FormFactor 4Q 2007 Earnings Call Transcript

FormFactor Inc. (FORM)

4Q 2007 Earnings Call

February 5, 2008 4:30 pm ET

Executives

Annie Leschin - IR

Igor Khandros - CEO

Ron Foster - SVP and CFO

Mario Ruscev - President

Analysts

Jim Covello - Goldman Sachs

Harlan Sur - Morgan Stanley

Timothy Arcuri - Citigroup

Gary Hsueh - Oppenheimer and Company

Chris Blansett - JP Morgan

Mehdi Hosseini - FBR

Patrick Ho - Stifel Nicolaus

Presentation

Operator

Good afternoon ladies and gentlemen and welcome to fourth quarter 2007 FormFactor Incorporated Earnings Call. My name is Lisa and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today's call Ms. Annie Leschin, Investor Relations. Please proceed.

Annie Leschin

Good afternoon and thank you for joining FormFactor's fourth quarter 2007 earnings conference call. With me on today's call are Igor Khandros, Chief Executive Officer; Ron Foster, Chief Financial Officer; and Mario Ruscev, President. Igor will provide a summary of our fourth quarter performance, review market segments and provide an update on outlook and long-term strategy. Ron will then take us through the preliminary financials, operational details and provide guidance.

Finally, before I hand the call over to Igor, I will review our safe-harbor statement. During the course of this conference call we will make forward-looking statements within the meaning of the Federal Securities Laws, including statements regarding markets in which we compete, our new production execution, demand for our products, our financial performance and our strategic and operational plans. These statements are based on current information and expectations and are inherently subject to change and involved risks and uncertainties.

Actual events or results may differ materially and adversely to those in our forward-looking statements, due to various factors including but not limited to, the continuing challenges and deterioration of the markets in which company's product are used including DRAM, the demand for certain semiconductor devices, the rate at which customers adopt the company's newly released products, implement manufacturing capability changes, make transitions to smaller nanometer technology nodes and implement tooling cycles, the company's ability to develop end market innovative testing technologies on a timely basis, to address production issues and efficiently scaled production of its harmony architectural product line, to deliver and qualify new products that meet customers' testing requirements on a timely and efficient basis, to execute it's cost reduction plan and implement measures for enabling efficiencies and supporting growth in its design application and other operational activities, and the company's ability to obtain tax and other costs advantages from its expansion of operations into Singapore.

The company assumes no obligation to update the information in this presentation, to revise any forward-looking statements or to update the reasons actual results could differ materially from those anticipated in our forward-looking statements. Please refer to the company's recent filings on Form 10-K for fiscal 2006 and 10-Q for Q3 2007 for additional information regarding the relevant risks and uncertainties.

Finally, a breakdown of revenues by market and geography and a scheduled reconciling our GAAP and certain non-GAAP financial information and guidance is available on our website.

I would now like to turn the call over to Igor Khandros.

Igor Khandros

Thank you, Annie. Hello, everyone and thank you for joining us. By this point, most of you have seen our press release. We are entering 2008 at an especially challenging time for FormFactor. Our customers are seeing deteriorating conditions in their markets, especially in the past 60 days and particularly a tough pricing environment in the DRAM segment.

We are also continuing to feel the affect of the new product execution challenges we experienced in 2007, which have contributed to a more difficult competitive environment. The combination of this factor has significantly reduced the outlook for the first half of this year. We're reacting to this negative confluence of events proactively by adopting a cost reduction plan that will among other things reduce our worldwide headcount by about 14%.

We are mobilizing the company to deal with the near term challenges efficiently. But we'll continue our research and development investments so that over the long-term, we can maintain and expand our technology and market leadership.

Now, let me quickly mention some key highlights from 2007 before I discuss the market segments and the outlook. FormFactor ended 2007 with revenues at $462 million, a 25.2% annual growth, roughly in line with our estimated market growth advanced probe card. DRAM remains the largest part of our business though all sectors grew in double digits.

During the year, the Company achieved a number of milestones including the expansion of its product line with the introduction of its Fine Pitch Wire Bond larger product for mobile consumers and automotive applications, A qualification and improvement in the manufacturing of the Harmony product for both DRAM and Flash applications, and the strength in our management team was mostly our new President, Mario Ruscev.

The year ended on a challenging note for FormFactor with fourth quarter revenues decreasing 4% sequentially to $120.5 million. The slower fourth quarter was largely due to the weakening market conditions and earlier execution issues associated with Harmany DRAM. DRAM remains FormFactor's most significant contributor in 2007 responsible for more than half of the Company's growth.

In the fourth quarter, 70-nanometer DDR2 and 1-gigabit were the major drivers behind the increase in DRAM revenues. However, our new product RAM challenges versus Harmony resulted in a mist of opportunities with a few customers causing the majority of the overall revenue shortfall in the quarter. We made significant progress in the manufacturing readiness of our Harmony DRAM product during the quarter, having reduced lead times by 30% and shift volume orders of this product to several customers.

