Teradyne, Inc. (NASDAQ:TER) Q3 2023 Earnings Call Transcript

Teradyne, Inc. (NASDAQ:TER) Q3 2023 Earnings Call Transcript October 26, 2023

Operator: Greetings. Welcome to the Teradyne Q3 2023 Earnings Call and Webcast. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note this conference is being recorded. I will now turn the conference over to your host, Andy Blanchard, you may begin.

Andy Blanchard: Thank you, and good morning, everyone, and welcome to our discussion of Teradyne’s most recent financial results. I’m joined this morning by our CEO, Greg Smith, and our CFO, Sanjay Mehta. Following our opening remarks, we’ll provide details of our performance for 2023’s third quarter along with our outlook for the fourth quarter. The press release containing our third quarter results was issued last evening. 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 ends. 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’ll 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 were available on the Investor page of our website. Looking ahead, between now at our next earnings call, Teradyne expects to participate in technology or industrial-focused investor conferences hosted by Baird, UBS and Wolfe Research.

Now, let’s get on with the rest of the agenda. First, Greg will comment on our recent results and the market conditions as we enter the fourth quarter. Sanjay will then offer more details on our quarterly results, along with our guidance for the fourth quarter. We’ll then answer your questions. And this call is scheduled for one hour. Greg?

Greg Smith: Thanks, Andy, and good morning everyone. Today, I will summarize our Q3 results, describe the current business conditions and provide some insight on how we’re thinking about 2024 and beyond. Sanjay will then provide the financial details on Q3, our outlook for Q4 and offer some comments on modeling next year. Third quarter sales and earnings were at the high end of our guidance range, as Robotics sales came in above plan and we cleared some supply constraints and tests. The second half of 2023 is playing out as we described in July. We expect to close out the year with strong Robotics shipments, amplified by new product shipments at UR and seasonally softer test shipments. In semiconductor test, the mobility correction cycle persists and shipments remain well below historic levels while our automotive test shipments remained high in Q3.

Memory test shipments in Q3 were down sequentially due to the timing of shipments, but demand remained strong. LPDDR5 and HBM, both of which require higher-speed testers, drove the results. In wireless, demand remained muted in the quarter, given the weak smartphone market and lack of new wireless standards this year. In system test, defense and aerospace, and storage test groups were unplanned while production board tests softened in the quarter. Robotics demand has stabilized. In the first half of 2023, demand was quite low, down 21% versus the first half of 2022. In Q3, demand strengthened, with revenue nearly at 2022 levels and up 20% from Q2. Our shipments have stepped-up, as we execute an aggressive ramp of the new UR20 product and PMI seems to have stabilized a bit.

Looking at the full-year of 2023, our estimates of the SOC test market size are unchanged at $3.7 billion to $4.1 billion, down about 15% at the midpoint from last year. The weakest segment of SOC is mobility, down about 40% from 2022 on slower complexity growth in smartphone semiconductors and year-on decline in units. The compute, automotive and industrial analog segments of the market will finish the year at similar levels to 2022. In memory test, we expect the market will be get the low end of the $900 million to $1 billion range, also unchanged from our July view. The demand for high-speed DRAM test remains high, as we close out 2023, which will help us tick-up a few points of memory share for the full year. Teradyne’s System Test Group will finish 2023 downward than 20% from 2022.

Within this group, we expect defense and aerospace will grow 10% year-on-year, as global defense spending ticked up. The other segments of the business were negatively impacted by over-supply in the HDD market and mobility weakness. Shifting now to Robotics. The macro environment for industry is incrementally better than last quarter, with global PMI stable or improving slightly. The highlight of the quarter is — was a well-executed volume ramp of our UR20 collaborative robot. We delivered more than 300 units in Q3 and we expect to deliver a multiple of that in Q4. The UR20 extends UR’s ease-of-use and quick ROI to higher payload and longer reach applications, expanding the market in many segments. The strongest segments for UR20 so far are welding and pelletizing.

