Teradyne, Inc. (TER) Earnings Call Transcript & Summary

Hello. Good morning. Thank you, everyone, for joining us on the third and final day of the Stifel Cross Sector Insight Conference. This is Brian Chin, analyst on the semiconductor capital equipment research team at Stifel. I would certainly like to thank Andy Blanchard, VP, Head of Corporate Communications at Teradyne, for joining us in this 30-minute virtual fireside discussion. Teradyne is a leading supplier of semiconductor automated test equipment and is also a major player in industrial automation with its collaborative robotics and autonomous material transport technology offerings. First, I believe Andy will give us a brief background on the company, and then we can spend the balance of our time in the fireside. And Andy, with that, please go ahead.

Yes. Thanks, Brian, and thanks, everybody, for joining us today. I'm going to give you a very brief update on the company. Teradyne is coming on 60 years this year. We, for most of those 60 years, have been a maker of automated test equipment for the electronics industry, whether circuit boards or more substantially, semiconductor test. And last year, that was about $2 billion of our $2.3 billion in sales. That's a very good, solid business generating low to mid-20s pretax operating profits consistently and the $300 million to $500 million in free cash flow per year. In 2015, we expanded into the Industrial Automation business. As Brian noted, we have an offering in collaborative robots and also in mobile autonomous robots. That business collectively, it's in our Industrial Automation segment, was about $300 million in sales last year. About $250 million of that was the collaborative robots, the fixed robots that are Universal Robots. The remainder was MiR and a little bit of an acquisition we had late in the year called AutoGuide. And the way to think about those businesses right now, they ran at about a 10% pretax margin on a non-GAAP basis. So you got to back out intangible asset amortization last year. And we'll continue to run them at kind of that 10-plus or minus percent PEBIT rate going forward while they're in this hyper growth stage. Long term, we think that, that market will grow -- or excuse me, that business will grow between 20% and 35%. 2020 is kind of a wildcard because of all the macro events around us. But again long term, we expect it to grow a 20% to 35%. The historical growth from 2015 has been just under 50% for that business. Now again, 2020 is an exception, but -- to that trend line, but it's still -- we feel we're in the very, very early innings of a long-term growth story regarding industrial automation. And with that, I'm going to just pass it back to Brian, and we'll do a bit of Q&A.

Yes. Thanks, Andy. Maybe to kick things off, I'd like to give -- or get into a few near-term topics, maybe at the forefront of investors' minds, and then we can shift into a discussion of some broader areas of interest. So I guess starting off maybe with supply. For many companies, the pandemic has disrupted operations, but for Teradyne to effectively 0 net effect in terms of the operating performance of the company. Maybe, Andy, can you share an update on whether this remains the case? Also, I guess, how the company has managed to overcome many of these hurdles? And also what steps or kind of actions is the company undertaking to mitigate future contingencies that might arise?

Yes. Well, first off, Brian, I know from the outside and from your perspective, it looks like it's neutral and no impact on Teradyne. If you talk to our operations guys, it'd give you a very, very different story. So in the first quarter, it was a game of whack-a-mole, right? And there were a number of issues in our supply chain that we had to work through. Fortunately, we were able to do that and still deliver the results within our guidance range. In the second quarter, as we replaced -- as we were setting guidance in April, the world was still -- there was still a lot of uncertainty related to supply chain. That continues, obviously, to today, but perhaps not as acute as it was in early April. We continue to play whack-a-mole, if you will, working through supply issues, especially since this is our peak shipment quarter for one important end market for us, the mobile phone end market, handsets in particular. And so we're trying to ramp shipments at the same time we're dealing with uncertainty in the supply chain. That's, by the way, the reason for the very wide revenue and EPS guide for this quarter. We typically have a $40 million or so revenue range in the guidance, the $110 million in the second quarter, and that's because of uncertainty in the supply line. I would just -- obviously, I can't give you a lot of detail of how we're doing on that without describing how the quarter is going to come in. But we are certainly working through those issues. The operations team is global for us, and they're working with our partners to get through it. Longer term, we are making some changes. So we've -- in this process, both in Q1 and into the second quarter, we've identified areas that could be strengthened. We're going to strengthen them. In some cases, that means redundancy within the same supplier, but moving to source material from multiple geographic locations of the same guy. And in some cases, it means adding a second supplier just to build some redundancy. And they'll be some cost impact to that alone. It's all within our model, but it -- there will be a cost impact. The other thing I'll note, by the way, on the supply thing is it hasn't only been ability to manufacture and the things you'd expect to have to resolve. The logistics part of it has been a big deal as well. So there's been an awful lot of having to replan and reroute and use nontraditional logistics suppliers to get the right material to the right place.