Looking at the first quarter of 2008, DRAM market conditions had deteriorated dramatically in the past two months. Typically, the advanced probe card market is not subject to the same cyclical fluctuations as the semiconductor or capital equipment industry. However, when memory prices are either very high or very low, near cash course, the probe card market can be significantly impacted. While bit growth has remained healthy, device prices for DDR2 512 megabit equivalent have stayed below manufacturing cost for several quarters.

More recently prices have been below cash course for some suppliers. While customers are faced with such challenges in economics, they must immediately take action to improve productivity and reduce cost by any and all means in order to preserve cash. This is causing customers to delay test capacity expansion in existing nodes and implement aggressive reduction in test times and in some cases in the degree of testing. In the company's history, the only example of DRAM environment resembling these current extraordinary conditions was in 2001 when the price of DRAM reached to low of about $0.75.

Due primarily to the market conditions, as well as the delay in the Harmony DRAM, FormFactor's DRAM bookings declined significantly. Our focus going forward was shifted to the demand generation side of the equation as we work to regain our lost position with DRAM customers who could not wait for our Harmony products. Although, we have made significant progress in manufacturing our Harmony products, the precise timing of the market recovery is still uncertain.

The competitive pressure we're experiencing is into lower end wafer contactor applications, which is affecting pricing and margins in the near term. For more complex high-end applications, we believe our products are differentiated; able to work in a wide temperature range in the smaller pad size and pitch with the highest pin-count in the industry.

As the market moves to sub 70-nanometer in DDR3 in the second half of 2008, the requirements for full wafer contactor will become even more stringent requiring the differentiated capabilities of our Harmony-based products.

Flash grew 53% for the year. NOR Flash experienced a very robust year driven largely by the increasing demand for Known Good Die. During the quarter Flash revenue fell due to slowness in our NOR customers buying patterns and then Harmony ramp issues.

Bookings rose in part through Harmony OneTouch orders, while NOR slightly decreased driven again by the ramp from one of customers tooling of 65-nanometer specific timing.

Our NAND Harmony one-touch cards now being used in high volume manufacturing, are showing excellent performance. As our manufacturing has improved, our lead times decreased. We now have the opportunity to grow in this area. Additionally, we expect our Known Good Die product offerings to continue to differentiate us in the NOR and specialty NAND markets.

SOC Logic business grew 15% in 2007, as we maintained our market share. In the fourth quarter, total SOC revenue fell due to a seasonal decline in the key customer. However, we continued our successful penetration of the Wire Bond logic market, rapidly increasing revenues from a small base for the second quarter in a row.

We received new design wins in the automotive segment and penetrated the consumer application segment with our TrueScale product. We reached another technology milestone for the TrueScale product family, for the Wire Bond logic market achieving 40 micron page. This product was qualified by new customers during the quarter and is now ready for volume shipments.

We believe TrueScale will address the limitations of conventional probe card technology which cannot scale to low 50 micron of high parallelism. TrueScale is designed to increase manufacturers throughput and lower test scores, while supporting their technology roadmap for smaller path pages. We expect to make continuing progress with this product family into Wire Bond market.

Our Known Good Die products had another very strong year growing 95% over 2006. Wafer-Level Burn-In grew 44% in 2007 as customers move more Burn-In of their devices to the Wafer-Level.

During the year, we shipped our first 300 millimeter one touch down Harmony Wafer-Level Burn-In product, setting an industry record of 40,000 pins. Wafer-Level Burn-In ended the year with the strong quarter growing 38% due to the ramp of 1-gige DDR2. HFTAP, a high frequency test probe also had a very strong year near tripling over 2006.

We continue to see increased adoption of our HFTAP products for NOR, mobile RAM and PSRAM for at speed testing. Having doubled our customer base in 2007, we are now nearly 20 semiconductor manufacturers using FormFactor HFTAP products their Known Good Die applications. We are confident that Known Good Die will continue to be an important contributor to FormFactor's 2008 and longer term growth as our complete suite of Known Good Die product serves as a significant differentiator.

Now, I would like to turn to the 2008 outlook. As I stated earlier, we've experienced a sudden slowdown in our DRAM business due to customer's cash preservation behavior. Though the overall good growth remains positive, DRAM semiconductor revenue in particular is currently projected to decline significantly, nearly 20% in 2008 due to the protracted oversupply. The recently communicated capacity investment pullbacks by DRAM manufacturers will hopefully be a step to advancing the market supply and demand, and pricing conditions are expected to improve in the second half of the year.

FormFactor operated best when DRAM pricing stayed above customers' manufacturing costs, and certainly above their cash course. In light of near-term market and certainties, we do not have a reliable basis, and we wish to project either market growth as a whole or FormFactors growth for 2008.

So let's talk about the visibility we do have. The current quarter looks very difficult. Ron will give you more details but we think that the overall market and FormFactor revenues will both be down in the first quarter. We are hopeful that the second quarter will improve our first, and then the second half of the year will be significantly better than the first half, but the precise timing of the recovery is speculative.

Broadly speaking, we know that the technology transitions will continue such as RAM of 65 to 68 nanometer technology and the introduction of DDS3 in the second half. And we as a market leader will benefit.