The distribution channel transformation that we described in the — in past calls is also making steady progress. Complementing our existing distribution channels with direct coverage at large accounts and adding OEM partners is a long-term project and we’re beginning to see positive benefits. For example, in the OEM space, we’ve added 48 new OEM partners so far in 2023, bringing the total to 144. And we’ve seen direct OEM orders grow nearly 20%, driven by the high demand from the pelletizing market. At MiR, our account strategy continues to deliver with our top 10 customers, expanding their collective installed base by over 15% year-to-date, a rank that’s more than 50% greater than the overall install base growth. Shifting to the future, I’d like to describe our current thinking about 2024.

Please bear in mind that it is still too early and visibility is too limited to be certain about what will happen next year. However, there are some longer-term trends that we expect to play out. As we previously discussed, we expect the SOC market and our revenue to grow from 2023 on broader 3-nanometer adoption in the mobility space, driving market growth and continued to strength in the compute market. The real question is the magnitude of the mobility recovery, which depends on smartphone unit growth, complexity growth and how quickly the industry can consume idle test capacity. For reference, we estimate subcon tester utilization is still low, up only marginally from our July estimate and well below the typical Q2 to Q3 increase. The automotive test market has been sustaining at a higher level in 2023 than we originally expected.

It appears that channel inventories in automotive are stabilizing and we have some — seen some spot weakness in the market. We aren’t expecting a significant change in the full-year market size next year, as unit forecasts and semiconductor attach rates, driven by the cross-over from internal combustion to EV remain bullish. The technology buys that have supported the memory TAM in 2023 should continue into next year and we expect the memory market to grow as HBM, DDR5 and LPDDR5 penetration expands to support AI and computing growth. In flash, as the protocol interface speeds continue to increase, we expect flash package test demand to grow as well. Overall, we expect the total ATE TAM to be up modestly from this year and the key factor is the strength in — of recovery in mobile.

Growth in our wireless business, LitePoint, will be strongly linked to handset growth, a recovery in the PC market and the start of the rollout of Wi-Fi 7. The supply-demand imbalance in HDD is likely to persist through 2024 and we expect HDD test to remain weak. System-level test will depend largely on smartphone unit growth in the near-term while we expect our defense and aerospace business to grow in 2024 on increased defense investments worldwide. In Robotics, we’re finishing 2023 on a positive note in a tough market, with Q4 revenues up about 10% year-on year on the strength of the new UR20 product introduction. That performance reinforces our optimism in Robotics. We see Robotics as a marathon, not a sprint. We are serving in a mark — an emerging market of $2 billion this year that we expect to grow to tens of billions of dollars per year in the future.

Our operating model for Robotics is built for that marathon, with a strategy that prioritizes product and support investments that deliver value to customers now. We are counting on building relationships with those paying customers to help guide our ongoing investments to meet their evolving needs for the future. The key to this strategy is driving towards our model of 5% to 15% profit from our Robotics portfolio. While we may — while we will fall short of this objective in 2023, it remains a key operating metric for 2024. We do this to ensure that we remain focused on our customers’ most important automation priorities while we grow the business. Rolling it all up, 2024 looks to be stronger than 2023, with all of the uncertainty around chip inventories, low utilization rates and macroeconomic worries.

I call it incrementally stronger, but we’ll get a better view over the next quarter or so. We’re also assuming a quarterly revenue profile in 2024, similar to 2023, with Q1 as the low-point and then growth from there. While early, we’re modeling Q1 sales to be similar to Q1 2023. As we finish the year, I’m encouraged by indications that our largest market, semi test, appears to have troughed in 2023 at a level that delivers an operating profit of 20% for the total company. We are confident about the long-term growth outlook of semi — of the semiconductor market, as the substantial fab equipment investments made in the recent past have not yet seen matching test investments. Also, we see consistent investment in tooling to enable continued process development, whether it is building a family of process nodes at 3 nanometer or enabling gate all around and two-nanometer technologies.

