Verigy, Ltd. F3Q08 (Qtr End 07/31/08) Earnings Call Transcript

| About: Verigy Ltd. (VRGY)

Verigy Ltd. (NASDAQ:VRGY)

F3Q08 (Qtr End 07/31/08) Earnings Call

August 21, 2008 4:30 pm ET

Executives

Judy Davies - Vice President of IR

Keith Barnes - Chairman, CEO and President

Bob Nikl - CFO

Analysts

Jim Covello - Goldman Sachs

Michael Chu - JPMorgan

Doug Reid - Thomas Weisel Partners

Mary Lee - Stifel Nicolaus

Gary Hsueh - Oppenheimer

Raj Seth - Cowen and Company

Krish Sankar - Banc of America

David Duley - Merriman

Olga - Lehman Brothers

Operator

Good day, ladies and gentlemen, and welcome to the Verigy Limited Third Quarter 2008 Earnings Call. My name is Michelle and I will be your coordinator for today. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

And I would now like to turn the presentation over to your host for today’s call Ms. Judy Davies, Vice President of Investor Relations.

Judy Davies

Thank you, Michelle, and good afternoon, everyone. Welcome to our financial teleconference for Verigy's third quarter and fiscal year 2008, 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 is available on our website. Should you not be able to locate this press release, please contact me at 408-864-7549. A replay of this call will be available via telephone and webcast from August 21st through September 4th. You may access the call by going to the Investor Relations section of our website.

As always we will be making forward-looking statements today, including the revenue and earnings guidance for Q4. These forward-looking statements 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 Form 10-Q and 10-K filings. 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 or our financial guidance. The only persons authorized to give financial guidance for Verigy are Keith Barnes, our Chairman, CEO and President, and Bob Nikl, our CFO.

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.

Now I will turn the call over to Keith.

Barnes Keith

Thanks Judy. Good afternoon everyone and thank you for joining us today. In my prepared comments, I will briefly discuss the macro economic climate because we think this has had an effect on our business. I will review the financial highlights for the quarter and present an update on our products. Bob Nikl, our CFO will provide additional details on our Q3 financial results as well as our next quarter's guidance.

As you know the recent stream of news coverage has been focused on high energy prices, increased commodity prices, increasing unemployment rates and further troubles in the financial sector with the ongoing problems in the mortgage and housing markets in the US and Europe.

Purchasing power, income and wealth have been eroded and credit remains tight. These trends have heightened fears about the economic outlook and pushed consumer’s sentiment down sharply. While there are positive signs such as strong global PC and cell phone sales. It’s difficult to predict how the overall economic conditions will impact our business over the next couple of quarters.

For our Q3, we delivered solid financial results that met our guidance for the 9th consecutive quarter. Total revenue was $179 million, a 10% increase from last quarter, while earnings per share on a GAAP basis were $0.29, an increase of 26% from Q2.

I would like to spend a few minutes discussing our business, beginning with the flash memory business. The flash memory market is driven by increasing demand for memory rich consumer product such as cell phones, MP3 players, game consoles and digital cameras. Demand for these types of products has been one of the strongest growth drivers of units and capacity for semiconductor memory manufacturers.

Big growth for flash memory and MCP has remained at high levels of consumption of memories and continues to reach all prime heights. So, if this is the case, why have memory tester sales dropped so sharply and suddenly? As you know the flash memory market is characterized by sharp swings in supply and demand. In addition to the volatility of this market, memory semiconductors have been challenged -- our semiconductor manufacturers have been challenged by aggressive pricing pressure, excess inventory and changing market dynamics. All of these have created significant turmoil in the memory market over the last few quarters.

As a result, many memory manufacturers continue to take steps to preserve cash by cutting their CapEx budgets, delaying equipment purchases or postponing new fabs. Additionally, some memory manufacturers have established joint ventures or strategic alliances in an attempt to gain greatest scale and resources in order to remain competitive. These are actions have contributed to a historically low memory tester buy rate. For calendar year Q2 or for calendar Q2 it was less than 1%.

