泰瑞達 (TER) 2003 Q3 法說會逐字稿

Good morning. (OPERATOR INSTRUCTIONS) I will now turn the conference over to Mr. Tom Newman, vice president of corporate relations.

Sir, you may begin.

Thank you Amy.

Good morning everyone and welcome to our discussion of Teradyne's most recent financial results.

I'm joined this morning by our chairman and chief executive officer, George Chamillard, our president, Mike Bradley, and our chief financial officer, Greg Beecher.

Following our opening remarks we will provide you with details of our performance for the third quarter of 2003, and with our outlook for the fourth quarter of the year.

First, however, I would like to address some administrative issues.

Teradyne's press release containing our financial results for the third quarter was sent out by business wire and was posted on our website yesterday evening.

If anybody needs a copy please call our corporate relations office at 615-422-2221 and we will provide you with one.

This call is being simultaneously webcast over our website at www.teradyne.com.

A replay of this call will be provided on our site starting at noon today eastern time.

If it's more convenient, you can also access a replay of the call by dialing 1-800-642-1687 in the U.S. and Canada or 706-645-9291 outside of the U.S. and Canada, and providing the pass code 3087243.

Replays from both sources will be available through the 29th of October.

It's our objective to use this call to comply with the requirements of SEC regulation FD.

Therefore investors should accept the contents of this call as the official guidance from the company for the fourth quarter of 2003 and beyond.

If at any time we communicate any material changes to this guidance, it is our intent to do so simultaneously to all investors to the best of our ability.

Investors should note that only George Chamillard, Greg Beecher, Mike Bradley and myself are authorized to supply company guidance.

The matters that we discuss today other than historical information include forward-looking statements relating to future financial performance and other performance expectations, changes in the company's business, statements as to bookings, backlog, pricing, design ends and demand for our products, and other opinions of management.

These forward-looking statements are made under section 21 (e) of the Securities Exchange act of 1924.

Investors are cautioned that forward-looking statements are neither promises nor guarantees, but involve risks and uncertainties that may cause actual results to differ.

Some of those risks and uncertainties are detailed in our filings with the Securities & Exchange Commission, including but not limited to our form 10-Q filed on August 13th, 2003.

We caution listeners not to place undue reliance on any forward-looking statements, which speak only as of the date they're made and we incorporate here the discussion of those factors.

Teradyne disclaims any obligation to publicly update or revise any such statements to reflect any change in expectations or events, conditions or circumstances under which any such statements may be based, or that may affect the likelihood that actual results may differ from those settle forth in the forward-looking statements.

As a final administrative issue, we want to make clear to investors that our prepared remarks will be presented within the requirements of SEC Regulation G, regarding generally accepted accounting principles or GAAP.

Therefore, some financial metrics presented by you during this call will be provided in both GAAP and nonGAAP or pro forma operating terms.

By disclosing this pro forma information, management intends to provide investors with additional information to further analyze the company's performance, core results and underlying trends.

Management utilizes nonGAAP measures such as operating results and earnings per share on a pro forma basis that excludes certain charges to better assess operating performance.

Pro forma information is not determined using GAAP.

Therefore, the information is not necessarily comparable to other companies.

Pro forma information should not be viewed as a substitute for, or superior to, data prepared in accordance with GAAP.

Investors will find a reconciliation of our GAAP net loss to pro forma net loss within our press release of last night reporting our third quarter 2003 results.

A reconciliation of all GAAP versus nonGAAP metrics, which are presented by Teradyne during this call are available on the company's website at www.teradyne.com, by clicking on investors and then selecting the GAAP to pro forma reconciliation link.

Now let's get on with the rest of the agenda.

First, our CEO and chairman George Chamillard will review the state of the company and the industry, will review our performance in the third quarter 2003, and will provide guidance for the fourth quarter of 2003.

Then our vice president and CFO, Greg Beecher, will review the details of our performance in the third quarter and will provide some additional details on our guidance for the fourth quarter of 2003.

We will then answer your questions.

For scheduling purposes you should note that we intend to end this call after one hour.

George?

Thanks, Tom and good morning to all of you.

Before we get started, I'm in Boston and many of you are in New York.

And since we're under safe harbor terms here, I feel very confident in predicting some of the outcomes of the playoffs today.

And for those of you going to the stadium, you're going to be very frustrated as game 7 is fought by the Red Sox.

But anyhow, Teradyne had sales in the fourth quarter of $329 million, and a loss on the GAAP basis of 28 cents per share.

The GAAP loss includes a loss of 14 cents per share for special items mainly related to asset impairments and the workforce reductions.

Teradyne's net orders were $336 million, up about 10% from the second quarter.

For the book-to-billed, slightly greater than 1, we increased backlog for the first time since the second quarter of 2000.

Net bookings in semiconductor test were essentially flat at $187 million, after two quarters of about 20% sequential growth per quarter.

Our Q3 net SemiTest orders were up 52% on a year to year basis, and the book-to-billed has (inaudible) greater than 1 in the last two quarters.

Our connections systems business had a great bookings quarter with 47% sequential growth.

For the first time in 10 quarters, the division had a book-to-bill of one or more.

In general, the growth was driven by an increase in demand from our major customers and also by the beginning of production demands from new programs and new products that use our neXLev connector.

