Teradyne Inc (TER) — Q3 2018 Earnings Call Transcript

Thank you, Michelle. Good morning, everyone, and welcome to our discussion of Teradyne's most recent financial results. I'm joined by our CEO, Mark Jagiela; and Chief Financial Officer, Greg Beecher. The press release containing our third quarter results was issued last evening and we are providing slides on the Investor page of the website that may be helpful to you in following the discussion. Replays of this call will be available via the same page after the call concludes. The matters that we discuss today will include forward-looking statements that involve risk factors that could cause Teradyne's results to differ materially from management's current expectations. We encourage you to review the safe harbor statement contained in the earnings release as well as our most recent SEC filings. Additionally, those forward-looking statements are made as of today and we take no obligation to update them as a result of developments occurring after this call. During today's call, we will make reference to non-GAAP financial measures. We've posted additional information concerning these non-GAAP financial measures, including reconciliation to the most directly comparable GAAP financial measures, where available, on the investor page of the website. Also, between now and our next earnings call, Teradyne will be participating in investor conferences hosted by UBS, Baird, Credit Suisse and Goldman Sachs. Now, let's get on with the rest of the agenda. First, Mark will comment on our recent results, current market conditions and outlook for the year. Greg will then offer more details on our quarterly financial results, followed by guidance for the fourth quarter. We'll then answer your questions, and this call is scheduled for one hour. Mark?

Good morning, everyone, and thanks for joining us today. As you saw in the release, we had a great third quarter with earnings above our guidance and we expect a strong fourth quarter as well. Today, I'm going to cover the third quarter and year-to-date highlights, provide a framework for looking at our midterm plan, and update you on our capital allocation strategy. In Q3, across the company, we saw a continuation of the 2018 positive trends we've described in earlier calls, as organic sales grew 11% and overall sales grew 13% year-over-year. In Semiconductor Test, we saw strong demand in nearly all end markets. In SOC, Eagle analog tester sales in the quarter were especially notable, coming in over a third higher than a year ago level and up over 20% through the first nine months of the year. This was driven by expanding analog demand for both automotive and industrial markets. We also had strong demand in the quarter for image sensor testers due to their continued expansion in both smartphone and automotive applications. RF tester demand was also ticking up, driven by next-generation mobile network devices with higher complexity than earlier products. This broad strength translates into a 2018 SOC market size that will likely exceed our earlier $2.4 billion estimate and end up in the $2.6 billion to $2.7 billion range. In memory, much has been written in the press about slowing frontend equipment investments, but to date, we have not seen any impact on our memory test business. Our memory shipments in the quarter grew 30% sequentially, and through nine months, totaled $226 million, up 87% compared to 2017. The aggressive adoption of higher-speed interfaces for smartphones and our Magnum product differentiation at package and now wafer test have provided a solid foundation to our growing memory business. At this point, our outlook for the memory in the fourth quarter looks strong and we expect the memory test market to end up between $900 million to $1 billion for the year. Our Industrial Automation businesses continue to grow nicely in the quarter. Universal Robots grew 46% in the third quarter compared with a year ago quarter and is up 42% for the first nine months of the year. I will note, however, that UR sales growth in China has slowed due to economic uncertainty at Chinese manufacturers caused by trade and tariff disputes. Excluding China, UR sales grew 54% in Q3 compared to Q3 of 2017. Primarily as a result of this, we expect UR's 2018 full year growth to be in the 40% to 45% range, down from our earlier estimate of 50%. We have not seen any similar slowdown in any of our Semiconductor or Electronic Test businesses in China. A key part of UR's long-term success is predicated on the expanding ecosystem of UR+, creating the broadest range of plug-and-play peripherals in the industry. We now have over 100 certified products in our UR+ program, and a rich pipeline of products undergoing certification and development. UR+ enables innovation at the edge, our partners' hardware and software add-ons and creativity take UR's cobots into applications much faster and more efficiently than we could do on our own. An interesting example of a recently certified UR+ application is an easy-to-train 2D vision application developed by Cognex and demonstrated at the recent IMTS trade show. This solution integrates natively into the UR software via our open API and guides users through two of the main challenges in vision-guided robotics, establishing the coordinated communication between the two systems and performing hand-to-eye coordination. This solution is applicable to a wide range of 2D pick-and-place tasks. Another recently certified UR+ solution is Boston-based Soft Robotics Development of a gripper aimed at handling delicate and easily damaged objects. Tight integration with our UR software delivers human-hand dexterity, adjusting grip force in real time, allowing the easy grasping of products from small bottles to soft sponges. MiR's revenues grew to nearly $7 million in the quarter and were on track for 100% to 150% year-over-year growth on a pro forma basis. The recently introduced 500-kilogram payload, MiR500, begins shipping in Q4, opening new markets for our mobile collaborative platform.

