Edited Transcript of TER earnings conference call or presentation 24-Jan-19 3:00pm GMT

Now let's get on with the rest of the agenda. First, Mark will comment on our recent results and the market conditions as we enter the new year. Greg will then offer more details on our quarterly and full year financial results, along with our guidance for the first quarter. We'll then answer your questions. And this call is scheduled for 1 hour.

Mark?

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

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Good morning, and thanks for joining us. Today, I'll provide a quick summary of our fourth quarter and 2018 results, discuss our outlook for the quarter and year ahead and outline our latest thinking about the long-term growth trends in Industrial Automation. Greg will then take you through the financial results, our updated earnings model and our guidance for the first quarter.

As you saw in last evening's press release, we had a very strong finish to the year, with company sales up about 8% from the fourth quarter of 2017 and non-GAAP EPS up over 35%. These both exceeded the top end of our guidance as Eagle Test analog and LitePoint's wireless sales were particularly strong on the revenue side, and our EPS benefited from both higher sales and record gross margins.

For the full year, despite a significant drop in sales to our largest customer, all other parts of the business showed strong results, bringing our sales to about $2.1 billion with non-GAAP EPS of $2.37 a share.

Looking more closely at the results, I'll provide a high-level summary of each segment, and Greg will take you through the detailed numbers. Overall, Semi Test sales in Q4 were up about 8% from the year-ago quarter, and SOC test sales were up nearly 18% on continued demand from analog, image sensor and high-performance SOC.

In analog test, we had record Eagle Test shipments in both Q4 and for the full year. In addition to the continued expansion of automotive and industrial applications, smarter consumer products are also boosting analog sales. Applications like smart speakers, smarter appliances, home security, combined with the wireless connections they require, all drive increased analog content and increased test demand. Along with every clever complex SOC controller that find its way into these smart products comes a multitude of analog sensors, power managers, motor controllers, actuators, audio/video drivers and enhanced displays.

In memory test, strong markets and new products resulted in our highest annual memory revenue in history. Our leading position in the flash final test market, combined with the successful product introduction and expansion into the wafer test segment of the memory market, delivered over 46% sales growth for a total of over $270 million in memory test revenue for the year.

It's not only big growth that's driving the market. The trend toward even higher speed interfaces in both flash and DRAM continues unabated. Combined, these trends drive more test complexity, more test seconds and a higher rate of memory tester obsolescence. In 2019, we plan to continue to expand our wafer test share position, and we plan to introduce a high-speed DRAM test version of our Magnum platform, giving us full coverage of the memory test market.

Looking at 2019 for Semi Test. There are conflicting indicators at play, making forecasting difficult. On the one hand, we have not seen any indication of a broad pullback in demand from customers, and the increased complexity trends and new design activity remains very high. On the other hand, we've seen 3 very strong years of test demand, with market growth rates well above our modeled 2% to 4% CAGR. We've also seen a pullback in the front-end CapEx spending that began last year.

Taking these factors into account, in SOC test, we expect the market to be in the $2.3 billion to $2.7 billion range. And for memory test, we expect the market to be in the $650 million to $750 million range. Both of these are down about 15% to 20% from 2018. While we also expect Teradyne Semi Test revenue to be down, we expect it to be down less than the market drop due to planned share gains in both memory and SOC as well as secular buying shifts balanced in our favor.

At LitePoint, Q4 sales were up 43% from last year's Q4 and up 18% for the full year. We are now entering the early stages of market growth, driven by both new WiFi standards and 5G. We're seeing early production test system buying for WiFi 6, and we're having early success with our 5G millimeter wave test products in the labs of leading silicon providers as they prepare for future production ramps. We expect continued market growth in 2019, driven mainly by wider deployment of these new connectivity standards, with 5G production test growth becoming more meaningful in 2020 and 2021.

In our System Test group, sales in the quarter were down from a year -- about 1/3 from last year's fourth quarter due to a very tough compare in the Storage Test business. As you recall, we received customer acceptance and recognized revenue for accumulated shipments of our new system-level test product in that quarter last year. For the full year of 2018, the group grew sales by 12% and operated above model profitability. We expect another strong year from the group in 2019.

