泰瑞達 (TER) 2006 Q3 法說會逐字稿

Good morning, my name is [Luanne] and I'll be your conference operator today.

At this time I'd like to welcome every to the Teradyne third quarter 2006 earnings conference call.

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

After the speakers' remarks, there will be a question-and-answer session. [OPERATOR INSTRUCTIONS] Thank you.

Mr. Newman, you may begin your conference

Thanks, Luanne.

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

I'm 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 third quarter 2006 as well as our outlook for the fourth quarter.

First, however I'd like to address some administrative issues.

Teradyne's press release containing our most recent financial results was sent out by a business wire yesterday evening, and is available on our website or by calling Teradyne's corporate relations office at 617-422-2221.

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 the replay of the call by dialing 1-800-642-1687 in the U.S. and Canada, or 1-706-645-9291 outside the U.S. and Canada and providing the pass code 8230256.

Replays from both sources will be available through the 2nd of November.

Investors should accept the contents of this call as the official guidance from the Company for the fourth quarter of 2006 and beyond.

If at any time we communicate any material changes to this guidance, it's our intention 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 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, statements as to inventory, bookings, backlog, orders, shipments, pricing, design ends, and demand for our products, capital spending, market share, and other opinions of management.

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-Q filed on August 10, 2006.

When we incorporate here the discussion of those factors, we caution listeners not to place undue reliance on these forward-looking statements which speak only as of the date they are made.

While Teradyne is under no obligation to update the forward-looking statements made today, any updates that we do make will be broadly disseminated and available over the web.

We want to make clear to investors that our prepared remarks will be presented within the requirements of SEC Regulation G regarding generally accounting principals or GAAP.

Therefore, if we use any non-GAAP financial measures during the call, you will find the required presentation of and reconciliation to the most directly comparable GAAP financial measure on the Company's website by clicking on www.teradyne.com by clicking on investors and then selecting the GAAP to non-GAAP reconciliation link.

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

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

Then our Vice President and CFO, Greg Beecher, will provide details of our financial performance for Q3 and our guidance for Q4.

We will then answer your questions.

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

Mike?

Thanks, Tom.

Good morning, everyone.

As you've seen from our press release, we ended the quarter with strong financial results.

We set a series of records, which Greg will review with you in a few minutes.

But, our bookings in the quarter were down significantly from the second quarter, leading to guide for lower revenues in Q4.

The SemiTest industry is clearly in a market correction.

Therefore, I'd like to spend some time this morning discussing my view of where the market's headed and how we'll be playing it both short and long-term.

After 7 straight quarters of increasing orders for our SemiTest products, we saw a drop of about 40% in orders in Q3.

As expected, our subcon customers pulled back the most.

Orders from them are down about 60% sequentially while our IDM customers were down about half that, about 30%.

This is a sharp correction, similar in many ways to the one in the second half of 2004.

At that time it was a steep -- actually it was somewhat steeper one quarter falloff in orders.

The 2004 drop was driven mostly by subcons as this one is.

Both were across a wide range of end markets, applications, and geographies and both occurred as the semiconductor companies were becoming more cautious about their own revenue projections as you've seen in a series of recent announcements.

On the other hand, there were some -- there are some important differences between now and two years ago.

First, the subcontract test companies in this cycle have demonstrated much more discipline in managing their assets.

They've avoided the heavy over-buying that in the past exacerbated the boom and bust cycles.

That increased discipline shows up in their test utilization, which fell off 20 points from their peak in 2004 and so far this year, it's down only 5 or 6 points.

As a result, subcons are currently not chasing a plunging utilization curve.

In addition, there's been virtually no cancellations or pushouts of backlog and short manufacturing cycles and lead times have allowed backlogs to remain secure.

In fact, customers are pressing for quick delivery of orders in backlog.

Now one other macro indicator is the industry buy rate.

SOC test customers have spent 2.1% of their revenue on test in the first three quarters of this year.

That's slightly up from the 1.9% average rate of the last 4 years when annual buy rates ranged from 1.8% to 2.1%.

Bringing that back in line requires a short-term crash diet rather than a prolonged hunger strike.

