泰瑞達 (TER) 2005 Q1 法說會逐字稿

At this time, I would like to welcome everyone to the Teradyne Inc.

First Quarter 2005 Earnings Conference Call.

All lines have been placed on mute to prevent any background noise.

After the speaker's remarks, there will be a question-and-answer period.

If you would like to ask a question during this time, simply press star, then the number 1 on your telephone keypad.

If you would like to withdraw your question, please press star, and then the number 2.

Thank you.

Mr. Newman, you may begin your conference, sir.

Thank you, Anissa. [ph] Good morning, everyone, and welcome to our call for Teradyne's most recent financial results.

I am joined this morning by our Chief Executive Officer, Mike Bradley, and our Chief Financial Officer Greg Beecher.

Following our opening remarks, we'll provide you with details of our performance for the first quarter, as well as our outlook for the second quarter of 2005.

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

Teradyne's press release containing our financial results for the first quarter was sent out by Business Wire and was posted on our Web site yesterday evening.

If anyone needs a copy, please call Teradyne's Corporate Relations office at 617-422-2221, and we'll provide you with one.

This call is being simultaneously Web cast over our Web site 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 5307013.

Replays for both sources will be available through the 4th of May.

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

Therefore, investors should accept the contents of this call as the official guidance from the company for the second quarter of 2005 and beyond.

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

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

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

These forward-looking statements are made under the federal securities laws.

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

Some of those risks and uncertainties are detailed in our filings with the Securities and Exchange Commission, including but not limited to our form 10-K filed on March 16th, 2005.

We caution listeners not to place undue reliance on any forward-looking statements, which speak only as of the date they are 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 in events, conditions, or circumstances, on which any such statements may be based, or that may affect the likelihood that actual results will differ from those set forth in the forward-looking statements.

We want to make clear to investors that our prepared remarks will be presented within the requirements of S.E.C.

Regulation G regarding generally accepted accounting principles, or GAAP.

All financial metrics presented by us during this call will be provided as GAAP numbers, except the quarterly break even numbers targeted for the later part of 2005, which will be at the profit before interest and taxes line, or PBIT line, and which also exclude any possible restructuring charges and future stock- based compensation charges.

In accordance with S.E.C. regulations, investors will find information relating to the break-even numbers on the Company's Web site at www.teradyne.com by clicking on Investors and then selecting GAAP to Pro Forma Reconciliation link.

Finally you should know that between now and the next conference call we'll be participating in more than a dozen investor events.

Among them: a CIBC bus tour in Boston on April 27th; a Merriman Curhan Ford & Co. road show in Boston on April 28th;

A Merrill Lynch tech gathering in New York on May 3rd and 4th;

CIBC tech conference in New York on May 10th and 11th;

J.P.

Morgan's 33rd annual tech conference in San Francisco May 17th through the 19th; a SC Cowan conference in New York on June 1st; a Friedman Billings Ramsey conference in New York on June 1st; a Solomon Smith Barney conference in Monterey on June 2;

Bear Stearns tech conference in New York on June 7 and 8; a Janney Montgomery Scott luncheon in New York on June 10th; a Janney Montgomery luncheon on June 15th; and a Moors & Cabot luncheon in Boston on June 16th.

Hopefully, all of these events will provide ample opportunity for investors to meet with the company as the quarter revolves.

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

First, our CEO, Mike Bradley will review the state of the company and the industry.

He'll review our performance for the first quarter of 2005, and will provide guidance for the second quarter.

Then our Vice President and CFO, Greg Beecher, will review the details of our financial performance in the quarter, and will provide some additional details on our guidance for the second quarter 2005.

We will then answer your questions.

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

Mike?

Thanks, Tom, and good morning, everyone.

In the first quarter, we had sales of 306 million, a loss per share of $0.27, and orders of $341 million.

Our orders were up 14% from last quarter.

In SemiTest, orders were up 11% with continued strong performance by our FLEX system on a chip tester line.

Product orders in SemiTest were up over 35%.

In our other businesses, orders were up 18%, with a strong sequential performance from connection systems, driven principally by new products.

Now let me try to paint a picture for you of the current environment.

In our core semiconductor test business, the market demand is gradually increasing, driven primarily by what I would call "performance buying".

By this I mean either added functionality for newer SOC chips, or purchases to impact, cost to tests for a series of new devices.

But capacity buying is spotty.

The net impact of the performance buying is that orders for our FLEX family are currently 42 percent of our total product orders.

As we've mentioned in the past, FLEX is the primary enabler to both our plants to continue gaining market share, and to our cost-reduction goals.

On the share front, the FLEX was a major factor in our market share gains in the SOC space this past year, and its momentum bodes well for more share gains 2005.

At this juncture the product has penetrated seven of the top 10 IDMs, six of the top 10 fabless companies, and 7 of the top 10 subcontract test houses.

The applications covered by the product range from automotive to wireless to set-top boxes, and to advanced processors.

Customers can get full-blown configurations of the FLEX that test the most complex SOC devices, as well as complete a test Ed configuration to the FLEX that deliver maximum parallels in the most cost-sensitive applications.

The first phase of the FLEX rollout is nearly complete.

We have all members of the FLEX family in production at customer sites around the world.

We've completed the first round of instrumentation, and we've received orders for well over 300 units.

