Verigy, Ltd. F3Q09 (Qtr End 06/31/09) Earnings Call Transcript

Verigy, Ltd. (VRGY)

F3Q09 (Qtr End 06/31/09) Earnings Call

August 20, 2009 4:30 pm ET

Executives

Judy Davies - VP, IR and Marketing Communications

Keith Barnes - Chairman, CEO and President

Bob Nikl - CFO

Analysts

Olga Levinzon - Barclays

Jim Covello - Goldman Sachs

Raj Seth - Cowen and Company

Satya Kumar - Credit Suisse

Patrick Ho - Stifel Nicolaus

Atif Malik - Morgan Stanley

Dave Dooley - Steelhead securities

Anupam Bansal - Credit Suisse

Presentation

Operator

Good day ladies and gentlemen, and welcome to the Verigy Third Quarter 2009 Earnings Conference Call. (Operator instructions)

As a reminder, this conference is being recorded for replay purposes. I would now like to turn the call over to Ms. Judy Davies, Vice President of Investor Relations and Marketing Communications. Please proceed Ma’am.

Judy Davies

Welcome to our financial teleconference for Verigy’s third quarter of fiscal year 2009, which ended July 31st. I am Judy Davies and I am joined by Keith Barnes, our Chairman, CEO and President, and Bob Nikl, our CFO.

Our Q3 financial press release was sent out today over the Business Wire, and it is posted on the company’s website. For any reason, should you not be able to locate this press release or require assistance in finding the information, please contact me directly at 408-864-7549. A replay of this call will be available via telephone and webcast from August 20th through September 3rd, and you may access the call by going to the Investor Relations section of the Verigy’s website.

We will be making forward-looking statements today that are based on current information and estimates and are subject to a number of risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. Factors that may cause results to differ materially from those in the forward-looking statements are discussed in our most recent periodic and current reports filed with the SEC. These forward-looking statements, including guidance, provided during today's call are only valid as of this date and Verigy undertakes no obligation to update the forward-looking statements.

In addition, during this call we will discuss non-GAAP financial measures including non-GAAP net loss, loss per share, and gross margin. You will find reconciliation to the most directly comparable GAAP financial measures on our website.

At the conclusion of our prepared remarks, we will open up the call for questions. As a reminder, this conference call is being recorded and will be available for replay in the Investor Relations section of our website at www.verigy.com.

Thank you all again, and now it is my pleasure to turn the call over to Keith Barnes.

Keith Barnes

Thank you, Judy and thank you all for joining us this afternoon. To begin, I am pleased to report that our fiscal third quarter results were consistent with the guidance we provided in May and reaffirmed on July 8th. We achieved our quarterly financial and operational objectives by maintaining tight control of expenses and through increase demand for our SOC products.

Revenue improved 23% from Q2 to $87 million, which put us at the higher end of our revenue expectation range. We continue to make good progress on our cost savings objectives and Bob Nikl will discuss this in more detail during his prepared remarks. Orders increased to 93 million from 83 million last quarter, resulting in a book-to-bill ratio of 1.07.

In the previous two quarters a significant portion of our demand was driven by technology buys. However, sales in the third quarter included a higher amount of capacity buys. Some of these capacity purchases were in response to customers refreshing unusually low inventory levels, while several systems in the quarter were tied to entirely new products.

As we entered the fourth quarter, some positive news began to surface. Market research firms are projecting that PCs, notebooks and smartphones will continue to drive growth for test equipment over the next few quarters. One research firm is forecasting growth of 16% for total ATE industry in the second half of calendar 2009, and estimating 32% growth in calendar 2010. Although these reports are encouraging, we remain somewhat guarded about the second half of calendar 2009.

We remain focused on customer support, product innovation and cost improvements. We believe that we have invested in the right markets and the right opportunities. We have expanded our served available markets to include the low-cost IC, DRAM and advanced probe card segments. For calendar 2010, we have doubled our SAM, our served available market from an estimated $1.3 billion to $2.6 billion.

I would like to discuss the opportunities for Verigy in each one of these markets. First one I will start with is lower cost IC segment. The proliferation of 8 and 16-bit microcontrollers and other low cost logic devices is driving the need for higher levels of parallelism and efficiency than current testers are able to cost effectively provide. We saw this as an opportunity to combine acquired Inovys technologies with Verigy created IP to develop the V101 platform. Entry into the low cost IC segment expands our SOC served available market by an estimated $400 million in 2010.