As a result, the industry could exit 2006 right on the four-year average of 1.9%.

So, we're in an environment where customers now get just a bit ahead of the curve, confident that it can quickly correct when needed.

As the device industry we serve grows from the mid $40 billion level per quarter to the $50 billion level, the quarterly SOC test market goes to an 800 million to $1 billion range an on average.

With our market share momentum and our break even, this means a healthy and profitable Teradyne over the cycle.

Given this environment, what's likely to happen at Teradyne and how are we going to operate through this down shift in demand?

While our new business model is designed to allow us to change shipments sharply, up or down, with little disruption.

The responsiveness of our supply chain should allow us to not have any significant inventory buildup as we ramp down.

Much of our manufacturing is outsourced so we can move our shipments down without heavy internal disruptions.

We'll continue to focus on our costs and our break even levels so our over the cycle profit targets are met.

Our gross margins and cash flow have done very, very well both at high levels of revenue and also as we've started to ramp down our ship rate.

And we expect to continue to perform well in these areas in the future.

And finally, we'll continue to improve the business model through this next year.

Let me finally turn to the issue of how we're positioned at the three quarter mark of this year.

In 2006, we've had two major objectives.

First, is solidifying our FLEX products in the marketplace and main -- and second is maintaining our break even levels at the levels achieved at the end of last year.

We're on course to meet both objectives.

We've crossed a major milestone in Q3 with the booking of the 1,000th FLEX system.

We also added three new FLEX customers in the quarter for a total now of 70.

Despite its success, however, FLEX is actually still in its early stages.

Our FLEX and our mainstream J750 products combine to give us a formidable one-two punch on performance and economics across a very wide spectrum of applications.

For several quarters now, the areas of biggest strength for our products have been automotive, power management, image sensors, microcontrollers, and wireless applications.

In the third quarter, these continued to be the strongest segments and we added new applications and high-end graphics, high-end microcontrollers, data conversion LANs, and video.

Now on the engineering front, essentially all of our technical resources, design, development, and applications are focused on FLEX and the J750.

They're developing and implementing capability to extend our already wide applications footprint to an even wider one with next generation instrument sets.

You'll be hearing about the results of those investments over the course of 2007.

Finally, we committed at the end of last year to hold our break-even at 250 million to 260 million in sales per quarter despite the growth we saw coming in early 2006.

We held the line on this.

And as Greg will describe, we have plans to make further improvements on that in 2007.

Maintaining a constant focus on our cost structure will allow us to achieve our longer term financial goal, maximizing our profitability over the cycle.

So overall, we're undeniably in a sharp market correction.

So far, as steep as that in the last cycle.

But steep enough to test every company in the industry.

The trends in utilization and lead times are both promising indicators of a healthier industry.

Nevertheless, we're geared up to drive through this period with very strong product momentum, with a steady hand on our R&D investments, and with a tight, tight grip on our costs.

Now let me turn it over to Greg for more details on the financial side.

Thanks, Mike.

And good morning, everyone.

Before I talk about the third quarter results or our guidance for the fourth quarter, I'd like to first summarize how 2006 is shaping up as a strong year for Teradyne, despite the current sharp market correction that Mike has just talked about.

First, if you take our fourth quarter guidance and add it to our first three quarters results of 2006, you'll see that 2006 is on track to be one of our highest years of profits.

This is significant in that the 2006 SOC test buy rate is expected to be about 1.9%, which we believe is a normal buy rate.

We've designed a business model that can earn healthy returns at a normal industry buy rate.

Next, 2006 is also on course to be a year with very strong free cash flow.

In the third quarter alone, our free cash flow, which is our cash flow from operations after deducting capital additions totaled $108 million.

This surpassed our last quarterly free cash flow record which was that of the second quarter of 2006.

So it's not just our expenses that have been sized differently, we have significantly altered the capital needed to grow and manage our business.

For example, with half the inventory needed at like sales levels.

Next our third quarter gross margin of 48.8% is as high as it has ever been on like sales volumes.

And we continue to further lower material costs, which should serve as a hedge against possible future aggressive competitive pricing.