Great. And this sort of the other hoops and hurdles you're going through right now, that's partly also influential in terms of just the very -- the near-term gross margin, which is not a trend, but just sort of like a near-term suppression as well as some of your product launches...

Yes. Yes. That's right. I mean we said in the second -- in the second half, rather, that we'll have some headwinds on gross margin, and that's primarily because of new product launches that are -- I should say, new product ramps that are ramping faster. So demand has been stronger for a range of new products than we had anticipated. And we're not as far down the cost curve on those as we had expected. So that's going to hit us in third quarter and fourth quarter, and we're back on model in the first quarter. And of course, that same operations' team is going 100 miles an hour to try to mitigate the impact of that as well, but it will have an impact.

Shifting to demand then. There seems to be a great deal of dispersion in demand trends across technology and other key end markets like automotive and as well as industrial. I guess 6-or-so weeks removed from the earnings call. Can you share any incremental updates on the demand profile for Teradyne's Semi Test business, perhaps across key product areas as well as the Industrial Automation business and across its key markets and geographies?

Sure, sure. I mean I think the way I'd describe it is, in Semi Test, the -- anything related to mobility, anything related to handsets, in particular, is very strong. So the whole chipset, everything that goes into the handset has been strong from image sensors to AP to RF and power management and all the rest. In the Automotive and Industrial segments, and again, I mean the Semiconductor Test now, those have been very weak. And Automotive has been weaker than we had expected. We came out of -- we weren't expecting a lot from Automotive, certainly in the first half. I think we mentioned in the April call that it's been lower than we had expected even coming into the year. So I think Automotive is in a bit of a lull for this year. I think last year, it was as well. So it's -- we had a couple of very, very strong years, and now we're dealing with a couple of weak ones. But I think that will pick back up the trends for Automotive are undeniable in terms of increasing semi content and the complexity of their content. But we are in a low right now and similarly, in the analog industrial side of things. In the industrial automation side -- sorry, in the industrial automation side of things, the fixed robots, Universal Robots have faced a very strong headwinds, right? They sell 3/4 of their product in Europe and North America. And in -- this first quarter was progressing along, those areas shut down, and those are largely shut down for most of the second quarter. So we're not expecting a lot from the fixed robot business in second quarter, and that probably extends in the third quarter because our thinking, there's a lot of opportunity longer-term as people look to reshore and/or at least disperse their manufacturing operations and also there may be even some benefit from people wanting to physically separate employees on a production floor and maybe that means putting some collaborative robots between them. But we think the long-term drivers of that remain the availability of labor, the economics of that labor and the drive for higher and higher quality of manufactured goods. And so those are the biggest drivers of the UR business and we -- Universal Robots business, and we expect that still to be the case. And maybe, again, it accelerates at some point in the future because of the pandemic, but we're not expecting that to happen in the very near term, maybe that's 2 or 3 quarters out, but it certainly not -- we don't expect it to be right in front of us. On the mobility -- on the mobile robot side of things, the MiR and AutoGuide, it's a little bit different story. MiR has actually -- it had a pretty good quarter relative to the rest of the automation world. In the first quarter, business was about flat, while overall, our business was down about 10%. And others in automation were down a lot more than that. And that's -- that relative better performance from MiR, we attribute to their exposure to the health care industry. They've got some products that have been in the hospital industry for a long time, shuttling material from a stockroom out to the point of use. But also, they've got some products they used in disinfecting areas and that -- customers that put products on top of our platform for disinfecting physical spaces. And that has helped them in the second quarter -- first quarter, and we're hopeful that it will help in the second quarter as well.

Okay. Great. I appreciate that, Andy. Maybe last near-term topic here. But certainly, a key area of focus for investors with respect to the company is the U.S. trade action against Huawei and its semiconductor design arm HiSilicon, that was announced last month. Given the company's evaluation now of its exposures, what are the direct and indirect implications for your business?