One would ask, when will the memory market rebound? Some people are expecting a recovery in 2009, but on one really knows. What we do know however is that digcounts continue to grow and as we have said in the past growing digcount drive tester sales. At some point memory manufacturers that have been waiting on the sidelines maybe compelled by again. There are some encouraging signs emerging from the market with new flash memory applications such as solid state disk drives, high depth video camcorders and flash memories potentially replacing DRAM and servers.

We believe that these applications could bolster sales of our flash memory testers in the future. While, the memory market is sorting itself out, we have been working on two strategic initiatives expanding our memory customer base and investing in new memory products. We have won several new memory evaluations for engineering development and we believe that these wins will eventually transition into high volume manufacturing orders at several key accounts. We also continue to invest in important R&D programs and remain on schedule to rollout major new products this calendar year.

We believe these products will significantly expand our memory served developer market. We cannot provide any specific details today, but we are very excited about the potentials in this space. We have also been placing stronger emphasize on our SOC business, which has been doing very well over the last few quarters. As you know, we support high-speed memory applications from our SOC division.

The high-speed memory market is characterized by devices with data rates in excess of 1 gigabit per second. The ATE revenue opportunity for this high-speed memory's is estimated to be about $60 million in 2008 and forecasted to reach about $200 million in 2010. This is a compounded annual growth rate of about 82%. We believe we are well positioned to capture a significant share of this market. Our 93K HSM product is already being used in volume manufacturing to test devices running between 2 & 4 gigabits per second and in engineering applications at virtually every high-speed memory manufacturer in the world.

We believe our competition is behind in this area. During the quarter, we introduced our HSM 93K 2200 system at the SEMICON West Trade show in San Francisco. This is the first tester available on the market. It is capable of testing 64 devices in parallel at speed for final test. With DDR3 memory is approaching 2 gigabit IOC boundary, we believe the HSM2200 offers the right combination of parallelism, speed and cost of ownership.

As DDR3 ramps to high volume, the HSM2200 will be upgradeable to a 128 site configuration by swapping our channel cards. This is the beauty of our scalable platform architecture. Our 93K HSM offers a unique cost effective and flexible growth path and customers are responding favorably.

In Q3 we received an order for a high-speed memory system which will be used for the characterization of GDDR5 devices. We also won repeat orders from major DRAM manufacturers for testing their DDR3 devices.

Now, I would like to turn to the total SOC business, including HSM. We are pleased to report $129 million of revenue, our highest revenue quarter ever for this product line. In addition, we delivered more than 100 testers with nearly half of these coming from the Flextronics China facility. We’ve now shift more than 300 SOC in memory systems from China.

Sales of the 93K were fueled by a healthy demand for wireless, PC and consumer mix signal devices, as well as several key wins during the quarter which I would like to highlight for you.

The first of these was a benchmark and a major European IDM against two other well known North American RF ATE suppliers. Verigy was selected based on with technical capability of the Port Scale RF product, as well as the flexibility in cost of ownership of the 93K platform. We believe that this win will lead to multiple systems and upgrade orders over the next 12 months.

We continue to be encouraged by strong customer interest in Port Scale RF. Q3 represented a record quarter for orders and revenue of Port Scale RF products. Since its introduction about a year ago, we’ve already installed nearly 100 Port Scale RF systems for several new opportunities still ahead of us. We’ve also received a multiple system order for the 93K from a large IDM to test their highly complex SOC device. The same customer placed a repeat order for additional 93Ks in our current quarter.

Another important win came from a large Japanese IDM that will use the 93K for development of their next generation DVD product, and we expect this customer will drive volume purchases in the OSAT channel over the next several quarters. The overall 93K utilization rate among OSATs was 88% in June and increased to 91% at the end of July.