Due to the protractive Harmony ramp issues we experience in 2007, FormFactor was not the first full-wafer contactor probe card company qualified at some DRAM suppliers. This resulted in the loss of business in the fourth quarter, which we believe the competition picked up at lower end DRAM applications.

With the recent improvement in our Harmony execution we demonstrated our ability to manufacture the industry's most advanced full-wafer contactor for high volume production environment. For example, FormFactor has already delivered a 40,000 pin probe card.

With the fundamental advantage of our 3D technology over 2D NAND technologies, we believe the FormFactor product is scalable for final geometrics and more complex such as DDR3, which will drive the full-wafer contactor market to more than 60,000 pins by second half of 2008.

As the advanced probe card business is fundamentally a design-based business, every new design presents an opportunity for us to demonstrate our technological differentiation and capture customers' next designs. We take our competition very seriously, but we will work hard to translate technological and operational advantages to improve the full-wafer contactor probe card market position as we have done in the past.

In summary, we are witnessing extraordinary conditions in our business, but the long-term advanced probe card market drivers continue to point to growing at the rate faster than the rest of the semiconductor industry. Our products and technology are into leading edge and though we have experienced significant difficulties with our Harmony product ramps, we have learned invaluable lessons and will be a much stronger company (inaudible).

During difficult times strong companies make the right investors and technology. They are 100% committed to doing the job there. We believe that FormFactor will continue to lead this market for many years to come.

As our full way of contactor Harmony based DRAM product enters the market in volume, we believe we will demonstrate our advantages. Additionally, we are just beginning to penetrate SOC and NAND flash markets where we can significantly grow our market share in the next few years.

We see 2008 as a transition year. As we work to resolve the issues we have had and introduce new products, invest in R&D and accelerate our product cycles and improved our execution, all of which will better the position FormFactor as a leader for the next decade.

Before I hand the call over to Ron, I would like to take a moment to introduce Mario Ruscev, our new President, who comes to us after many years at Schlumberger.

Mario Ruscev

Thank you, Igor, hello everyone. I feel privilege to be a part of the FormFactor management and I look forward to speaking to all of you in the future calls. There obviously has been some significant changes in the environment, my first month at the Company. In order to weather these challenging times, we are taking a few of the following actions.

First, we are reducing our cost structuring as announced and this includes the work for reduction that Igor mentioned, in order to maintain our financial help. We're also improving our ability to deliver custom products, who custom a worldwide on timely on cost effective basis by moving design on application activity closer to them and increasing our presence in geographical areas where we operate. As an example, by the third quarter all designs needed for the Japanese market will be done in Japan and this will also be true for Korea by the fourth quarter.

We also continue our investment in R&D, in order to maintain our technological leaderships. In 2007, we do estimate that our R&D investment was about twice as high as for all of our competitors combined. And last, we are conducting a solo review of how many product introductions and how we'll implement the changes to our product introduction process.

Now I would like to turn the call over to Ron Foster.

Ron Foster

Thanks, Mario. I will focus my comments on three areas. First, I will provide a summary of fiscal 2007, second, I will review our Q4 results, and third, I will conclude with guidance for Q1.

Let's start with the brief summary of 2007. 2007 was a solid year from both the operating and financial performance perspective. Here are some of the key highlights. Revenue grew 25% to $462 million. Gross margin improved from 50.1% in 2006 to 53.4%. On a comparable non-GAAP basis excluding FAS 123R option expense, gross margin improved from 51.3% in 2006 to 54.6%. GAAP operating margin was 20.2% in 2007 compared to 18.1% a year ago.

Operating profit dollars on a comparable non-GAAP basis grew 37% year-over-year. We achieved our target annual non-GAAP operating profit model of 25% for the year. GAAP earnings for fully diluted share grew $0.26 over last year to $1.47. We added $84.8 million in cash from operating activities and free cash flow was $36 million for the year. 2007 ended with $572 million in cash and investments and increase of $78 million compared to 2006.

Looking at our various market segments in 2007, DRAM revenue increased 19% to $323 million, accounting for 70% of our revenues in 2007. We expanded in the Flash market increasing revenue 53% to $89 million or 19% of total revenue. Known Good Die revenue consisting of our Wafer-Level Burn-In and HFTAP products was up 95% in 2007 to approximately $78 million as we saw increased adoption for mobile and PSRAM, at speed testing. And finally Logic revenue grew 16% to $45 million representing 10% of total revenue in 2007.

I will now provide specific comments on our Q4 results. Revenues were $120.5 million down 4% over the third quarter and up 22% versus Q4 '06. Weaker than expected order flow in the quarter reduced the amount of business that we had expected to book in turn in the quarter.

DRAM revenues which accounted for 75% of revenues in the fourth quarter increased 10% sequentially to $90.2 million. Flash revenues declined 38% sequentially to $19.9 million representing 17% of revenues in the fourth quarter, coming of a strong tooling cycle for NOR in Q3.

