Oct 30, 2009
Executives
Andy Blanchard - VP of Corporate Relations Mike Bradley - CEO Greg Beecher - CFO
Analysts
CJ Muse - Barclays Capital Jim Covello -Goldman Sachs Gary Hsueh - Oppenheimer Krish Sankar - Bank of America-Merrill Lynch Vis Vellore - Credit Suisse David Duley - Steelhead Security Patrick Ho - Stifel Nicolaus Jagadish Iyer - Arete Research Krish Sankar - Bank of America-Merrill Lynch Robert Weaver - Forest Investments Raj Seth - Cowen & Company Atif Malik - Morgan Stanley
Operator
Good morning. My name is Molly and I will be your conference operator today.
At this time I would like to welcome everyone to the Q3 Teradyne Earnings Call. (Operator Instructions).
Thank you. Mr.
Blanchard, you may begin your conference.
Andy Blanchard
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To view them, go to investor portion of our website and click on the GAAP to non-GAAP reconciliation link. Also, you may want to note that between now and our next conference, Teradyne will be participating in the Sidoti & Co.
New York Emerging Growth Conference on November 20, the Credit Suisse First Boston Technology Conference in Phoenix on December 2 and, the Barclays Global Technology Conference in San Francisco on December 9, and Eric May luncheons in Chicago, Boston and New York on November 11, December 14 and 15 respectively.
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Mike Bradley
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Let me start with the semi test side of the house. Last quarter you will recall our overall semi test booking doubled from the level of Q1.
In this third quarter, we topped the Q2 total with bookings of just over $230 million or about a 70% growth over the second quarter. Our IDM and fabless specifiers led the way with bookings more than double the level of Q2.
The OSAT business totaled about $50 million, equal to our second quarter order rate. So, both customer segments have more than tripled since the low levels of six months ago.
From a device segment perspective, we saw very strong growth in power management applications, while our wireless business was still strong it was complimented by micro controller, storage and analog segments, which posted healthy growth in the second quarter.
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Now, turning to our revenue guidance for the fourth quarter, our semi test revenue will again grow sequentially while our systems test revenues decline due to the lumpy nature of some of their businesses. In short, we will have system test shipping at the past Q2 level while semi test will have doubled over that same time frame.
I also want to mention that this rapid ramp in semi test business has in fact put strains into our supply chain. The front part of the ramp was achieved through some inventory drawdown throughout the supply chain.
With that inventory consumed, we were experiencing more part shortages which is moving our lead times out of a bit. Greg, will comment more on that shortly.
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Greg Beecher
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Let me first start with our third quarter results. As you know, we generated a 9.6% non-GAAP operating profit on sales of $262 million.
Given our current cost structure and breakeven, this is seven points to eight points higher than we achieved at comparable sales levels during the last five years. Though much improved from prior periods, it is lower than our target model at $275 million as we had record hard disk drive sales and systems test this quarter, which has lower gross margins than the company average.
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However, some businesses have higher gross margins and higher operating expenses than the company average, while others have lower gross margins and lower operating expenses, but they all need to get to the same 15% or better objective over a normalized cycle.
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However, some businesses have higher gross margins and higher operating expenses than the company average, while others have lower gross margins and lower operating expenses, but they all need to get to the same 15% or better objective over a normalized cycle.
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As you might expect, the model will be affected in two dimensions. First is the amount of revenue that we will need to achieve our model 15% profitability, will increase as we fold-in these new businesses into our model as our combined gross margins are lower than the company average.
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As you might expect, the model will be affected in two dimensions. First is the amount of revenue that we will need to achieve our model 15% profitability, will increase as we fold-in these new businesses into our model as our combined gross margins are lower than the company average.
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Turning next to the continued surge in demand. Product shipments increased 78% from the second quarter to the third.
As we said a quarter ago, we staged some finished goods inventory to respond to the anticipated demand increase. This along with draining the existing inventory in the supply chain helped keep our third quarter lead times quite short.
However, as we move through the quarter lead times extended on average to about 6 to 10 weeks. We continue to work with our key suppliers to respond to this increased customer demand.