Despite these many wins we are not immune to the current economic conditions that are causing semiconductor manufacturers to reassess their purchasing plants. In recent weeks, customers have become more cautious with their outlook and a few have pushed out of orders. As a result, we expect to see some softening in Q4 as reflected in our next quarter guidance.

Now I would like to discuss a new addition to our Board of Directors and a newly creative position of Chief Operating Officer. We are pleased to add Bobby Cheng to our Board of Directors. Bobby will officially join us in September and brings a wealth of business and leadership experience throughout Asia.

We are pleased that Jorge Titinger has joined the company, as the company’s Chief Operating Officer. As COO, Jorge will be responsible for advancing or is responsible for advancing the performance of our products, optimizing our business operations and driving higher overall product quality. Jorge has a strong background in operations with KLA-Tencor and Applied Materials. Both Bobby and Jorge will bring tremendous value to Verigy.

To summarize, Q3 was a good quarter for Verigy, especially given the challenges in the memory market and the macro economic environment. We will actively pursue opportunities in the SOC and memory market through continued customer focus and new product development. We feel good about our performance. We feel that we are position to accelerate faster than our competitors and capture market share when the upturn comes.

And with that, I will turn the call over to Bob.

Bob Nikl

Thank you, Keith and good afternoon everyone. I will review our financial performance for the third quarter, provide an update on our share repurchase program and present our guidance for Q4.

Overall we were very pleased with our results this quarter, which met both our revenue and earnings expectations. Orders in the quarter were $165 million, which resulted in a book-to-bill ratio of 0.92 and ending backlog shippable in the next six months stood at $205 million. However, we clearly began to see some softening in the last few weeks and customers are become more cautious and adopted a wait and see attitude.

Orders by region were as follows, Asia-Pacific 81%, Americas 11% and Europe 8%. The orders split between IDM and fabless versus OSATs was 40% and 60% respectively, compared to 61% and 39% respectively last quarter. In addition, this quarter represented a record order quarter for 93Ks in the OSAT channel.

Revenue of $179 million represented a 10% increase from last quarter and fully diluted GAAP earnings per share of $0.29, compares to $0.23 per share last quarter, a 26% increase. Regionally, the revenue mix was as follows, Asia-Pacific 82%, Americas 14% and Europe 4%.

Overall this order and revenue composition has remained fairly consistent over the past few quarters. Revenue split by products and services was 77% and 23% respectively and was essentially unchanged, compared to 75% and 25% last quarter. Services revenue increased 3% over the last quarter to $41 million and was again a new record for this business, which is becoming an important part of our recurring revenue stream.

During the quarter, we had three greater than 10% revenue customers, but we are not in a position to disclose, who they were. However, we are pleased with the volume of business, which earlier design wins are now yielding. As previously stated, revenue for our SOC products was $129 million or 72% of total revenue, as our Port Scale RF products continued to account for an increasing portion of the revenue mix. In fact Port Scale RF revenue nearly doubled over last quarter.

Revenue for our memory products was approximately $9 million, an increase of $3 million from last quarter and continues to reflect memory customers reducing or delaying their test equipment purchases. The timing of rebound and flash memory remains uncertain.

Gross margin on a GAAP basis, was 46.4% compared to 47.5% last quarter. Excluding the impact of $1.2 million worth of restructuring charges and cost of sales for a relatively small early retirement program, gross margin would have been 47.2%, essentially flat with last quarter.

R&D spending was $27 million or 15.1% of revenue and was $1 million higher than last quarter. As Keith mentioned earlier, we continue to invest in programs, where we believe we can expand our [SAM] and gain additional share. SG&A was $40 million or 22.3% of revenue, an increase of $3 million from last quarter. The higher spend was due to cost associated with increased sales and marketing activities as well as higher variable compensation expense.

Total share-based compensation expense was $4.3 million compared to $4.2 million last quarter and consistent with our earlier guidance. Operating profit was $15 million or 8.4% compared to $14 million or 8.6% last quarter. Excluding a total of $2.1 million related to the early retirement program mentioned previously, operating margin would have been 9.7%.