The Logic revenue was $10.4 million representing 9% of revenues, a decrease of 5% over the third quarter due to the cyclical declines related to a key customer's product transition. However, we are well-positioned as our existing customers moved to high parallelism, high-speed testing. KGD revenue in Q4 was up 18% from Q3 at $25.6 million and up 284% over a year ago.

Fourth quarter bookings were expectedly weak at $93.9 million, a decrease of 25% over the third quarter and an increase of only 3% over the same period last year. Although, Flash and SOC bookings were up sequentially, DRAM bookings dropped 36% as some customers have delayed or cancelled the purchases of probe card to deal with severer margin problems.

The weak bookings led to a lighter than normal loading in our factory in the last month of the quarter and generated the lowest level of beginning backlog for the up coming quarter since Q4 2005. Good execution and shortening cycle time enabled us to turn 62% of the bookings in the fourth quarter.

Now, I will discuss our GAAP P&L results and some key non-GAAP results to supplement the understanding of our financials. Our schedule that provides GAAP to non-GAAP reconciliations is available on the investor portion of our website.

Let me review some key financial information for Q4. GAAP gross margin for the quarter was 51.1% below the 53.2% for the third quarter, primarily due to the lower production levels in the quarter. Non-GAAP gross margin was 52.2% also down from last quarter. GAAP operating income for the quarter was $22.1 million or 18.4% of revenue compared to $27.1 million and $21.6 million in the third quarter.

On a non-GAAP basis operating income for the fourth quarter was 23.3%. Interest and other income for the fourth quarter decreased slightly quarter-to-quarter to $6 million from $6.2 million last quarter, the decrease was attributable to slightly lower interest rates. The yield on our cash investments in the quarter was 4.3% with a mix of taxes exempt and taxable investments. Even the current outlook for interest rates, we would expect our interest income to come down to a level of approximately $5 million per quarter in Q1.

The effective tax rate for the fourth quarter was 37%, excluding the impact of the one-time Singapore intellectual property buying. As we mentioned in the last quarter, a cornerstone of our plan to expand in Singapore includes transferring intellectual property rights there along with manufacturing. This quarter's tax rate includes a onetime royalty pre-payment as a partial buying for the IP transfer to Singapore, this payment increase for Q4 tax rate 12 percentage points to 49%.

Given the market challenge as we see in the very near-term, we've decided to revise the timing of our expansion plans in Singapore. We still expect to have customer support and sales and marketing activities up and running as planned in 2008, but we are delaying the production ramp by approximately six months and expect to begin manufacturing in Singapore no sooner than late 2009. The planned tax rates for 2008 and 2009 will be in the mid 30% range with a ramp-up production, tax rates in 2010 and beyond should decline significantly.

Net income for the fourth quarter was $14.3 million and $0.29 per fully diluted share on a GAAP basis, including the impact of the one-time buying of intellectual property by Singapore. Excluding the buying, net income was $17.7 million and $0.35 per fully diluted share. This compares to our guidance range of $0.32 to $0.36 per share, and $22.2 million or $0.45 per fully diluted share for Q3.

Now, turning to the balance sheet and cash flow statement. Cash and marketable securities totaled $572.3 million in the fourth quarter, an increase of $32.9 million from the third quarter. Cash from operations was $43 million. We spent $19 million on capital expenditures compared to $14 million in the third quarter. DSOs declined to 45 days in the fourth quarter compared to 48 days in the third quarter. Net inventories decreased by $3.3 million during the quarter to $29.3 million. Inventory turns were 6.9 in Q4 down from Q3.

Now, let me give you guidance for Q1. Weak beginning backlog and some DRAM customers' decision to delay probe card purchases and to reduce expenses in the near-term has resulted in a declining outlook in the first quarter. Consequently, we expect revenues to be in the range of $70 million to $80 million.

With the rapid revenue decline in Q1, we expect to have a GAAP net loss in Q1. Excluding one-time restructuring costs that will be incurred in the quarter, the net loss is projected to be between $0.09 and $0.19 per share. One-time restructuring costs, which consist primarily of severance costs related to the workforce reduction will be $4 million to $5 million, or $0.05 to $0.07 per share.

A GAAP EPS includes about $0.09 incremental stock comp expense. On a non-GAAP basis excluding stock comp expense and one-time restructuring cost, we expect an operating loss of between 6% and 19% and earnings per share to be between a loss of $0.10 per share and breakeven.

Headcount at the end of the fourth quarter was 1,187. The cost reduction actions we announced today will result in a workforce reduction of about 14% from the current level. This combined with other costs cutting actions we are taking in the quarter will reduce our spending run rate by about $4 million per quarter beginning in Q2.

Now, let us open the call for questions. Operator?

Question-and-Answer Session

Operator

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

Jim Covello - Goldman Sachs

Good afternoon, guys. Thanks so much. The first question -- I have two questions, the first question is just how do you figure out with everything that's going on, what's a secular problem in your business versus what is a cyclical problem in the DRAM industry? So, when you are making the cuts, how do you decide how deep the cuts are fixed -- some manufacturing problems and some potential share loss that you might not get back versus the cyclical DRAM issue that will eventually recover?

