Edited Transcript of TER earnings conference call or presentation 24-Apr-19 2:00pm GMT

Mark?

--------------------------------------------------------------------------------

Mark E. Jagiela, Teradyne, Inc. - President, CEO & Director [3]

--------------------------------------------------------------------------------

Hello, everyone, and thanks for joining us this morning. My prepared remarks will provide a summary of our recent results, describe current conditions in the markets we serve and provide an update on how we're looking at the full year. Greg will then take you through more details on the quarter.

Our first quarter sales of $494 million and non-GAAP profits of $0.54 per share came in ahead of our January guidance. This was due to a few strong pockets of notable demand. First, image sensor tester sales were the highest on record as the proliferation of cameras and smartphones, automotive, industrial and security applications continues to expand rapidly. Second, semiconductor test capacity for devices used in 5G base stations and related infrastructure began to ramp. This was primarily for high-performance digital infrastructure processors and represents the very early phase of what is expected to be a multiyear ramp-up capacity for a variety of 5G technologies. And third, in Industrial Automation, we saw the beginning of some large deployments of UR cobots at enterprise-level accounts in automated assembly applications.

Elsewhere in Semi Test, aside from our one large account, demand for mobile device testing remains high and trending ahead of 2018 levels. At our large account, we expect another downtick in demand this year but overall in line with our annual guidance.

Demand for RF test capacity for legacy standards is low, but interest in RF test capacity for next-generation ultra-wideband, WiFi and 5G standards is growing and should expand throughout the year.

In analog test, after a record 2018 for our Eagle product line, shipments for the automotive, industrial and consumer markets cooled in the quarter and came in about as expected. We expanded our footprint in the high-powered discrete modular test with the acquisition of Lemsys early in the quarter, which strengthens our position in the electrification trends of vehicle, solar, wind and industrial applications.

In the memory test side of the market, our sales were strong and level with the fourth quarter at $48 million. Demand was well distributed across flash package test and flash and DRAM wafer test, and we expect a slight uptick in Q2 driven by high-speed protocol test of flash devices.

In Wireless Test at LitePoint, sales were down sequentially but up 29% compared with Q1 of 2018 as we're seeing early step-ups in buying for ultra-wideband, WiFi 6 and 5G.

In System Test, sales were up both sequentially and year-on-year. The sequential increase was due primarily to growth in our hard disk drive test demand as test times for high-capacity drives continue to expand with density.

In Industrial Automation, sales grew 35% from Q1 '18 driven by both UR robot growth of 16% in the quarter and the addition of MiR and Energid. Three points are noteworthy in these results. First, as noted earlier, we are beginning to see a mix of larger deployments of UR cobots. As we described in past calls, we've been increasing our sales investment at enterprise-level accounts, and it's encouraging to see early results of this investment paying off. Following a 6- to 9-month period of evaluation, 2 of these large customers are now moving forward with deployments at a rate of dozens per month that should extend through the rest of the year. One of these customers is concentrated in China, and the other is geographically distributed.

Second, the arsenal of certified products in our UR+ program continues to grow and uniquely reduces the application's development time. We began the UR+ program in 2016 and by the end of 2017 had about 60 solutions available. 1 year later, it was over 130 solutions, and by the end of this year, we expect over 200. These products range from cameras to grippers to welders and screwdrivers and much more. A key part of our strategy is to push the competitive boundary in our price and hardware performance. Our UR+ playbook is very clear, provides a software and hardware platform to allow the development of a broad range of peripherals that are easy to deploy, reliable and have a short ROI. In doing so, we are able to leverage the talent of over 400 global UR+ partners to address more of the market than we could alone. This provides our customers with a range of solutions that gives them the flexibility to meet their immediate requirements and have the flexibility to redeploy our cobots to handle other tasks they may encounter. This is a significant distinction between UR and other emerging cobot competitors, large and small.

Third, a year ago, MiR joined Teradyne, and we're delighted with the results. After growing 163% last year, we are planning to about double again this year. Earlier this month, we introduced 2 significant new products to fuel this growth. One is a 1,000-kilogram payload, pallet-ready mobile robot, and the other is an AI-enabled camera that feeds into our fleet management software to provide better navigation. Think of it as a Waze-type augmented information system for mobile cobots where cameras monitor congestion points in a factory and use machine learning to classify and inform our fleet-wide navigation engine. This advanced warning system provides for increased navigation efficiency and safety.