Well, the direct implications of it are pretty limited because there -- most of the product from that is sold to outsourced assembly and test partners of Huawei and HiSilicon. And they've got to go get a license. Now obviously, indirectly, that has an impact on us, if they were going to -- if they don't get those licenses and they can't do business with them. But the direct impact were once removed from it. But that said, there's a ton of ambiguity in those regs. And so it's not clear whether Huawei would be able to purchase from merchant silicon provider, which -- in which case, the impact would be neutral because that silicon still needs to get tested, and we've got strong share across the players that would be providing that. And in the event that they're not able to provide an equipment at all, somehow, the trade stuff shuts Huawei down entirely, which I think is probably unlikely. But if that was the case, then we'd expect the market would adjust. There are products that can substitute for theirs, and the market would adjust accordingly. And we'd, again, see a pretty neutral exposure because we play across the whole market.

And you're kind of referencing -- because I think some of the exposure has been on the infrastructure side. And as you've referenced in the past, you've eaten pretty well from that particular part of the addressable market. So even if that was to shift to another infrastructure supplier, you think you'd be kind of in a similar position?

We do. Between us and our competitor, we have about 90% share. And this puts and takes with -- in every circumstance, but we share the market pretty evenly across the space. So we don't feel it'd be a big headwind of one way or the other.

Okay. Maybe more like a timing thing as kind of one vendor sort of has to move backward and other ones will kind of fill that void, maybe it's more of a timing or anything...

Yes. I think -- I mean the way we model it is, it would be a lot like it is in the handset market. The infrastructure stuff would be a lot like handset, where -- whichever semi provider is in an investment cycle to support their respective customers, you'd get a short-term bump for whoever is the test equipment provider for that guy. But over a multiyear period, it is pretty neutral.

Okay. Maybe just one last question. Well, at least in terms of this more kind of near-term things, but tying together a sort of the last 2, historically, there is a classic seasonality to the business, in particular Semi Test. 3Q sales, down, call it, 20%, 25% sequential, usually based on the timing of customer product ramps, like smartphones, as you referenced, in particular. Last year, things did play out different. 3Q was up sequential in large part due to the timing of that 5G kind of infrastructure ramp. So I guess given that this might -- and I don't think it was expected in the first place to be recurring certainly about magnitude this year relative to last year. And are there any factors that, to some degree, might offset the typical seasonal down pattern in 3Q?

Yes. Well, I -- yes, I think 3Q and the fourth quarter from where we're sitting, it's kind of a black box to us because there's a bit of a disconnect between the macro environment and the demand environment, right, for semiconductor test equipment. And so it looks very strong from our perspective, but we also are a capital equipment provider, and we know that the demand is great until it's not, right? And so it's very hard for us to judge what third quarter or fourth quarter is going to look out -- look like. We're kind of 8 to 10 weeks. So we're seeing into early August or thereabouts. But it's a real hard call for us. So I wouldn't put a lot of stock in past seasonality patterns.

Okay. That's helpful. I guess before moving into some more questions, let me just remind the audience if they have questions, feel free to submit online, and we'll try to get to them as well. I guess moving on a little bit here. We -- I don't think Teradyne breaks it out this way, Andy, but we put wireless communications in totality at well above 50% for Semi Test. And that goes, as you've mentioned apps processors, imagers, analog, et cetera. I do think where sometimes it gets a little tricky for investors is understanding where the incremental growth from 5G, I guess, has, one, already materialized, and then, two, is yet to be realized. And I guess your wireless business, as you referenced, clearly is strong here in first half, but that -- less to do maybe with 5G per se and more to do with kind of the device yields exiting the fab and increases in chip complexity. So I guess, can we spend a few minutes revisiting the $400 million to $500 million of incremental 5G TAM the company has referenced in the past and kind of break down how much of this TAM increase has occurred and kind of what's remaining? And also, maybe what you expect to be tied to 6 -- sub-6 gigahertz, 5G versus millimeter wave 5G?