Igor Khandros

Well, as you can imagine, this is highly unusual time for us. The way we are look at it, as I mentioned if you look, for example, at Q4 and you look at the $5 million shortfall between mid-range of the guidance and what we delivered, majority of that $5 million is where FormFactor did not compete for full-wafer contactors business, so that was lowest competition.

If you look at outlook for Q1, roughly, and it's very hard to be precise, but roughly we see it as two-thirds is basically a market-conditions issue. It is extraordinary times where basically people wakeup one day, and their DRAM cost is below cash costs, and what you need to do immediately is to take actions the next day that -- where you bring it to or above cash costs, right. And your costs you bring up to or above pricing.

So in order to do that you take whatever actions you must take -- to take whatever risks actually you must take and that has reflecting our business. We believe that's two-third of the problem. One-third of the problem is that, FormFactor, especially at one customer constellation but it's -- when the full-wafer contractor demand with there, we did not compete well due to Harmony introduction problems. And now, we have to sum up these issues behind us. We're ramping Harmony, and we have to go back and compete.

Jim Covello - Goldman Sachs

Okay. And thanks for that. And the other question, just as relative to the cash position -- if you look at where the stock is in the aftermarket. It's really not that far above that the net cash position of the company, and obviously it sounds like you'll burn little cash in the first quarter, but it looks like as the company steps in and take actions relative to buying back stock being aggressive in that regards, considering the cash position relative to the overall market cap of the Company.

Ron Foster

Jim, this is Ron. We're certainly seriously considering stock repurchase scenarios and actively looking at that relatively to our total cash position. By the way, looking at Q1 based upon the guidance I gave you, I think we'll still be on an operating-cash-flow-flat kind of scenario. And we're also looking at our cash balance, looking at repurchase, but also waiting against other potential future uses of cash as we continue to invest in our business and expand for growth.

Igor Khandros

But Jim, really, I mean, what the company is going to do is what companies that aspire to be great do in such cases, and that is, we're just going to go back to basic, we're going to learn lessons, learned on, as Mario mentioned, on this Harmony introduction, and we'll make sure that we do things a lot better in the future? We will continue investing in R&D, and we'll make sure that technologically, we'll continue building the gap between us and competitors and based on doing things fundamentally right. We believe that we will regain our financial performance, and we will regain our market position, and we'll regain confidence of investors. I mean, that's fundamentally what needs to happen.

Jim Covello - Goldman Sachs

Thank you.

Igor Khandros

And that's what we are committed to do.

Ron Foster

Thank you, Jim.

Operator

Your next question comes from the line of Harlan Sur with Morgan Stanley. Please proceed.

Harlan Sur - Morgan Stanley

Thank you, and good afternoon. It still seems like the team is losing opportunity to your competitors here in the first quarter because you are not satisfying the Harmony demand out there. I think your previous target was to improve capacity by about 2X in Q1. First question is, did you hit that target, and the second question is: Will FormFactor be in a position to satisfy the pipeline of Harmony business starting in the June quarter?

Igor Khandros

Yeah. We actually are on track now with Harmony, and yes, we will increase capacity by factor of 2 or more. And yes, we believe that we'll be on track to ramp Harmony production. We'll compete very, very hard with both DRAM and Flash products.

Harlan Sur - Morgan Stanley

So do you think you'll be in a position to satisfy the pipeline of Harmony demand for the second quarter?

Igor Khandros

The answer is yes, and we work very, very hard on demand generation right now.

Harlan Sur - Morgan Stanley

Okay. Great. And then you've talked a lot about weakness in the DRAM market space. What are the demand trends you are seeing in the NAND flash business? You know capacity out there are still fairly robust, technology transition are still progressing as planed. I'm just curious as to what you are seeing in that segment of the business?

Igor Khandros

Actually, if you look at current environment, I mean there is a confluence of several things here, and that is when your cost is at or below cash cost you immediately take actions in order to not basically haemorrhage cash, I mean we'll know that. So what people do is, for example, 200 millimeter capacity went off the market, so that had an impact. Second is, people will delay and of course, they communicate it. The capital investment -- they are lowering, most of the companies is lowering the outlook.

You will probably see very short-term, say, Q1. You will see fewer bids produced and what happen is that 65 to 68 technology transition is still very early, it's really not yielding. Companies are putting unusual amount of emphasis, and I must emphasize unusual on squeezing whatever extra percentages of yield in existing 70-nanometer product.

There is really most companies rent 70-nanometer -- there is maybe one constellation that's ramping it right now. But what people will do is, they'll put their engineering not on running new things, they will put it on squeezing out the extra percentages of yield. That will not result an extra probe-card business.

And the last thing is, in the past, we have always benefited from customers carrying suites of probe card in the likelihood that you can sell two 512 megabit devices for more money than 1-gigabit. It's just an example, but there have been many, many situations like that when density is consistent in the market or architecture is consistent in the market. In the environment like this, you're just not going to do that, you'll just take a risk and basically just carry one and they'll do it for 1-gigabit DRAM so that you spend less on packaging. You need to package two 512 devices and you don't need to package 1-gig device.