Other income was $6 million compared to $3 million in Q2 and this sequential increase was due to the impact of a non-recurring remeasurement gain of $2.4 million recognized on Euro denominated VAT receivables that were collected during the quarter. From a bottom line perspective, the total cost of the early retirement program and the net remeasurement gain essentially offset each other.

Our provision for income taxes was $3 million unchanged from last quarter. We are currently estimating that our full year tax rate for this year will be between 12% and 13%. Net income of $18 million was $0.29 per share on a fully diluted basis compared to 14 million or $0.23 per share last quarter.

Now I would like to review our balance sheet. We ended the quarter with $467 million of cash and marketable securities, an increase of $13 million from last quarter. Free cash flow was $23 million. We were active in returning value to our shareholders by purchasing approximately $640,000 of our shares and an average share price of slightly less than $23. While remaining repurchase authorization totals approximately $5.4 million shares and $135 million and we expect to repurchase approximately $2 million shares this quarter.

Accounts receivable was $87 million and DSO was 44 days, a decrease of six days from last quarter. 93% of our trade receivables are current at quarter end with nearly all less than 60 days. Inventory was $86 million compared to $81 million last quarter and days of supply was 86 days, a decrease of two days. Depreciation and amortization expense was $4 million, as was CapEx spending. Fulltime regular headcount was approximately 1600 down slightly from Q2.

Now for our next quarter guidance, as a result of the recent weakening market conditions, we expect revenue to be in the range of $155 million to $165 million and GAAP net income on a fully diluted basis to be in the range of $0.12 to $0.17 per share. The earnings per share calculation, assumes weighted average shares at the end of our fiscal year to be approximately $60 million.

This concludes our formal remarks on the quarter and we'll now open the call for questions. Before I turn the call over to Michelle to give the Q&A instructions, let me request that you limit yourself to one question in order to give everyone an opportunity to participate. Michelle, please open the line to questions.

Question-and-Answer Session

Operator

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

Jim Covello - Goldman Sachs

Good afternoon. Thanks very much. The question on the guidance relative to the revenue guidance I think, you explained well with some weakness of the customers, but I am surprised the earnings are coming down so much with only a pretty modest decline in revenue especially with the share count coming down. Can you help us fill in the gaps there between the top line and the bottom line, what is causing the reverse operating leverage?

Bob Nikl

Yes, sure Jim. A couple of points to make; I would say from a modeling perspective for next quarter, we are looking at about a full point decline in gross margin which is both volume driven and to a certain extent pricing pressure driven. So, while we maintain flat gross margin this quarter, we are expecting about a one point decline.

I am expecting to see some OpEx sequential decline, but at the moment, I think we are looking at something like $1 million to $2 million. That in the fact that the non-recurring gain and OI&E this quarter is not going to repeat itself, is how I would reconcile to the bottom line guidance.

Last but not least, the buyback, you just can not lock $2 million off this quarter and share count because EPS is calculated on a weighted average basis. So, the timing of the repurchase determines your ultimate EPS calculation.

Jim Covello - Goldman Sachs

Right, but that also works both ways, because if the quarter ended lower than where it started. So you start with a little bit of a benefit, but I certainly understand that.

Bob Nikl

Yes. So that pretty much is how I would characterize the earnings guidance.

Jim Covello - Goldman Sachs

Okay, thank you.

Keith Barnes

You bet.

Operator

Your next question comes from the line of Michael Chu of JPMorgan. Please proceed.

Michael Chu - JPMorgan

Hi. Thanks for taking my question. One of your competitors also indicated that in the second quarter they had strong orders from [so called] on RF customers and that there might be some period of digestion heading into the third calendar quarter. Is that the reason behind the weakness in your guidance going forward?