While the timing of test investments will be driven by end-market chip demand and complexity growth, we are confident that this investment will happen. To be clear, our customers are still cautious about their near-term demand and we’re reflecting that caution in our initial outlook for next year. But long-term, there is significant upside potential. In Robotics, we have a pipeline of new products, new applications and distribution changes that are now beginning to yield. At the end of the day, the global population trends are inarguable. The long-term demand for advanced automation must grow to deal with the increasing shortage of manufacturing workers. That coupled with market conditions that favor low-cost, short-ROI automation investments and our team’s growing execution skill, I expect renewed growth in Robotics in 2024 as well.

With that, I’ll turn things over to Sanjay for the financial details. Sanjay?

Sanjay Mehta: Thank you, Greg. Good morning, everyone. Today, I’ll cover the financial summary of Q3, provide our Q4 outlook and update you on our supply chain and resiliency progress. Now to Q3, third quarter sales were $704 million with non-GAAP EPS of $0.80, both at the high-end of our guidance as Robotics delivered above plan and some supply constraints eased in Test. Non-GAAP gross margins were 56.6%, in line with our guidance. Non-GAAP operating expenses were $243 million, down about 3% from the second quarter on spending controls and lower variable compensation. Non-GAAP operating profit rate was 22%. We had two 10% customers in the quarter. The tax rate excluding discrete items for the quarter was 14.5% on a GAAP basis and 15.7% on a non-GAAP basis.

Semi test revenue for the quarter was $498 million, with SOC revenue contributing $404 million and memory $94 million. As noted earlier, we continue to see strength in SOC concentrated in auto end-market and image sensor parts of our business in the quarter. Memory sales continue to be weighted towards technology retooling for higher-speed protocol flash for smartphones, DDR5 and HBM DRAM for server applications. System Test Group revenue was $83 million, with $38 million in storage test, as SLT in HDD production demand remains muted. In wireless test, revenue was $37 million in Q3, with low demand from both PC and smartphone end-markets. We expect this market trend to continue over the next several quarters. Now to Robotics, revenue in Q3 was $86 million with UR contributing $71 million and MiR $15 million, which was above plan, as Greg noted.

Shifting back to the company-level financials. Our free-cash flow was $140 million in the quarter and we returned 97% to shareholders. We repurchased $119 million of shares in the quarter, paid $17 million in dividends and settled $9 million of debt. We have the final $24 million of convertible debt, which will be repaid in the fourth quarter. We ended the quarter with $820 million in cash and marketable securities. Now, to our outlook for Q4. Q4 sales are expected to be between $640 million and $700 million, with non-GAAP EPS in a range of $0.61 to $0.81 on a 162 million diluted shares. Fourth quarter guidance excludes the amortization of acquired intangibles, restructuring and other charges. This outlook is in line with our July view at the company level for the second half.

Our revenue guide for Q4 has no material supply constraints. As supply has become more in line with demand, we are now back to including normal supply issues in the revenue range. As a result of supply and demand coming into balance, our lead times continue to improve. This enables customers to place orders more in line with our incremental production requirements. In Q4, there is a component of this behavior, but we expect to see more book-ship variability in Q1, as lead times continue to be reduced. Fourth quarter gross margins are estimated at 56% to 57%. OpEx is expected to run at 35% to 38% of fourth quarter sales, in line with Q3. Non-GAAP operating profit rate at the midpoint of our fourth quarter guidance is 20%. A little more color on gross margins and OpEx profile for the second half.

Recall, our long-term model has gross margins at 59% to 60%. In 2021 and 2022, we were in our model range, with margins of 59.6% and 59.2% respectively. In our July call, we noted the gross margin profile by quarter, which show lower gross margins in Q3 and Q4 due to the timing of spending to strengthen our supply chain but that we expected our full-year 2023 gross margins in the 57% to 58% range. That outlook is unchanged. Turning to resiliency spending, in our operations, manufacturing spend will continue in Q4 but the spend associated with enabling our new factories to be qualified and producing testers is behind us. Packing up inventory and some capital equipment from old locations is what is left to do for our manufacturing in Q4. In short, we have successfully completed our objectives of moving many product lines to new locations.