Thanks, Mark, and good morning, everyone. I'll start with a quick summary of the key highlights of 2018, as the finish line is nearing. I'll also cover a few of the common investor questions we're fielding, along with the third quarter results and fourth quarter guidance. Starting with the financial highlights. Despite the first half mobility speed bump, our 2018 top line should reach about $2.1 billion again this year, driven by Industrial Automation growth partially offsetting the Semi Test decline. Gross margin should run at 57% again, above our prior 54% to 56% historical average. Moving further down the P&L, our non-GAAP operating profit rate is trending to 24%, with strategically higher Industrial Automation investments. Non-GAAP EPS at the mid-point of our guidance will be $2.24, down from $2.34 last year. On capital deployment, we're pleased to have acquired both MiR, the leader in autonomous mobile robots, and Energid, the leader in robotic motion control software, this year. Both MiR and Energid are benefiting from a host of synergies inside of Teradyne, while maintaining their nimbleness and speed of execution. As Mark noted, we're on track to buy back $750 million of our stock in 2018. And since the start of 2015, we've bought back $1.2 billion at an average price of $28.68. To offer some longer term perspective on our strategy, we led the automation of testing integrated circuits decades ago. Now many years later, our semiconductor testers are churning out billions of devices weekly, and we're the leader in the ATE industry in financial performance. Fast forward to the present, and we've set our sights on leading the automation of repetitive tasks with Universal Robots and MiR cobots. These safe and easy to train cobots allow factory and service workers to avoid those highly repetitive and tedious tasks that are poorly suited for humans. It was just three years ago that we acquired Universal Robots, which added only $42 million to our 2015 sales. Now in 2018, our Industrial Automation segment, including Universal Robots, MiR and Energid, is on track to achieve over a quarter of a billion in sales. We also expect that by 2021, we'll be near $1 billion in Industrial Automation sales. These next generation automation businesses have favorable long-term secular trends, such as the worldwide shortage of workers, particularly for robotic-type tasks, cost and inflation worries, increasing quality requirements, and growing global industrial competition. Now, shifting to the key 2018 product highlights. Universal Robots released its next-generation e-Series product line. The e-Series advances the standard for ease-of-use and safety, while adding a built-in sense of touch and more computing power for our hundreds of third-party developers. The e-Series began shipments mid-quarter and will continue to offer both the original and e-Series, targeting different market price points. MiR is making a big splash too with the recently introduced MiR500. This heavier payload autonomous mobile robot is well suited for pallet-sized movements and is expected to ship in volume this quarter. We've also grown the UR+ certified third-party offerings from less than 60 at the end of last year to 112 at the end of the third quarter. This expanding collection of targeted proven solutions is a key driver of UR's ongoing growth. At a recent trade show, we also showcased Energid's Actin path planning software on our UR cobot, demonstrating the potential to greatly expand UR's addressable market for 3D pick-and-place tasks. Moving to Semi Test, we've nearly tripled our addressable memory test served market with our new Magnum wafer level test product that shipped in volume in the third quarter. This product is also in multiple broader evaluations and is well suited to the higher-speed protocol interfaces required in premium smartphones. In SOC Test, as you've seen, we're well-positioned in the growing automotive and industrial end markets, but we're also aggressively driving our R&D efforts to attack that technology inflection point that Mark noted. For example, we've successfully intercepted the market with ATE solutions for 5G millimeter wave devices, and for serial data links up to 60 gigabits per second, including PAM4 for chips being developed for data center and communications networking. So, all told, 2018 has been a very strong year, expanding our product solutions and addressable markets. Now, let me quickly turn to some of the most frequently asked questions, including, will we see a memory decline or broader slowdown? How are trade uncertainties and tariffs likely to affect us? How can we stay in the lead at Universal Robots? And finally, do we expect mobility to turn back on next year?