Keith Barnes

Well, I think it is a couple of things, Michael. First of all, there was quite a few orders that were going through digestion in the OSATs, but also they are very cautious on their buying trends in the August period, because they do not know what is going to happen for the holiday rush. One of the good things is that the utilization rates are trending up. As I said in my prepared remarks, there are over 90% now which is very good for this time of the year. So, it could be that they are just being cautious and things might pick up later on, but we struggle with putting the guidance together because we are seeing more caution now than we did a few weeks ago.

Michael Chu - JPMorgan

As far as on the memory side, is that going to be pretty much flat next quarter, is that might well be a guidance or would you think we will continue to see weakness there?

Keith Barnes

Yes, so on the memory side, at this point; it is probably the least visible piece of the business to us. Memory manufactures have really been holding off. We have never seen memory test valuate below 1%, we are seeing that right now. They are doing absolutely everything they can to hold off. We have seen some push-out in the memory space. So, it is not likely that memory is going to snap right back. I will just remind you that in the past when we have seen similar situations, we have also seen memory manufacturers get our orders and have to respond very quickly and take systems without very much notice at all. So, if you go the other direction but we are being cautious.

Michael Chu - JPMorgan

Okay, thank you. That helped.

Keith Barnes

Yes.

Operator

Your next question comes from the line Doug Reid of Thomas Weisel Partners. Please proceed.

Doug Reid - Thomas Weisel Partners

Thanks for taking my question. Bob, just wondered if you could update us on the outlook to achieve total outsourcing from Flextronics in China. Are you still in track for the end of the fiscal year 100%?

Bob Nikl

As a matter of fact, I think we had an outstanding quarter with Flex China in Q3. In fact roughly 40% of all SOC revenue was based upon Chinese shipments. Let me just clarify though from the standpoint of a 100%. The intent is to get most of the mature product line transitioned to China by the end of the fiscal year and we are clearly on track to do that. We are still going to maintain things like HSM in Germany, at least in the near-term. Quiet frankly at the moment because of how strong the SOC business has been, we are not uncomfortable with having two sourcing sites, as a matter of fact, had we only been in one physical location this quarter, we would not have been able to ship the $129 million revenue that we recognized this quarter.

Doug Reid - Thomas Weisel Partners

Then if I would squeeze a quick one on the Inovys product offering any update there since SEMICON West?

Keith Barnes

We are still on track to report the software product over the 93K, we are working through that. Our plans were to have that finished in a quarter or two and but we were still working through it, but nothing major to announce there.

Doug Reid - Thomas Weisel Partners

Okay. Thank you.

Operator

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

Mary Lee - Stifel Nicolaus

Hi, this is Mary Lee for Patrick Ho. So, how did the July quarter track in terms of orders and revenue, and did you see any push-outs as the quarter progress. Did the October outlook get progressively worst as your July quarter ended?

Bob Nikl

Mary, I believe the quarter tracked very well. The recent quarter is evidenced by the numbers that we reported. The way I would characterize what we are seeing just in the last few weeks is reasonably good visibility through the end of September. It is the back calendar quarter which all of the sudden seems to be very cautious. The OSATs clearly are running at what we think our attractive utilization rates, but in many instances we have been asked to just hold off shipping right now. What you tend to hear is well it might be a 30 day push, it might be a 60 day push. It might fall into the backend of the calendar quarter. Now unfortunately in our case, the backend of our calendar quarter is our fiscal Q1 of next year. Hence a conservative view with respect to the Q4 revenue guidance.

Mary Lee - Stifel Nicolaus

Okay. Just as a follow-up are your memory customers telling anything else additional?

Keith Barnes

Well additional, I mean there has been news out there from some of the customers with respect to them pushing their fabs out. I do not want to talk about individual customers, but I think that is been in the news. So I think there have been a number of situations where people have either cut CapEx or push things out. So I think there is a question whether or not memory is going to pick up in the first half of '09, second half of '09 that is jointed question.

Mary Lee - Stifel Nicolaus

Okay. That was helpful. Thank you.