During the quarter, we sold our first V101 system to a customer in Asia and received an order from a leading SOC foundry. The foundry customer selected the V101 for its higher parallelism, throughput and ease of use and has already converted two of its devices from a competitive system on to the V101.

We are currently working with several other opportunities and ramping the V101 for increased shipments over the next few quarters. DRAM, including high speed DDR3 and GDR memories is another important opportunity for us.

Earlier this month, our supplier reported a shortage of DDR3 devices as buyers shifted their purchases from traditional DDR2. DDR3 is attractive because it uses as much as 60% less power than DDR2 while providing up to twice the bandwidth. Some industry sources are projecting the new mobile products such as thin laptop computers with consumer ultra-low voltage technology, scheduled for release later this year will use the higher speed, lower-power DDR3 devices.

We believe that these devices in addition to the special DDRAM memories such as GDDR and XDR are creating new opportunities for our 93K HSM system. The 93K HSM is currently installed at all the major DRAM manufacturers. Today, we believe that most of the GDDR5 devices are being tested on a 93K, and we will continue to work with our customers on DDR3 final tests, high volume manufacturing opportunities for 2010.

Now, let’s move to commodity DRAM and Flash. Our V6000 is being evaluated at several strategic accounts across all memory segments, including DDR3 Wafer Sort. During the third quarter, we began to see increased activity from non-expansion customers and recorded a slight uptick in memory orders. Memory ATE purchases continued to be slow for all competitors, and we expect investments to continue at low levels through the remainder of calendar 2009. However, when the market does recover, we will be ready to address the needs of NAND and/or Flash, DRAM, and multiple or multi-chip packages for our V6000 and 93K HSM systems.

Another new market for us is the advanced probe card market. I’d like to explain in a few minutes and discuss a little bit more about the Touchdown Technologies acquisition, which expands our SAM by approximately $500 million in 2010. For those of you who are new to Verigy, we acquired Touchdown, a venture-backed company on June 15 on an earn-out basis. We expect Touchdown to begin contributing revenue in 2010.

Memory devices requiring performance and reduced power present numerous wafer test challenges for semiconductor manufacturers. Manufacturers must manage higher frequencies, lower voltages, greater functional integration and thermal performance as well as shrinking dye features. Touchdown's advanced MEMS probe card addresses these challenges through its [acutorque] probe technology and monolithic substrate architecture.

Acutorque probes can be positioned very close together to address shrinking dye features. The resulting increase in probe density translates to the capability for higher parallelism, and a lower cost of test. Touchdown's monolithic substrate architecture enables improved accuracy and stability of temperature. Because their unique architecture is capable of performing accurately at a variety of temperatures, it helps memory manufacturers improve wafer sort and yields.

All of these attributes are critical for cost-effective testing, for a wide range of memory devices, including DDR3. Today Touchdown is working closely with an important customer to develop a 300-millimeter DDR3 application.

In the future, when we couple touchdown's technology with our V6000, we believe we will be able to offer customers a test cell of delivering the highest parallel testing available from any memory ATE supplier.

In addition to these new markets, we continued making investments in our traditional markets, like high-end mix signal and RF. I would like to touch on some of those recent successes we've had with the 93K. The SOC market comprises multiple segments and in the RF area we continue to win designs. During the quarter, we had several wins in the wireless LAN, GPS and handset segments, including 4G LTE are long-term evolution devices.

While revenue from Port Scale RF continues to be meaningful in Q3, the strongest demand for the 93K came from the graphics processor segment. GPUs represented a significant portion of our SOC business in the quarter.

Overall 93K utilization at OSATs increased from 61% at the end of April to 74% at the end of July. While these utilization rates are still at low levels, we expect them to continue to improve. There are other indicators of an improving environment. Some foundries recently stated they expect their fab utilization rates to remain over 80% in Q4 due to an increase in orders from networking and handset manufacturers.

Our manufacturing transition is progressing according to plan. Production has begun on the 93K systems at Jabil; and earlier this month we had our first customer shipment for Penang. We are transitioning the remainder of our products and continue to expect the transition to be substantially complete by the end of the calendar year.

Now I would like to highlight two awards that we received in the quarter. Last month, STATS ChipPAC recognized Verigy with a supplier of the year award for demonstrating excellence in quality, on-time delivery, technology, service and cost competitiveness.