Shifting to Industrial Automation. 2018 was an important year for IA at Teradyne. We added MiR to extend low-cost, easy-to-train, safe, collaborative robots to the mobile robot market. Secondly, we added Energid and their team of motion control software experts to extend the bounds of addressable markets for UR's innovative arms. These extensions will begin hitting the market in 2019. Third, our UR+ open API platform continued to expand from about 60 to over 130 certified plug-and-play partner applications. Fourth, we expanded our product reach with major new product introductions at both UR and MiR, substantially expanded our global organizational capabilities and delivered another year of mid- to upper-teens operating profits.

From a starting point of $42 million in sales in 2015, IA delivered over $0.25 billion of sales in 2018. Although annual revenue of $261 million was up 54% from 2017, it was about $20 million below our target for the year. Continued softness in China and in the automotive sector resulted in Universal Robots' growth rate of 38% for the year and 28% in the fourth quarter compared to the year-ago periods.

We have not experienced any meaningful competitive headwinds, but rather see economic slowdown and uncertainty weighing on UR growth. On the other hand, MiR had both a fantastic quarter and year, growing close to 200% in the quarter compared to the year-ago quarter and over -- and 150% growth annually on a pro forma basis.

As we did in 2018, this year, we will continue to increase investments in Teradyne's high-growth Industrial Automation businesses to widen and deepen the moats around our leading positions in fixed and mobile collaborative robots. Given the 38% growth rate for UR in 2018 and the likelihood that softness in China and automotive will persist in 2019, we are modeling IA growth in 2019 at about 35% to 40% and bringing our midterm IA growth model down to a 30% to 40% range. This pushes out our $3.50 to $4 a share earnings target out about 1 year, from 2021 to 2022. Greg will cover this in more detail.

On the capital allocation front, we'll continue to buy back shares in 2019 with a planned repurchase of at least $500 million in shares while maintaining the dividend at the current level. We also continue to actively look at a wide range of M&A opportunities primarily centered around Industrial Automation.

Before closing, I'd like to announce that after 18 years of transformative leadership as Teradyne's CFO, Greg Beecher is planning for his retirement, and Teradyne is planning for a smooth transition. Greg has a very flexible time frame and will continue on as CFO as we run a succession process that includes both internal and external candidates.

With that, I'll turn things over to Greg.

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

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Thanks, Mark, and good morning, everyone.

I'll start with the quick highlights of 2018 and then offer some comments on 2019, including our capital allocation plans. I'll also offer some perspective on our strategic position and the market trends at the business segment level and update you on the changes that we've made to our midterm financial model. And then I'll close with the fourth quarter results and first quarter outlook.

On the 2018 financial highlights front, our $2.1 billion of sales and $2.37 in non-GAAP EPS was quite good. We grew EPS $0.03 over 2017 despite slightly lower sales and increased strategic investments in Industrial Automation where we grew OpEx over $50 million. This included folding in 2 acquisitions and further scaling our sales, support and development resources across the automation businesses. On the other side of the EPS ledger, we picked up 1 point of gross margin, shaved our tax rate 2 points and reduced our diluted shares by 5%. So the net is a slight gain in EPS and a much stronger Industrial Automation strategic position.

In 2018, we also achieved growth in all of our businesses except SOC test, which experienced an off year due to lower mobility buying by a large customer. As expected, the highest annual growth was in our Industrial Automation segment, which includes Universal Robots, MiR and Energid, where sales grew 54% to reach $261 million. Universal Robots saw annual growth of 38%, reaching $234 million. As Mark noted, this was below earlier expectations, with strong headwinds in China and some slowdown in Tier 1 automotive buying. MiR, the industry leader in autonomous mobile robots, grew full year sales over 150% to $31 million, up from $12 million in 2017. We recorded $24 million of those sales in our 2018 results as the MiR acquisition closed partway through 2018.

Memory test was a standout performer within Semi Test, with sales growth of 46% to $273 million for the year in an overall memory test market which exceeded about $950 million. Gross margin for the full year was 58%, a new company record. Favorable mix, along with material cost reductions at UR, drove this result. For example, our Industrial Automation gross margins expanded from 56% in 2017 to 59% in 2018. Teradyne's supply line group continues to play a key role in both improving IA gross margins and our ability to scale up these fast-growing businesses.

At the company level, we achieved a very healthy non-GAAP operating profit rate of 25% even with a significant expansion of our Industrial Automation portfolio and headcount. 2018 IA hiring, which reached nearly 250 people, helped us extend our cobot product lead, develop and market more applications, cover larger accounts, generate more qualified leads and better support our channel partners.

