FormFactor Inc (FORM) 2005 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the fourth quarter 2005 FormFactor Inc. earnings conference call. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded for replay purposes. And now I would like to turn the call over to your initial host for today's call, Ms. Annie Leschin of Investor Relations.

Good afternoon. Thank you for joining FormFactor's fourth quarter and fiscal 2005 earnings conference call. With me on today's call are Igor Khandros, Chief Executive Officer, Joe Bronson, President, and Ron Foster, Chief Financial Officer. Joe will provide a summary of our fourth-quarter performance and fiscal year 2005 performance, and then review the status of our target markets, provide an update on our factory, highlight recent announcements and update and review our corporate priorities. Ron will then go through our financials in more detail and provide guidance.

Please note that details of the Company's revenues and bookings by market segment, as well as a breakdown of its revenues and the reconciliation of guidance -- excuse me -- with the implementation of FAS 123 will be found on the investors section of FormFactor's Website, concurrent with Ron's comments, at www.FormFactor.com.

I would like to take a moment to mention that during the first quarter of 2006, the Company will be presenting at the Thomas Weisel Partners conference on February 6th, and at the Goldman Sachs conference on February 27th. As details become available and as other events occur, we will make additional announcements.

And finally, before I hand the call over to Joe, I will review our Safe Harbor statement. During the course of this conference call we may make projections within the meaning of the federal securities laws, including statements regarding FormFactor's growth and financial performance, as well as our strategic and operational plans. These forward-looking statements are based on current information and expectations, and are inherently subject to change. Actual results may differ materially and adversely to those in our forward-looking statements due to various factors, including, but not limited to, the rate at which customers adopt the Company's newly released architectures, technologies and products, the extent to which chip manufacturers modify announced capital equipment expenditures and device roadmaps, and the Company's ability to efficiently complete the transition to its new factory -- to its new manufacturing facility and execute on its property expansion plan. Please refer to the Company's recent filing on Form 10-K and 10-Q for more detailed discussions of the relevant risks and uncertainties. FormFactor undertakes no obligation to update any forward-looking statements, or to update the reasons actual results could differ materially from those anticipated in forward-looking statements.

Now I would like to turn the call over to Joe Bronson.

Thanks, Annie. Welcome, everyone, and thanks for joining us today.

Throughout the fourth quarter, FormFactor saw significantly stronger demand than anticipated during the quarter, once again posting record revenues and bookings, improving profitability, and continuing to ramp capacity. Fourth-quarter revenues grew 15% sequentially to 71.8 million. Gross margins continued to improve to 49%, versus 45.3% last quarter, and our profitability also grew to 25% GAAP EPS. For the year, revenues grew 34% to 237.5 million, up from the 177.8 million the prior year, while GAAP EPS also increased to $0.73 from $0.63 in 2004.

Markets for our customers are growing robustly, as the convergence of new applications for advanced chips, such as NAND flash and advanced DRAM, combined with technology and production capability, is increasing [bit] demand for these advanced products. As such, we see the advanced probe card market growing more rapidly than previous industry projections, as new market forces and FormFactor-enabling technologies accelerate demand. We believe 2006 has the potential to be another strong year, with multiple business drivers generating momentum throughout the year.

The key metrics driving our business include overall bit growth, design volume growth and the increasing wafer capacity. FormFactor's strategy of continuously expanding our advanced state-of-the-art probe card capacity enables us to deliver products that provide the most cost-effective test solutions to our customers.

We saw particular strength in memory products, especially in DDR, and the continuation of trends in various market segments, including DDR2 adoption in volume, continuing move to 90 nanometer and below, and strong growth in mobile consumer applications, such as mobile RAM, and the critical need for KGD -- known good die. These architectural changes, technology transitions, or capacity expansions that our customers are undertaking all result in additional tooling cycles increasing FormFactor's business.

We continue to focus our efforts on execution, ramping the new factory and planning for the next level of production. The product development pipeline is full, and we will introduce new products in NAND flash, KGD, wafer level burn-in, and various DRAM products to meet customers' technology roadmap requirements.

In the fourth quarter a number of key trends emerged, which not only drove our record revenues, but also point to another strong quarter in Q1. Logic and DRAM were the standouts in Q4, as was KGD. DRAM was once again the strong performer in the quarter and continues to account for the majority of our revenues. We saw a continuation of last quarter's trends, including better-than-expected DDR buys given the advantageous pricing, and strong DDR2 sales. Mobile RAM declined, as expected, due to seasonality.

DRAM will continue to drive much of our business due to the proliferation of DRAM designs and the growing need for known good die. Additionally, as some customers move to add NAND flash capacity, there is an opportunity for other DRAM suppliers, such as the Taiwanese, to meet that demand. We believe five 300 millimeter fabs from memory are being built in Taiwan this year.