Overall, we are very pleased with the responsiveness of the supply chain as it gets stoked up after quite a respite. However, the fact is that we are carefully monitoring the total supply chain along with our major contract manufacturer to ensure that the lead times remain in line with customer needs.
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Now, moving to the third quarter results. The top line of $262 million was up $92.6 million or 55% from the second quarter.
Semi tests contributed $70 million of this increase for a total of $173 million and system tests contributed $22 million of the growth for a total of $89 million. Within that $262 million, service revenue was $56.9 million, up slightly from $54 million a quarter ago.
Semi test service revenue was $40.6 million, up from $37.6 million a quarter ago. Product turns business was 37% versus 40% a quarter ago.
In semi tests, product turns business was 50% versus 62% a quarter ago. Memory revenue was $7.9 million in the quarter, up from $2 million a quarter ago, which was all flash memory.
Moving down the P&L, non-GAAP gross margins increased from 29.5% in the second quarter to 42.5% in the third quarter due to higher volume. Product margins were adversely affected by mix in system tests and a product obsolescence charge of $6.9 million.
R&D expenses were $38.3 million or [14.6%] of sales compared to $38.5 million or 22.7% of sales in the second quarter. SG&A expenses were $46.3 million or 17.7% of sales compared to $47.3 million or 27.9% of sales in the second quarter.
Operating expenses of $84.6 million were down slightly from the second quarter and included the benefit of about $6 million from temporary seller related reductions. Our net non-GAAP interest and other expense was $1.8 million, taxes were a benefit of $1.5 million in the quarter, and our headcount totaled about 2,900 people.
In the third quarter, semi test sales were 66% of the total and system test group was 34%. Systems test sales were at record quarter levels.
Our book-to-bill ratio for the third quarter was 1.10 for the overall company, 1.3 for semiconductor test, and 0.62 for a system test. At the end of the quarter our backlog stood at $336 million, of which, 83% is scheduled to ship within the next six months.
Cash flow from operations totaled approximately $94 million after capital additions of $9 million. Again, the majority of this increase was from advanced customer payments.
Depreciation and amortization for the third quarter was $34 million, including $6 million of stock-based compensation, $8 million for acquired intangible asset amortization and $2 million for amortization of the GAAP imputed debt discount. As noted in the press release, sales for the fourth quarter are expected to be between $255 million and $270 million, and non-GAAP EPS range is $0.12 to $0.17 on a 181 million diluted shares.
I should add that the guidance includes the full reversal of a temporary pay cuts and a more normal product mix, but also excludes the amortization of acquired intangibles, the purchase accounting inventory step-up charge, and the non-cash imputed interest on the convertible debt. Our GAAP EPS range is $0.04 to $0.09.
Now, moving to the P&L percentages expected in the fourth quarter. We expect gross margins to be 47% or 48%, while R&D should be 15% or 16% and SG&A should be 19% or 20%.
Non-GAAP net interest expense is expected to be about $2.3 million and the tax provision should be about $2 million. In summary, our model is performing quite well.
We are penetrating new markets and we are adding muscle to the balance sheet. Our main focus short-term is making sure our supply chain responds to demand in addition to maintaining very strong cost discipline.
Now, I will turn the call back to Andy.
Andy Blanchard
Thanks, Greg. Molly, we would now like to take some questions.
Operator
(Operator Instructions). Your first question comes from the line of C.J.
Muse with Barclays Capital.
CJ Muse - Barclays Capital
I guess the first question on the high-speed memory front, in terms of the multiple orders there. Can you comment, does that mean you were named the second source vendor there or are they still looking at three different vendors?
Mike Bradley
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CJ Muse - Barclays Capital
Just to confirm, I believe you said memory, total revenues was $7.9-million?
Mike Bradley
Yes.
CJ Muse - Barclays Capital
Can you expand on the trajectory from here I guess including high-speed memory, what the puts and takes are and what we could expect as we enter 2010 for that line item?
Mike Bradley
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CJ Muse - Barclays Capital
In terms of the non-GAAP pro forma, there is a line for profit sharing. Is that stock base compensation?