I'll take a shot. There's a lot in there. I'll take a shot at it so correct me if I miss things. The -- first off, that $400 million to $500 million is company-wide, right? So this $300 million to $400 million we estimate in Semiconductor Test, another $100 million, maybe it's even a bit more than that in the LitePoint TAM. And to date, we estimated last year that 5G was around $200 million of the $3.3 billion TAM for SOC test in 2019. I think it's important -- 5G is a big deal, of course, but it's really important to keep it in perspective in that the mobility component of SOC last year was about $1 billion -- $1.5 billion, $1.6 billion. So almost half of them of the SOC market was mobility, and 5G was $200 million. Let's call it, 1/8 of that market. So the overwhelming driver of the mobility test demand is everything else. The AP imager, the power management, all the other -- but the big digital, in particular, is the big driver of that market. And we're seeing that again this year. And so in 2020, we think 5G is probably somewhere $200 million to $300 million in semiconductor test and probably approaching $75 million or $100 million in LitePoint's business. And remember, these are annual numbers, right? So the way we envision it is that 5G is going to incrementally expand that SOC TAM by $300 million to $400 million. Last year, we were 200-ish into that. This year, maybe it's $200 million to $300 million. And when we get millimeter wave and shipping in volume across the industry, we would expect to be at the high end of that $300 million to $400 million range. But that is probably a couple of 3 years from now. So we think millimeter wave is going to trickle out over an extended period. In the meantime, most of the investment is for sub-6 gig. So 5G is an important component of the SOC market. We're well positioned in it. We feel very good about the whole -- our position in millimeter wave and all. But I just want to make sure that it's in context because the big driver in this thing, the big nut continues to be the AP and the chips around it.

Okay. That's good context. I appreciate that, Andy. I guess you just referenced sort of millimeter wave, getting in the sweet spot here now maybe for a few years out still. I think that's consistent with some of the messaging we've heard even at this conference early in the week with other folks and stakeholders there. Would you characterize that maybe as a delay, maybe not significantly, but a delay somewhat relative to maybe the company is making even a year ago or less? And I guess by that same token, do you think sub-6 gigahertz rollouts are maybe progressing faster at all, even in spite of the pandemic?

Well, by the way, I'm going to risk confusing the hell out of everybody with the following comment here. Millimeter wave, we think, is a 2020 -- maybe late '21, but more likely '22, '23. That said, millimeter wave in 2020 has been far stronger. Millimeter wave test equipment demand has been far stronger than we expected. And that's one of the reasons why we talked about that gross margin hit in the second quarter -- in the second half as that ramps the new products that we have serving that aren't as far down the learning curve as we had expected, as we would have -- as we had planned. And so in the very short term, even though the market forecasters are thinking that there's going to be 10 million to 15 million millimeter wave handsets out of 200 to 300 5G handsets, out of 1.2 billion, 1.3 billion total handsets, it's a tiny piece of it. But boy, it's driving a lot of test demand earlier than we expected, and we think that's probably related to early learning on the devices, the fact that there's no installed base. So every bit of incremental demand requires you add some incremental test capacity. So it's a bit puzzling that, that part of has been as strong from a test equipment perspective. As far as the rollout of millimeter wave across the industry and all that, I think it's playing out as we had expected. I mean we didn't expect it to be real strong early on in terms of number of units in the total handset shipments, and it doesn't look like it's going to be, but it is driving a lot more test than we expected. And we don't expect that to be linear going forward, of course, but there's a big initial investment going on right now.

Got it. That's helpful. I guess the commentary maybe here is that it's very narrowly scoped at the moment. And so you probably need more breadth for that market really to open up. Is that fair?

Yes. Yes. And by the way, you also need the infrastructure in place. So it's a bit puzzling because there's apparently a fair number of millimeter wave handsets being built, but it's not clear that there's a lot of millimeter wave infrastructure to support those handsets when they get out.

Got it. Chicken in the egg or egg before the chicken or whatnot. The -- sticking here with the broader test market and what kind of -- went again for assurance in the automation side of the business. But just quickly hyperscalers. It's sort of certainly up and coming part of the computing market, and they've got their A6 workload-specific chips. Do you see -- when do you see maybe a meaningful increase or step-up in sort of the test TAM driven by that? Kind of, maybe you could walk us through that in the company's position.

Yes. I think it's probably -- the whole AI market last year was under $100 million, the AI test market, and that was dominated by the big cloud -- the big guys serving the data center and cloud providers. But I think you're right, all of the hyperscalers, we're all trying to create the spoke silicon that aligns to their specific algorithms that they're using. And so I think that will start to matter to the test equipment industry, probably next year, maybe a tiny bit of it late this year, but next year and beyond as those designs move from the drawing board into volume production. There's a few, obviously, that are out there that are pretty high profile, but the real volume, we think, is probably a year or so away.

Okay. Great. That's helpful. And maybe quickly on one more thing on memory. Calendar '19 was really strong flash investment year. You've seen continued momentum in the first half. Do you see those upgrades, capacity upgrades tied to the faster smartphone and SOC interfaces? Do you see that staying at these levels given the sort of -- what we've already seen a sustained period of investment? I guess any other -- so I guess that sort of the focal question.