We had exceptionally strong DDR revenues, increasing 248% over last quarter. This was driven by the continuation of the trend towards the coexistence of current and next-generation architectures. This is the result of stronger-than-expected DDR pricing, which has allowed some companies to shrink to the next node, while increasing margins, before making the jump to DDR2. This equates to additional tooling cycles, and thus more probe card sales for FormFactor. As a result, DDR volumes increased and, given the strength of bookings, will continue to do so in Q1 as well.

With the dedicated notebook chipsets and new architectures requiring graphics and DRAM, we see the proliferation of new memory architectures occurring. DDR2 is the first piece of the story. We expect DDR2 to be a major event in 2006, driven by the commercial introduction and availability of Yonah and major tooling events throughout the year, including the move from 90 nanometer to 70 nanometer, and a transition from 512 meg to 1 gig. We anticipate DDR2 will take over, and, as a market leader, we expect to be the major beneficiary of this tooling cycle.

In mobile RAM, coming off the strong holiday season in Q3, mobile RAM declined in Q4, experiencing expected seasonality. However, with the continuing strength in consumer and mobile devices, especially cellphones and portable electronics such as the Apple iPod, we expect mobile RAM to pick up in Q1, similar to last year, as key customers gear up for the year. Fueled by consumer market trends such as streaming video cellphones, as well as the move to 512 meg 90 nanometer in the first half of '06, and later to 80 nanometer, total mobile RAM bit output is expected to nearly double in 2006.

KGD is another factor driving mobile RAM, as testing before packaging plays strongly to our core capabilities in this consumer market segment. By the end of this year we expect to see 512 megabit mobile RAM stacked to one gig modules, enabling streaming video in cellphones. This will propel the global RAM market and drive the need for KGD.

The industry is continuing its march towards finer geometries. With 74% of our DRAM revenue now derived from 90 nanometer or below products, and virtually all from 100 nanometer or below, and 43% sequential growth in our Q4 shipments from these designs, the 90 nanometer transition will be completed this year. Revenues from 70 nanometer more than doubled in Q4, reaching nearly $2 million.

As our customers forge ahead to the next generation of 70 nanometer, some are making an interim state step to 80 nanometer. Once again, any technology transition is beneficial to FormFactor, as these customers require new sets of probe cards for the same product and represent a new tooling cycle.

As the buildout of 300 millimeter facilities continues, we see substantial business potential, as these expensive facilities require state-of-the-art technology and equipment, including advanced probe cards, to ensure return on investment.

Flash revenues declined slightly in the quarter, as expected. Our market share in NOR was once again strong, as customers slowly adapt larger active areas. Our NAND flash strategy is to achieve commercial availability of our one touchdown solution, and sync with the ramp of 300 nanometer and the [texture] infrastructure transition to one touchdown, which we still expect to be in the second half of '06. We are on track with this strategy, entering multiple evaluation engagements with key customers.

We have completed our first Harmony architecture probe card field trial, which began with an early adopter in the second half of '05. Product performance exceeded expectations. We expect to see significant revenues for our probe card based on Harmony platform in the second half of '06, with everything centering around 300 millimeter. Harmony will be the cornerstone of flash and then DRAM for the next several years.

Logic was a standout performer in the quarter, with both revenues and bookings increasing significantly. We continue to derive the majority of our logic revenue from high-performance flip chip microprocessor and chipset applications, where we received more design wins this quarter. We anticipate further design wins in tooling cycles in 2006 to build the foundation for growth in this segment.

Traditionally, we continued to execute on our strategy of diversifying our customer base, having penetrated major video gaming and graphics customers and other flip chip applications. We also made solid progress in customer qualifications of moving these products into production so we are prepared for volume shipments.

FormFactor recently announced its entrance into the parametric wafer testing market with its new product, Takumi. Takumi achieved all of our quarterly revenue targets and acquired four new customers during the quarter. Along with the traditional end-of-line measurements, the new Takumi product line enables electrical performance assessment in line with the wafer fabrication steps of the devices. While the parametric market is modestly sized at present, we see this as a very strategic step to drive electrical testing into the front-end of semiconductor manufacturing.

As we have anticipated for sometime now, the need for our customers to identify known good die earlier on waivers is becoming extremely important. With the proliferation of systems in a package, and rising packaging costs, customers are driving the migration of final package tests onto the wafer. We believe FormFactor is the only company with a comprehensive suite of wafer test products to address this market through a combination of industry-leading wafer level burn-in products and high frequency [tests and probes].

The UPstream product line for wafer level burn-in had another strong quarter, driven by a rise in KGD applications and a growing customer base. We have a strong production pipeline and anticipate that strength should continue throughout 2006, resulting in a potential high double-digit percentage growth opportunity. Fueled by further customer wins and adoption of wafer level burn-in, FormFactor's UPstream solutions enables lowest cost and increase of yield in the back-end.