The assembly test business are 18% sequential growth in sales as they recovered from a weak second quarter.

I'm sorry, 18% sequential growth in orders, as they recovered from a weak second quarter.

In the other test category, net orders were sequentially down 26% with broadband test up about 24% and diagnostic solutions down about 35%.

To summarize, bookings company-wide have increased each and every quarter for the last ten quarters and in Q3 they slightly exceeded sales providing a book-to-bill ratio slightly greater than one.

We continue to make significant progress on reducing our losses, and expect to break even on a pro forma operating basis in the fourth quarter.

During the third quarter, the efforts we had to reduce material cost including sourcing and lower cost regions continued to have increasing impact.

Our headcount, counting temporary and permanent employees, declined 6% during the quarter.

These headcount reductions, coupled with all the other actions we have taken over several quarters, should reduce our break-even operating sales level on a pro forma basis to under $340 million in Q4.

So how do things look for the fourth quarter?

Well, we believe we'll see more of the same.

In other words, a steady improvement in business across the board.

We are currently projecting fourth quarter sales to be between $335 million and $340 million, and break-even results on a pro forma or operating basis.

Let's take a closer look at each of the businesses and review the trends we are seeing.

Unlike in the first half with our SemiTest upturn driven entirely by a high SOC test systems.

In Q3, broadened significantly to encompass more customers.

Wireless consumer data communications markets drove many of our systems types.

There was a definite broadening of the orders.

In Q3, 55% of our orders came from ten accounts.

While in Q2, 73% of the orders came from ten accounts.

This broadening of orders is an encouraging sign that the recovery may be gathering some momentum.

We had good product momentum in the quarter.

Tiger orders included a major production win at an IBM in Asia for multiple systems.

The FLEX system continued to gain momentum as it marked its first quarter of double digit unit orders.

Three IDMs ordered multiple flex systems for productions, while a competitive design win in a power management application drove multiple orders from FLEX's first subcontract test customer.

FLEX also was selected by a large IDM in Europe to replace a competitive platform for RF testing.

The FLEX open architecture program also gained momentum in the quarter, with the announcement of the availability of one of a series of third-party instruments under development.

The FLEX architecture offers a most economic solution for an increasingly broad list of SOC devices, and should continue to gather momentum into the future.

The catalyst SOC test system had a very strong order quarter, with more systems booked than at any time since the third quarter of 2000.

The orders were driven mainly by consumer applications, such as optical disk drive devices using CD write units and DVDs, and by wireless applications including advanced cell phones and wireless LANs.

More than half of the system orders will be shipped to subcontractors who benefit from the strong market share position of catalysts with their IDM and fabless customers.

The 750 had a strong booking quarter in Q3 after a weak order quarter in Q2.

The resurgence was driven mainly by capacity expansion orders from several IDMs from microcontroller applications.

And finally, after a slow down in the orders in second quarter, the IP 750, our image sensor test system, resumed momentum in Q3 with capacity additions by several of our major customers in Japan.

Connection systems had an almost 50% growth in orders from the second quarter, as four of our major customers doubled their orders from Q2 to Q3.

As several public reports indicate, business for high-end routers, storage systems, servers, telecom systems is increasing and Teradyne's business is benefiting directly from that.

We had a significant number of pull-ins and expediting requests from customers during the quarter.

TCS is continuing to gain traction with new products like neXLev and GBX connectors, as well as with high performance circuit boards.

The improving business environment is only part of the TCS third quarter story however, since we also took some major steps to improve its long term profitability.

For instance, we drove a favorable mix change towards higher margin connector and back plane products by exiting some lower margin EMS business.

And we repositioned the PCS fabrication facility towards an asset light strategy, by outsourcing more of their lower technology boards.

As a result, connection systems is positioned to be profitable at current business levels.

Orders in the assembly test division were up almost 20% on a sequential basis from a weak Q2.

There were two bright spots in the quarter that should provide some added upside in the future.

First, our position in Mill Arrow Testing (ph) continues to improve.

We received an order in the quarter for the Navy’s RT cast program, which a follow-on to a multiyear program we have participated in since the mid '80s.

The new version should contribute to our sales for several years.

Our position at Mill Arrow also strengthens, us as we continue to expand from being prime an instrument provider to a system provider with our Spectrum 9,000.

For instance in Q3 we had record orders for the Spectrum system, and about 75% of the Mill Arrow bookings came from this product.

The other bright spot relates to a capability we have in our newest product test station.

As more and more electronics becomes mobile, designers increase battery life by running the semiconductors at lower voltages.

A concern is that at the drive pins can damage these devices.

We have a feature in test station called safe test, specifically engineered to address this concern and is becoming widely accepted.

As in all of our businesses, assembly test has an ambitious program of cost reduction.

We will be doing the worldwide system integration and test of test station in Shanghai by the end of the year.

This, combined with our Asian material sourcing efforts, will allow us to become (inaudible) among the lowest cost producers of in-circuit testers in the business.

In broadband tests, we are having success in customer trials, but volume orders continue to be delayed.

In the quarter, we concluded successful trials of our Celerity DSL deployment production the U.S. and in Australia, and we started a trial in China's Quongdong province.