This is our second consecutive year in which we have been honored with this award. The second award was the Supplier Excellence Award from a large foundry. This award is given to suppliers, who display excellence in product quality, world-class service and support and a commitment to technology.

During the third quarter, we issued convertible notes with $138 million of gross proceeds. The proceeds from the convertible notes provide Verigy with an increased flexibility to among other things, invest in strategic growth areas. Although we do not have any specific acquisitions planned. We intend to take advantage of strategic opportunities if they arise. Bob will discuss the principal terms of the convertible notes in a moment.

In summary, we charted a path for growth with several new products. This growth is built on a foundation of a solid SOC and memory install base and great customer service. Further, we have laid the groundwork for an effective and efficient cost structure for 2010 and beyond. When the market recovers, we believe our operating leverage and earnings power will be greater than ever.

Companies that make the right investments and strengthen their balance sheet in the downturn are going to be the ones that will be in the best position to achieve growth in the upturn. We believe that we are in that category, that we have the right product portfolio to maintain a leadership position and build upon that going forward.

With that let me turn the call over to Bob Nikl, our CFO, who will take you through our recent financial results and the outlook for next quarter.

Bob Nikl

Thanks, Keith and good afternoon everyone. We are pleased with our third quarter results and what continues to be an historically weak demand environment. During the quarter, we made further progress in reducing our break-even point, significantly improved our gross margin and cash usage and considerably strengthened the balance sheet with our recent convertible debt issuance.

I will be discussing the convertible notes and our cash usage as well as the progress we have made towards our $100 million break-even target and the impact that the Touchdown acquisition will have on our plans.

Please note that our GAAP financial results include charges related to the company’s restructuring and manufacturing transition actions, charges related to the company’s acquisition of Touchdown, and an impairment charge for an auction rate security.

Third quarter revenue was $87 million, a sequential increase of 23%, and within the expectation range previously provided. Our financial results continue to strengthen with two consecutive quarters of increasing backlog and book-to-bill ratios of greater than 1.

System sales were 67% of total revenue this quarter, compared to 59% last quarter. SOC business was again the largest contributor, with sales of $54 million, which represented an increase of 42% sequentially, and benefited from strong demand in the GPU segment.

Memory sales remained flat at $4 million, and again benefited from collections for the systems that were shipped last year, but for which revenue wasn’t recognized due to collectability issues.

Q3 turns business was 60% compared to 75% last quarter, and we had one greater than 10% revenue customer. Services and support revenue remained flat at $29 million and represented 33% of total revenue, compared to 41% last quarter. Regionally, our revenue mix was as follows: Americas 17%, Asia-Pacific 79%, and Europe 4%.

Orders were $93 million and were 12% higher, resulting in a book-to-bill ratio of 1.07, and our backlog increased to $92 million from $84 million. Regionally our orders mix was Americas 9%, Asia-Pacific 86%, and Europe 5%. Orders from IDM and fabless customers were 39% of the total, while the remaining 61% came from OSATs and foundries. This compares to 40% and 60%, respectively in Q2.

Gross margin improved to 40% from 31% and was better than our original expectations. On a non-GAAP basis after excluding the impact of restructuring and transition related charges, gross margin was 42%, an increase of 8 points from last quarter. This sequential improvement was primarily a result of lower cost of material as well as the benefit of our continued cost savings initiatives. Our reported R&D this quarter of $25 million included $4 million related to the write-off of acquired in-process R&D from Touchdown.

After excluding this one-time charge, R&D was essentially flat from last quarter and $7 million lower than Q3 of last year. SG&A was $29 million, an increase of 1 million from last quarter and $11 million lower than the year-ago period. We saw a relatively small sequential increase in SG&A as we achieved the higher end of our revenue range and also included a half quarter of Touchdown expenses.

After excluding the effect of the charges mentioned earlier, total operating expenses of $50 million represented an increase of approximately $2 million from Q2. Interest income and other expenses net were approximately 1 million and we also recorded an impairment of 1.5 million for an auction-rate security.

Our net loss was $21 million or $0.35 per share and after excluding the impact of the charges discussed earlier, our non-GAAP net loss was $14 million or $0.24 per share compared to a $0.44 loss per share last quarter. As you may recall in Q1, we began implementing temporary and permanent cost savings measures to reduce our quarterly breakeven point from a $140 million to $110 million by the end of this calendar year.