Operator

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

Gary Hsueh - Oppenheimer

Yes, hi Keith. You talked about buy rates and I am just wondering how you internally frame discussions about '09 for planning purposes? There is a dichotomy here in terms of buy rates, the SOC buy rate is actually up pretty well and its quested last quarter and its coming off a peak above 1.5%. As you said, the memory buy rate is well below 1%. So, it is a dichotomy in buy rates for these two different segments. How does that map into your planning or thoughts into '09 and what CapEx environment do you think you were looking at in terms of '09?

Keith Barnes

Well, it is a very good question. I do not want to talk about our planning because that is just not something we want to get into, but I will just say that, with this dichotomy that you explained it makes us more difficult to understand how to view this. There are a number of people, who we believe need to buy memory products next year and who have been holding off and holding off and this buy rate is just unbelievably low.

Conversely on the SOC side, even though the buy rate is more traditional, the utilization rates are still picking back up. So, we think that with the new products that we built and the high utilization rates that SOC, we are hoping will continue to be strong. So, there is definitely divergence in the way we look at both of those businesses. I am hopping that the memory market snaps back. Given that, it is been a couple of quarters and we have not seen that and the buy rates are low, we are hesitant to call that.

Bob Nikl

Gary, one thing I just [dwell] on to Keith's point, I suppose if what we have been hearing in the last couple of weeks was raped around order cancellations. We could probably be more precise. What we are hearing is, what I would deem moderate push outs and gain it is just a sense of cautious conservatism on the part of some of the customers, because they are just waiting for more of a signal like thing from the standpoint of what the holiday buying pattern is going to actually look like. Unfortunately at this point on the calendar end of August it is just not really that clear yet, at least that is our sense.

Gary Hsueh - Oppenheimer

Okay. Just a follow-up question. I mean, you typically provide some commentary outlook on utilization rates particularly on the 93K. What is your sense here in October, are people just basically holding you up on purchases, trying to sustain a relatively high utilization rate and should that be what we expect to see when you report the October quarter?

Keith Barnes

Well, the utilization rate as I said over 90% and in the most recent month, and that includes some of our single density machines, which were the older product. So, the utilization rates on the non-signal density products were even higher to me that is a very good sign. As Bob was saying earlier, there is a push and hold attitude right now, waiting to see what happens with the holiday season. If there is a reasonable amount of holiday buying, we could see this turmoil positive but we are just been cautious from the last couple of weeks [attaining] these push and hold.

Gary Hsueh - Oppenheimer

Okay. Thank you.

Operator

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

Unidentified Analyst

Hi, this is (Inaudible) for Satya. Actually you talked about Port Scale RF doubling during the quarter. How do you see that going forward even that the SOC overall is beat?

Bob Nikl

Port Scale RF continues to be very strong. The customers, who have purchased it, really like the product. They continue to purchase it in reasonable volume. We worked on a couple of accounts recently, which we expect to buy volume over the next 12 month period. So, we think that this will be a continuing product of growth for us as we move forward.

Unidentified Analyst

Okay. One question on the DDR3, when do you see that increasing in volume? Is it going to be like first half or second half next year?

Bob Nikl

Well based on what we have seen this is the higher gross margin, higher end memory product for a lot of this manufacturers. They seem to be pretty pleased with the products that they have gotten from us. So, we are hoping that we see more volume production purchases in first half of next year. Again the whole memory market has been slow but we would hope to see that in the first half.

Bob Nikl

Okay. Thank you.

Bob Nikl

You bet.

Operator

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

Raj Seth - Cowen and Company

Hi, thanks. Keith, just a little follow-up on the push out? Is there, are you seeing customers just turnoff or as everybody across the board slowing formally, is there any particular sector, graphics, wireless etcetera. Is there anything you can read into the push outs of the segment effect?

Keith Barnes

Raj, it is a good question, but the answer is not really. We have seen a push and hold attitude by a couple of OSATs. I think it is because, it is murky to them what their end customers are going to be seeing in terms of their ramps and so I think they are just holding until they get that information, and that hold might not be a long period of time. On others they have pushed for, in one case two quarters, but it is not really pattern that we are not seeing a prolific pattern.