And we were technical selections for further DSL testing at the Czech phone system.

We also saw some renewed interest in companies wanting to very much in voice infrastructure.

With local voice revenues in decline, investments that lower the maintenance cost for operating companies are once again candidates for investment.

During the quarter we received orders for line diagnostic units for two European customers for over $1 million dollars.

On the cable side of the business, Net Flair test product continues to drive reductions in calling handling—reductions in dispatches in a trial that's under way in the U.S.

In Teradyne's diagnostic solutions business, we saw a slow down in orders in the quarter on the service based side, although manufacturing test remain strong.

DS (inaudible) shipments fell 15% from the Q2 levels but the group held its PBIT flat in dollars.

The long term trend towards more modules and more complex modules in vehicles and lower industry profits is causing an across the board reexamination of manufacturing by OEMs, of how they can lower the cost of manufacturing, cost of warranty support and the cost for repair capability in their dealer network.

We have ongoing projects to help them solve these issues and we have the technology to extend their current solutions towards that goal.

The bottom line for this past quarter, then, is gradually increasing orders, with important order momentum for our new products, coupled with an improving cost structure.

This will enable us to achieve break-even on a pro forma operating basis in the fourth quarter.

Now let me turn this over to Greg for more details.

Thanks, George.

And good morning everyone.

Our sales of $329 million were essentially flat with the previous quarter, and also at the sales level of a year ago.

We had a GAAP net loss of $53.5 million or 28 cents per share on 189.5 shares.

This net loss included a loss of 14 cents for special items, related to asset impairment, workforce reductions, mortgage prepayment penalties, and the impact of accelerated depreciation.

Our gross margin was

$98.6 million or 29.8% of sales on a GAAP basis and $97.2 million, or 29.5% of sales on a pro forma basis.

R&D expenses on both a GAAP and pro forma base were $61.2 million or 18.6% of sales.

And SG&A expenses were $60.1 million, or 18.2% of sales on a GAAP basis, and $58.6 million or 17.8% of sales on a pro forma basis.

We provided $2.2 million in foreign taxes in the quarter.

Our quarter ending headcount was 6,779 people including 6,340 regular people.

This total reflects a reduction of about 400 people during the quarter.

From a product point of view, third quarter SemiTest sales were 57% of the total, connection systems was 26%, assembly test 10%, and broadband test and diagnostic solutions, or other test business was 7%.

On a geographic basis, sales broke down as follows.

U.S. was 36.3%, Europe was 14.4%, Japan was 8.8%, Korea was 2.4, South Asia was 28.7, Taiwan was 7.5% and the rest of the world was 1%.

We had net bookings of $336.3 million after less than $1 million in cancellations.

On a sequential basis, our total net bookings were up 10.4%, SemiTest was flat at $187 million, ATD was up 18.2%, connections systems was up 47.2% and our other test businesses, they were down 25.8%.

On a year-over-year basis, total net bookings were up 43 -- 45.3%.

SemiTest was up 51.9%, assembly test was down 6.4%, connection systems was up 105% and our other test businesses were down 24.9%.

Our product distribution of net bookings was 56% SemiTest, 28% connection systems, 11% assembly test and 5% for our other test businesses.

Our book-to-bill ratios, based on net bookings, were therefore 1.02 for the overall company, 1.0 for SemiTest, 1.12 for connection systems, 1.11 for assembly test and .72 for other test.

At the end of the quarter, our backlog stood at $375 million, of which is 84% is scheduled to ship within the next six months.

On a geographic basis, our net bookings for the quarter were distributed as follows.

U.S., 38.8%.

Europe, 12.7%, Japan, 7.8%, Korea, 5.0% South Asia 28.0, Taiwan 7.5%, and the rest of the world was .3%.

Moving to the balance sheet we ended the third quarter with cash and marketable securities of $542 million, up about $10 million over the end of the second quarter.

Note also that the $542 million is net of a $46 million prepayment on mortgages on some of our California properties.

We also generated approximately $45 million from expiring stock options in the quarter.

Accounts receivable stood at $225 million, or 63 days sales outstanding.

Up two days from the prior quarter.

We ended the quarter with inventory of $221 million or 16.8% of annualized sales down $13 million from the end of Q2.

We spent $20 million on capital in the quarter while depreciation and amortization was $37 million in the fourth quarter.

As George mentioned, we expect sales to be $335 million to $340 million with break-even results on a pro forma operating basis.

Although we expect that there will be special charges in the quarter, we are not able to project them with any degree of certainty at this time.

Our guidance there are is all being given on a pro forma basis.

We expect gross margins of 34%, and we also expect R&D and SG&A to be each about 17% on sales of $335 million to $340 million in the fourth quarter.

We plan to reduce inventory by at least $10 million in the quarter and to spend $20 million or less on capital, depreciation and amortization should run around $37 million.

We expect to end the quarter with cash and marketable securities of $550 million or more.

And now I'll turn it back to Tom.

Thanks Greg.

Amy we'd now like to open the discussion for questions.

Our first question comes from Dennis Wassung with Adams Hill.

I wonder if you could touch on the SemiTest orders for the quarter were flat quarter to quarter.

I guess if you could go into a little bit more detail on that.

It sounded like if order strength broadened across the tester product line quite a bit this quarter.