As to growth, 2006 is also on course to be a year of strong design win performance and market share momentum in semitest.

With plenty of further opportunities to expand beyond our 1,000 FLEX installations at customers.

In our non-semitest businesses,we've had steady growth overall and good bottom line improvement.

Rest assured, we're committing -- we're committed to making sure that these businesses stay healthy, both over the short and the long-term.

Now, in addition to all of this, we will also be taking our quarterly break-even revenue targets down from the $250 to $260 million range we previously announced for 2006 to a range of 240 to 250 million in 2007.

You'll remember that we have defined our quarterly operating break even as the amount of quarterly revenue needed to break even at the PBIT line and this excludes stock based compensation and any specials such as restructuring costs or gains on the sale of real estate.

Now, let me take you through some of the details of the third quarter and then get to the guidance for the fourth quarter.

Our sales in the third quarter of 359 million were down 8.3% from the previous quarter and 22.3% above the level a year ago.

Our non-GAAP earnings per share from continuing operations for the third quarter totaled $0.24 per diluted share.

On a GAAP basis, we achieved $0.33 per diluted share.

Our non-GAAP results exclude gains from the sale of real estate, offset to a lesser extent by employee severance charges as well as a tax benefit from the sale of TCS.

A reconciliation of the GAAP to non-GAAP results is provided in our earnings release.

Our third quarter gross margin percentage was 48.8% of sales, down a percentage point from 49.3% in the prior quarter due to lower volume and offset in part by a slightly favorable product mix.

R&D expenses were 53.3 million or 14.8% of sales as compared to 53.6 million or 13.7% of sales in the second quarter of 2006.

SG&A expenses were 71.8 million or 20.0% of sales as compared to 75.6 million or 19.3% of sales in the second quarter.

This decrease was due to an insurance recovery related to a second quarter loss of spare parts in Taiwan due to a fire at a third party site.

As we commented last quarter, we reported a $2 million charge in the second quarter for this fire loss.

In the third quarter we were able to recover this $2 million charge.

Restructuring and other was a net credit of 15.1 for the quarter and has been detailed in our earnings release.

Our net interest income was 8.9 million, up from 8.2 million in the prior quarter.

This was due primarily to higher cash balances.

Our income tax rate was 9.8 million in third quarter, reflecting a tax rate of 13%.

Our quarter ending head count was about 4,300 people, including approximately 3,885 regular employees.

Year-over-year our regular head count is down 8% from 4,200 to 3,900 while sales are up 22% from 294 million to 359 million.

Third quarter semitest sales were 79% of the total, assembly test 12%, and other tests 9%.

On a geographic basis, our third quarter sales in descending percentage order broke down as follows.

U.S. was 22.5%, Southeast Asia 17.5, Japan 17.1, Europe 13.5, Taiwan 12.2, Korea 7.8, Singapore 7.0, rest of the world 2.4%.

We had net bookings of 239.2 million in the quarter.

On a quarter-to-quarter basis, our bookings were down 40.8%, semitest was down 43%, assembly test down 12%, and other tests was down 60%.

On a year-over-year basis, total bookings were down 20%, semitest was down 28%, assembly test up 55%, and other tests down 29%.

Our book to bill ratios were 0.67 for the overall Company, 0.64 for semitest, 1.0 for assembly test and 0.44 for other tests.

At the end of the quarter, our backlog stood at 315 million, of which 84% is scheduled to ship within the next 6 months.

This compares to 435 million at the end of the second quarter of which 86% was scheduled to ship within the next 6 months.

On a geographic basis, our bookings for the quarter again in descending percentage order were distributed as follows.

U.S. 31.2%, Southeast Asia 18.6, Europe 15.7, Japan 10.7, Singapore 10.1, Taiwan 6.8, Korea 5.6, and rest of world 1.3%.

Now moving to the balance sheet, we ended the third quarter with cash and marketable securities of $1.147 billion.

This is up 32 million from the 1.115 billion at the end of the second quarter.

This week we retired our remaining convertible debt balance of 261 million.