The next phase for FLEX is to achieve the manufacturing model for gross margin performance, to keep expanding the number of device test program platform, and to broaden the instrumentation portfolio.

As part of this second phase, we're moving resources from R&D into applications engineering.

This is a natural transition as we continue R&D at the instrument design level and focus on test development and customers.

As you know from our last call, in addition to our focus on FLEX, break-even reduction is a major goal for us this year.

To put the cost-reduction issue in perspective, the total SOC test market is currently operating at about $500 million per quarter, down from about $800 million per quarter six to nine months ago.

Even with our strong share position, we must stay focused on reducing costs.

In a few minutes, Greg will update you on our progress, but the essence is that our break-even reduction goal that we shared with you on the last call remains a key objective this year, and while much of the work to get there bears fruit in the second half of the year, we've made considerable progress on the initial actions required to get us to our fourth quarter target on schedule.

These include manufacturing cycle times and fixed-cost reductions in semi-tests, achieving material costs down in mix improvements as the FLEX volumes increase, and moving more volume manufacturing offshore, particularly in our Connection Systems division.

We still have a considerable way to go this year on the cost front, but we have not altered our objectives in this area.

Now, I talked a lot about our SemiTest business and about FLEX.

Let me spend a few minutes giving you the flavor for our other businesses before I turn the discussion over to Greg.

Orders in our Connections Systems business rebounded 30% sequentially from the low-Q4 level, and they are now 8% below the peak quarter of 2004.

The excess customer inventory level in that quarter are behind us in all of our end markets.

The primary strength in the quarter came from our wireless base station covered driven primarily by 3G deployment from major service providers.

A significant portion of our TCS order increase came from new products and new records were achieved by NeXlev and GbX connectors.

We also had a record 62 design wins in the quarter, again dominated by these new products.

The division made very good progress in the quarter on its major cost-reduction initiatives.

Against the goal of accelerating the relocation of our volume manufacturing to our low cost manufacturing plants in Mexico and Asia, we ended the quarter with about 50% of our connectors and 80% of our back plant assemblies manufactured in low-cost regions.

We're now setting up local suppliers in those regions to allow the full cost reductions to be achieved by year end.

In our Assembly Test business, orders are were down 19% after a seasonally strong Q4.

In the the Mill/Aero segment, our backlog allowed an increase in shipments to their highest level in recent years.

Overall, our strategic position in the Mil/Aero segment has improved over the past year as we've achieved penetration into a broad array of new defense programs.

On the commercial side, though, orders were down over 20% sequentially, with softness in North America and strength in Asia, particularly in China.

During the quarter, we introduced our first 3D X-ray inspection system, and we won orders head to head against our major competitor.

Our X-ray product, called Clearview, is differentiated by both through put and the accuracy of its fault diagnostics.

In our other test activities, Diagnostic Solutions had a seasonally strong quarter with orders almost doubling.

Our orders included a break-in to a new major OEM, as well as follow-on business from our major Asian OEM.

And in Broadband Tests, orders were down, but those orders came from a series of customers who are upgrading their line test architectures, thereby positioning these lines for future DSL test capability.

Now in total, the visibility on demand across our businesses remains very unpredictable.

Although customer utilization rates in SemiTest are no longer declining, there continues to be excess capacity in the customer-installed base.

In addition, semiconductor manufacturers are extremely cautious in their revenue forecast, and their overall planning horizons are very short.

As a result, our guidance for the second quarter is for sales to be between $290 million and $320 million, with a loss per share between $0.24 and $0.35.

Now I'll turn it over to Greg for more details on the first quarter's results and the second quarter's forecast.

Greg?

Thanks, Mike, and good morning, everyone.

Our sales from the first quarter, of 305.6 million, were down 19% from the previous quarter, and 29% below the level of a year ago, with a net loss of 52.6 million, or $0. 27 per share on 195.6 million shares.

The net loss included restructuring charges of 10.6 million, which consisted of severances and vacated lease charges.

Our gross profit was 89.1 million, or 29.2% of sales, down from 35.2% of sales in the fourth quarter.

This decline was primarily related to reduced SemiTest volume.

In addition, within SemiTest, the product mix further pulled down margins as the mix was heavily skewed to our newest FLEX family members, which start out at lower-gross margins as material costs reductions significantly accelerate when we move from small lot builds into production manufacturing with our outsource partners.

The early configurations of the latest additions to the FLEX family also contain less instrumentation.

There was also aggressive pricing and support provided this quarter, some of which is temporary, and some of which not.

R&D expenses were 64.2 million, or 21% of sales, as compared to 63.1 million, or 17% of sales in the fourth quarter.

SG&A expenses were 65.3 million, or 21% of sales, as compared to 62.1 million, or 17% of sales in the fourth quarter.

Percentage increases are the result of the declining sales as well as both R&D and SG&A increasing in total by about $4.3 million from the prior quarter.

The primary reason for this increase is that we reduced our variable compensation more significantly in the fourth quarter; that it was under under the rate that we are currently accruing at in the first quarter.

Restructuring and other charges were 10.6 million for the quarter, primarily consisting of severances for 339 people, lease termination charges, and charges for contractual penalties associated with the resizing of the Connection Systems segment.

We provided 1.5 million in income taxes in the quarter.

Our quarter ending headcount was 6,676 people, including 5,920 regular employees, which represents a decrease of 429 people during the quarter.