Bob Nikl

Raj it is Bob. The closest correlation I could give you is that for us it is somewhat you need to have three 10% SOC customers in one quarter. So, the customers that placed multiple system orders would say, okay I am going to push out some percentage. 10%, 20% of the order I gave you. If you look at the customers that only bought one or two systems, then you are not really seeing the behavior. So it is really wrapped around, I think digestion plays visibility for the ultimate end demands. So they are hedging their bets, and there is just not much we can do about it in the near term because we are in a position certainly to meet their demands because they had placed the orders.

Raj Seth - Cowen and Company

Are you seeing any material impact here from your large graphics customer or you announced such a big contract last quarter, is that planned or this is not a material factor?

Keith Barnes

No, not at all.

Raj Seth - Cowen and Company

Okay. Keith, if you had a crystal ball and somebody suggested to you that we were going to bounce at this level for…

Keith Barnes

Maybe if you might funk to bunk this question around.

Raj Seth - Cowen and Company

Yes. What do you think about expense levels; if it becomes clear that we are going to stay at these levels, maybe a bit below, do you start taking extra expenses or are you happy with the cost structure here?

Keith Barnes

Well, I could say I am never quite happy with the cost structure. So we always are going through and scrubbing things regardless of how well we are doing, we do that all the time. So, we will continue to do that. I think what is more important is that we have some really good projects and programs that we are working on which we think will allow us to take significant market share as we go forward and we want to make sure that we are focused on getting those projects and programs completed and we need to make sure that there is a level of stability in the company that allows people to really work through those things on schedule. So, although we will be looking at some things where we do not feel that there is any structural problems that we need to deal with.

Raj Seth - Cowen and Company

Okay, thanks for that. Bye.

Keith Barnes

Good day.

Operator

Your next question comes from the line of Krish Sankar of Banc of America.

Krish Sankar - Banc of America

Hi, thanks for taking my questions. Sorry to even bother, I might have missed some of the early part of your conversation till it is exhibited by the need, but just trying to get a sense of how do you look at it, I know you did not guide me on one quarter, but if you can see qualitatively assuming memory status low level for a while. As you see some push outs, it seems optimistic that utilization rates is till pretty high. How do you think January is going trend in terms it is really SOC. You think if utilization seems so high there, sub-cons might come back or is it too early to make that call or are there other parts like our equipment probably helped masking weakness in the sub-con guiding SOC?

Keith Barnes

Yes, let me answer that one, Krish. There is really three parts in terms of the answer to that question. The first one is that we are making sure that we are prepared to respond to an uptick orders from either the memory customers or the SOC customers, because it is just quickly as they push out, they may become the answer to that. We are well prepared to take their requirements if they pop up.

Secondarily, we are still moving ahead with next generation product, so if things pickup next year we do not want to be caught flat footed not having the next generation product available. I think there was a two really important things in terms of trying to get a crystal ball out and figure out, what is going to happen in the memory space, we just talk and go there because it just been too much turmoil in that space, in many respects, we are just staying close to our customers, making sure that we win evaluations and being prepared to respond when they start buying again.

Krish Sankar - Banc of America

Okay. Just a follow-up, let me ask in a different way. Forget memory for a second how do you look at SOC trending into the January quarter or past October quarters?

Keith Barnes

Well, first of all in the last two years, we have introduced a lot of products, which we think have increased our sure developable market in SOC quite a lot. We will be putting more emphasis on our SOC delivery of those products and given that, that path a stronger space, that we are playing in. Internally we are just putting more resources on that. So, we see SOC is being stronger going forward in memory, but again that can change as soon as the memory manufacturers require product. We just do not know when that is going to be.

Krish Sankar - Banc of America

Thank you.

Keith Barnes

Okay.

Operator

(Operator Instructions) Your next question comes from the line of David Duley of Merriman. Please proceed.