We also increased our stock buyback beyond our $750 million target to $823 million in 2018, buying back 22 million shares. Since the start of 2015, we've repurchased 50 million shares at an average price of $29.44. So apart from our healthy financial performance, we strengthened the company principally by expanding our served markets, adding new products and scaling our Industrial Automation businesses. I'll highlight these as I go through the segments.

First, in Semi Test. The expansion in memory wafer-level test delivered nearly $40 million of new business in 2018. In SOC test, we're seeing high demand for 5G millimeter wave test capability from leading customers for development and early preproduction volumes. Shipping this year, we expect these 5G engineering testers will position us quite nicely for the subsequent volume production starting in late 2020 and 2021.

As Mark provided our ATE market size estimates for 2019, I'll just simply add that in the midterm, we see numerous positive trends for test with 5G millimeter wave, autonomous vehicles, AI devices, augmented reality, big data. While we'll ride these positive inflections, we expect the market will remain somewhat volatile as manufacturers affect annual tester buying. These include chip complexity, unit growth, yields, customer-specific test strategies, utilization levels and so on. I'll remind you that this volatility is not new, and we've built our operating model to flex up and down with market demand swings and still deliver solid financial performance.

The other quick reminder in Semi Test is that annual buying shifts at individual customers can favor us or our principal competitor. In 2018, these shifts significantly favored our primary competitor. So for the first year, after 6 consecutive years, we didn't gain share this year. However, our long-term plan remains to get back on that share gain trend line.

In Industrial Automation, MiR had the expected 2018 breakout year with stand-alone sales of $31 million as more industrial companies take advantage of our next-generation automation to move both piece parts and heavy pallets. We're also seeing some early hospital applications, moving medicine and supplies from stock rooms to nursing stations throughout the hospital. This is an entirely new vertical with a potential to grow nicely given the increasing cost pressures on hospitals.

On the new product front, the MiR500 was added to the product lineup and, in the fourth quarter, was autonomously moving pallets at multiple customers with greater safety and lower cost than the traditional forklift transport method. We expect that MiR will deliver upwards of 100% growth in 2019.

Through 2018, Universal Robots grew at 56% cumulative rate from 2015 full year sales of $61 million. But for 2018 alone, growth slowed. We saw a sharp drop-off in China during the second half, along with some softness in Europe principally tied to the automotive sector. On the competitive front, we extended our cobot lead with the e-Series, which enables faster training, higher safety, more compute power and a sense of touch. We also broadened our application reach, now fielding over 130 certified third-party plug-and-play accessories in our UR+ program. We'll continue to expand this number as we strengthen the technical and commercial support for the hundreds of independent developers in the program around the world.

We're launching a number of new initiatives in 2019 to accelerate our lead generation and expand our direct customer touch, which should yield in the second half of the year. We also expect multiple waves of adoption ahead. With larger companies gravitating to cobots, we also expect new enabling technologies such as low-cost 3D vision and path planning to expand the cobot served market into more complex pick-and-place tasks. New applications using AI for training and fast adaptability and manipulating objects should also expand the range of cobot applications. In addition, we expect steady forces such as labor shortages, higher quality requirements, cost pressures, including inflation effects, will continue to stimulate wider UR adoption.

Shifting now to System Test, which includes our Defense & Aero, Production Board Test and Storage Test businesses. Sales grew 12% to $216 million over the '17 levels, and the segment operated above model profitability. We expect strong performance again in 2019 as Defense & Aero continue to benefit from new program buying and the ongoing upgrade of legacy defense systems. In Production Board Test, we pioneered high-throughput, in-line panel testing, and that's now becoming more mainstream. In Storage Test, both our semiconductor and our 3.5-inch hard disk drive customer are forecasting healthy 2019 demand.

Turning now to Wireless Test demand at LitePoint. The group grew sales 18% and operated above model profitability in 2018. Over the midterm, we expect continued healthy growth in Wireless Test, with 5G cellular providing the biggest added lift.

Now to the fourth quarter wrap up. At the company level, our sales were $520 million, the non-GAAP operating profit rate was 26%, and non-GAAP EPS was $0.63. We had no 10% customer in the fourth quarter and one for the full year. Non-GAAP gross margins were 60% in the quarter, with favorable product mix. You'll see our non-GAAP operating expenses were down $2 million to $175 million compared to the third quarter due to lower variable compensation accruals and a onetime $3 million credit, partially offset by IA hiring, principally from bringing on more than 20 very talented people from Rethink Robotics.