Before I get into more details of the quarter, I would first like to give you an update on where we stand on our program to reduce break even.

Just to review, our pro forma break-even reduction plan is to resize the business so that at about $330 million in quarterly revenue, we will be able to break even at the PBIT line, excluding stock-based compensation charges and restructuring-related charges.

The program is currently on schedule for the fourth quarter.

At this pro forma modeling level, our gross margins and operating expenses would total about 36% each.

I'm sure the obvious question is, why can't we get to $330 million faster?

Let me try to explain that and why we get there in the fourth quarter.

First, the largest reduction at this point would be in SemiTest, where we plan to take the break even down about $25 million in revenue break-even dollars.

The break-even savings come from some mix improvements that improve in the second half.

One example is that we have an inventory liquidation sale of an old platform that will impact us in Q1 and Q2.

Thereafter, our inventory cost on our books for this platform is essentially zero, and while we don't anticipate future sales, if there are, the margins will be very high.

A second example on mix is our newest addition to the FLEX family, where we move it into production volumes in the second half, where we will receive much lower material costs from our suppliers.

Further, our fixed manufacturing costs are lower on FLEX as a result of much higher yields and much shorter cycle times in our factory for product configurations and tests.

These savings show up as the mix moves more to FLEX, and as we get all of the yields on the new instrumentation that is coming out of engineering in 2005 also up to the 90% yield levels.

Longer term, there are additional savings beyond 2005 with the FLEX manufacturing model as the cycle times are much shorter and we outsource all but final configurations and tests.

Now, moving to TCS, the break-even plan focuses mainly on moving our high-volume manufacturing to low-cost regions.

So far we have taken actions on about 2/3 of the plan from a head-count sense.

The full benefits of this migration program, however, are not expected until the fourth quarter.

The program is being pushed aggressively and is constrained only by the obvious requirement to ensure ongoing, high-quality shipments to our customers.

The follow-on savings from lower costs naturally lag as the sellers must be qualified.

There is also a list of actions below the gross margin line that we plan to implement in the second half of the year as the platform engineering work declines.

These additional reductions are necessary in part to compensate for some of the pricing actions relating to some highly-contested business that we have won.

Now, let's get back to details of the quarter.

SemiTest sales in Q1 were 48% of the total, Connection Systems 31%, Assembly Tests 12, other tests 9.

On a geographic basis, our fourth quarter sales broke down as follows: U.S., 39.2%, Europe, 14.9, Singapore, 6.8, Taiwan, 4.8;

Southeast Asia, 17.9;

Japan 6.4, Korea 3.1; rest of world, 6.9%.

We had net bookings of 340.7 million in the quarter.

On a quarter to quarter basis, our total net bookings were up 14%, SemiTest was up 11%, Connection Systems up 30%, Assembly Tests down 19%, and other tests was up 48%.

On a year-over-year basis, that is Q1 of last year to Q1 of 2005, total net bookings were down 38%.

SemiTest was down 55%, Connection Systems down 3%, Assembly Tests up 12%, and other tests was down 13%.

Our book to bill ratios were 1.1 for the overall Company, 1.1 for SemiTest, 1.1 for Connection Systems, 1.0 for Assembly Tests and 1.5 for other tests.

At the end of the quarter, our backlog stood at 443 million, of which 71% is scheduled to ship within the next six months.

On a geographic basis, our bookings for the quarter were distributed as follows: The U.S., 39.8%;

Europe, 16.4;

Singapore, 9.5;

Taiwan, 5.8;

Southeast Asia, 17.0;

Japan, 6.8;

Korea, 4.5; and rest of the world, 0.2%.

Now moving to the balance sheet.

We ended the first quarter with cash and marketable securities of 587 million.

During the quarter, we further paid down our convertible debt another $20 million, and contributed $10 million to our pension plan.

Apart from the net loss, the first quarter is when we settled many of our employee liabilities, such as variable compensation, 401(k) match, and profit sharing programs.

Accounts receivable stood at 218.6 million, or 65 day sales outstanding, with greater shipment skew at the end of the quarter than normal.

We ended the quarter with inventory of 256.6 million, or 3.4 turns, down 6.4 million from the end of the fourth quarter.

We spent 31.8 million on capital in the quarter, net of sales of related capital equipment.

This was primarily driven by continued customer evaluations of our new SemiTest products.

Depreciation and amortization was 26.8 million.

In the second quarter of 2005, as Mike mentioned, we expect sales to be between 290 and 320 million, with a loss between $0.24 and $0.35 per share, assuming a $1-million provision for foreign and state taxes.

This guidance also includes pretax restructuring and other charges of approximately $17 million.

We expect gross margins to run between 26% and 31%.

R&D will run between 20% and 21%, while SG&A will run between 21% and 22%.

We expect to increase inventory by 15 million, and expect to decrease AR by at least 15 million.

In addition, we expect to spend 30 million or less on capital.

Depreciation and amortization should be around 27 million.

We expect to end the second quarter with cash and market securities of around 530 million.

And now, I'll turn it back to Tom.

Thanks, Greg.

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

Certainly.

At this time, I would like to remind everyone if you would like to ask a question, please press star, and then the number 1 on your telephone keypad.

We'll pause for just a moment to compile the Q&A roster.

Your first question will come from Murali Abburi with J.P. Morgan.

Yeah, hi.

I had a couple of questions.