I would like to thank our internal teams and our partners for their tireless effort in de-risking our supply chain. Some component qualification will continue in 2024, but the majority of the test operational resiliency spending is behind us. Regarding OpEx, as noted, our full-year spend will be flat to slightly down versus 2022 spend levels. This is due to both spending controls and lower variable compensation. Recall our operating model has a variable component for operating expenses where the model flexes compensation expense with revenue and profits. As both are lower than 2022 levels, we’re spending less than 2023. As revenues are expected to grow in 2024 and future years, that variable compensation component will also grow. For the full-year 2023, at the midpoint of our guidance, revenue will be slightly below $2.7 billion with non-GAAP EPS of $2.85 and operating profit of 20%.

Gross margin for the full year should be about 57.5%. Our GAAP and non-GAAP tax rates are forecasted to be 15.75% and 16.5% respectively in 2023. Looking at 2024 business levels. Greg noted we expected revenue growth in 2024. How much growth is tough to call at this point. Starting the year with Q1 2024 revenues, similar to Q1 2023 levels, Q1 is expected to have unfavorable product mix yielding lower gross margins than Q4 2023. For the full-year 2024, we expect gross margins to be better than ‘23 on higher volume and lower resiliency spending. Summing up, our second half is playing out as expected with the highlight being strong execution by our UR team, as they ramp UR20 to meet high customer demand. For the full-year, while the end markets have softened in 2023, our company operating model has flex cost down to support profitability while enabling our R&D and go-to-market investments to support our long-term growth objectives.

We’ve transformed our supply chain to reduce geographic risk and strengthened our operations capacity. From a shareholder return perspective, year-to-date, we’ve returned 181% of our free cash flow to owners. Our cash position and strength in our balance sheet enables us to continue to invest in strategic organic initiatives and has the firepower to support a wide range of M&A options for inorganic growth in the future. With that, I’ll turn the call back to Andy. Andy?

Andy Blanchard: Thanks, Sanjay. Operator, we’d now like to take some questions. And as a reminder, please limit yourself to one question and a follow-up.

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Q&A Session

Operator: Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Tim Arcuri with UBS. Please proceed with your question.

Tim Arcuri: Thanks a lot. Greg, you had talked about there being some critical points where utilization has to get to, to then see mobility start to grow again. So how do you think about where we are sort of in aggregate? I know your large customer has their own dynamics. But how do you think about where we are right now in terms of utilization versus where you think we have to get until before the non-large customers would come back and start to buy again?

Greg Smith: Yeah. That’s — thanks, Tim. So the — right now, our — I’m hesitant to give you exact numbers because our measurements of utilization are indirect. So we tend to look more at the changes from quarter-to-quarter than the absolute level. But they are significantly lower than what we’ve seen for people to want to buy. So — and there’s also a big difference between our IDM customers and our OSAT customers. So our IDM customer utilization by our measurements are up in the low 80s, and that’s usually at a high enough level that trigger buys. Our OSAT customers are like 20 points lower, there’s usually a few points of inflection, like an increase in utilization from Q2 to Q3, we saw very little in our data this time. And so it’s still on the order of 20 points lower than what we’re seeing inside of IDMs. So I think there’s a pretty big hill to climb in terms of utilization before that would trigger buys from OSATs to support the mobile space.

Tim Arcuri: Thanks a lot. And then as you think about your — I mean I think a lot depends on your large customer next year. But as you think about — you read some of the plans in terms of what they’re planning to do and having a new chips throughout the entire product portfolio going from N3D to N3E, through the entire product portfolio, you do get 30% more transistor density. So it depends on the die size, obviously, but it does seem like there’s going to be a fairly solid increase in transistors across the entire portfolio next year. So maybe can you just — I’m not asking you to predict what happens with that large customer, but can you talk about sort of the things that you’re watching to sort of determine whether you think that next year could be a good year for that customer or not?

Greg Smith: Sure. So yeah, I’m — I think we’re both sort of working off of the same source data when it comes to like reading the tea leaves about this large customer. We don’t really know what their product plans are. The things that we are watching for are how quickly 3-nanometer goes into their high-performance computing process — products that the more of that product line that’s on 3-nanometer, the more complexity there will be, and that’s a tailwind towards loading. The next is what’s the relationship between — like how do they use the next-generation 3-nanometer process? Do they use that to try to decrease dye size and attack cost? Or do they use that to add features to sort of keep dye size the same, add a lot of complexity.