So all of these things in the very short-term are impacting our business. As you said, as you look at mirror long-term, yeah, people will ramp 65- to 68-nanometer technology very, very hard. I mean, they have to. Those who by the mid-year are not really yielding their technology will get a huge disadvantage, so they'll be ramping. That's why we feel that the first half will be challenging. We believe second half will be stronger, and that's one of the main reason people will be ramping DDR3 in the second half. This is going to be a major event.

So these things will happen, but when you're operating at above cash costs, it's almost like deep freeze -- and you basically think of cash preservation, you do very few new things, right? And this is the confluence of kind of events that we're facing with now.

Harlan Sur - Morgan Stanley

Okay. Last question for Ron. How many and who are your 10% customers in the December quarter?

Ron Foster

Harlan, there were three same as last quarter. So it's roughly the same breakdown of heat expansion and power chip.

Harlan Sur - Morgan Stanley

Okay. Thank you.

Operator

Your next question comes from the line of Timothy Arcuri with Citigroup. Please proceed.

Timothy Arcuri - Citigroup

Hi, guys. Obviously the issues with Harmony seem like they weren't really capacity related, so it wasn't kind of a shortage of your capacity as I think you were suggesting last call. I guess it seems like the issue was more or is more kind of products specific, which maybe like an architectural or technical issue with the actual product.

Can you go back and can you really detail what the specific issue was, because I know last quarter you were kind of saying you didn't have enough capacity, but it sounds like it was a product-specific issue and maybe you can detail what exactly it was and maybe that will help us be convinced that it's behind you. Thanks.

Ron Foster

So the problem we communicated last quarter was capacity related. In other words, we just -- where we were as I mentioned then or in the assembly and test part of the flow of the product. We clearly had a bottleneck, and we were doing a lot of learning and actually in Q4 we've made some a major progress there, and what we started doing in Q4 is using automated tools for clarification on assembly of that product.

So there has been a lot of work done in the factory. We reduced cycle times in Q4 by 30% on that product. So reducing cycle time also increases your basically capacity because you move more through the factory. And we are now, I mean, for example; we'll ship now, I'd say, almost 22 touchdown probe cards. Remember majority of full-wafer contactor market today is probably at four to three touchdowns. And we shipped I'd estimate 20 two-touchdown probe cards. We have several one-touchdown probe cards with 40,000 pins in production.

So there has been a lot of learning. It is a complex product to produce. So this is not a situation where you'd say, I've solved all the problems of, you try to ship hundreds of these cards per quarter, you have to streamline your manufacturing, you need to automate more, you need put more tools, you need to train more people so it's going to be work, it is a complex product, but it is a very capable product. It's a product that will afford us differentiation that at very high pin counts, at very fine features. Company is working very hard, and that's one of the focuses from Mario and that is to understand what lessons we must learn revenue to change our skill mixture structure, where do we need to automate and we must, you'll see us doing better as we go.

Timothy Arcuri - Citigroup

Okay. Just one quick follow-up on that, Igor.

Igor Khandros

The only way, Tim, I can convince you is when you see us performing, I can convince you by talking.

Timothy Arcuri - Citigroup

I agree. I guess on that point can you -- there has been a lot of concerns about the competitive gap between your product and other folks product narrowing. However, some of that sounds like it was due to your own inability to actually build the product. So, I guess, are there any recent examples that you can maybe point to that the new card is in the marketplace competing against the competitions card and at least recently has one based upon your newly found ability to actually build the card?

Igor Khandros

Well, remember, this is still early in this market, and getting this precise information at this stage, in full-wafer contactors rollout in the industry is difficult. I can tell you that we have products out there. That it is our belief today -- product we shipped in fourth quarter of last year, and we don't believe other companies could ship. That doesn't mean that competitors are not learning and making progress.

So that's a dynamic situation, but we also are making further improvements, and as you know, we are also investing in R&D. So again, we believe that we shipped one touchdown product, that's 40,000 pins. We believe that it was the most capable product in the market. Now, clearly competition took up some demand, that some customers that caused the swing for right so they are clearly capable.

And again, this is not a situation where you talk your way out of it. We will compete our way out of it. We believe as we start shipping Harmony in high and high volume, putting it on customer's floors that we will demonstrate basic fundamental advantages of our technology. That's what we believe and we need to prove it now.

Timothy Arcuri - Citigroup

Okay. Thanks.

Operator

Your next question comes from the line of Gary Hsueh with Oppenheimer and Company. Please proceed.

Gary Hsueh - Oppenheimer and Company

Yeah. Hi, Igor. My question is just -- it seems like you basically opened Pandora's box in here in terms of market loss, and I certainly think you guys have a technological ability to kind of gain it back with Harmony. But I just wonder how easy is it to kind of recoup what your original thought was in terms of pricing on Harmony? And b), if you can't really recoup it -- introductory price that you had and vision for this product -- how do you go about in '08 lowering materials costs, lowering your overhead, and improving gross margins in a challenging market share environment in '08?

