we really don't know what the adoption rate is going to be. So what if there is going to be a pause in customers adopting the end products? So then what happens to the probe card growth rate prospects? If you could help me with those items?

Then also the third and last question has to do with Harmony. Did you say that you have multiple orders from a single customer in Korea or you have multiple orders from multiple customers?

So the first one maybe was on growth. In mobile DRAM, as we talked I think in quite a bit of detail at the Analyst Day, what really drives FormFactor business in memory, for example, is bit growth, design proliferation, design growth and continuing transition of final test from packaged test onto the wafer. FormFactor has the ability to actually amplify all three by getting say customers to test at higher parallelism and therefore reducing cost of tests.

If you look at mobile DRAM, bit growth is certainly a very, very significant driver and I believe it's projected to have a 90% bit growth this year. And every bit needs to be tested. Now of course, customers make progress in terms of continuously trying to reduce test times. But bit growth currently is outgrowing those results. So you have -- you're testing more bits. Also, mobile DRAM is a low-power architecture. And in addition to what you normally test in main memory DRAM, you must test certain refresh modes. So normally, you get longer test time per bit in mobile DRAM than you do in a regular -- a main memory PC architecture.

Then, what you have is you drive different designs. For example, you have now 3G phones towards the end of the year that will require 1 gigabit of mobile DRAM. And there are actually some phones on the market today that require that. If you run 512 megabit mainly designs -- so you'll be forced to put two chips into one basically multi-chip package or two chips in one package. So of course, you are compelled then to ramp 1 gigabit. And you'll go ahead -- but if you try to ramp 1 gigabit on your existing process, you may find that it's very hard to do. It just becomes very high cost. So it probably drives your desire to do it say in 70 nanometer. Every time you make the change, that's a new design, which means a distinctly new order from FormFactor.

Of course, the third factor is that mobile DRAM is driving known good die. It's driving wafer-level burn-in -- and by the way, we're pretty happy about the progress we've made and are making this year. But on top of wafer-level burn-in, what's happening now is mobile DRAM now is about 100 megahertz. So you now have 133 and 166 coming out. The significance of that as it relates to our business is that customers used to be able to use a regular probe card that FormFactor designed pretty well and actually use regular probe cards to do say 66 or under 100 megahertz kind of testing.

Now customers will have to buy our K1 and K3 products. These are products specifically designed for high frequency test. So what happens then is that for each mobile DRAM design, we potentially can sell up to three probe cards -- a sort probe card, high-frequency probe card and a wafer-level burn-in probe card. (multiple speakers) So those factors make it very attractive and a significant growth driver. Sorry, you were asking something.

It seems to me that the mobile DRAM could actually present you with more than $320 million of --

Oh no. But mobile DRAM's portion of overall DRAM market, if you look at total bits shipped in mobile DRAM compared to total DRAM, that's probably around 6, 7% today. So when you take the two, it's -- but if you look at how much of FormFactor-driven business is driven to it, the impact is pretty significant, right? It's a pretty good business for us. So those two balance. I hope I answered your question on that. Sorry.

Then, the next question was on DDR2 and DDR2 is here. Whether Vista is earlier one month or later one month, it's here. And companies will bring out 70 nanometers, or some companies are trying to bring out 80 nanometers and then go to 70. They will do new designs in existing densities. Or if they are running 70 nanometers and they want to go to 1 gig, that's a new design as well.

So it's design activity in this technology transition -- architecture transition that will drive our business one way or the other. As you know, a majority of systems or a lot of systems are shipped today are what so-called Vista ready. So companies already are shipping boxes so that when consumers buy them, if Vista comes out, they could just install the Vista operating system, right?

But on top of that, when the true what they are called Vista premium systems come out -- and again, it happens among the four, say it happens sometime in Q1 -- companies need to be ready -- DRAM companies with their products by the end of Q4, right? Beginning of Q -- which means they need to place first articles with FormFactor. It is likely sometime in Q3 and place reorders in Q4. So that's kind of how it works. But Vista being a month late, we don't believe would have a significant impact on our business because industry is preparing for Vista.

And the last question you asked me was about Harmony.

Harmony orders.

We are right now in early adopting relationships with several customers, and early adopting relationships have to do with making sure that the test or interface works -- it's a one-touchdown product, so you need to work out all the quirks out of the system. Customers will be placing first articles or already placed first articles this quarter and we see reorders in Q4. It's not one customer. We have several early adopting customers working with us.

Kevin Vassily, Susquehanna.

Maybe Igor for you, there seems to be if you talk to some of your customers and even some of the test or [a-to-e] providers that there is concern that the cost of test in the NAND segment is starting to increase at a rate they are beginning to be uncomfortable with. So I thought, Igor, maybe you could make a comment on kind of what you guys are seeing there and maybe compare and contrast that with the cost issues that the DRAM customers that you had were facing when you first started serving that market.

Yes, I did see that particular small article about NAND Flash test scores. Please understand that large portion of those remarks are directed to final test -- package test scores. And those score scores stack high and as package test step-by-step migrates to wafer. That is an opportunity we believe for our customers to reduce cost of sales significantly.