Greg Beecher
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CJ Muse - Barclays Capital
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Greg Beecher
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Operator
Your next question comes from Jim Covello with Goldman Sachs.
Jim Covello -Goldman Sachs
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Mike Bradley
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Jim Covello -Goldman Sachs
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Mike Bradley
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Jim Covello -Goldman Sachs
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Mike Bradley
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Jim Covello -Goldman Sachs
Very helpful. On the high-speed memory, congratulations on getting the recognition there, what do you think the timing could be for; A, following orders from that customer, and then; B, potentially orders from a second customer who I believe you might be engaged with now?
Mike Bradley
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Operator
Your next question comes from the line of Gary Hsueh with Oppenheimer.
Gary Hsueh - Oppenheimer
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Mike Bradley
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Gary Hsueh - Oppenheimer
So it would seem to argue to me that you are looking at basically a base case for semi test revenue on a normalized basis in 2010 somewhere around a $1 billion, and consensus right now is at 1.1, and I think there is a lot of short-term fear about how seasonally week Q1 could be. In terms of the overall market, you guys believe for sure that if semi CapEx is growing then you revenue should grow and semi test buy rates should grow?
Mike Bradley
Did you say a billion in SOC?
Gary Hsueh - Oppenheimer
Yes.
Mike Bradley
Yes, so a billion on SOC, then the market has to be over $2 billion. Do the math around $2 billion and 40 plus percent share you get 800.
So, 800 to 900 is probably okay.
Gary Hsueh - Oppenheimer
Just along these lines, did you give a number in terms of a target revenue range for HDD test next year?
Mike Bradley
You mean in estimating for different models what might you put in?
Gary Hsueh - Oppenheimer
Yes, for HDD test next year, was number given out?
Mike Bradley
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Operator
Your next question comes from the line of Krish Sankar with Bank of America-Merrill Lynch.
Krish Sankar - Bank of America-Merrill Lynch
Mike, you said about Eagle Test having record bookings in Q3. I was just trying to understand, is it fair to assume the Eagle Test business is running at its traditional peak capacity which is about mid to high $30 million run rate for revenue and maybe like a $40 million bookings run rate?
Greg Beecher
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Krish Sankar - Bank of America-Merrill Lynch
On the HDD side of the business, I know you guys said $30 million to $50 million and it could be higher. Did you see any pull-ins this year from 2010?
Greg Beecher
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Krish Sankar - Bank of America-Merrill Lynch
Just a final question, on the high-speed memory not to be beat a dead horse, but in terms of DDR3 specifically, can you tell like how many customers are you actually engaged with today?
Mike Bradley
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Operator
Our next question comes from the line of Satya Kumar with Credit Suisse.
Vis Vellore - Credit Suisse
This is Vis Vellore for Satya. Actually can you share what the service revenues were for semis and system tests for the September quarter?
Greg Beecher
Yes. The semi service revenues were $41 million and the system test service revenues for the third quarter were $16 million.
Vis Vellore - Credit Suisse
Okay. Then at these levels of $250 million to $270 million revenue run rate, how should we think about OpEx coming back?
Greg Beecher
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Operator
Next question comes from the line of David Duley with Steelhead Security.
David Duley - Steelhead Security
Congratulations on a nice quarter. Did you mention what the book-to-bill in the flash business was and was there more than one customer ordering there or was it just one?
Mike Bradley
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Greg Beecher
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David Duley - Steelhead Security
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Greg Beecher
In terms of revenue we did have one 10% customer during the quarter.
David Duley - Steelhead Security
Will you disclose the name of that in your filings?
Greg Beecher
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David Duley - Steelhead Security
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Mike Bradley
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David Duley - Steelhead Security
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Greg Beecher
We had payments from a customer and received a payment upfront. It gives them better position in our slot plan.
They get a slightly better discount, but commercially, it works for both parties. So, they are securing capacity and they see some greater test demand and then they want to get ahead of it.
David Duley - Steelhead Security
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Greg Beecher
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Operator
Your next question comes from the line of Patrick Ho with Stifel Nicolaus.