If you look at your inventories and backlogs, can you tell us approximately what percentage of those are FLEX, ask what come from the other platforms, and related to that as you convert your customer base to FLEX, do you think you're going to --- see any potential back log cancellations?

Murali, the inventory -- the back slog is, as we disclosed, the FLEX system is now about 45% of our bookings, and that becomes, with the short lead times and the low backlogs, that represents about what our backlog mix is.

All right.

Do you expect to see further inventory write-offs as you transition your platforms to FLEX, or do you think you will be done after this quarter?

We're not expecting any inventory write-offs.

That risk exists, and we'll monitor it as the rest of the year unfolds, but we're not anticipating that currently, but that risk exists.

All right.

And then, I know you don't like to comment on bookings directly, but if you could just talk about how you see the next quarter unfolding in terms of your booking strengths?

Well, let me talk about it in terms of utilization, because I think the bookings forecast, which we, as always, don't forecast.

It's a very, very cloudy picture on the bookings front anyway.

But I think the indicator that we all look at and try to read the tea leaves on is what's the utilization on the installed base?

The last time we talked, last quarter, the install base utilization was still trending down.

It had been doing that for six or seven months through the end of 2004.

Our data says that the utilization at this point has flattened.

There are pockets where it has gone up a little bit, but if you look in aggregate, you'd say that utilization has stopped its downward trend.

Now, the question is where is it going to go from here?

Is this a pause on a further continuation down?

Is it going to to stay flat, or is it going to move up?

What customers are telling us is two things.

One is, that they think that the lowest utilization level is behind them.

I think they would characterize that as being at the beginning of this quarter, meaning the beginning of Q1, beginning of the year.

So they are starting to see some signs from their customers that have caused the back end of Q1 to go up slightly, but what we're hearing from is that they are anticipating that utilization will increase.

None of those customers can tell us what in the slope of that curve is at this point, but there's a reasonably consistent message from the customer base that the low point on utilization is behind them.

All right.

And one final question from me.

Your backlog for the last two or three quarters has been running at less than 3.5 months of sales.

Given your bookings in March, it assumes you could have potentially guided to a higher revenue level for the June quarter.

Is there any particular reason you're not?

There's always a lot of movement in the backlog, so part of the existing bookings shift around from quarter to quarter, but the simple answer is that the shipments are based upon the requested delivery times from the customers, and we've got about $10 million more of backlog in our second quarter than we had in our first quarter, and so we've raised our guidance by that amount.

But the guidance and the uncertainty around shipments still remains pretty high, so we've kept the band of guidance around a $30 million level.

All right.

Thanks.

Yeah.

Your next question is from Jim Covello with Goldman Sachs.

Hi.

A couple of quick questions.

On the profitability side, what is the timeframe for getting better margins on the FLEX product, whether it be just, you know, coming up the learning curve, or being able to add more instrumentation to each -- to each tool, and then, you know, on the aggressive pricing aspect, is there any thought of walking away from revenue because it becomes unprofitable at a certain point?

In terms of the -- Jim, this is Greg, in terms of the FLEX margins, the FLEX margins get better throughout 2005, much more in the end part of the year, as we are getting instrumentation from our engineering organization that will be brought up to 90% yields.

Once that occurs, we need less people in the organization to do final configuration and test, so that will happen throughout the year, but it will be back-end loaded.

As we move into production manufacturing which occurs in the third quarter for one of our newest members, we'll get some benefit at that point in terms of lower material costs.

And to your question about --

Let me address the question.

Your question is on pricing, and is there business that's unattractive to us, or will we just follow price down, I think is the blunt question your asking?

Yeah.

Let's see.

A couple of pieces.

All -- all of the business, even from the install base, is under price pressure, so we do have, on every transaction, pressure to reduce price, because our customers are feeling the same pressure from their customers, obviously.

But on the, you know, purchases of -- of follow-on units, there is some price stability in that segment of the market, and I think your question is around new opportunities, what's our strategy around those opportunities?

Yeah.

And, you know, we look at them as a net present-value calculation.

There are clearly some business opportunities that are hotly contested in a market that's down almost 50%, and it's fair to say the market is incredibly disruptive at this point.

There is no pricing stability on those -- on those pieces of potential business.

So we assess each one on the basis of what we think the present value of that customer is, and how aggressive we can be on price, what we can do on costs, and it's far more than a -- you know, kind of a straight gross-margin question.

We look at what it takes to support a customer, what scale of install base they have, what level of investment and support it requires.

So it's piece by piece.

We're not -- we don't think the market is elastic, that if we lowered price we would get more volume, and we certainly don't look at every piece of business the same way.

And as Greg mentioned, there were some very competitive and aggressive pricing scenarios over the last six months, some of which we participated in.

And those were share gain initiatives for us.

That's helpful.

Final question from me.

On the competitive front, seems like you're doing much, much, better than some of your competitors, who may wind up having a tough go of it this time around.

But on the other side, it seems like a couple competitors are doing, or maybe at least one competitor is doing a little better.

Can you help us to characterize that, especially in the SOC test base?

Thanks.

Yeah.

Well, let's see.

Let me recap where I think market share has ended up on the 2004 picture.

And as I said last quarter, the quarter before, and the quarter before that, the data on 2004 gets solidified frustratingly late in -- in the subsequent year, but it's shaping up now where I think you'll see reports from outside -- outside agencies, third-parties that track that, our share position in the SOC space has moved from the low 30% level, 30%, 31%, to the mid-level of the 30s, slightly higher.