Igor Khandros

So it's always easier to be the first one in than coming in and trying to recruit something, It's not easy; it will not be easy. The question is, do we feel we are capable of doing it? The good news is that our business is design driven business. Every time there is a new design up for business, we have a chance to compete. It's a new game for every design. So therefore, there will be ample opportunities for us to go back and to regain our position where we lost it. We didn't lose it everywhere, all right, but in cases where we have to [hide], there was a chance with every design to perform.

In the second half, you will have new DDR3 architecture ramping, and if you look at the DDR3, it will drive pin counts. For example, there will be demand for 60,000 pin-probe cards. We believe we can make one round. And, again, we don't have precise information about competitive capabilities, and clearly competition was capable to pickup the business, but we believe we'll have significant advantages as we head to more and more complex architectures as we head towards 65, 68 nanometer technologies with finer pitches potentially, finer dimensions. So that's where it will get laid out, but I do not assume it will be easy. It's going to be a lot of hard work for the company.

Gary Hsueh - Oppenheimer and Company

No, that's fair enough. Igor you mentioned basically reduction in terms of cycle times. Certainly, that's going to be favorable in terms of gross margin going forward on a Harmony product. Anything else, any other kind of low-hanging fruit in terms of material cost reduction on Harmony that you can guys basically implement to sort of buoy gross margin there in their product?

Igor Khandros

There are ongoing-cost reductions, cycle-time reductions and productivity-improving efforts that are going on. So, yes, you should expect us to be continuing making progress. And, again, that's one of the things where Mario in his first month here has been very much focused with the team on.

Gary Hsueh - Oppenheimer and Company

Okay.

Operator

Your next question comes from the line of Chris Blansett with JP Morgan. Please proceed.

Chris Blansett - JP Morgan

Hi, guys. When you think about the personnel cuts throughout the company, are they job-specific, or you how should we look at these? And then Ron, I guess you said earlier what it would -- how it would impact your operational costs, could you repeat that?

Ron Foster

Yeah. I'll take the first part of the question, Chris. In terms of that personnel cuts, we cut in most all the areas with a notable exception of R&D, where we continue to invest, as Igor already mentioned, the heaviest cuts where in operations obviously given the lighter capacity loading and some of those were temp employees et cetera, that we have in our factory.

In terms of the operating-costs reduction, it will cause us in restructuring cost $4 million to $5 million. And we believe that we will get about $4 million cost-run rate improvement starting in the second quarter $4 million expense reduction out of those headcount reductions and other cost reductions.

Chris Blansett - JP Morgan

Should we see most of that show up in the SG&A side?

Ron Foster

Both manufacturing and in SG&A.

Chris Blansett - JP Morgan

All right. And then when you think about the weakness you saw in DRAM, was this concentrated in your top DRAM customers, or was it pretty broad base for all of your DRAM customers?

Ron Foster

I think it's -- the weakness in DRAM is broad base.

Chris Blansett - JP Morgan

Okay.

Ron Foster

It basically is an issue that the price for the product sending on the company, but its hovering somewhere around cash cost. And so it's not -- it just can not possibly be a long-term condition for the industry. So, clearly something is going to give here.

Chris Blansett - JP Morgan

I had two quick ones here. One is, Igor you mentioned low-end applications for OneTouch probe cards, and I'm a little confused because I would have assumed that any OneTouch application is kind of considered -- you get a better premium for that probe card?

Igor Khandros

I understand the question. The market is for full-wafer contact, and where competition came in is not for one touchdown testing, basically you may contacted its contacts, most of the area, almost all of the wafer, but then you step it four times.

And we already also made a contactor that just touches it in one and tests in one touchdown. So the market for full-wafer contactor typically is one-to-four touchdowns. Today, most of it is four and three touchdowns. We've shipped significant amount of two touchdown cards, actually. And you'll see -- at the end of this year and certainly in '09, you will see more one touchdown – one- to two-touchdown applications.

Chris Blansett - JP Morgan

All right. Last one on the transition to Singapore: Even though the near-term conditions are a bit weak, why would you want to delay that transition and not just shove it out there sooner to get the cost saving sooner?

Ron Foster

Chris, this is Ron. We are continuing our plans with Singapore. We've simply delayed it six months. As I commented earlier, we are going to be rolling out in 2008 our sales activities and marketing activities in Singapore, which are steps in that direction. We are making the investments in the IP transfers, which is a step in the direction of Singapore. So all we're dealing with here is a slight out of about six months in terms of our planned schedule.

Chris Blansett - JP Morgan

All right. Thanks Ron.

Mario Ruscev

I just have one comment on that. When you do this move, it's very time-consuming for the management, and now we have some -- we want our management to be very focused on a few other areas as you expect but three different main reasons to delay it now.

Chris Blansett - JP Morgan

Thank you, guys. I appreciate it.

Ron Foster

Thank you, Chris.

Operator

The next question comes from the line of Mehdi Hosseini with FBR. Please proceed.