Yes. Could we just kind of speak to UR for a minute or so? Could you just refresh us on the exposure UR has in China? And also, speak to the investments, maybe in the quarter, to UR and how that, again, plays out?

On the China portion of UR's business is somewhere – it's roughly in the sort of 15% range. And that can move a little bit quarter by quarter, but that's a rough number.

Okay.

And the growth rate in China through 2017 was ahead of other large regions like North America and Europe. And this year, it's been lagging. And in particular, in the third quarter, we saw sort of a plateauing there. So, you can probably do the math from that, but 15% of the total and it's – again, what I said in my script is if we take out China in the third quarter, we're at about a 54% growth rate in all the other regions. On the OpEx, I'll let Greg answer it.

As to the investment level, in the short-term, we wouldn't do anything different. The investments, they tend to be lower-cost investments per person in China. And we do believe long-term, it will be a very high-growth market. It's just in this period where capital equipment – even though it's a very low cost with a faster return, it seems as though there is just greater uncertainty and there's a bit of a pause. So we need to see how that plays out. But I would not advocate cutting back spending now, because I think long-term, this is going to be a significant part of Universal Robots' business.

Hi. Thank you for taking my question. Mark, a couple of analog companies, TI, STMicro are seeing industrial, auto, semiconductor weakness in the December quarter. I'm just curious why you're not seeing it, if it's baked into your guidance. And I understand you guys are seeing some weakness on the UR side. And then I have a follow-up.

Yeah. Frankly, our analog demand has been quite bullish and accelerated in the third quarter, in fact. So part of that is due to what I would say is back to this issue of test intensity. So some of the – even though our customers' sales may not be growing as fast, the new devices going into automobiles are incrementally complex and need more test time. So there's always a bit of an ebb and flow of how much test is needed per, let's say, ASP of an analog chip or any chip.

Okay. And on the Industrial Automation side, you guys have talked about start-up companies as being more of a competitor to UR business than the traditional robotic companies. What is the closing of the Rethink Robotics mean for you guys? And if there's any interest in looking at their IP?

So Rethink is a great example of the fact that a rising tide doesn't float all boats. It does predicate – product differentiation matters. That's what UR has had. That being said, there's some very talented, creative people that developed a product line at Rethink. And we took the opportunity to hire a large portion of that to bolster our roadmap plans at UR.

Hello?

Yes.

Can you hear me?

Yes.

All right. Thanks. I wanted to talk about your big SOC customer and the degree to which they might come back next year. And of course, we know that all the new models are using the new AT. And that the AT is – it's the biggest transistor jump than we've seen in a long time. So obviously, test times have gone way up. So that would normally suggest a pretty good year from them for you, but that didn't happen. So it's kind of hard to believe, I guess, that the customer just massively overbought testers this year. So it begs the question that maybe there's something structural happening there? And so I guess my question is, do you think there is something structural going on? And if so, would you guys even know about that? Thanks.

Yeah. I think, Tim, without, again, being too specific, I think that earlier in the call, I outlined sort of four things that can go on to sort of pull this north or south. And transistor count, if it, like I said, grows 50%, that should, everything else being equal, yes, grow the test intensity by about 25%. And in most years that's exactly what happened, but there's other factors like yields that can swing this equation. So that would be something to consider. There's other factors like smoothing out production instead of peaking production in the summer. And there's this third factor of how much tuning is needed for the part, separate from just checking the transistors are they working, but essentially making the part work better or not. Different algorithms come in and out of how to tune the part year-to-year and that can affect it. So, within that mix, there was a very-you could call it a structural change, but there was enough improvements in areas like yields and in smoothing to mitigate much of the test time.