If you just talk a little bit more about that I'd appreciate it, thanks.

Dennis this is Mike Bradley.

Flat bookings in SemiTest a wider range of customers less concentration than we had last quarter.

About evenly split between our IDM customers and our fabless subcon customers.

Geographically I think orders were reasonably similar to the prior quarter as Greg went through.

I think the change that you've seen on a six-month basis, if you took the past six months and the prior six months, you would see that our subcon fabless business has grown dramatically to the point that it's about 50% of the business in the past six months.

That's about a 3X growth over the prior six-month period.

Dennis Wassung Okay.

Looking forward to Q4, when you project the revenue picture of $335 to $340, what is your expectation on the booking side?

Are we going to stay above a book-to-bill of 1?

I know you typically don't give detailed bookings guidance but any commentary on that side?

You're right, we don't typically give booking guidance.

But it would be certainly a realistic assumption that we think that's the case for us to be projecting orders as we have.

Projecting shipments as we have.

Dennis Wassung Okay.

And last question, if you could give the -- you mentioned the customer concentration, sort of lowering a little bit here.

You said in Q2 it was 73% of orders were the top 10 accounts.

What was the Q3 number?

I think we said -- let me get it. 55% came from the top ten of Q3. 75% in Q2.

Dennis Wassung Great, thank you.

Yes.

Your next question comes from John Pitzer with First Boston.

When you look at the charges in Q4, is that for actions already taken or will there be additional actions taken in Q4?

The special charges in Q4, there would be some actions that would be taken in the quarter that were results in charges and I'm not able to get into those in any specificity at this point.

Generally speaking, John, we have difficulty in trying to estimate special charges, because there's many factors that affect real estate valuations or possibly impairments of long lived assets.

So there will be some small charges that we know of now.

But it's hard to say if there will be much larger charges at this point.

And then getting back to the SemiTest order book for Q4, can you help me what was IDM versus sub con, what do you expect that to do in the fourth quarter.

And in addition, George, kind of reading through your prepared remarks it sounds like the FLEX was strong in (inaudible), the catalyst was strong in Q3, does that imply Tiger was down sequentially and could you talk about the product momentum of the Tiger back half of the year?

Let pee start with Tiger and have Mike pick it up.

Tiger had double digit bookings in the quarter.

So where was the weakness to get flat?

Tiger was down in the quarter.

But still had double-digit unit orders.

Okay.

And so the catalyst -- you cataloged others correctly.

And then the mix between IDM and sub con how that could go from Q3 to Q4?

I think it would be fair to speculate about the same ratio that we've had over the last six months.

As you know, the lumpiness in the business can skew that.

But if you look back six months, you would see, as I said, about an even split between the IDMs and the subcons.

To the extent obviously that the IDMs outsource as their utilization rates go up, the subcons could take a larger portion of the overall business.

And then two other quick ones-- utilization of the tester base in the field now and lastly, I'm going to try to ask the bookings question again, book-to-bill of 1, are you guys confident that bookings grow here in Q4 so we're on a revenue path for growth in Q1?

Let me answer the utilization first, John, and then I'll talk about the revenue and then I'll have George talk about expectations.

The utilization rates as, in the industry trackers, the test segment utilization rates are registering, 80s plus percent utilization rates.

We tracked a large portion of our installed base, obviously we don't meter the systems and can't track them hour by hour.

But across the product line, in both subcons and IDMs you'd find a range of 80% plus across the products.

The comparison between last quarter and this quarter, they look reasonably close with some improvement or increase, most dramatic increase has been on the Tiger segment.

To comment on the booking side, let's look at some data and then try to add some opinion to it.

If we look at bookings on a four-quarter rolling basis, we've had bookings have grown eight quarters sequentially.

And for them to grow in Q4, if we had bookings about the same level we had this past quarter, that would still -- that would still support that.

So the issue is, there's been a steady growth in bookings, if you average it over fourth quarters or any.

And if you look at data you see outside, it -- you don't see the reason to think that will change.

We don't think there will be a significant cancellation, which would be negative bookings to us.

At this point a very high percentage of the orders we have in backlog shipped in Q4-Q1, and you string it together.

And I think that where the orders -- the shipments we've sized at support our view that we see things keep going about the (inaudible) they're at.

And George, just another way to ask that, historically you guys have talked about the potential for sort of pent-up demand up there out in the marketplace and maybe in order in significant inflection in order rates.

Do you see that potential in the calendar fourth quarter?

Well, we didn't see anything based on the order -- the bookings pattern during Q3 that led us believe there was a sharp inflection point that we're at so far in the quarter.

I think there was more of an inflection point in TCS business, since it was two or three or four customers who really started drawing product at a rate much greater than they had been recently.

But I don't think there's any compelling evidence right now that there's an explosion in front of us close-in.

I think visibility also, John, is such that we might not know if it's around the corner is the other thing.

So you almost never see those things coming.

We know customers bought test systems they think they need to support themselves through the holiday season.

They're working awful hard to avoid having to add an awful lot more.

You know, it's still -- it's still unclear.

Great, thanks guys, appreciate it.

Yes.

Your next question comes from Bill Lu with Morgan Stanley.