Mehdi Hosseini - FBR

Yes, thank you for taking my questions. Most of my questions regarding current business have been answered. But Igor I was wondering if you could talk about Logic. In the past, you have talked about all opportunities and everything. How come those opportunities haven't materialized given the weakness you've seen in the memory market, I thought maybe by now you would have made up for the miss, but what are the challenges there that you are facing in the Logic market?

Igor Khandros

So in Logic, actually where we fit right now as we look at 2008 and beyond, you will see Logic being the potentially fastest-growing business at FormFactor. As a matter of fact, we projected to our goal all other segments of our business. So what was very important last year is to introduce this new what we call TrueScale product, which addresses high-parallelism, fine-pitch and wire-bonded, market applications, and it's actually performing well --we actually have additional design wins, and it bodes well for 2008 Logic growth.

In the past, we described first Known Good Die as an engine for growth, and as I mentioned previously, we almost doubled last year, and Known Good Die longer-term will still be very, very important engine of growth for FormFactor. And Logic, SOC is also going to be a significant area for growth for us. So I do not necessarily see it as -- I see it as a good storage.

Mehdi Hosseini - FBR

Does your technology or methodology require any changes to the test platform or testing technology?

Igor Khandros

No, we design our new products for all market segments, whether it's a flash, DRAM or SOC to fit existing tested platforms.

Mehdi Hosseini - FBR

So this is more like a plug and play?

Igor Khandros

When we roll out our products, we make sure that vast majority of installed base of testers out there can use our probe cards, yes and there was quite a bit of work that goes in to making sure.

Mehdi Hosseini - FBR

As a follow-up, help us understand what needs to happen for your customers to adopt your high parallelism in the largest non-microprocessor market, what is the current challenge or what is the milestone that you have ahead?

Igor Khandros

It's just a change, in most cases the change from traditional probe cards, the people have had 10, 20 years of experience of using, and they had their organizations designed and focused on how to use these needle cards, and now you are using NAND base-probe cards. So it's basically, you need to qualify people who have to be confident that once they let you in the way, that they now run every following designs. So you need to synchronize the design rules, you need to synchronize how the metallization is contacted by these probe cards to do quite a bit of work before you say look from here on you can just use it and it takes an effort, but again we're making good progress there.

Mehdi Hosseini - FBR

Okay. Thank you.

Ron Foster

Thank you.

Operator

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

Patrick Ho - Stifel Nicolaus

Thanks a lot. Can you just provide some clarity on, I guess, the issues with Harmony. And I think Ron you mentioned the R&D will continue to be the focus for the company. Are these still R&D and engineering issues that you are still trying to work up because I guess going back into -- just looking back at some of the previous quarters, you mentioned that there were production capacity constraints. I think one quarter before that there were customer integration issues. I mean have all the engineering issues been resolved, or is this something that could still linger over the next couple of quarters?

Igor Khandros

Harmony is no longer in R&D. Harmony is getting ramped in manufacturing. So the issues with Harmony, is now automation. The transfer from engineering to manufacturing is largely finished. There is still quite a bit of engineering involvement, but you basically have now automation and manufacturing engineering and assembly and test organization, building and shipping this product.

When we talk about our future R&D investments, and FormFactor spends in R&D twice as much as the rest of five largest competitors combined, we are investing in multiple new products. So the comment that made was that in this environment what FormFactor is going to do is continue investing heavily in R&D. So both in probe card market but also a new market that FormFactor, new businesses FormFactor will build that we will be the leader [for the one third]. So the R&D in '08 is not Harmony, this is a little bit new product.

Patrick Ho - Stifel Nicolaus

Okay, fair enough. And I know you don't want to give specific guidance on the June quarter, but given the steep decline from Q4 to Q1, is there any possibility of a snapback in Q2 based on the market conditions improving or is Q2 dictated more by the market or your ramp up Harmony?

Igor Khandros

So the short answer is that as I mentioned in my script, we expect today we hope that Q2 is stronger, clearly stronger than Q1, and we certainly believe that second half of the year will be significantly stronger than the first half.

Now having said that, you can see that we are in the environment right now where we just need to stay very, very focused on short-term execution. Now, this is not an easy time to predict exactly the timing of this improvement.

Patrick Ho - Stifel Nicolaus

Okay, I guess, yeah, I understand that part. But I guess I am just trying to figure out, is the incremental gain going to come from the market turnaround or your execution on the Harmony?

Igor Khandros

It will be both. We believe that the market for our products, especially in the second half, will be significantly stronger. We believe that FormFactor will compete a lot stronger also in the second half and we'll also -- if anything else, we believe that the lessons we've learned last year is new product introduction will make us a much better company and you will see us over the long-term introducing multiple new products a lot better than we have done it last year. So, all of that will bode well for our growth.

Patrick Ho - Stifel Nicolaus

Okay. Thank you.

Igor Khandros

And with that, we thank you all for joining us today. That concludes our question-and-answer period, and we certainly look forward to seeing you at the upcoming conferences and on our next quarterly earnings conference call. Thank you all very much.

Operator

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

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