At the end of Q3, we achieved our quarterly cost and expense goals by lowering our overall cost structure by approximately $30 million, including the partial quarter of operating costs related to the Touchdown acquisition. On a go-forward basis, our model will necessarily move incrementally higher to account for both the inclusion of a full quarter's worth of operating costs for touchdown and investments that we make in its business to scale from the very low levels of capacity that exist today. These investments will consist of both headcount and CapEx. For next quarter, we expect the company's overall operating breakeven level, including the impact of Touchdown and stock comp expense to be in the range of $114 million to a $115 million.

Now I'd like to review our balance sheet and cash performance for the quarter. Ending accounts receivable of $35 million was down $9 million, and DSO decreased to 36 days compared to 56 days last quarter. This improvement was due to both to higher AR collections and less back end revenue loading compared to last quarter. Our receivables quality and collection profile remained benchmark with over 97% of our accounts receivable current, and no write-offs during the quarter. Inventory increased by $3 million to $64 million, and CapEx was $2 million in the quarter.

Depreciation and amortization expense was $8 million which included the one-time $4 million charge for Touchdown's in-process R&D. Regular full time employee headcount at quarter end including our new Touchdown employees was 1484, an increase of roughly 25 from last quarter.

Excluding Touchdown, our headcount declined by 31 in the quarter and our overall headcount has declined by approximately 200 regulars and 150 temps and contractors since the beginning of our resizing program.

Now to cash. We ended the quarter with $442 million of cash and marketable securities which includes the net proceeds from the convertible notes.

On July 15, we priced the $120 million of convertible senior notes due 2014 with an interest rate of 5.25%. The over allotment for another $18 million was exercised bringing the total gross offering to $138 million and yielding net proceeds of $133 million. Based on the conversion price of $13.11 which represents a 25% premium from our share price at the time of pricing. Our potential stock dilution is approximately 10.5 million shares.

The terms allow us to call the bonds after three years if our stock is trading at 130% or more of the conversion price. Free cash flow was a negative $13 million compared to a negative $38 million last quarter and the decrease in overall cash and marketable securities excluding the convertible debt was only $9 million which included $2 million of cash for Touchdown.

Now our outlook for next quarter: Revenue is expected to be in the range of $90 million to $100 million Our loss per share on a GAAP basis is expected to be in the range of $0.32 to $0.24 and after excluding restructuring and manufacturing transition related charges, loss per share on a non-GAAP basis expected to be in the range of $0.25 to $0.17.

Share-based compensation expense is expected to be between $4.7 million and $4.9 million. Weighted average shares outstanding for the fourth quarter is expected to be approximately 59 million. As a reminder, there is no dilutive of impact to our per share calculations due to the convertible notes, while we are in a net loss position.

This concludes my prepared remarks, and with that we’ll now open up the call for your questions. Jeneta?

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of CJ Muse with Barclays. Please proceed.

Olga Levinzon - Barclays

Hi, this is Olga Levinzon calling in for CJ. Can you talk about your gross margin outlook within your guidance, and how you see that breaking down between the product side and the service side?

Bob Nikl

Sure, Olga. I think overall what we’re expecting is flattish to up slightly. The up slightly would be determined by, if I’m at the higher end of the revenue range. As far as the split between product and service, again not too different from this quarter.

I think our service business was at 31% in Q3, and the hardware piece of the business was around 45% or so. I wouldn’t see much upside on the service gross margin, but again potentially on the hardware side, given the revenue outcome.

Olga Levinzon - Barclays

Is there a reason why the service gross margin declined from last quarter even though revenues were flat?

Bob Nikl

Well, yes interesting thing. On a rounded basis they're flat. To the first decimal point they're down a $0.5 million, which is about 2 points of the 4-point margin decline, and then we also had a little bit of unfavorable warranty expense inside at the service business itself.

At the total company level however, warranty expense actually is favorable quarter-on-quarter; but the way we allocate internally, part of that decline resides in the service business, but that's pretty much the bulk of the drivers for the quarter-on-quarter change.

Olga Levinzon - Barclays

Okay, and then, on the break-even target that you outlined of $114 million to $115 million, what percentage of that increase from the previous $110 million is Touchdown additional expenses?

Bob Nikl

Well, again, based upon my prepared remarks, most of the deviation is due to Touchdown. We believe we are on target, on plan now for the $110 million break-even with regard to the cost structure, pre-acquisition and I don't anticipate any degradation in that in Q4.

Olga Levinzon - Barclays

Do you expect the 114?