Yes. Our view is the market is probably somewhere in the $700 million to $800 million range long term. And in January, we estimated it was about $700 million this year at the midpoint of our estimate. We kind of pulled that back in April because we don't know what the second half looks like. But the driver of that market remains the transitions to higher performance memory, and in particular, higher speed memories, both in flash and in DRAM. And so we're very early in the rollout of the next generation of protocol memories for smartphones. And there's a one flavor for iOS phones. There's a different flavor for the droid phones. So again, we're probably just in the initial phases of that. And so that's got, in our view, has legs. And then we're just in the first few innings of the LPDDR5 story in DRAM. And fortunately, Teradyne now has a position there, so we'll get some benefit from that as well going forward. So I think the memory market is going to be reasonably healthy from an equipment perspective, test equipment perspective, for the next couple of years. But again, the equipment markets can change on a moment's notice. So that's Andy's outlook for the future here.

Yes. That's fair enough. Switching gears to robotics here, no pun intended. I guess in the businesses that complemented each other well into test, semi and more broadly, right, it's well in the path towards achieving sort of those mid-term revenue profitability targets you've communicated in the past. You've provided to straight a bit from that path based on maybe the protracted weakness in those underlying markets. So I knew you touched on this a little bit earlier, Andy, but what other sorts of signals are you getting from your direct as well sort of the partners that you use for distribution integration? What signals are you getting sort of in terms of the urgency or timing for some of those customers to rekindle their investments and be it in, let's call it, collaborative robotics in particular, since that's been pretty soft?

Yes. Well, I think the pandemic has prevented companies from entertaining demos and on-site activity of suppliers like us because they're -- they've been -- if they haven't been shut down, they've certainly shut down their factories to outside visitors. And so there's a lot of interest in some of the new products like we introduced a bin picking solution. And the demo activity and the like has been very strong on that, but that funnel is kind of getting -- is getting pretty full, but nothing's getting through the funnel because customers want to see things demonstrated on their own floor in their own environment with their own products. And so I think for the next quarter or 2, that business is going to have a pretty good headwind because you got to first get the factories back open. You've got to reconstitute your workforce and production. And then you can start looking at, okay, how do I optimize it? And are there points where I can bring in automation to relieve choke points in your labor force? I don't think people start out with that because I think the first order of business is just to get back on their feet.

Got it. So you can do virtual financial conferences, but virtual kicking the tires is more difficult. If...

It is. Right, right, right. People want to see how it's going to work in their operation.

We're kind of right up here against the end of our time. But maybe just one last quick thing, sort of you alluded, Andy, that Teradyne is a great cash generator year in, year out, spend the buyback, I think. But when some of these uncertainties abate, I'm sure that will kind of lift as well. But M&A has certainly been a part of the strategy certainly, in terms of automation. I'm just curious does that landscape look more fertile now based on sort of how valuations have ebbed? And also, kind of what's the company's willingness to pursue adjacent robotics markets, not just from a product standpoint, but like other verticals like outside and manufacturing, such as like e-commerce, logistics and so many?

Yes. We -- I mean we look at a lot of things. And you're right, the strategy is to look for opportunities to play into our high-level IA strategy, which is use advanced technology to make the workplace safer and more productive. And so there's a lot of companies doing some very clever things on the development side, both from a sensor perspective and from a kind of a decision-making perspective, that could be a nice fit. And we could very easily lever into our products, mobile and fixed. The dilemma is those valuations have been pretty stressed in our view. And to date, I don't know that we've seen much change in that. I think in the past, it's taken 6 to 9 months for those valuations to come down to reality when there's a downturn. And so we're kind of -- we look at a lot of stuff, and we'll act if it makes sense for us. As far as going into a very different environment, a very different product area, we look at a lot of things, but we're certainly most comfortable in the mobile autonomous robot area and the collaborative fixed robot area. And again, if we could see a smooth way to lever into a larger and faster-growing market, we look at it. But we're not feeling like we've got a hole in our product line that we've got to go fill. We've got plenty to do with what we have.

I appreciate that, Andy. I guess with that, we've reached the end of our allotted time. Thank you again, Andy, and thank you to the audience for joining us today.

Great. Thank you, Brian, and thanks, everybody, for joining us. Take care.