So we’re watching very closely to see how that plays out. And then the last is, if there’s any change to the strategy of using the N-1 processor in the lower-end phone product line. If that changes, that compresses the period of time that they have to build the — up chips, and that helps to drive peak loading. So we don’t have information about that. We are — so we’re being pretty cautious in terms of how we model that going into the future. But there are — like as you point out, there are a number of things that could drive some upside.

Tim Arcuri: Great, Greg. Thank you.

Operator: And our next question comes from the line of Krish Sankar with TD Cowen. Please proceed with your question.

Krish Sankar: Yeah. Hi, thanks for taking my question. I’ve chosen to — first one is on next year outlook to follow up on an earlier question. Historically, your big customers come around April or May timeframe to confirm kind of like a [Tesla] (ph) outlook for the year. Was it a similar — and it seems like that was a different pattern this year. Do you expect to go back to regular patterns next year? Or is it still too early to commit this call? And I have a follow-up.

Greg Smith: So I think that they actually followed a familiar pattern this year. But what ended up happening in April, May was that they ended up meeting not a lot of additional capacity. So I think we’ve pointed out in prior calls that we expect that major customer to be less than 10% customer in 2023. But we haven’t seen any significant change in the timing. The thing that we said in the prior call about this was we didn’t see — like, we didn’t have demand confirmed in that April, May timeframe, but there was still some uncertainty about what their peak loading might be and whether they need additional capacity. And that played out the way it played out. So I think they’re still on basically the same schedule.

Krish Sankar: Got it. Got it. Very helpful. And then a quick follow-up on the auto market. You said that it’s been strong. We’ve seen some spot weakness, but still expected to grow or be strong in calendar ’24. Is that purely because you think increasing in semi content is going to offset unit weakness? Is there anything else you’re seeing in autos? Thank you.

Greg Smith: No. So I think that what we’re seeing in automotive is most of the players in that space, they’re large IDMs and they all have significant capacity expansion projects in process. And they’ve — and with the lead times that they have for front-end equipment and where our lead times were running, say, even six months ago, they needed to place orders way in advance. And as they’re building out that capacity, they need to phase their deliveries so that it lines up with their commissioning. And — so we’ve seen some rescheduling, but we haven’t seen anything that we would consider to be a significant signal of demand change.

Krish Sankar: Got it. Thank you.

Operator: Our next question comes from the line of Mehdi Hosseini with SIG. Please proceed with your question.

Mehdi Hosseini: Yes, thank you. I have two follow-up. And I’m not going to ask you about how to forecast iPhone 16 builds for next year. But what I want to learn is, actually, I want to get an update on the compute end market. We all hear of more of an ASIC design ramping, hyperscalers ramping their own ASIC solution. By now, everyone has seen the Graviton and TPU in the headline. And in that context, what’s the update on Teradyne’s content market share? And I have a follow-up.

Greg Smith: Okay. So right now, the computing market, if you — like, just to sort of break it down, there are a couple of components of the compute market. There’s end equipment PCs. That part is significantly weak and continues to be. Then there’s cloud computing, and the thing that’s driving cloud computing is really AI acceleration. The beneficiaries of that are GPUs and then hyperscalers doing their own silicon. There’s definitely increase in the amount of bespoke silicon that’s going in, but it’s still dwarfed by sort of traditional GPU-driven accelerators at this point. The TAM, sort of the amount of testers that are being sold to support the hyperscalers is very — it’s not very consistent at this point. We had a big hit last year, from a revenue perspective, it’s quieter this year, but we think that this is something that’s going to play out over probably the next three or four years.

So we’re really looking at it in terms of socket wins. And right now, I can tell you that we are on track with socket wins. We have low share in traditional compute. We were aiming to try and win half and half, like half the battles we get into on hyperscalers, and that’s about what we’re doing this year, that we’re winning half of the sockets that we are fighting for and the other guys winning the other half.