Keith Barnes

Olga, we're going to have to cut you off and move on to the next questioner.

Operator

(Operator Instructions) Your next question is from the line of Jim Covello with Goldman Sachs. Please proceed.

Jim Covello - Goldman Sachs

When think about the comparative growth rates of some of your competitors in the industry, is it just fair to think about analog exposure being the difference between your revenue and the order growth and the revenue and order growth, some of your competitors, because otherwise SOC part seems reasonably comparable; is that right?

Keith Barnes

Yes, SOC were in good shape. Some of our competitors have analog and have other elements in their business that we don't have, whether it's hard disk drives or (inaudible) space or other component.

Jim Covello - Goldman Sachs

So, on an apples-to-apples basis do you guys feel pretty good shape that way?

Keith Barnes

We do.

Jim Covello - Goldman Sachs

Okay and then I understand what you talked about in terms of the break-even targets and the reasons for the changes there. Any update on the mid-cycle numbers that you guys have talked about or on the $150 million quarterly revenue run rate you can do 15% operating profit. Any update to that with the Touchdown acquisition?

Bob Nikl

Well, sure. Touchdown would incrementally impact that. The difficulty right now for us is it's a bit of a moving target, because as I said in the prepared remarks, we're starting to assess the investment requirements that Touchdown is going to need in order to optimize its potential. So, the $114 million to $115 million sure would have a similar type of effect on the mid-cycle model, but right now I would be delight to get the $110 million and worry about the mid-cycle a little farther out.

Operator

Your next question comes from the line of Raj Seth with Cowen and Company. Please proceed.

Raj Seth - Cowen and Company

Hey, Bob one of your mentioned what utilization was and the OSAT I think 74% was the number quoted. Is that consistent in the IDM as well or is there a material difference?

Keith Barnes

Well, we don't track the IDM separately. I’d say that they're increasing as well though. We're seeing increased utilization pretty much across the board, Raj.

Raj Seth - Cowen and Company

Keith, can you characterize a little bit the conversations that you are having with customers? I know visibility obviously in the calendar of Q4 is somewhat limited, but how would you characterize the tone of conversations that you're having and I don't know if there is a way to characterize the way people are feeling about the upcoming holiday season at all, but if there is, it certainly be useful.

Keith Barnes

I would say at the beginning of last quarter people were extremely cautious and trying to answer the question, are we just replenishing inventories and then I think they found that they were replenishing inventories, but there was a lot of new designs that we had been working with them on which were going into production. So, a number of the purchases that we saw during the quarter were beyond just putting the inventory back in order, lots of new designs.

Then as we said in our remarks, the GPU sector took off pretty well and I would say that people for the most part are pretty positive about the next couple of months. This quarter I think is more upbeat than we have seen customers in a while. The OSAT still only buy when they have to, but they are buying because they do have to. We saw a reasonable amount of upgrades and some new systems in two quarters ago and we see lot more system sales in this last quarter. So, I think things are improving.

Raj Seth - Cowen and Company

One last one, if I might. On the NAND side, you mention that you expected that area to be quiet through the end of the calendar year. Is there a utilization figure in that space that you can quote or is there anything that triggers buys other than I mean I guess it must be utilization. What's utilization in the NAND space now look like in and are you hopeful that you begin seeing stuff when you turn the corner on the New Year, or is that too uncertain to call at this point?

Keith Barnes

It’s a bit uncertain to call at the moment. Certainly, the chip count is going up, and we believe utilization’s going up and nobody tracks it, including us and so, you know, I think all we can do is, is kind of give you some color with respect to what we’re hearing from those customers and I think because of some of the general consolidation and some of the uptick in volume people are feeling a little bit more bullish about 2010. Prices have also firmed up a bit. So, they are more positive than we’ve seen them in a long time. The memory business is a strange business; when they actually do need to buy a product, you get very little warning. So, what we’re doing is, we’re preparing to be able to ship product in anticipation that things will start to improve in the first half of next year. If it happens earlier, then we’ll be in a position to take care of it.

Operator

Your next question comes from the line of Gary Hsueh with Oppenheimer & Co. Please proceed.

Unidentified Analyst

Hi, this is [Wayne] for Gary. First one is regarding DDR3 transition. We’ve heard probe card companies have been receiving a lot of orders for DR3. It sounds like the transition is accelerating. So, for your DDR3 opportunity, could you characterize a little bit more when you expect to see orders for DDR3 testers, and in which area is it the high speed one or the commodity one?