Shifting to our outlook. The market conditions we're seeing in both our Test and IA businesses are essentially unchanged from what we saw at the start of the year. In Semi Test, our full year outlook for the SOC market remains in the $2.3 billion to $2.7 billion range, down about 17% from the midpoint of last year.

In Memory, given the well-reported slowdown across the market, we are reducing our full year market estimate by about $50 million to $600 million to $700 million, down about 30% at the midpoint from 2018. Offsetting this, we expect LitePoint and our System Test markets to be up about 10% from last year based on early-stage adoption of new wireless standards and a continuation of System Test trends seen in Q1.

In Industrial Automation, we continue to see some of the same headwinds that began to emerge last summer in China and in the automotive supply chain in general. Balancing those headwinds is an internal data showing accelerating monthly growth in IA shipments through March. For the full year, we're keeping our IA growth projection at 35% to 40% and the longer-term rate at 30% to 40%.

Summing things up. In Test, the demand drivers of unit growth and device complexity remain in place across all of our test markets. For example, we're beginning to see 5G-related test demand in both Semi Test and at LitePoint. Recall, when 5G-millimeter wave is adopted in mainstream handsets, we expect the test -- related test volume to represent about $300 million to $400 million of the Semi Test TAM and about (inaudible). We will be ramping to those levels over the next 3 years or so as deployments of 5G roll out globally. So despite year-to-year volatility, we remain very optimistic about the systemic sector growth in Test.

In IA, we've got a great product lineup that's well aligned to global demographic, quality and economic trends, which we expect to drive high growth for years to come. Our next-generation intelligent automation capabilities are reshaping the nature of industrial activity worldwide. We are investing in these software-rich, technology-driven building blocks of the future because we believe we are very early in the transition from centralized, complex and costly automation, usable by only a small percentage of global manufacturers, toward a distributed, easy-to-implement, low-cost automation that's available to nearly all industrial companies regardless of their size or automation proficiency.

In closing, I'll note that as previously announced, Sanjay Mehta will join Teradyne as our next CFO effective tomorrow. Sanjay brings a wealth of experience in finance, the semiconductor industry and China operations to Teradyne. At the same time, Greg has served 18 years as Teradyne CFO and has been instrumental to our evolution as a company. This will be Greg's last earnings call, so I'll turn it over to him for details and final thoughts.

--------------------------------------------------------------------------------

Gregory R. Beecher, Teradyne, Inc. - VP, CFO & Treasurer [4]

--------------------------------------------------------------------------------

Thanks, Mark, and good morning, everyone. I'll provide some key highlights, cover UR's market advantage and longer-term outlook, then I'll move to the first quarter results and second quarter outlook.

First, though, our first quarter sales of $494 million and non-GAAP EPS of $0.54 came in slightly above the top end of our guidance, and EPS was 20% above our year-ago start. The EPS year-over-year improvement was principally due to favorable product mix and share buybacks, offset somewhat by higher Industrial Automation OpEx, including having MiR and Energid in our 2019 first quarter results.

Our second quarter guidance for sales of $520 million to $550 million with non-GAAP EPS of $0.56 to $0.65 shows sequential 8% revenue and 12% non-GAAP EPS growth at the midpoint. That has us striking to similar first half sales with non-GAAP EPS up about 10% compared with a year ago.

While there are pockets of Semi Test buying in support of 5G infrastructure and image sensor for handsets and security, as Mark noted, annual semiconductor units are forecasted to be well under the 10%-plus growth rate of the prior 2 years. So we're conservatively planning for a flat to slightly softer second half in Semi Test albeit with considerable uncertainty.

Second half growth Industrial Automation should fill the gap so that the first and second halves should be pretty symmetrical from a revenue and EPS perspective.

Semi Test volatility has been the norm for many years, so we long ago structured our operations with these swings in demand. For example, in the current decade, our non-GAAP operating profit rate has averaged 23% over the last 9 years and swung from a high of 28% in 2010 to a low of 18% in 2013. In the last 3 years, with Industrial Automation in the fold, we've averaged a 24% non-GAAP operating profit rate and $420 million in annual free cash flow. As a result, we don't need to spend resources on judging where we are in a particular cycle; rather, we keep our focus on our midterm growth plan.

As outlined last quarter, we set our sights on reaching $3.50 to $4 in EPS by 2022, which requires Test sales growth of 3% to 5% off of 2018 and Industrial Automation growth of 30% to 40% off 2018. We're confident in both of these assumptions and are executing our plans accordingly despite the bumpy ride.