Yeah. Hi. Thanks for taking my question. I had two of them. One is Mark or Greg, if you look at all the analog digestion that's going on and the fact that memory slowdown – or you guys see the memory impact two to three quarters after the frontend guys. Historically, your Q4 has been this low water mark for Semi Test revenues and it's improved in Q1. Is it fair to assume, given all that's going on, Q1 sequentially could be down from Q4?

I think could – as a could statement, yes, I don't know that that's what we would expect. I think, for example, in the automation businesses, Q4 is always a peak. And as they become a larger – and then Q1 is down from Q4. That's been true for the past four years. We expect that again next year. And as they become a bigger part of Teradyne, that will tend to drive that negative delta, Q4 to Q1. The Semi Test piece, usually we begin to see the very beginnings of the mobility ramp for the summer at the tail end of Q1, but that can move around between sort of March and April. So that's kind of the one wild card.

What's happening in Industrial Automation, C. J., is, last year, you might recall, Universal Robots by itself got to 19% operating profit. It wasn't mid-20s. It was 19%. And frankly, that was higher than what we were planning. And we didn't hire as many people as we wanted to, particularly in North America. So we had some catching up to do in North America. So 19% was, again, artificially high. If you go back a year earlier to 2016, it was 15.5%. So it's kind of been mid-teens. It'll be mid-teens this year again. I think what really is going happen with Universal Robots, or you can put the whole Industrial Automation together, is that as we build out the infrastructure and are not expanding into new territories or hiring new channel managers, then we're going to get profit drop during the sales growth, a custom with what we see in other businesses. But because it's growing so fast, we're still catching up our infrastructure. And the model we showed longer term, we still believe that model is reasonable and achievable. It's aggressive and credible. So that's what we're targeting. We'll look at it once a year to see if there's any fine-tuning, but overall, I think the range is probably pretty good.

Hi. Thanks for taking my question. I just have a couple of quick ones. One, on the auto space, can you help us understand what your overall exposure is to the auto market?

Let's see. I'm going to just look at some numbers here for a minute. So I would say, in general, revenue-wise, we are around $200 million or so a year of Semi Test revenue due to automotive, maybe a little – it swings between $200 million to $250 million, but in that range.

Thank you very much. Maybe just following off of Weston's question regarding China and the tariffs. Given some of the potential market opportunities longer-term in the local Chinese memory market that you detailed, I guess, first remind us where the Magnum is produced? And what can you do potentially to shift manufacturing around to, I guess, supply that market if the tariff get a little bit out of hand?

Well, on that score, the Nextest Magnum product is in Malaysia, so it's not in the U.S., which obviously is a plus. Now, we have – about a year ago, we did – there's a small amount of testers that we would ship into the U.S., very small for engineering characterization. We were able, given the unique configuration of those testers, to move those to other sites outside of China and do the box-build configuration and then avoid the tariff legitimately. So there is some ability to move some things around, but you can't move large amounts of manufacturing.

Thanks for taking my question. Most of them have been answered, but just a couple of follow-ons, I guess. You've mentioned in the past that advanced packaging like InFO more test intensive than a standard package. Could you just remind us how much more test-intensive one of those types of package is than a standard package?

Yeah. So, there's a couple of factors. One factor is the degree of, let's say, contacting or parallelism you can achieve with some of these advanced packages is limited compared to a traditional semiconductor package. The same essential complexity in an advanced package versus a traditional semiconductor package could be, or has been, recently about a 20% bump on the advanced package side in terms of test time. And then, the other factor that we get is the level of interconnects that need to be tested and the degree with which some – it's not on all the same piece of silicon. So the characterization of crosstalk and impedance mismatches goes up when you're in an advanced package environment. So the amount of testing of those interconnects necessarily goes up. That's a less impactful, but it might be like a 5% header. So when you put the two together, maybe 25%. So overall, China should be – if our worldwide share right now is roughly 30%, China should be slightly better than that, starting out.

Okay. And then, you mentioned about Chinese memory. I guess what you said is, you haven't really seen those guys start to buy back in equipment. Will you have the same type of market share with those domestic memory guys in China that you have currently in the market? Or do you expect it to be higher or lower? Help us handicap that.