Burn-in testing after a die is packaged is not cost-effective, as it requires an entire package to be thrown if a single die is bad. Plus, customers are challenged with delivering wafers with KGD mobile devices. Our customers are now utilizing probe cards incorporating our UPstream technology solutions as a vehicle to meet the higher reliability requirements for mobile and KGD applications, to manage the cost of packaging bad devices, to maximize yield and reduce cycle time until the cost of ownership by moving burn-in upstream to the wafer level.

I'd like to give you an update on the progress in manufacturing. As we mentioned two quarters ago, we chose to make incremental investments in order to ramp the new facility more quickly and achieve new revenue targets of greater than 80 million. Today, significantly increased market demand is compelling us to accelerate our capacity expansion plan. We continue to add capacity, and as the results show, we are ahead of the revised volume target we set for the fourth quarter. We made expected margin progress for the quarter on strong demand and productivity improvements, as the Company was able to ramp the new facility, while executing 15% sequential revenue growth.

We have moved virtually all operations to the new site, and now the revised higher demand picture afforded by the marketplace opportunity requires additional capacity planning. In order to meet the market upside we see developing in the marketplace over the next few years, we are now planning our manufacturing strategy for the next stage of our growth. Based on current demand projections, we are planning capacity for the near-term at 100 million to 125 million a quarter, and 150 to 200 million a quarter in the longer-term.

As such, we are evaluating a variety of tactics to best meet this demand. We are in the initial planning stage of a distributed manufacturing operation that would put additional back-end manufacturing processes, which constitute everything outside of wafer manufacturing, but including assembly and test, closer to our customers, beginning with one touchdown NAND flash production. We will also increase the capacity of our new facility in line with the business growth. We expect further gross margin improvements in the next few quarters as the new factory continues to ramp, due to yield improvement, labor productivity improvement and infrastructure capability.

We also held the formal opening of our new Taiwan applications and service center in [Shinshu] Taiwan on January 16, and were very pleased with the response and attendance from key executives from our Taiwanese customers. Our investment in Taiwan is a demonstration of our commitment to provide rapid turnaround support and applications for Taiwan, Korean and Japanese customers locally, improving their wafer testing capabilities significantly. We believe our global service and applications capabilities are core to our strategy of capacity expansion.

FormFactor is a growth company that develops advanced technology to enable the increased productivity of our customers. We expect 2006 to be another significant growth year for FormFactor. Industry fundamentals have improved, with significant good growth and improving unit growth, as the technology and tooling cycles of our customers are now converging with their customers' drive to introduce exciting new products in both the consumer and industrial markets.

2006 will be a landmark year for FormFactor in terms of new product introductions. These products will address NAND flash and logic markets and significant opportunities in DRAM. Market research indicates that DRAM growth was moderate over the last few years -- approximately 35% bit growth per year -- compared to current market projections. For the first time we will see the coexistence of three types of DRAM architectures. (indiscernible) memory for PCs and servers, brackets memory at 512 megabit, which is GDDR3, and mobile. We should be significant beneficiaries of this positive DRAM trend, and we are planning to satisfy a significant portion of this demand.

Consumer market-driven growth, exemplified by the proliferation of 3G phones, will drive significant demand for performance, bit growth and density of mobile RAM in 2006 and beyond. For FormFactor, this means faster transitions to KGD and wafer level burn-in testing, and faster adoption of our advanced UPstream and (indiscernible) products. We are planning an introduction this year of the first NAND flash-specific product, which is one touchdown 300 millimeter product based on our Harmony architecture.

We believe the market requirements are increasingly playing to our strengths. FormFactor is mission-critical for wafer probing and advanced device (indiscernible) due to probe count and parallelism, densities and electrical performance requirements. These market trends, coupled with our advanced technology and our expanding global manufacturing capability, position FormFactor to capture a significant portion of the large market ahead.

I believe the outlook for FormFactor is strong, as market demand for our products continues in all segments. Overall, the key areas of strategic focus are growth opportunities in all market segments are even greater than previously anticipated. With the ramp of our new facility, we are now in the planning stages for the next level of capacity to ensure we meet this large and growing demand. And we continue to develop industry-leading, cutting-edge products to meet the advanced technology requirements of our customers, and we expect 2006 to be another record year.

I would like to thank our employees for their hard work and dedication in making this a successful quarter.

I'd like now to turn the call over to Ron Foster, our CFO, who will provide more detail on our fourth quarter and fiscal year 2005 results, and our guidance for the first quarter of 2006.

Thanks, Joe. Now I would like to highlight the financials for the quarter and provide a few more details.

Revenues for the quarter were a record $71.8 million, an increase of 9.4 million, or 15% over the third quarter, and an increase of 25.7 million, or 56% compared to the same period last year. Revenues for the year were 237.5 million, up 34% from the 177.8 million last year.

From a geographic perspective, we saw strength across most regions, especially in Japan and Taiwan. As predicted, we are already benefiting from our direct selling model in Taiwan, where revenue jumped to its historic high. We are seeing foundry customers increasingly adopt our technology and are moving to higher levels of parallelism on their test floors. Japan also achieved record revenues in the quarter, as demand for DRAM probe cards continued to grow. North America revenue declined sequentially off a strong seasonal market for consumer and mobile products.