First of all a question for Mike, I've talked to several of your customers in the last month or so and I'm getting positive signs in 2004 spending for testers.

I wonder if you agree with that if you have a forecast of your own for backing capital spend in 2004?

Bill, let's see, the expectations are that the -- this year will end about 30% up in the SOC market space, with a capex rate that's still pretty depressed.

You know, maybe scraping up to about a 2% level coming up from 1.5% the prior two years.

So there are some signs, capex, buy rate.

This is buy rate, yeah.

So you know, on the trajectory, you would say over the three-year period, '03 is ending with a -- with a higher buy rate than it has been in the last couple of years.

Obviously, if the level of business stays flat, through '04, we'll get growth in '04 just from the trajectory quarterly growth in 2003.

So I think even a balanced view would come out for some growth in the '04 period.

Now, projecting that is only important if it changes what we do.

And therefore, we're focusing on how much flexibility we have to move up or to move down.

We think under almost any scenario we can project for '04, we can execute a ramp to meet the demand.

I'm just asking that because it seems like this is slightly off here, do if I do the seasonality here?

Say it again here?

Bookings in the third quarter seems to have flattened in ATE.

Is that because ever seasonality that your customers have already gotten what they needed for the Christmas build season, but it will resume later on?

Well, I don't know.

I've looked over the years at trying to put seasonality onto the bookings looking back.

And I don't I don't think that there is a conclusive data supported analysis that says that the seasonality in Q3 would therefore support a burst in Q4.

Okay.

We've had -- the industry's had up Q3s and down Q4s in the past.

Let me ask another way then.

If your customers want some more tools by Chinese new year, say, when would they have to order by?

Well they would be ordering them in the third quarter and right now.

Okay, okay.

And then just on breaking maybe for Greg here, are you expecting to break even in each of your divisions or are some going to be lagging the other divisions?

We would expect our goal is each division would break even in the fourth quarter but we realize for some divisions it's a greater stretch and it's possible one of our divisions might lose a million or so only to be made up by another division.

We are shooting for all of them to break even and you might have a little variation around that.

Okay, thank you.

Your next question comes from Shekhar Pramanick from Prudential.

We got about two weeks into this quarter under the bell.

Is incremental feel you are getting from customers is same level as third quarter was ending or with it a little better, and lastly if you look maybe nine to 12 months out, where do you see TCS revenues would be and marriage profiles if you can talk about it?

Mike Bradley again.

Let me comment on the SemiTest what we'll call the close-in hour by hour reports.

Let's see, I don't think we're seeing much different entering the first few weeks of the quarter.

The question I think in a broader sense that you're asking is, is the trajectory of bookings that we've just come out ever maybe the weekly bookings picture of Q3, indicate anything about what Q4 should be?

In other words, a strong finish to Q3 could suggest sustained growth in a higher Q4.

If you look back a number of quarters, let's say eight or ten quarters, you would find that Q3's profile, if I can use the term the hockey stick, the back-loaded bookings, falls about in the middle of the last eight or ten quarters in terms of the back-end loading.

So it's the median of all of those quarters.

If you took quarters that were more heavily back-loaded, in that eight to ten quarters, you'd find that about half the time a heavy back-loaded quarter is solid by an up sequential quarter, and half the time it's followed by a down sequential quarter.

So I'd like to be projecting here, you know, that there's a trend that you can look at the last few weeks of the prior quarter, and then have a pretty strong conclusion about the subsequent quarter.

But I really don't think the data supports that.

And the TCS business?

In terms of the -- this is Greg.

The TCS business a couple of things are happening at TCS.

We are focusing our efforts on making sure the business that we have is interesting, profitable business.

And some of the higher level assembly business, we've gotten in the past is less interesting to us.

So you've got to sort of factor in there might be some of that business that will come out and it has come out the past couple of quarters.

So we're going to probably lose $15 million, $20 million of revenue that is not interesting to us.

But we are more than going to replace that with other revenue that fits the core of what the division does.

And what the division has been doing recently is focusing on much more the connector products to get greater penetration of those products as well as their back plane assembly business.

So I think what you'll see with TCS is growth, but you'll also see a richer mix of business looking into 2004.

Thanks.

Your next question comes from Mehdi Hosseini with Soundview Tech Group.

I was wondering how you could let me understand, SemiTest unit volumes improved but in terms of dollar bookings it actually flattened out.

So obviously there is pricing pressure.

To what extent would you expect the pricing environment remains tough in the fourth quarter, early next year, you also have -- you're facing new competition on top of the existing competitors?

And secondly, I would expect the majority of the leverage in the model coming from SemiTest.

So given the fact that you're still facing competitive price environment out there, to what extent are you able to expand margins, overall margins going into 2004?

Okay, Mike Bradley again.

I think there are two things happening in terms of ASTs and I'll come to pricing pressure in just a second.

But you also have to factor in configuration to systems.

And there's a very, very wide range of configurability.

That is a factor in what the ASPs are by system type.

Having said that, there's obviously continued pricing pressure in the market.

It is -- I would not characterize the market as having relaxed in terms of pricing pressure at this point, even though, you know, demand in the market as I said before the growing.

Lead times remain -- remain very short and visibility is also very short-term.

Having said that, there are some indications of some easing of pricing pressure relative to overall supply.