So we think there is a -- against the different numbers, you're going to see anywhere between 4% and 7% percentage points gain.

And that has born out what we've been predicting through the course of the year, that we thought we would move up considerable amount of share in the year.

Now, as I had mentioned, I think on a couple of calls ago, a big chunk of that is the FLEX.

We've also got some share gains that are driven by the Tiger, and we've also seen the expansion of the J750 into probe testing on a much higher level, so the 750 has also been a participant, a contributor to share.

Now, on the competitive front, what I had said last quarter was that Advantest was likely to be the other share mover in the SOC space.

I think that's still my view for 2004, and they've done that with a new platform.

Now, beyond that, there are pockets of share movement that have certain segments that are dominated by different suppliers.

Those pockets will move, and those will shift -- those can shift share if those segments move.

But I think those are the two, Teradyne and Advantest are likely to be the big share movers up -- when all of the numbers are in, in 2004.

Thank you.

Your next question is from Mehdi Hosseini with Friedman Billings Ramsey.

Yes, I have two questions.

First of all, regarding the gross-margin story, not to beat on a dead horse, but it seems to me that you're making a bet that volume ramp for FLEX would pick up in the fourth quarter, and that's where you're going to realize most of your gross margin expansion.

And second question, which is more as a clarification, did you say that $10 million of backlog was moved from Q1 to Q2, and that's why your revenue guidance isn't much consistent with the 14% booking growth in the Q1?

Mehdi, I said that our -- our slotted orders for the second quarter net have moved up $10 million.

Okay.

And then regarding the break even, and hitting that new target of 330 million, would that be fair to assume that more than half of the -- more than half of the savings, or gross-margin expansion, is going to come from volume ramp for FLEX?

Mehdi, this is Greg.

No, we're not counting on volume.

If we did get strong volume, that would help us considerably.

How we would get there, though, is when we get tie bite the 50th unit of one of our FLEX products, which we will get there with the current level of business in the second quarter, our costs go down considerably, so even at this low level of business, we get to that unit where we get better price, and we're out of small lot builds.

We are also lowering our manufacturing costs through outsourcing, as well as reducing the level of resources we have in final configuration and tests, irrespective of volume, and sometime it's easier to do that when there isn't volume in front of you.

So we feel pretty good about that part of the gross margin story.

I guess I'm just trying to understand if there's been a pricing pressure, and I do understand Mike's comment on this, but if there has been pricing pressure, what's going to make your customers to pay more six months out, when they're already given a pretty steep discount today?

Yeah.

Let me --

All right.

Go ahead.

--try and take that.

If you look at our business over any period of time, you know, this goes back five years, 10 years, and this is probably true for many other businesses, you are always going to find there is some number of pricing that is more strategic, and there's a lot of reasons around a particular set of pricing decisions, and -- nd what has happened in this particular quarter is more of that buying hit us this quarter when there's low levels of volume.

When you look at the pricing across our portfolio, customers that don't have the characteristics that cause us to look at certain accounts differently, you would likely conclude that the margins should be similar to what they were in the past.

Gotcha.

Thank you.

Yeah.

Your next question comes from Tom Dipoli [ph] with Merrill Lynch.

Yeah, good morning.

You talked about performance-driven demand this quarter.

Do you think you can regain, and probably more importantly, maintain profitability before capacity orders come back?

Well, I think capacity is going be to required for us to get the semiconductor test business back over the $200 million, $220 million volume level.

I don't think there's enough performance buying to move us up from the mid-100s, 150 to160.

That won't be done strictly by performance buying.

So, some capacity has to come back for us to get back to the break-even level in semiconductor tests.

Okay and is the current break even for SemiTest still in the 210 range?

Or is that varied this quarter?

The SemiTest break even, keep in mind we calculated each quarter based upon the mix of business, it's up to about 220, but will still hit it's main destination of 195 at the end of the year, and SemiTest this quarter is where we had some of our gross-margin issues, whether it's selling a Legacy platform at close to zero margin, as well as some strategic deals that hit this quarter.

Okay, and finally, is there still about a 15- point gap between the IDMs and subcon utilization rates?

That's about right.

It's still -- the IDMs have stayed stable and strong.

The subcons have -- that gap widened during the course of '04 from about 10% to 15% and it's about the same now.

Okay.

Thank you.

Your next question is from John Pitzer with Credit Suisse First Boston.

Yeah.

Good morning, guys.

A couple questions.

First, when you look at the March quarter, you guys did certainly better than midpoint on the revenue, but you missed your gross-margin guidance.

Can you help me understand what the biggest Delta was there?

Okay.

In terms of the gross-margin guidance, there were a series of items, John.

It's almost four or five.

So let me give you a few.

We had more demand for one of our FLEX products that is before what we call the 50th copy in the cost for that product, because it's basically prototype building versus production manufacturing, so the manufacturing costs are higher, and the cost comes down once we get past unit 50.

We also had in this quarter some FLEX strategic deals where we provided some incentives to customers, whether it's free training, free applications, free software and some other support to customers to help them get FLEX populated with test programs faster, and that's a program that some part of it is the first six months of this year, some part goes through the end of the year.

So that is -- at one level, it's temporary, another level it goes to the fourth quarter.