DRAM revenues were up 15% from the last quarter. Although we experienced quarterly fluctuations, we continue to see solid demand for both DDR and DDR2 probe cards. As mentioned last quarter, some customers are moving to 90 nanometer on DDR before making the full transition to DDR2, and we are also seeing some customers make an interim step to 80 nanometer, as Joe mentioned. Each of these transitions results in additional tooling cycles, and thus more probe card sales for FormFactor.

Flash revenue fell 7% versus the last quarter, as NOR declined sequentially. Given our high market share in NOR, this volume tends to move with overall market trends. We expect NOR to grow at moderate rates in 2006. NAND revenue grew during the quarter, and we continue to expect significant growth in NAND to come in the second half of 2006 as we roll out our new Harmony-based platforms.

Logic revenues were the standout for the quarter, increasing 42% sequentially, as business with our current and new customers expands. Revenues from wafer level burn-in products also grew significantly in the quarter, up 24% sequentially. Wafer level burn-in revenue reached double digits for the year, growing 379% year-over-year. The majority of our current burn-in business is being generated in our DRAM segment, although we are seeing increasing traction in flash as well. A breakdown of revenue by market and geography is available on our Website.

Fourth-quarter bookings grew to record levels once again, at 82.2 million, up 31% over Q3, and up 102% from the same period last year. Sequential and year-over-year increases occurred in all of our markets. Orders were the strongest in Japan, Taiwan and North America. DRAM bookings increased a healthy 26% from Q3, driven largely by strong increase in DDR. Flash bookings grew in the quarter due to an increase in NAND flash as we move into the market, and we expect strong growth in the second half '06. Logic bookings were very strong, up 107% sequentially as we expand our customer base. We turned less than 50% of our Q4 bookings in the quarter, leaving a healthy backlog position as we enter Q1.

GAAP gross margin for the quarter was 49%, up from 45.3% in Q3. Strong volume growth helped lift margin, as we continued to ramp capacity. Manufacturing has successfully transitioned through the most difficult phase of the production ramp. All production processes are now fully functioning in our new facility, with output and yields improving steadily. We continue to operate a few discrete processes in the old site to smooth the transition to higher-than-anticipated revenue levels.

We spent approximately 750,000 in nonrecurring start-up costs this quarter, compared to 2.3 million in the third quarter. Going forward, we will no longer report start-up costs as a separate item, as we do not expect these costs to be significant, and any residual will be incorporated into our operating model.

As start-up activities concluded in the third and fourth quarter, we reassigned some of the workforce into production to support the higher demand levels. These resources are included in our operating results for the fourth quarter and our operating model going forward.

Due to the higher-than-expected demand we are experiencing, we have elected to keep our old facility open longer in order to achieve a higher revenue ramp. Although the cost reduction associated with closure of the old site will not be achieved in the near-term, the incremental revenue ramp and resulting higher earnings per share makes the plan cost-effective and puts us in better position to meet increasing customer demand.

While we could deliver the target gross margins of 75 million revenue through the closure of the old site, we have chosen to keep pace with the higher demand rather than sacrifice this revenue and EPS growth. With revenue growth supported by these incremental investments, we will continue to expect to make sequential gross margin progress in the coming quarters, and expect to reach the target gross margin range in later 2006, given robust revenue growth.

As Joe mentioned, we are developing manufacturing capacity plans for future revenue levels up to 200 million per quarter and beyond. Our planning work is confirming the financial leverage that can be achieved going forward through productivity and volume increases. Although our new factory is more capital-intensive, we expect depreciation costs as a percentage of revenue to decline as production ramps through 2006 and beyond. Material and labor cost reductions are planned through continuing yield and productivity improvements.

Now, operating expenses. Operating expenses for the quarter were 21.3 million, up from 19.8 million in Q3. As a percent of revenue, operating expenses declined from 31.7% to 29.7% sequentially. R&D increased 1 million, as a number of key development programs continued to ramp. Sales, general and administrative expenses increased due to headcount-related expenses, including the buildup of our new organization in Taiwan and a seasonal increase in audit and compliance fees.

Operating income for the quarter was 13.9 million, or 19.3% of revenue, well above last quarter at 8.5 million and 13.7%. Interest and other expense -- interest income and other expense for the quarter was 933,000. The interest income amount from our investments in primarily short-term tax-favored securities is higher than last quarter and last year, due to higher investment rates and balances.

The tax rate for Q4 was 29.1%, which compares to a tax credit of $760,000 in the third quarter. The tax rate for the year was 21.6%, due to the benefits of an R&D tax credit study and the release of previously accrued tax contingency reserves.