Keith Barnes

So, Wayne, the first area we would expect to see this is in the high speed memory area, because there are not very many good opportunities out there for those customers. My guess is you'll start to see it in this coming quarter or the following quarter because it's clearly been a long time since these people have purchased systems for those parts. The second area will be in the early part of 2010, as we get through the evaluations with the V6000 systems, which we're focusing on that today.

Unidentified Analyst

The second question is regarding the OpEx. R&D is running at 21, excluding the $4 million assets from Touchdown and SG&A is running 28. So, the total OpEx is 49. That includes the additional expenses after the acquisition of Touchdown; is that correct?

Bob Nikl

It includes a half a quarter's worth of Touchdown expenses, since we closed on June 15.

Unidentified Analyst

So the outlook for next quarter at around 50 million, that includes the full quarter, so it's probably up another $2 million, right?

Bob Nikl

Potentially yes. I mean, you know, what I'd like to try to not get into is parsing out all of the detail about the Touchdown part of the business on a quarterly basis; but as I said earlier, the base business, the OpEx is flattish, notwithstanding the upward guide in revenue. So, whatever incremental increase in OpEx we experience would be primarily due to the Touchdown investment.

Operator

Your next question comes from the line of Satya Kumar with Credit Suisse. Please proceed.

Satya Kumar - Credit Suisse

Keith, I think you were saying that you're optimistic with the increasing the utilization that you're seeing across the board, but also a little bit cautious towards the second half. I was wondering if you could provide any color on the order intake happened this quarter, with the typical quarter, where you see in early significant recovery or are you seeing push outs versus (inaudible) can you add some color on that?

Keith Barnes

Yeah. Well, first of all, Satya, this is not a typical period, so it's hard to say, that we're seeing anything like typical quarter. We're coming off the bottom obviously from a very rough period and so I don't think that there is a momentum yet that you would normally see in most up cycles, okay.

So, we're cautious about this up cycle, because the ability for this to snap back as quickly as it has in past cycles is something that's unknown. So, I can only relate to you what we're seeing out there and generally speaking, we're seeing the utilization rates go up in the SOC space. We're seeing, the same thing occur with the memory products that the utilization rates are going up, but obviously they've been holding off on purchases for much longer than the SOC folks have.

There's been a lot of design wins that we've been getting over the last few quarters that have been turning into first upgrades to existing systems in either the technology buys out there for the foundry or IDMs and then technology buys even for OSATs, when they're bringing their first system up and now we're seeing more capacity buy.

So, in general, even though the utilization rates are still picking up, we think they will continue to pick up and it will be a slow grinding recovery over the next few quarters. Now there is some brightspots that we have seen recently and will probably occur with some customers, but in general this is going to be unlike most recoveries I think we have seen in the past.

Operator

Your next question comes from the line of Patrick Ho with Stifel Nicolaus. Please proceed.

Patrick Ho - Stifel Nicolaus

One on the SOC and one on the memory: on the SOC side, can you just describe or give color what market segments you’re expecting to see strength in the fourth quarter and on the memory side, Keith, maybe you can just give a little color in terms of what the drivers are on the NAND flash side that will drive new test capacity issue. As the NAND flash market moves to multilevel sales and increased density. Could that be the driver as the industry goes through the 3X note?

Keith Barnes

Yes. You bet. So, let me take the SOC side first and I think that we continue to see strength in the customers, who are building chips for netbooks and the cellphone. They were strong a quarter ago. They are strong this quarter. I think they'll be strong as we go forward. RF continues to be an area, where that we have seen strengths for the last 18 months and we expect that going forward.

We also expect with our new HSM system that we will see traction in that area for the high speed DDR3 and XDR devices. Also there is some netbooks, which are using those graphics, graphic DRAMS as well that should help and solid-state disk drives and the high-end consumer area for NAND are the two drivers that we see.

Operator

Your next question comes from the line of Atif Malik with Morgan Stanley. Please proceed.

Atif Malik - Morgan Stanley

A question on the market share; you guys said in the prepared remarks that you’ll continue to capture additional market share. If I look at your SOC revenues and divide by the North American, shipments that are reported on the monthly basis as a ballpark, your market share seems to be in the high-teens around 18% for first half of this year. How should we think about the sustainability of that market share in second half?