We look into the aftermarket, and in the SemiTest space, we are hearing that there is some strengthening of used equipment pricing.

And that is -- you might take that as the leading indicator that there could be some firming up of overall pricing and a squeezing down of the excess supply that's in the market.

But I would not characterize this as either a quarter of increased price disarray, or aggressiveness, nor is it -- is it firming up where we've got, you know, a return of pricing power.

It's very competitive on the pricing front.

This is Greg.

I might add a few thoughts as well.

The other actions we're taking to address some of the concerns you might have in the competitive environment is -- I think we described some of this in the past -- we are procuring boards and components from low-cost regions, and that's going to help us with our direct material costs.

We are also doing final configuration and test on our J-750 product in Shanghai.

That's going to help us as well.

As you went back to the last cycle in an area such as service, just as an example.

Our service board repair was all done in the U.S.

And in this cycle 90% is off-shore in low-cost locations.

So there is actually a long list of things that we've done, actions that we've taken that will help us on the cost side.

And we would expect that our profit drop through on SemiTest in this upcycle will be similar to what it was in the prior cycle based upon the cost changes we've made as well as we have greater leverage in our R&D and SG&A.

So we fully expect to get the same drop through an incremental growth in semi.

Gross margin to match the prior cycle but at a lower revenue level?

Greg Beecher Well, I think it's safer to say at the profit line, we are confident in the drop-through.

Now, whether gross margin is a little bit lower as percent, but that's made up in R&D and SG&A, that's certainly possible.

But it's very hard to be precise as to, you know, how steep is the ramp, what's the mix of products, there's so many variables.

But when we put everything into, you know, some reasonable mayor scenario planning based on examples we've taken, putting aside whether it's gross margin SG&A or R&D, we are very comfortable will the same profit drop through as the same price cycle.

We have not traded you know fixed cost for high variable cost, we have not do done that.

We have been very selective.

So we've retained the attractive drop-through.

And you're highlighting exclusively the SemiTest business, correct?

Greg Beecher That's -- that's SemiTest, that's where the question started.

But the other divisions we've taken similar actions.

Test station product to Shanghai, we're going to product source low cost locations as well.

Each division including TCS is taking available what's available today to work the cost side very differently.

Mehdi Hosseini Thank you.

Your next question comes from Nick Tishchenko of Fulcrum Partners.

First book beings in the quarter, does it have to do with a change in demand for mid range testing as opposed to the demand for high-end testers during the previous quarters, and because of shift in demand you have flat bookings in terms of dollars, but what's happening with the demand in terms of units?

And the second question, I'll ask after the answer.

Okay.

Nick, the -- I don't think there's a macro-movement here reflected in the quarter between going from high-end testers to mid-range testers if that was your question.

Certainly the mix of our testers this quarter did that.

But part of that is that at the high end, the demand has been reasonably lumpy -- this is for Tiger -- and it has come from the -- principally on the subcon side where the buys come in those batches versus more linear fashion in the IDMs.

So I wouldn't conclude that there's a macro-shift as reflected from Q2 to Q3 towards mid range.

I definitely would acknowledge that the overall cost to test since the buy rate has declined, there is an absolute consistent shift towards more productive tests or platforms over the last couple of years, and that is, I don't think that's just a function of going to lower capital cost testers, it's as much a reflection of going to higher parallelism testers than it would be to lower capital cost.

Thank you.

I hope that you are right.

But if you look at already high utilization rates in the high-end manufacturing facilities, it looks like we are seeing the change in trend.

And the second question relates on your open architecture based on FLEX.

Because it is based on FLEX, it certainly is going to address mid range test, what are you going to do with the high end, how are you going to address this open issue of open architecture at the high end?

This is a question about how you are going to face the threats from advent test.

On the open architecture front, we call the system Open FLEX with its ability to integrate third party instrumentation in a universal slot concept.

So we see that that product is, in a way, the reason we call it FLEX is because it can flex in the dimension of cost to test with high parallelism and it can flex up in terms of performance and instrumentation.

So the FLEX is the basis, it's the foundation for our open architecture offering in the marketplace.

Thank you.

Your next question comes from Brett Hodess with Merrill Lynch.

My question is on the TCS side of the business.

You're making cost reductions and shifting the mix hopefully back more towards the connecters in the back planes.

This business had healthy operating margins, do you think that the actions that you're taking in the mix shift that you're taking can get had that business back into the same operating margins you saw in the past or could they still be better than other contract manufacturers but not as high as they were in the past?

That is certainly a tough question to answer.

I think the actions will certainly get us above contract manufacturers, I think there's little doubt of that.

And the period in the past was a time when there was high growth and companies were obviously very focused on reliability.

And weren't as focused on cost, and we all know the world's changed quite a bit.

We are on have obviously doing a lot ourselves to improve our cost structure, our footprint in TCS.

So I think a lot of the actions were taken in pruning the portfolio and expanding on the connector, the core of the IT business, we have reasonable expectations that we could achieve similar profitability that TCS did in the past and the thing you can never really sort out is how fast a ramp obviously has to do with how much money you can make.

Just a quick follow-on, is the connection part of business more competitive than it was say back in the 2000 peak given a lot of the, you know, product announcements in the connector world from some of the other pure play connector players?