Net income for the quarter was a record 10.5 million, or $0.25 per fully diluted share, versus 9.8 million, or $0.23 per fully diluted share during the third quarter, and 5.8 million, or $0.14 per fully diluted share during the same period of 2004. Net income for the year reached 30.2 million and $0.73 per share, compared to 25.2 million and $0.63 per fully diluted share in 2004. Cash and marketable securities were 214 million in the fourth quarter, up 10 million from the third quarter.

DSOs were 42 days in the fourth quarter versus 43 days in the third quarter, despite significant shipments to Japan and a high proportion of Q4 shipments occurring in the last month. Net inventories increased by 4 million during the quarter to 18.4 million, in support of our strong backlog and improving shipment linearity on the front-end of the first quarter. Despite this increase, inventory turns remain relatively constant at about nine turns.

Cash flow generated from operations during the fourth quarter was $17.7 million, an increase of 6.2 million compared to the third quarter, down 1.3 million from the same quarter of 2004. During the fourth quarter we spent 9.1 million in capital expenditures on a cash basis, same as the third quarter. The majority was spent on equipment for the new factory. 1.8 million was received from the issuance of stock associated with the exercise of employee stock options, down from 6.1 million in the third quarter. Given the higher market growth rates we are now anticipating for 2006, we expect to spend around $30 million on capital in the current year, somewhat higher than our earlier projection. We anticipate capital expenditures to support business growth will average between 10 and 12% of revenue annually. Headcount continued to increase at a moderating rate, to 850, up from 801 in the third quarter.

Now let me provide some market context for our guidance going forward. As Joe has mentioned, we are seeing strong growth opportunities in all of our markets. Industry analysts have revised upward their forecast for 2006 and 2007 DRAM bit growth, which is now projected to exceed 45% this year, and to be higher next year. Flash bit growth is predicted to be in the 60% range this year. Consequently, we expect advanced probe card market growth this year to be greater than 25%, similar to our longer-term compound annual growth rate we communicated last quarter. Known good die, which ships package-level testing to the wafer level, will be a growth accelerator over the next several years.

With this, let me give you our guidance for the first quarter of 2006. The Company will be implementing FAS 123 stock compensation expense in the first quarter of this year. This will impact most of the expense categories reported on our income statement. Since it is a non-cash item and not directly comparable to prior period reporting, we will address stock compensations separately each quarter in guidance and actual reporting. A schedule will be provided on our Website, which reconciles the new GAAP guidance for Q1, including FAS 123, to the historical GAAP reporting used in Q4.

We expect revenues for the first quarter to be 73 million to 76 million. GAAP operating income is projected to be in the range of 16 to 18%, including about 4 points of FAS 123 stock comp expense. Excluding FAS 123, non-GAAP operating income guidance is 20 to 22%, compared to the Q4 performance at 19%. We target GAAP earnings per share of $0.20 to $0.22 per fully diluted share under the new FAS 123 reporting methodology. With implementation of FAS 123, we have projected $0.05 reduction in EPS related to stock-based comp, included in these GAAP results. This would translate to non-GAAP EPS guidance of $0.25 to $0.27 when comparing Q4 actual results of $0.25.

The tax rate is expected to increase to approximately 35%, from the 29.1% rate in Q4. The increase is principally attributable to the expiration of the R&D tax credit. This credit expired on December 31, 2005, which reduces our forecasted EPS for the first quarter by $0.02. As has occurred numerous times in the past, if the provision for the credit should be reinstated later this year, we will adjust the tax rate down for the entire year at that time.

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

(OPERATOR INSTRUCTIONS). Jim Covello, Goldman Sachs.

This is Amanda Hindlian in for Jim Covello. A couple of questions. The first question is, as you add capacity to the new facility to meet the greater demands that you talked about in your prepared remarks, can you update us on what this may mean to your target margin model?

As I laid out in brief in my comments, we are seeing as we're laying out capacity plans that we are going to have financial leverage in all the structure of our factory costs going forward, and we believe that we can achieve the target margin range later in 2006 with the growth we're foreseeing, and we can maintain that margin performance over time as we continue to expand capacity, even at the higher growth rates that we have been talking about of greater than 25% compound annual growth rate.

The second question is, your revenue guidance for Q1, is that essentially in line with what the true underlying demand environment is? Or are you finding yourself a little bit capacity-constrained in terms of being able to meet customer requirements?

We're seeing that as the volume that's available to us in the first quarter, given the bookings and the terms that we expect in the quarter. We are continuing to ramp the factory's capacity and meet customer demand as we go.

I want to add one point. The fourth quarter had 14 weeks of production. The first quarter has 13 weeks of production. So we're getting more productive with that guidance.

Mark Bachman, Pacific Crest.

Can you give us some guidance here on your capacity additions? I guess first off, how long are you going to keep the old factory open and what are the costs associated with that? In other words, did you also have to extend the leases on that? It was my understanding that your leases were due up here in mid '06. Also, how are you going to be ramping capacity? Where do you expect to be in the near-term and by the end of '06? And then maybe you can touch on a little bit more about your ideas about expanding possibly into Asia for some of your manufacturing.