Turning to Industrial Automation highlights. We had first quarter sales of $66 million or 35% growth over the first quarter of a year ago but down sequentially due to normal seasonality as distributors often buy a bit more in the fourth quarter to max out on available discounts. This typically does not affect second quarter sales buying as fourth quarter buying is burned off by mid-first quarter. So although there were cyclical headwinds across global industrial markets, we see strong secular growth looking ahead.

Universal Robots had a 60% gross margin this quarter, up from 51% in 2015 principally due to synergies from Teradyne, which I'll touch on later. At UR, we continue to see very high interest from SMEs for existing applications such as machine tending and packaging, but we're also encouraged by the large order sizes that Mark noted. This wave of demand is driven by high operator turnover rates along with ongoing pressure on labor costs.

Another wave that we expect is bin picking, which has been referred to as the Holy Grail for manufacturers. Later this year, we plan to release a bin picking solution that combines UR's easy-to-train model with Energid's pathfinding and motion-control software allowing for precise part placement after the pick. More on this in future calls.

Turning now to MiR, which continues to be a standout performer. After the very successful launch of the MiR500 last year, MiR has just delivered an encore with its new MiR 1,000-kilo product introduced this month. These 2 heavier payload products can do much of the transport work of a traditional forklift but more safely and at a lower cost. They self-navigate and learn their environment, can be called or dispatched from a smartphone, tablet or fully automated through an ERP system. And they work seamlessly with their sister, AMRs and a fleet. MiR is targeting about $60 million of sales in 2019, up from $31 million for the full standalone year in 2018.

Mark noted the key highlights in Test, so I'll note a few things that may help you in your full year modeling. In Semi Test, 2019 will likely be a year of digestion, with sales declining 5% to 10%. Highlighting the strength of our operating model, we expect this to deliver 20% plus operating margins. For the other test businesses, at LitePoint and System Test combined, we expect annual revenue to grow 10% or more with profit growth of 20% plus from last year.

Before I get to the financial details of the quarter, let me address some frequently asked questions on the cobot market size and Universal Robots market advantage. First, UR has just scratched the surface of the opportunity for cobots. We proved the industry has cumulatively sold about 60,000 cobots to date against an estimated opportunity of a few million given today's cobot capabilities. New capabilities like bin picking expand the market by 50% or more, and there's a nice pipeline of new solutions planned that will continue to drive the TAM higher in the years ahead.

So the next question is why isn't it easy for competitors to gain traction in this growing market, too. First, as you might expect, the traditional robot companies seem to be focused on their large installed base customers who value compatibility with their high-payload complex robots. It's a very big challenge to leverage their platforms designed for automation experts into an easy-to-use or flexible cobot designed for shop floor-level skill sets. UR, on the other hand, encapsulates that complexity and designs their cobots specifically for easy training and flexibility. That's a hard thing to do. Further, traditional robot companies' distribution doesn't easily reach to SMEs and does not include an open ecosystem, which for us attracts many third-party developers and new applications.

New entrants for cobot start-ups face some of the same design challenges in getting the product right and safety, repeatability, ease of use as well as building effective global distribution and partner ecosystem networks to meet the broad scope of customer applications. We're not confused that a potential market this big will attract competition, though. There are dozens of competitors today, and more will likely enter. And their capabilities will improve over time. The point is, today, they're not there yet, yet the path to commercial success in industrial markets is a difficult one, and significantly, we're not standing still. So in line with the strategy Mark described, our UR focus remains on expanding our competitive moats and product flexibility, distribution to SMEs and large accounts and attracting even more third-party developers to our open platform. There will no doubt be ways of adoption over the next several years, including large companies deploying automation beyond individual plant manager investments as workforce demographics, quality requirements and cost pressures will be relentless forces driving more widespread cobot deployment.

Regarding margins, our pricing remains very attractive for our customer ROI calculations, even against lower-price competitors. Safety, repeatability, accuracy and reliability required to support industrial operations 24/7 remains a major competitive mode, especially for the new entrants. We also have significant cost advantages from volume buying and innovative flexion techniques. For example, since we acquired UR in 2015, we have taken down the bill time from 10 days to 1.5 days. This includes using our cobots in numerous assembly and calibration tasks. These production advantages and material cost savings have brought our UR gross margins up to 60%, about 9 points higher than when we acquired UR in 2015. An additional benefit of the shorter manufacturing cycle time is its significant production space freed up, allowing us to operate with our current footprint through 2023.