I think there is no question everybody sees that's an area where the margins are better.

If you can have a highly differentiated product.

And so the catalog, if you will, that the world has to offer in terms of product has certainly broadened.

But at the same time, the issue is, people just are not buying the individual connector, and the real value-added from working with Teradyne or TCS is the understanding of how to take the connector as a component and package that in a system where you can get the high performance from the system.

And I think we're still far ahead of the competitors in that capability.

Thank you.

Your next question comes from Mark Fitzgerald with Banc of America.

I'm curious what it would be on a GAAP basis and second question how can you forecast break-even on a pro forma if you don't understand what charges you're going to be taking in the fourth quarter?

Well, that's -- Mark, this is Greg.

That's the reason we do it on pro forma because if we did it on GAAP, GAAP would include severance charges, asset impairment charges, and we're unable to project those possible charges at this point, similar to our past several quarters.

We've provided guidance only on a pro forma basis because we just can't estimate the special charges.

And therefore, we are providing --

That's assuming then that you know what you're taking out to get to a break-even then?

It just doesn't make sense if you can't -- I mean you told us you can't forecast the charges at this point, they're uncertain.

Yet you're going out and saying you can get the break-even.

If they're uncertain how do you know you can get the break-even?

We're saying on a pro forma base and the pro forma basis excludes the charges.

Let's pick a number --$5 million -- that we would not known of today and it gets identified late in the quarter because we decide to downsize some other operation.

That $5 million charge I have no visibility to it today.

And we think of that more as a restructuring, getting the footprint right, and we call that out as a special charge so we take it out.

So it is almost the inverse of how you're thinking of it.

It is frankly no different than other companies who are similar to us project their next quarter results.

They also do it on a pro forma basis because they cannot forecast GAAP because of these special charges.

All right.

I'll have to think about that a little carefully.

Let me ask on another area here.

On the subcon space, 50% of the mix it's been up threefold in the last couple of quarters here.

How confident are you that that's sustainable at flat or continuing up into the first quarter?

Well, that's a -- that's a way of asking, are we projecting up-looking.

I think the reason we would say that the subcon segment has some resiliency going forward is because it is driven by both the fabless customers of the subcons and by IDMs who are outsourcing.

And it's that double push.

If the utilization rates in the market overall are as high as being reported, then the excess short-term capacity tends to drive towards the subcons and we've seen in general that the subcon market has been the place where you see that -- that demand being reflected.

So I integrate that and say I think the subcons have at least a fair chance of retaining a large portion of the buying going forward.

Actually, there's an argument, is that what you would like to see or not?

Would you rather have the IDMs who historically have been buying in the 70% range, would you feel the IDMs coming back stronger, the path -- which is what they did in Q2 to Q3, would you rather see that or would you rather see the contractors holding the rate they're at?

And I look at the strengthening in the IDM buying as a more positive sign in terms of broad momentum.

Because they're willing to make the capacity commitment rather than pushing it off on to subcontractors and have a variable problem.

But that's a -- you could argue either side of that, I suppose.

But are you saying then, you expect the mix to move towards the IDMs?

I mean, it's --

Well, expect as strong (ph).

I think if it did, you know, if that would be more consistent with my view of what would be a healthier business for the industry.

All right.

It just seems that these guys -- I mean you talk about 80% utilization rates but given what they've been ordering over the last two three quarters as they bring that on it would seem that would solve that capacity tightness.

The problem you have with utilization rates, because you look at this thing and say the utilization rates have been high compared to history for a long time.

What's going on.

And I don't know what the exact number is but let's say one-third of the installed fleet the world has isn't capable of testing a bunch of products.

And so that -- that one-third might be at a very low utilization rate, and some other portion of the installed base is very high.

And the 80% or 85% is a blended number.

The real issue is, is the -- as some of the devices that customers have that are now 130 nanometer and so on, the leading edge devices, what is the capacity utilization for those components, and will those components get into large volumes which would stimulate -- would stimulate buying.

That's what I think the problem is with just looking at utilization as a blended number.

Okay.

Thank you.

Your next question comes from Edward White with Lehman Brothers.

Hi, two-part question.

First, on the broadband test, can you talk a little bit about when you expect the volume purchases might come in?

And is it something that would happen over a time frame of quarters, or are we talking years, before these guys really start to look at this?

And then secondly, you talked about a little bit more interest in voice infrastructure.

Can you talk a little bit more about what's behind that, what you think might be driving that?

Well, let's see, when did we hope the large deployment orders would come in?

We hoped that a year ago, and you know, many quarters.

And the issue is, what's the barrier for the customers deploying DSL testing?

And since most of it is focused in North America of course there's a lot with the fact that the customer is not in a very healthy situation and DSL deployment has been much slower than anyone had hoped for.

I think the fundamental question though, is you got to say that could happen any time. that could happen this quarter, next quarter, the quarter after.

Because the fundamental demand for broadband and the fundamental requirements for be able to economically deploy it, and support it, are going to be there whenever the broadband explosion finally comes.

Certainly in DSL.

What is the other part of your question?

The voice infrastructure--

That's an interesting one.

We sold some LDUs which is the measurement hardware that's out in the, you know, not in the central office but out in the field sites supporting the central office.