The tax rate was 16% for the year. On a GAAP basis, we also benefited from more favorable tax treatment for our repatriated cash than we had expected. We bought back 7.8 million shares for $261 million at an average price of $33.51 in the quarter. And we end the year with cash and marketable security balances of $1.2 billion. We increased the IA earnout accrual balance to $71 million, an increase in the quarter of $10 million, based principally on strong MiR performance.

Shifting now to our midterm earnings model. Factoring in both recent history and our latest outlook, we've updated the earnings target of $3.50 to $4 of non-GAAP EPS to slip out a year into 2022 rather than 2021. We've provided an updated slide in our investor deck, but at the high level, we've pulled back on UR's growth rate and have set the IA midterm growth rate to 30% to 40% going out through 2022. We've also reflected an 8% lower share count due to a lower buyback price in 2018, and we're also adding another year of buybacks by going out a year. So keep in mind that some of the numbers change as we're adding a year, but the takeaway should be that we're confident that our test businesses have secular growth and strong profitability and our high-growth IA businesses should be approaching $1 billion by 2022 with 20% or better PEBIT.

Shifting now to capital allocation. We're targeting to buy back $500 million of our stock in 2019. As in the past, there's a programmatic and an opportunistic component to the plan. At the same time, we have a very active IA M&A funnel, which is why we maintain dry powder on our balance sheet.

Let me quickly talk about OpEx as that's an area that we are strategically growing in our Industrial Automation businesses to expand our competitive moats to remain the leader and capture the highest amount of the available profit pool. We plan to grow IA OpEx from $33 million exiting the fourth quarter to about $50 million a quarter in the second half of 2019. Similar to last year, we plan to operate the IA business around 15% PEBIT for the year. In test, we plan to keep OpEx approximately flat in 2019, apart from normal changes in variable compensation.

Shifting to our outlook for the first quarter. Sales are expected to be between $460 million and $490 million. The non-GAAP EPS range is $0.39 to $0.47 on 177 million diluted shares. The first quarter guidance excludes the amortization of acquired intangibles and the noncash imputed interest on the convertible debt. First quarter gross margins are estimated at 58%, down 2 points from the fourth quarter due to product mix. The first quarter OpEx, running at 38% to 40% of first quarter sales, is up about $10 million from the fourth quarter due to further IA distribution and product development investments, principally at Universal Robots and some onetime Semi Test NRE expenses. The non-GAAP operating profit rate at the midpoint of our first quarter guidance is about 19%. Our tax rate for 2019 is estimated at about 16%.

Looking a bit closer at 2019. We expect gross margins to be in the range of 57% to 58%. Non-GAAP interest income, excluding the noncash imputed interest from the convert, is expected to be about $3 million a quarter, factoring in interest income on our cash balances, partially offset by the 1.25% annual coupon on the convertible debt. And we've earmarked $90 million to $110 million for CapEx.

So we start 2019 with a portfolio of healthy test businesses and a much stronger Industrial Automation portfolio. We'll remain disciplined in capital allocation and in our fixed costs in our mature test businesses while also aggressively scaling Universal Robots and MiR, given the long-term high growth rates. Remember that we long ago led the automation of the testing of integrated circuits. Now we're helping to relieve humans of the most tedious and repetitive task with safe and easy-to-train cobots. From where we sit, the future of Teradyne looks quite bright.

With that, I'll turn the call back to Andy.

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

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Thanks, Greg. Tiffany, now we'd like to take some questions. (Operator Instructions)

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Vivek Arya with Bank of America Merrill Lynch.

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Vivek Arya, BofA Merrill Lynch, Research Division - Director [2]

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Congratulations and best wishes to Greg on his retirement. For my first question, IA has been a very strong growth driver for you, but over the last year, we have seen some downshifting of growth assumption. I understand the China aspect, but I believe you mentioned China is only about 15% of sales, if I recall. So what are the trends outside of China that are driving the demand? So that's the near-term question.

And longer term, if IA growth is in the mid-30s right now, how do you plan to organically maintain this exact growth rate over the next 3 years?

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Gregory R.