We also continue to build competitive moats with new software features, developing a vibrant ecosystem of UR+ accessories, advancing our distribution excellent with SMEs and large accounts and application breadth and expertise.

Now moving to the details of the first quarter. Our sales were $494 million. The non-GAAP operating profit rate was 22%, and non-GAAP EPS was $0.54. We had no 10% customer in the quarter, and gross margins were 58%.

You'll see our non-GAAP operating expenses were $179 million, up $4 million from the fourth quarter but less than the forecast primarily due to pushouts of Semi Test and OE expenses. Comparing our first quarter OpEx of $179 million versus the year-ago period, it's up by $14 million primarily due to the addition of MiR and further distribution and product development investments at UR.

Semi Test sales were $341 million in the first quarter, with SOC making up $293 million and Memory Test sales of $48 million in the quarter. Semi Test service revenue totaled $78 million in the quarter.

In Industrial Automation, sales were $66 million, a new first quarter record. Regionally, IA's first quarter sales broke down 44% in Europe, 28% North America, 23% in Asia and 5% rest of world.

System Test sales were $58 million, and Wireless Test sales were $29 million in the first quarter.

Let me move to a few GAAP items. First, we had a tax benefit of $15 million in the quarter due to a $26 million release of tax reserves based upon the successful completion of an IRS examination. We also adopted a new lease accounting standard, which added $51 million to our assets and a similar amount to our liabilities. This applies to operating leases greater than a year, which were previously disclosed in our footnotes.

Regarding capital allocation, our balanced approach for 2019 includes $500 million targeted for buybacks, about $63 million for dividends and, of course, maintaining dry powder for selected Industrial Automation M&A.

Cash and marketable securities declined in the quarter by $208 million to $997 million driven by that balanced capital allocation strategy, which included $156 million of share repurchases, $35 million for earnout payments tied to Universal Robots and MiR and $16 million of dividend payments.

Turning now to the guidance for the second quarter. Sales are expected to be between $520 million and $550 million, and the non-GAAP EPS range is $0.56 to $0.65 on 173 million diluted shares. Q2 guidance excludes the amortization of acquired intangibles and the noncash convertible debt interest. The second quarter gross margin should run at 58%, about flat with the first quarter. And total OpEx should run from 34% to 36%. The operating profit rate at the midpoint of our second quarter guidance is about 23%.

Let me quickly cover OpEx plans for 2019, which were essentially unchanged from our January call. We expect full year Test business OpEx spending to be about flat year-over-year, apart from normal variable compensation changes. In Industrial Automation, we expect to grow quarterly OpEx to the mid- to high-40s towards the end of the year, up from about $33 million in the fourth quarter of 2018. Notwithstanding our planned Industrial Automation investments, we expect us, I think, to achieve mid-teens operating profit rates for the full year.

Shifting to taxes. Our full year tax rate is expected to be about 16%, unchanged from our January estimate.

So now for my parting remarks. After 75 mostly enjoyable conference calls, I can safely say that Teradyne is the strongest it's been in my tenure. Teradyne has Test businesses expected to grow 3% to 5% annually on a trend line with strong growth and operating margins and the leading cobot arm in autonomous mobile robot platforms, which we expect to grow at a 30% to 40% rate annually through 2022. Teradyne generates significant free cash flow, has a strong balance sheet and has the capacity and capability to successfully make more Industrial Automation test moves. Teradyne will no doubt continue to be admired as both a leader in test equipment and one of the few companies who has successfully added a new growth platform with next-generation automation.

With that, I'll turn the call back to Andy, and shortly, the reins over to Sanjay.

--------------------------------------------------------------------------------

Andrew J. Blanchard, Teradyne, Inc. - VP of Corporate Relations [5]

--------------------------------------------------------------------------------

Thanks, Greg. Danny, we'd now like to take some questions.

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) Our first question comes from Mehdi Hosseini with SIG.

--------------------------------------------------------------------------------

Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [2]

--------------------------------------------------------------------------------

First one has to do with the 5G. Mark, can you help us understand what are the specific opportunities like market segment? You referenced base station, but I want a bit to understand a specific content exposure that you have there. And I have a follow-up.

--------------------------------------------------------------------------------

Mark E.