Five or six or seven years ago.

And of course as time has gone on, technology in the LDU has improved dramatically.

And with the improvements in the LDUs the customer is able to get much higher dispatch accuracy, which is one of the fundamental characteristics that impact the economics of servicing this network.

And so customers are coming back and saying how about upgrading the LDUs we have in the field which are primarily for voice.

Okay.

Finally, what about -- if you look at the assembly test area, do you think the strength that you saw in bookings in the quarter is sustainable, or is there -- you know, is that too hard to predict?

Well, I think assembly tests, the pieces of assembly test in-circuit test around Mill Arrow, in the mill aerospace, that's obviously large programs of long cycle times.

The in-circuit test business is still, if you look at the full range of products and markets, that is the market segment that still has the excess capacity, as evidenced by the aftermarket which is significantly larger than it is in SemiTest.

Okay.

Thank you.

Your next question comes from Jim Covello with Goldman Sachs.

Thanks.

I’d like to revisit Mark Fitzgerald's question on cost structure.

Maybe another way to ask it is do you have to take additional restructuring actions in order to get to the break-even in the fourth quarter?

Looks like you've got to take $20 million in costs out of the model, it looks like a lot of that is coming out of COGS, are there additional actions you have got to take during the quarter?

And then I have one follow-up.

The actions to get to the break-even at operating level pro forma of $335 million to $340 million 99% of the actions have been taking place.

There's one very small action that needs to be taking place, it's very small.

Other than that, it is -- the plan is hard-wired to achieve the break-even.

Okay.

Then in particular, on the COGS line, then, can you explain to us what you've done?

Is this just sourcing the materials from Asia, or what else is it that you've done to kind of lock that in place?

In terms -- in terms of the COGS line, there is a number of actions we've taken.

The actions include everything from getting some help from material cost down, we expect that will get about percentage point help from material cost down from sourcing in Asia in the fourth quarter and we expect that will grow into 2004.

We have also taken down the indirect labor in some of the infrastructure.

We have consolidated locations.

And we've also reduced the size of the printed circuit board shop up at TCS and we mentioned that we're going to outsource the mid or lower tech boards.

So there's a long list of actions but the actions in that area have been taken.

So there's nothing left to do in that area.

That's helpful, thanks.

And two other quick ones.

How much leverage do you think is left on the gross margin line as revenues improve?

Is there going to be some cost, incremental cost that come back up as revenues ramp during the course of the upturn or are you pretty confident that the cost structure is set at the current level and you can ramp revenues with the current capacity?

We are very comfortable that we could ramp with the current capacity.

To give you quick numbers because we've done testing ourselves, if we grew to $400 million, we picked up 4 points using the manufacturing facility more efficiently.

And if we grew to knife million we picked up 8 points.

And we don't see we would need to add manufacturing capacity or fixed assets for a long period of time we could double before we need to do that.

We have taken out a lot of manufacturing but what we have left we think it's the right footprint for the leverage we want going forward.

Helpful also thanks.

Final question would be on the linearity of the TCS orders.

Can you talk about a little bit about how those orders came in at the end of the quarter, linear, more back end loaded, more front end loaded?

I think each of the individual customers broke at a different part in the cycle as opposed to being a hard movement at the end.

And so does that give you more or less confidence about the sustainability of those orders into the next quarter?

I think the thing that I saw more encouraging is that gave us a higher percentage from the top few customers this quarter.

And what I'm hoping to see next quarter is that the percentage from, let's say, the top 10 will be a smaller percentage showing a broadening.

And I think that's what's more apt to happen.

Similar to what you saw in SemiTest in Q3 you're hoping to see this TCS in Q4?

Yes.

Thanks very much.

Amy we've run over the hour.

Would you take the last question.

Final question with Glen Young from Smith Barney.

Thanks, most of my questions have been answered but wanted to get some color.

Someone mentioned taking some share in RF in Europe, wondering if you could elaborate on that a little bit?

I can't elaborate in terms of identifying where that business is.

What I would say is that on the RF technology segment of the market, we've had very, very strong quarter worldwide.

I think our bookings in RF catalyst, mostly catalyst based bookings, you'd have to go back to somewhere in the mid '00 period to get the level of orders on RF.

So RF across the board has been a very strong segment for us across the quarter.

And you specifically said that was a share gain circumstance is that right?

Yes.

Thank you.

All right.

Let's see.

We'd like to thank all of you for participating and for your interest in the company.

And for your information, we'll be participating in the following investor events between now and our next earnings conference call.

The Prudential conference in New York on October 28th and 29th.

A Jane and (ph) Montgomery Scott luncheon in Chicago on November 13th, CS First Boston Tech Conference in Phoenix December 2nd through 5th.

A Jane and Montgomery luncheon on December 15th and one in New York on December 16th.

Note that our next earnings release will be Wednesday, January 14th at approximately 630 p.m.

East Coast time and that will be followed buy conference call at 10 a.m. on Thursday January 15th.

Note also that we're planning an analyst day to be held in the Boston area early in 2004.

And we'll be providing you with more information on that event around the end of the year.

So thanks for your interest today and we'll see you next quarter.

This concludes Teradyne’s third quarter 2003 earnings release conference call.

You may now disconnect.