Now, we are in wafer test of course one-touchdown NAND Flash or what we call one-touch Harmony probe card is a reduce to reduce test scores. For example, 40% of time in wafer test in Flash today is downtime. So we've designed a product -- it's an interesting product that deals with that problem. So we certainly are committed to reduce test scores associated with 40% inefficiency. And in the past as you know, it was mainly done by parallelism. But in this case, it will be parallelism and significant gains in productivity. So, that's what we're going to do. It's not that different from what we've seen in the past scale and directly to your question. But this kind of amount of an inefficiency, this 40%, it is unusual. So at least it presents significant opportunity for us.

Another thing about NAND Flash and test scores is that known good die testing will come for NAND Flash and that will require -- because frequencies will get to 100 megahertz. And that will probably require another insertion. And for us, it's a different product. But again, there, you can reduce test scores by parallelism. We will have such products. And of course, they do some burn-in. Again, there, you address test scores by higher parallelism. So different companies in NAND Flash business have very different test strategies. Most of them, for example in wafer test, have one insertion. Some of them have two insertions. So it's a lot more complicated subject as it relates to each particular memory manufacturer.

Vishal Shah, Lehman Brothers.

I had a question on the NAND market. It seems a number of your competitors have one-touchdown NAND cards in the field already. I just wanted to understand how your customers see your solution versus competition. I know you talked about throughput advantage. But are customers receptive to the throughput advantage? And are you able to command the same premium pricing you get in DRAM and your margins in NAND versus DRAM please?

That 40% downtime number came from customers. So they are not happy about it. That's basically tests are sitting there non-productive and in fact, there's infrastructures sitting there and unproductive. That's one area. But all the other advantages -- when we normally enter a market and all other advantages that we provide in terms of throughput and uptime, in terms of contact quality, in terms of our ability to ship a card and install it and make sure that it runs, in terms of our design capabilities that work well with customers' own designs whether it's -- there needs to include this quarter or there needs to include parallelism on a given test or you know -- all of those advantages go into total cost of ownership model.

So as we said before, we see this as a very attractive market to us. And of course, what's also coming in NAND Flash is known good die testing. There, we're the only company with a complete suite of probe cards for that. So we believe we will have very compelling advantages.

Would your margins -- gross margins be the same in NAND versus DRAM?

So when we enter a market with a new product, our product requirement documents and execution a size that we expect to obtain pretty much similar margins across all products. And of course in some cases, there are situation of actions we need to take. But that's how we normally operate.

Mark Fitzgerald, Banc of America Securities.

I just was curious here on the new manufacturing sites for the back end that you are putting overseas kind of timelines for those. And is there any risk that that can erode margins in the short-term, while you try to build those out and fill them up?

Let me answer that. We're planning to make geographic selections, and we are in the process of doing that and planning the entire exercise. This isn't going to be like the startup of the first factory. We believe we will be able to do this with minimal impact because the first round is assembly and test capability in a region close to the customer base with design and application support. So that will not be an expensive proposition in comparison to what we did with a wafer fab.

As we get bigger and approach the plus 150 per quarter, probably closer to 200 million per quarter, there will be dealing with a wafer fab investment. Of course, that would probably have some impact of course. But I think in the assembly and test and global infrastructure, we should be okay.

Just a quick follow-on. Historically, seasonality has been pretty strong in the second half of your year. And your guidance suggests that that's broken down. I was curious if seasonality doesn't matter anymore or you're just up against really tough comparisons here in terms of the first half hasn't been so strong.

This is Ron. It's a little difficult for us to measure seasonality when we've got a lot of business value propositions that have gone on historically when you're making comparisons to our history. We've got capacity activities -- have been going on in the factory. We've got new products that have been coming into the flow. And very notably now the thing that you need to take away from this conversation is the fact that we've got a whole bunch of new product activities coming on in design roles right now in our operation. So we see that that is going to be ramping activity through the whole second-half third quarter and significant high-volume possibilities in the fourth quarter.

So that is going to -- that is a whole new set of activities and new set of markets that we're going to be engaged in in the second half with first our one-touchdown NAND product, as Igor and Joe already commented, and then of course exiting the year in '07 with our fine-pitch logic entry. So we see a steady ramp of new product activity with a factory that is capable of handling it.

Let me just add to that. If you look at it, for the past four quarters, we've grown on the average about 15% quarter-over-quarter. And if you listen to our remarks earlier, we feel pretty good about second half and especially we feel pretty good about what will happen towards the end of the second half. We feel pretty confident that both the industry drivers and new product -- the confluence of those two things will let us do very well then. And we are guiding up in this quarter. So I think -- I don't think anything is breaking down here.

I did want to add to the previous question that you ask about whether this overseas investments will have impact. Ron and Joe consistently maintained that we would finance our capital expenditures with about 10 to 12% investment in capital per year. So you should not see huge exceptions to that.

Yes, we see that as a long-term model and that our depreciation expense will be fairly constant to current levels going forward. We went through some of that in our Analyst Day review. The other thing you should bear in mind, as I commented briefly and Joe also did, we've had a 68% year-over-year growth in the first half. And we have communicated it and believed that the markets are growing 30% plus in advanced probe cards and we're going to participate in that over time. It is not -- it is not a reasonable expectation we can grow at 68% forever. But we certainly see continuing robust growth with a 50% year-over-year growth in the third quarter in the guidance that we gave -- 50% plus, and we see additional momentum in the fourth quarter.

At this time, there are no further questions in the queue. So I will now turn the call over to Mr. Ron Foster for any closing remarks.

Yes, I would like to thank you all for joining us today, and we certainly look forward to seeing you in upcoming conferences. Thank you.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.