Then we had some strategic business that was heavily contested where our customer bought more units than we would have anticipated in this one particular quarter for the strategic business, but over the life of the program and where this business drives other business for us, it will be quite attractive.

But the mix of that business coming in a low-revenue period quarter throws off the percentages.

And if you look at the margins of the Company versus prior periods with large numbers -- you know large margins of customers, I think through you will conclude that the margins will similar as the past and one of two strategic deals don't change the fundamental earnings power of the Company, because we've always had some of those based upon the unique characteristics of some of these -- some of these shootouts.

And I take it some of those issues are persisting into the second quarter, because if you look at the top end of you revenue range of 320, you're only getting to the bottom range of your initial gross-margin guidance for Q1?

Right.

You're absolutely right, John, and this one is a little easier because there's one big one.

There is one large one here versus my last description was, like, five or six things going on.

This one is the Legacy Logic platform.

We think it could be $7 million, $8 million, $9 million of return with close to zero margin.

It's going to go through the second quarter.

Results, we're very glad to liquidate that inventory, and if there's any further demand, which we're not counting on, in the third quarter, we have no net inventory in our books, all we have is reserves So that's the biggest one item that's throwing off Q2.

It's more the Legacy inventory liquidation.

And then a couple of clarification questions.

One, what do you define as getting beyond just small-lot buildings?

Is it 50 or more systems per quarter?

And I'm still a little bit confused when you look at your break even in Q4, do you anticipate test pricing to get better from current levels?

And if you do, can you help me understand, because my belief is that Advantest is knocking on the door, but real tangible market-share gains haven't been that apparent to Advantest yet, and if they start to gain share, wouldn't pricing get worse in the back half of the year as things get more competitive?

Yeah, we're not counting on imprisonment in test pricing, we're counting on improvement in lowering the cost.

We have a clear line of sight.

There's one of our products that we basically have negotiated with one of our suppliers, that well in advance that after the 50 copy, we get a different pricing scheme.

We haven't done that with all of our FLEX family members, but we did with this one member, and we're going to get to the unit 50 in the second quarter, so post that, we'll get a better cost deal.

So that one, in my mind, is fairly on in, that that cost down will be achieved, and we're not counting on some help in pricing.

The other thing that's sort of in the background here is with our FLEX manufacturing model, if you look at how we can lower our fixed manufacturing costs with FLEX, you know, over a cycle.

Over a full cycle, it's about two gross-margin points, and the concern we have is those two points, which come over time, will get some of that in the fourth quarter, will get rounded up to about a point the fourth quarter, more to come in subsequent years.

You know, can we keen that two points of gross margin, or do we give that back because of competitive pricing pressure.

I raised that with John because there is two points of good news we have that is available to us that we did not have in the prior cycle.

And just finally, is Advantest having an adverse impact on pricing today, or is that something that we should be concerned about later on the year?

I wouldn't characterize pricing disruption as specific to any one competitor.

In the markets in which the competitors exist, or participate, in the horizontal markets of device segments, the pricing pressure is -- comes from all quarters.

Now, Advantest has deeper pockets than some of the other competitors, and has more ability to disrupt the market with price, but they need, as do other competitors, the instrumentation to participate in all the markets, in order to be disruptive in them.

Great.

Thanks, guys.

Yeah.

Your next question is from David Duley with Merriman.

Yes, I was wondering if you could talk a little bit more in detail about the strength of your SOC business, and why your products bookings are up so much there?

And just remind us of where we are on FLEX cycle times, and maybe between the -- kind of the small, the mid-range and the high range, the bigger model?

Okay.

Let me talk about the SOC momentum.

I mentioned before, I think the market share numbers are bearing out that we've made some headway over the last 12 months, 15 months.

The basis of that is coming from the architecture of the FLEX, and the FLEX is trying to do two things in the market place of SOC.

One is to stretch across the widest range of device technologies.

If we can do that, we get a benefit to customers because they have high reuse of that capital for the ever-changing SOC device architectures and the mix of products that they receive from their fabs, and, secondly, and it also gives us the benefit of the engineering leverage, because we have the ability to stretch our engineering across a wider set of served markets.

The second architectural attribute of the FLEX is that it is unique in its design for parallelism.

So if you thought about it as the parallel test memory market architecture in SOC, that would be a reasonable way to think about it.

How do you get more than one device or two devices or four devices tested in parallel?

And we now have many applications where we've got device applications, device solutions in production in high- parallel mode.

So that's -- that's the value proposition of the product.

And what is happening is that that's fanning out now.

It's in the IDMs, it's in the fabless customers, and it's in the subcontract test companies.

So I think the benefit in terms of leverage of capital and of velocity of devices across that capital, the overall throughput of the test cell are proving out, and that's what's causing us to broaden the install base.

I think the way I would characterize 2005 compared to 2004, 2004 was a period where we had to convince customers that that value proposition was possible, and we did that through demonstrating on their floor FLEX in parallel for SOC applications.

Now that we've got the system in to many customers, this turns into a socket by socket war, if you will.

And in some sense, the socket war is easier since you have the equipment in, than trying to break in with a piece of equipment in a green field.

Is there any one particular segment?

I think you mentioned, Mike, automotive, set top box, processors,, wireless.

Any of those areas really where your products have caught on more than in other areas?

Well, I think the strength in the -- there isn't one that stands out.