Patrick Ho - Stifel Nicolaus
A couple of house keeping questions first. What were your stock options this quarter and what can I assume for a tax rate in 2010?
Greg Beecher
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Patrick Ho - Stifel Nicolaus
Tax rate for 2010 now that you are back in profitability?
Greg Beecher
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Patrick Ho - Stifel Nicolaus
Just some broader I guess market related questions now. In terms of the SOC test business, you mentioned that you are still waiting for the emergence of some sectors like CMOS, image sensors and automotive, do you see that coming back in Q4 or do you see your current market segments being the same drivers in Q4?
Mike Bradley
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Patrick Ho - Stifel Nicolaus
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Mike Bradley
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Patrick Ho - Stifel Nicolaus
The final question is on cash usage. Now that you are starting to generate positive cash flow, you guys were active in buy backs in the previous cycles.
Is that something that you are going to look into in 2010 once again?
Greg Beecher
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Operator
(Operator Instructions). Your next question comes from the line of Jagadish Iyer with Arete Research.
Jagadish Iyer - Arete Research
Two questions, one is that, one of your competitors earlier this week suggested that the memory market is basically going to be doubling in 2010 and again progressively move into 2011. I just wanted to ask you Mike, what kind of position do you expect as you exit 2010 in terms of memory market share for you guys?
Mike Bradley
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Jagadish Iyer - Arete Research
No, 2010. As you exit 2010.
Mike Bradley
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Jagadish Iyer - Arete Research
The other question is that with TI moving to 300-millimeter analog, I just wanted to find out how well are you positioned to capture that portion of the business?
Mike Bradley
I missed the question.
Jagadish Iyer - Arete Research
Texas Instruments moving towards 300-millimeter analog process starting up later this year and early next year. I just was wondering how well are you guys positioned to capture the test portion of the 300-millimeter analog business there?
Mike Bradley
There is no issue there. TI is one of our major customers and we are well positioned in a number of segments with their business.
So I think we will be able to ride that transition.
Operator
Your next question comes from the line of Krish Sankar with Banc of America-Merrill Lynch.
Krish Sankar - Bank of America-Merrill Lynch
Can you guys tell little bit more on the seasonality of the HTD side of the business?
Greg Beecher
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Krish Sankar - Bank of America-Merrill Lynch
Then the IDM-OSAT mix was is it 79% and 29% in Q3?
Mike Bradley
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Operator
Your next question comes from the line of Robert Weaver with Forest Investments.
Robert Weaver - Forest Investments
A number of convertible bond issuers from earlier this year have taken actions to get those bonds off your books. Is that something you guys have looked at it all in terms of doing an equity flush out of those?
Greg Beecher
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Operator
Your next question comes from the line of Raj Seth from Cowen and Company.
Raj Seth - Cowen & Company
Mike, could you comment a little bit more on what you are seeing in the sort of low end J750 microcontroller test space? I thought that when we last talked that was one of the businesses that was still off.
In your prepared commentary it sounded like microcontrollers picked up. Maybe you can remind me how big in normalized environment that segment of the market is relative to the total?
Mike Bradley
Yes, Raj, are you asking for how microcontrollers fits into the total test market not Teradyne, right?
Raj Seth - Cowen & Company
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Mike Bradley
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Operator
Your next question comes from the line Atif Malik with Morgan Stanley.
Atif Malik - Morgan Stanley
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Mike Bradley
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Atif Malik - Morgan Stanley
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Greg Beecher
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Atif Malik - Morgan Stanley
One last one, AMCO reported yesterday and they are saying that seasonality for 1Q could be single digit. Just want to get your thoughts on what kinds of seasonality we can see in 1Q?
Mike Bradley
For revenue, which is in demand in this quarter, we think there is a digestion going on so that people will watch for the sell through in the holiday season. So, our expectations are that things are tonally, demand is a bit down in this quarter so that the Q1 numbers could be lower.
Operator
There are no further questions at this time.
Andy Blanchard
Great. Thank you all for joining and we look forward to talking to you next quarter.
Mike Bradley
Okay. Thank you.
Operator
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