Keith Barnes

Well, first of all, the OSATs are not in that market share number. So, given that we have a fair amount of OSAT revenue, you’d have to take a look at the ending numbers, including OSATs and then make that calculation. So, that’s probably why it seems a bit off to you.

Atif Malik - Morgan Stanley

I see and then a question on DDR3; I think in the past you have said the DDR3 opportunity is around $100 million next year, and I just wanted to get an update and where you think the opportunity is. Can you comment on the reuse of DDR2 testers for DDR3 right now?

Keith Barnes

Sure. So, first of all, yes, do see reuse in the testers occurring, and I think that memory manufacturers are trying to squeeze their testers as far as they can go, but the DDR3 testing that’s occurring is happening below 1 gigabit per second, and if you have to test devices at a higher speed than that it clearly you need a different system for it.

Operator

(Operator Instructions). Your next question comes from the line of Dave Dooley with Steelhead securities. Please proceed.

Dave Dooley - Steelhead securities

I was wondering if you might be able to help us understand what the assumption is for Touchdown revenue or probe card revenue in your upcoming quarter's guidance and then as a follow on, with gross margins being flat and let's say $8 million or $9 million sequential increase in revenue. I was wondering why they will be flat and not be up?

Keith Barnes

Let me give a little bit of background on the Touchdown Technology acquisition which may help everybody to understand why we said that we expect revenues in 2010 and didn't put too much in Q4. First of all, this is a venture startup company, and we have had visibility on or with the company for some time now.

When we acquired it, we did so knowing that the technology was good technology that we expected would be -- it turning to revenue within a relatively short period of time. We bought the company on an earn-out basis, and we have several designs currently in evaluation or being prepared for shipment to customers, and/or even in with customers and we just didn't feel comfortable putting any revenue numbers out there until we had a little bit of time understanding the revenue dynamics for the company.

So, we're just not putting very much in the Q4 expectations, and the expectations would be that they'll start to see revenue early in 2010 ramping through the year, and so that's kind of the story, Dave. I don’t want to have us get too far ahead of ourselves. They got great products. We're doing lots of evaluations. We've got cards in with customers right now and cards yet to go, but these evaluations take a little bit of time.

Bob Nikl

Dave, to your second question, with regard to the margin, I had said they'll be flattish to up slightly. The reason why perhaps you're not seeing as much as you're liking to see or expecting to see as the result of four quarters inclusion of Touchdown.

Operator

(Operator Instructions). We have a follow-up question from the line of Patrick Ho with Stifel Nicolaus. Please proceed.

Patrick Ho - Stifel Nicolaus

Keith, what could be the driver for new capacity additions? Do you think the transition to 3X node and I guess multilevel sale devices, could that be, I guess the tipping point for new NAND flash test orders in 2010?

Keith Barnes

Well, I mean, it's possible. I don't have any specific data on that. So, it's something we can look into and potentially get back to you on; but I don't have personal knowledge of the end demand of that area.

Operator

We have another follow-up question from the line of Satya Kumar with Credit Suisse. Please proceed.

Anupam Bansal - Credit Suisse

This is Anupam for Satya. This is regarding your [TSM] order. Is it incremental to subcons or is it gaining share in the subcons? The TSM $22 million order you got recently?

Keith Barnes

Okay. I'm not sure we said who the order was.

Anupam Bansal - Credit Suisse

No, basically reported in the Taiwan Stock Exchange.

Keith Barnes

Yes, okay.

Anupam Bansal - Credit Suisse

So, I was wondering whether it's incremental due to subcon or is it into shares?

Keith Barnes

I don't think we break that out.

Bob Nikl

Yes, we wouldn't normally not comment on that at all, I mean the fact that there are regulatory filing requirements in Taiwan. I don't think it compels us to be any more informative with regard to our customers' business than they themselves have already provided.

Anupam Bansal - Credit Suisse

Just a housekeeping question. What could be the other income levels in Q4?

Bob Nikl

I would say, for modeling purpose, 021 from a net expense perspective.

Operator

At this time, there are no further questions. I would now like to turn the call back over to Judy Davies for any closing remarks.

Judy Davies

Thank you, Jeneta and thank you everyone for joining us this afternoon. Downloadable fiscal third quarter financial tables, including the income statement, balance sheet, and full GAAP to non-GAAP reconciliation can be found on the Investor Relations website at www.verigy.com. Please feel free to contact the Investor Relations department at 408-864-7549 with any follow-up questions. Thank you for your participation and continued support. This concludes today’s call.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Have a great day.

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