The main attribute of a FLEX is why we call it FLEX, is because it covers so many different application spaces.

So it really does range from linear, automotive, wireless, and the most recent version of the FLEX is at the top end and the processor end.

So I would be doing a disservice to one of the business units inside semiconductor tests here if I said one stood out.

It really is a broad application space, and I think that's what is one of its appealing attributes, is it allows heavy, heavy reuse across market segments.

Greg, you do want to talk about the cycle times on FLEX?

Sure.

The cycle times on FLEX, the short answer is: In the third quarter of this year, we expect the FLEX products to be on what we call the model receiving the cycle time goals.

What's happening to get us there in the third quarter is we are finishing the work on getting the yields up to 90% on new instrumentation that is coming out of engineering, and we're also outsourcing some more of the manufacturing.

We are reasonably confident we will get FLEX to the model, the manufacturing model, in the third quarter, and just as further background, the FLEX manufacturing costs versus the Legacy manufacturing costs, are about half when you compare it against revenue, meaning FLEX at reasonable volumes, can be manufactured in the Company for about 4% of sales.

The Legacy was probably about double that.

So the FLEX manufacturing model is something we're excited to get to, and we have plans to get there in the third quarter.

Now, having said that, we're still going to be aggressively selling our very successful Legacy products as they have a long life in front of them, and plenty of applications where they are still the best-performing tester, so we'll have two manufacturing models for a period of time.

Thanks.

Your next question is from Timothy Arcuri with Smith Barney.

Hi, actually I had a number of questions.

I guess my first question is, based upon your break-even comments on your last conference call, you said that your cost structure at 330 would have produced, you know, kind of a 39% gross margin.

Now you're saying that it's down to about 36%, and you are kind of making it up on the OpEx front.

So in the last three months, what's changed kind of with respect to what your gross margin would be at that $330 million-revenue level?

Okay.

What we have -- what we are doing is we see that some of the gross margin pricing pressure is likely to be permanent, and similar to what it has been in the past, so we, looking back at our model, were likely too optimistic earlier, and we think the pricing assumptions we're looking at now, in terms of periodically some contained pricing for strategic reasons is something that, one, we'll see in a contained, more isolated, manner.

And, therefore, obviously that creates a bigger break-even problem for us, so, therefore, we've had to go to operating expenses to solve the problem to get back to 330.

So our game plan is to hit operating expenses in the second half of the year such that we can get back to 330 million at gross margins of 36%.

Okay.

Let me ask you a couple of follow ups.

I guess, if I just look at the business kind of holistically, TCS is really as good as it has been during the last four years, despite lots of disappointments froom your end-market customers.

ATD is solid, you know, at kind of high levels, You know, broadband is pretty good.

It really seems -- and, you know, you've also cut your head count by about a thousand heads relative to the peak.

So you have already let go of lots of personnel, yet we still keep getting hit with these one-timers each quarter where it keeps pushing up break even in SemiTest.

So , when you look at what the right break-even level is, is in fact 330 maybe not the right level?

You know, should we be considering taking it even lower than that?

Good question, Tim.

Let me describe how we're looking at this.

The reason we have this strategy of moving up on share is because unless you get a substantial share, and meaning we're at 35 now, we need to go at least to 40% market share.

Unless you do that, it's hard to describe a business that can deliver profitability without changing the cost structure dramatically.

Now, why do we think the level of around $200 million is appropriate in SemiTest?

The current CapEx rate is slightly below 2%.

I think everyone will remember that in the past, 3% was the number, and then 2.5%, and then 2%.

Over the last three years, it has been 1.9%, and we think if you take this year in, you'll have another -- if you take another three-year period, '03 '04, '05, it will be about 1.9%.

That rate of under 2% is the one we're modeling.

Do the math on the size of the overall market that's driven by the currently $150 billion semiconductor SOC market, and you end up with a market that on -- over the cycles, you have to get north of 35% to have a profit level for our business sized at around the $200 million break even.

If we can't get above -- you know, if we can't move up, constantly move up in share, then the only path left to us is to cut on the expense side.

Now, we're doing both in parallel, because we are committed to get Semiconductor Test under $200 million, but I would say to you if we're not able to keep growing on market share, then that's the path we have to take, is to be more severe on the cost side of the equation.

To date, though, the strategy of gaining share has been successful.

The points of share gain that we've made in '04 have more than paid for the expenses of our R&D during the course of that period.

That's why we're staying hard on that schedule.

At the same time, I won't deny that our margin compression forces us to be more aggressive.

We have to go after more in order to get our break even down into the $330-million level, and get our SemiTest gross-break even underneath 200 million.

We have more to do.

Yeah, okay, maybe, Mike, and if I could ask one more follow up?

Sure.

I guess we keep cutting -- it's kind of addition by subtraction.

Really, we keep cutting to keep our head not even above water, but just even with the water level, if you will.

So if you just look strategically at the business, you have a bull market going on in the memory business.

Obviously you don't serve that business, and the SOC market seems to keep shrinking because of pricing, and it's a brutally competitive market.

So is there any thought by the Company to maybe get back into the memory test business, given, you know, the dynamics going on there, relative to what's happening in SOC?

If there's there's a technology, a performance disruption opportunity, we keep our eyes on the memory market, we have a lot of technology in the Company that could be leveraged into memory, but based on where that market is today, we currently don't have a product to field into the memory space.

Operator?