Let me start, and you may want to add a little bit. What we're doing now is we have to -- we are going to add capacity to the $100 million per quarter level, and we are in the process of doing the planning for that. And we are going to do this with the new facility.

As far as the old facility goes, we're still going to look at the situation for -- it's a lot easier to have capacity that already exists than to bring on new capacity in time. So that's more of an insurance policy, which costs us a little bit of margin in the short-term. So we will take a look at this on a quarter-by-quarter basis, but the first leg of capacity that has to be put in is between 10 and 125 million.

With respect to the global strategy, we want to put additional operations into -- outside of wafer fab capacity, into areas that are closer to our customers. And we are in the process of planning and putting together implementation plans for doing that.

(multiple speakers) a little more color on that. The key message here is that it's not about execution now, it's about expansion. And we are realizing the growth opportunities that are before us. Our new factory is performing as designed -- in fact, at higher levels than we originally anticipated for this timeframe.

But to be specific about the old site, in short, we are losing about 2 points of margin staying in the old site. However, we're more than offsetting that impact with higher volumes and the resulting higher EPS associated with where we are operating right now, and see that we are operating in 2006. So in terms of the leases, we can extend them on a pretty much month-by-month basis at this point, so that's not a big issue. We are evaluating longer-term capacity options, including back-end distributed manufacturing, evaluating dual site and insurance supply choices, cost reduction opportunities in terms of where we locate, including tax opportunities, and along with that, evaluating old site options as part of that total mix. So that assessment is going on. But as I commented, we're generating higher EPS and we will be moving continually up in our gross margin into our target range as we go through the year.

I guess just a follow-up then on the manufacturing side. Give us an idea of where you are with leadtimes right now. It's my understanding that with the new factory, you should be seeing a 35% reduction in leadtimes that should enable you to either capture more market share to those customers that you couldn't supply before. When should we -- what's your benchmark for us to measure you buy? When can we see that 35% reduction in leadtimes?

I think we'll have to give you another update on that. Basically, we just completed the ramp in a very frenetic Q4, which we got done. And we are doing a lot better job this quarter on a linear basis. And there's a lot of cycle time reduction programs that are being executed. So I think we still have work to do to get to that level of cycle time reduction, because of the rate of new product introduction that's coming. So we have to put all that in perspective.

Let me just say a little bit more. The leadtimes will improve this year, and also you will see new product being introduced that are from ground up designed for markets like NAND flash that will have pretty aggressive leadtimes. So, as Joe mentioned, there is quite a bit of work going on, and you should be seeing improvements. As far as quantitative data guidance, again, as Joe mentioned, we'll probably brief you later in the year on that, how we're doing.

(OPERATOR INSTRUCTIONS). Bill Lu, Piper Jaffray.

This is actually Dennis Cong calling in for Bill Lu. The first question regarding your capacity extension. For the 20 million incremental capacity, what kind of capital spending you are budgeting for? Another way to look at this -- is this incremental capacity increase going to be less expensive comparing [to the first phase] of the new facility?

In terms of our capacity build-out, we anticipate that we are going to be able to operate with capital expenditures over time in the 10 to 12% of revenue range, so that's a way to think about it. And we also see as we are building out the capacity structure, given the significant investment we made in our new facility here, that we will get leverage on our capital structure, and depreciation as a percent of revenue improvements as we build out more capacity.

In terms of the timing, so I would expect you're looking at adding the 20 million capacity in this quarter. Is that right?

Not this quarter, but certainly -- don't forget you have leadtimes for equipment deliveries. So we will want to get it planned and executed within the next six months.

I see. And my last question is that -- can you give an update on the ruling regarding the patent (indiscernible) judgment with the (indiscernible) case?

So there has not been really any material news. Some rulings are coming up in [SCICOM Korea] case. There will be other news coming out this year as there was a [U.S]. case. And the way you should be thinking about this litigation, rulings will not impact short-term business picture for FormFactor. What FormFactor is doing, it's a long-term effort to avert long-term problem. And that's how you should be looking at it. And we will do what it takes to make sure that we defend our IP, but do not expect material business impact on FormFactor.

Doug Reid, Thomas Weisel.

Congratulations on a great quarter. A couple of questions. Wonder if you can give a little more color on the competitive landscape beyond the patent issue in Korea. Broadly, what are you seeing on a segment basis? And can you confirm whether or not you're able to get the market share up on the advanced probe card area from '04 in '05? And secondly, if you could give the percentage of revenue from 70 nanometer and below.

Let me take the first part of the question while Ron looks up the second answer. The competitive landscape has not changed during this quarter. What we see is a fairly fragmented landscape, which means not only fragmented size of competitors, but which means also fragmented R&D efforts by competitors. Actually, 2006 is going to be a remarkable year for FormFactor in terms of new product introductions which are the outcome of several years of very heavy R&D investment. We will introduce half a dozen new significant products in 2006. We expect that the gap should not be thinking between us and competition; it may even widen. That's what we are working to.