David Duley -Merriman

Yes, give me your guidance. You would expect the SOC business to be the key component of a down revenue quarter in this upcoming quarter. Is that mainly coming from the subcon area or the IDM area and is there any particular end markets that seem to be weaker than the others?

Bob Nikl

Yes, so I think we have partially addressed that earlier Dave. The end market equation I do not think really is particularly informative here. I think for our particular case its very customer specific and it is wrapped around, how many systems have been ordered and how many they want to take right now? I just do not know what else to add to that.

David Duley - Merriman

Okay. I am sorry. I just want to make sure I understood what you have been saying. Just two other housekeeping questions and I apologize, if you answered one of these. I did miss one question. The gross margin assumptions for the fourth quarter are roughly what and I know you do not want to tell us who the 10% customers were. Could you give us what the percentages were?

Bob Nikl

Actually I do not have that in hand. In terms of the gross margin guidance, I said we would expect gross margins to decline perhaps a point sequentially.

David Duley - Merriman

Okay.

Bob Nikl

As a result of both volume and some pricing pressure.

David Duley - Merriman

Okay. You do not have those percentages, were they are roughly all right around 10 or was there a 20% greater customer or just getting some idea as to how the top?

Bob Nikl

Sure. Sure, I will concede one point. One was as much a 20% but that should not be a surprise because I think last quarter, we had announced a really significant order from established customer and the bulk of that had shipped.

David Duley - Merriman

Great, thank you.

Bob Nikl

Okay, Dave.

Operator

Your next question comes from the line of C.J. Muse of Lehman Brothers. Please proceed.

Olga - Lehman Brothers

Hi, Olga calling in for C.J. Thanks for taking the question. Can you touch on more about ASP pressure that you are talking about. Are you seeing that more or so in any specific end market or IDM versus OSAT, where and how do you look at that heading into the January quarter given the limited visibility that you have there?

Bob Nikl

Well. I think that, given the fact that we have taken some larger volume orders, typically when you do that, there is a little bit of pricing pressure when you are competing against other people who are also quite thirsty to get those orders. That is one factor. I would not necessarily say, its OSAT versus Fabless/IDM, it just happens to be that some of these larger orders become more competitive, but we certainly are happy to have taken them away from the competition.

Olga - Lehman Brothers

So, from the smaller orders you have not seen an intensification on ASP pressure?

Keith Barnes

Not, really. It is usually the bigger ones.

Olga - Lehman Brothers

Okay. How should we think about, service gross margin on a continuing basis?

Bob Nikl

So I think, although we increased by roughly a gross margin point sequentially. We closed out the quarter about 29%. Where I would like it to trend is the high 20s to the low 30s, without too much of a plus or minus 2 points on either side.

Olga - Lehman Brothers

Okay. Then, given your focus on R&D, even though you are talking about OpEx next quarter declining by $1 million to $2 million, do expect R&D to go up or stay at this level?

Bob Nikl

I think we will see some sequential decline in R&D, because as we have been saying the last couple of quarters, we really have not throttled back on the R&D program spending. So, there has is been a fairly high mix of project material, as that starts to ease off now when we get closer to the finish line, R&D should trend down a bit.

Olga - Lehman Brothers

Okay, great. That is all I had. Thanks so much.

Keith Barnes

Thanks, Olga.

Bob Nikl

Thanks Olga.

Operator

(Operator Instructions). There are no further questions at this time. I will turn it back to you, Ms. Judy Davies, for closing remarks.

Judy Davies

Thank you, Michelle and thank you everyone for joining us this afternoon. Please note we will be participating at the Morgan Stanley Semiconductor and Semi-Cap Equipment day in Chicago on Tuesday, August 26th and Verigy will host an analyst event in New York City on Monday October the 6th.

Invitations for analyst event will be emailed within the next couple of weeks. If you are interested in attending, please contact me at 408-864-7549. Thanks again and Michelle, I will turn it over to you.

Operator

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.

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