Your next question will control from Patrick Ho with Legg Mason.

Thanks a lot.

Can you just help me understand one thing?

I think last year when the FLEX started gaining momentum, and things were going well, he gross margins didn't obviously seem to be impacted, but now it seems like there's a lot more of the costs and manufacturing cycle times related to it.

Was there a big change in last year in terms of the FLEX cost, or are they just being more apparent in this current environment?

This is Greg.

What's happening now is first of all, in the current environment, sales are really low, so any little aberration from what you consider normal gets magnified.

But putting that aside, when we add new members to the FLEX family, the newest member, in all cases, starts out at lower margins.

That's always been the case with the new platform, as there's less instrumentation on it, and the manufacturing costs are higher, and that's simply what's happening this quarter.

That gets corrected over late-second quarter.

Third quarter, you'll see that problem go away.

We won't be talking about that problem in the third quarter.

Okay.

So just to clarify, last year when you did roll out the FLEX, and things were going well, because I remember your discussions about how the FLEX, the cycle times were so much shorter than your quote old Catalyst products, and that was suppose to obviously help margins down a lot.

That thesis is still intact?

Yes.

Okay.

And just a final question, in terms of your other businesses, when do you start reevaluating whether there are long-term growth opportunities for the Company, given some of the losses, and I'll just use, like, the Assembly Test business which has been very inconsistent, what type of point do you look at whether this is going to be going to be part of your core overall business?

Patrick, we've renovated a lot of those businesses now inside of those business units in terms of products we are investing in and ones that we've deselected, but the broad -- the general answer is, those are always under re-evaluation.

Our objective is to get them healthy.

They're part of our portfolio, if they can contribute.

If they're for valuable to someone else's portfolio, obviously we consider that, too, but our objective has been to get those into position where they can make a contribution to the EPS.

Great.

Thanks a lot.

We would like to take the last question, please.

Most certainly.

Your last question will come from Steven Pelayo with Fulcrum Global Partners.

Great.

Thanks.

Just a couple of quick ones here.

The size of the SOC market: You talked about 35% [inaudible] market share.

What was the size of the market in '04?

Currently running, you said, about 500 million per quarter.

What was it in '04?

What what do you think it is in '05?

Well, it's 3.1 billion in '04, and '05, and you extrapolate the current run rate in the first quarter, it's a $2 billion market.

And then you just have to say what do you think the CapEx rate will be, the buy rate will be through the course of the year.

Right now it's running at 1.4% by the way.

When you look at that change, I'm just curious, there's a lot of talk about permanent pricing pressure out here.

I know you can't really do a units versus ASPs because of configuration differences, but in general, how much would you attribute to pricing, the shrinking of the whole pie here for the SOC market?

I think it is much more to do with productivity than it has to do with price.

The ability of the equipment to handle a greater variety of parts, and to do that with higher throughput is having the biggest impact on the market, and that's counteracting the complexity curve, which is continuing to go up at a tremendous rate in all segments.

Okay.

So looking forward, do you think we've got the bulk of those efficiencies, if you will, of the productivity gains, and so we maybe we can start talking about kind of, I don't know what you would call it, a tester intensity level stabilizing, at least?

Well, I think you have to say, what do you think the CapEx rate, thee buy rate is going to be for the level technology in the industry, and it has been -- I don't think any of us see thats a a 3% or a 2% CapEx rate going forward.

Our business plan is modeled around it being below 2%.

Okay.

My last question just was there is a lot of focus on Advantest as a competitor potentially gaining some market share, I understand actually Agilent has done a pretty good job with some new configurations with their 93K.

Have you seen increased pressure from them as well?

Well, we're seeing everyone in every market.

I don't want to be too glib about it but Agilent is fielding a new generation of product and instrumentation, so, we see them on every front where they have the instrumentation to compete.

Okay.

We're strong, as you know, in the chip and the photographics space, and we have had some success there, but, frankly, we have a small position, all of that has been achieved over the last couple of years, but it's a small piece of our market share gain.

Excellent.

Thank you.

Maybe I could take just one minute here at the end, because I want to make sure that we're communicating a couple of things.

First is that our -- our approach over the last couple of years, the focus on market share and get profitable growth from market share, has been successful through '04, because it contributed -- the share gains contributed more than half of the profits of our business.

Each point -- using the math that we just said, each point of share is $20 million or $30 million, and the present value of a customer can be measured -- in the big customers, in the hundreds of millions of dollars, so the market share strategy has been critical to our momentum so far.

At the heart of that is the level of investment in R&D that we recognize has been supercharged over the last couple of years, but that's been working.

The third thing is we do know that our break-even challenge is greater.

There is margin compression in the business; there is more than anyone has anticipated.

It makes our break-even objective harder to achieve, but we're committed to achieve it, and we'll do that in the course of this year.

The final thing is, I think everybody is saying, with all of these questions, that we've got an industry that is in turmoil, and it has to, in some way, shake out.

Because this scenario, in a static sense, going forward, can't be survived by everyone, and it's our intent to emerge from that cloud stronger, based on the strategy that we've had in place.

At the same time, we've got our eye on the ball with regard to expense and break-even reduction, and we need to deliver that this year.

Thanks, everyone, for your attendance today, and we'll talk to you next quarter.

This includes today's Teradyne Inc., First Quarter Earnings Conference Call.

You may now disconnect.