As you heard from Joe and as you heard from Ron, what we're busy with is to do prudent planning for how we increase capacity in a fiscally responsible way to meet what looks like will be very, very good demand in areas where we are a mission-critical supplier to our customers. And that's what we are busy with. So I do not believe that there's going to be a significant change in the competitive picture.

I think you were asking about 90 nanometer and below revenue volume in the fourth quarter. It was about 74%

Actually 70 nanometer, if you could provide that.

I quoted $2 million of business in the fourth quarter, and it's primarily from a very few customers.

70 nanometer is getting ramped, but also as I think Joe mentioned, what is also important -- some customers are taking an 80 nanometer milestone before they get to 70, and that is very positive for us as well.

Murali Abburi, JP Morgan.

I had a couple of questions regarding the guidance. One, given the fact that you guys have bookings of 82 million, your guidance looks a little bit conservative there in terms of the topline. Are you expecting a similar (indiscernible) ratio to get to that number, or what is your expectation there?

As you probably know, we have fairly high turns ratios that typically occur, so a good chunk of our bookings actually turned in the fourth quarter. And going forward we see a healthy backlog. It's probably at the higher end of our six to eight week kind of range that we would typically expect. But, with normal turns, perhaps a little bit lower than average we would see, we would come in at our guidance. So that's how we built that up.

Are you capacity constrained at all, or does it presume that you're not capacity constrained, your guidance for the first quarter?

We're continuing to ramp the factory to meet customer demands, and we are in good shape in terms of our expansion.

I would like us to not worry about being capacity constrained. We are just in an expanding mode.

A quick question on your flash business. Given that both logic and DRAM grew so fast, did you guys have to walk away from, as you call it, less mission-critical flash opportunities? Is that why the flash bookings didn't grow? Or is there something else there?

As you know, as Ron mentioned, we have significant market share in NOR flash and NOR flash seasonality such that (indiscernible) that you saw. What we are doing now, we are in the process of developing a product which is -- from ground up is designed for NAND flash. And as you know, NAND will grow 60% in terms of bit growth this year. And we plan in the second half of this year to take advantage of NAND flash market with this product, which we believe will be a landmark product for NAND flash. It will be one touchdown 300 millimeter product based on Harmony that will incorporate other elements that will make it very competitive in many ways, including leadtimes.

The thing I would add to that, what Igor is saying, is that we are planning to have that in place for volume production in the second half of '06. And we are planning that into all our capacity activities.

Mehdi Hosseini, Friedman Billings Ramsey.

You're talking about insufficient capacity. I'm just wondering what are the constraints to accelerate adding capacity at your new facility. And then, if you could touch on your addressable market. In your presentation material you talked about an addressable market of 1.1 billion by 2007. You had about 22% market in 2002. And as you roll into '07, with 1.1 billion and all the opportunities in flash and logic, to what extent would you expect your market share to increase?

Let me take the first part of the question, and then maybe, Joe, you can cover the addressable market. In terms of adding capacity, as we've commented in earlier conference calls, we have significant capacity in our new facility to expand. And what we're doing is initiating those moves earlier, and that is what this is all about. So this is just adding on to the prior quarter's comments we made that we have capacity in our new facility to expand out. Given the growth we're seeing in the market longer-term, we're beginning to think beyond the levels that we've been discussing, even related to the stage of our new facility. And that's where the longer-term capacity plan is going in. In terms of how fast we can do it, we can do it fairly quickly, because it's a matter of putting just additional equipment in place where it's needed.

And the second question is, yes, we see a significant addressable market in 2007 and beyond. We believe we are -- what it looks like, and as you can conclude from our remarks, we're pretty optimistic about the demand [peaks] for this year, and actually [somehow] it is spilling over to the next year.

DRAM business, where we are so well positioned, is becoming a really more and more remarkable business for us, because it used to be that it was driven by just one DRAM architecture for main memories in PCs. And now, we could have three, moving forward, very, very important drivers in DRAM. One is, again, main memory, which is DDR2. Second is mobile RAM, where we potentially will sell three probe cards into each design. And then, what's evolving now is GDDR3. And it is projected by the middle of next year that an average (indiscernible) based box will have 512 megabytes of the graphic GDDR 3 memory. And those are very complex designs with a lot of pins per chip. Designs where they're more complex, of course, revenue impact is positive. So these things are happening.

On the chart that we communicated to you about addressable markets, we talked about KGD opportunities. We believe the second half of this year will be, again, a very important step for known good die adoption, as testers will become available for higher-frequency testing, starting with mobile DRAM, and stacked packages are now proliferating into many applications. So that is going to be -- will continue being a very significant source of growth.

And the [amplification] that FormFactor provides for the market -- which really, people who estimate the market size never take into account, really -- and that is that we can come in and increase parallelism significantly, and afford our customers lower cost of sales. That is happening as well. I mentioned that we will be introducing one touchdown 300 millimeter NAND flash products, which is just a manifestation of all this remarkable phenomena.

So to answer it briefly, we anticipate that the growth rate will be above 25% for FormFactor, based on all these factors. We will bring out half a dozen of new products this year, and some of these will allow us to grow more rapidly in logic markets -- in logic markets outside of our traditional strength base, which is area array, microprocessors and chipsets; now we can address any logic application. So that really bodes very well for our growth.

[Tim Schultz Meilaender], Morgan Stanley.

Congratulations on a very strong set of results there. I have just a couple of questions. The first one was on the target gross margin. I just wanted to kind of get your sense, without being too specific here -- but I'm taking away from the call that factoring in FAS 123R, that 53 to 55% gross margin is the target that you expect to achieve in the back half of this year. So that kind of 400 to 600 basis point uplift, should we expect that to be sort of relatively linear as revenues grow beyond this quarter? And then I have a quick follow-up.

Just to be clear, and I'm glad you brought up the question, the target gross margins were built excluding FAS 123 implementation. So when we're talking about that, we're still talking about it on the non-GAAP basis now that we've implemented FAS 123. So, just want to be clear on that. We do expect to see sequential improvement in our gross margin as we move through 2006. And our guidance is consistent with that in the first quarter. So I can't say it's going to be smoother or linear, but we expect to have sequential improvement move in that range.

But maybe that it won't -- even though it improves, it won't necessarily get in that range by the end of this year? It may be more of a sort of '07 and beyond story?

No, I'm saying that we expect in later 2006 to be in our target range, given the robust growth we're seeing in front of us now.

Got it. I guess the second question sort of has two parts. You previously have given us the split in DRAM bookings between DDR1 and DDR2. Just wondered if you had that. And then the kind of second part was, obviously, we've seen a lot of investment in DRAM capacity amongst the semi cap group, with positive implications for you. I guess I'm just taking away from your commentary here that you guys seem pretty comfortable that you don't see sort of significant risks of overcapacity. Would that be a fair takeaway? Thanks very much.

I think with the ability of now several memory makers to switch capacity between DRAM and NAND, and with the outlook -- and by the way, on top of that, specialization by some DRAM makers to a certain market, I think that outlook in DRAM actually right now is very positive, very, very strong. We see significant growth projected growth in design activity, which is really what drives our business. And so I -- also, FormFactor is not exactly as a capital equipment maker. We do well when people struggle with ASPs, nonuniformities in different market segments. What they do is they run more designs. And when they run more designs, FormFactor sells product. So right now, the outlook is very positive in DRAM for us. And Ron will take the first part of the question.

In terms of DDR1, DDR2 breakdown, we've typically given percentage ranges, and talked a little bit about that today, but let me give you sort of the forward-looking sketch on this. We saw very strong DDR1 business this quarter, and even bookings. So DDR has been amazingly strong throughout '05. And we see some of that continuing to early '06, but we do believe that DDR2 is coming on very strong, as evidenced by engagements with customers and the chipset transition that's coming. And we believe that bit parity will probably occur in the first quarter here pretty rapidly with the availability of the new chipsets. So the way to think about it is we had big growth in DDR1 this quarter, we had good order strength, but we have a lot of DDR2 business coming on very fast. And some of that will even be turns business in Q1. So that's the way to think about it. DDR2 is probably going to start transitioning into a dominant position in the first quarter.

The growth of DDR2 will be driven by -- Yonah is available in different notebooks. It's going to be a big story. And of course you'll have growth for Vista-ready systems, which will get shipped before Vista is available.

With that, we'll take one last question.

Kevin Vassily, Susquehanna.

Another question, if I could, on the distributed back-end manufacturing strategy. Maybe you could talk a little bit about what the main kind of driver behind doing this is. Is it really, really cost-effective? Are your customers asking for co-location? Is there something about time to market that helps? Maybe shed a little more light on what's driving this.

FormFactor is a supplier of products which are custom for every design for every customer. Therefore, long-term, the Company is very focused right now on how to service customers moving forward. Long-term, the business becomes not just about delivering hardware, but it will become more and more about applications, which is our area of strength. We want to look local to customers around the world eventually. And that is why we have now facilities in Japan, in Korea, now in Taiwan; we have facilities in Europe. And fortunately, the distributed manufacturing strategy and local location kind of strategy around the world, and especially in Asia where a majority of our business will be -- that also, as Ron mentioned, will be cost-effective from several standpoints long-term, we believe. So what you will see us doing is developing product strategies that adopt the distributed manufacturing strategy around the world that will make it easy to implement it.

I want to thank you all for attending our fourth-quarter earnings conference call, and we certainly hope to see you at upcoming conferences and at our next earnings call. Thank you.

Thank you.

Thanks.

Ladies and gentlemen, we would like to thank you for your participation in today's conference, and this does conclude the presentation. You may now disconnect.