Last quarter about this time, we announced that we had received board approval to buy back 400 million of our stock over a 2 year period.

As we noted in our release, we repurchased 8.5 million shares at an average price of 12.83 totaling $110 million in the third quarter.

This leaves us with a remaining authorization balance of $290 million coming into the fourth quarter.

In the third quarter, capital additions, net of sales related capital equipment were 24 million, depreciation and amortization for the third quarter was 24 million, including 6.1 of stock based compensation.

Accounts receivable stood at 232 million or 58 days sales outstanding, down from 65 days in the second quarter.

This improvement in days sales outstanding is due principally more to more linear shipments in the quarter.

We ended the quarter with product inventory of 96 million, down 15 million from the end of the second quarter.

This is another new record in inventory turns for Teradyne.

In the fourth quarter of 2006, we expect sale to be between 255 and 275 million with net income per diluted share from continuing operations of between $0.01 and $0.05 per share.

We expect gross margins to run between 55 and -- 45% and 46%, excuse me, R&D should run between 19% and 20%, SG&A should run between 27% and 28%.

SG&A will have higher costs in the fourth quarter due to transition expenses from the increased outsourcing of IT and the consolidation of our real estate into the our North Reading campus.

We expect to be about flat in inventory dollars and accounts receivable to decline about 40 million.

In addition we expect to spend 25 million or less on capital.

In the fourth quarter, our depreciation and amortization should be around 23 million, including about 6 million of stock based compensation.

Our tax expense in the fourth quarter, is expected to be about 1.5 million.

Now, in summary, we had the highest quarterly free cash flow of record in our history of 108 million of third quarter.

Our new business model is also delivering attractive gross margins. 2006 is shaping up to be one of our most profitable years, and that is with a normal buy rate of about 1.9%.

We plan to lower our quarterly break even revenue targets down further in 2007.

Overall, our model is in good shape and not in need of disruptive change.

We are very focused on getting to our model of 15% PCIT, or process cycle, which as commented in our last call requires some SOC test share gains from our current position.

Now I'll turn it back over to Tom.

Thanks, Greg.

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

Certainly. [OPERATOR INSTRUCTIONS] And your first question comes from David Duley with Merriman.

Congratulations on a nice operational quarter.

Couple questions.

What would be your target for cash flow in the fourth quarter?

Cash flow in the fourth quarter, we'd expect we'd probably have about 20, 25 million of cash flow.

Okay.

And could you remind us last time you talked about kind of peak to trough orders being sharply down.

What was that decline from peak to trough and how would you compare it to what you expect this time?

It was, Dave, it was about 70% down in the '04 cycle from the -- from peak to trough this time.

I'm talking about semitest now.

And so this is less than that.

The peak of course, was also less.

So if you look at any calculations of peak whether it's buy rate or actual bookings, that was lower.

So about 40%, 43% this quarter and it was about 70% in the last cycle.

Okay.

And would you expect this to kind of be the end of this particular decline I guess is kind of what my probing is about?

We don't know for sure.

The things that argue that the market in favor of the market being able to make the quick adjustments is the whole issue around lead times.

And with short lead times, customers can make faster and faster corrections.

So, you know, the logical conclusion is that when the adjustment takes place, it likely takes place all at once.

But I'm not predicting , have we hit the exact bottom.

But I am saying that the market characteristics and the supplier capability allows our customers to move much more rapidly.

Okay.

One final thing from me is you mentioned some share gains that would be required.

Could you maybe review what you meant by that?

Yes.

Our model takes, first of all into account, how big's the end market, semiconductor market, what's the range of buy rates that that market can support?

And therefore how's our break even set up and do we need additional revenue, additional market share to be able to get to our end objective.

If you take the total market and not take it just this year.

This year's a -- it's a $3.4 billion semitest market.

What we did is we said let's take last year and this year.

Let me say one thing quickly first.

This year's buy rate for 2006, as I said before, is equal to the 4-year average.

So it's not an overheated year.

It certainly was a little high in the front end, 2.1%, but that's adjusting down quickly.

So anyway, quick math is that would give you a market this year in 3.4.

If we take last year's market and add it together, divide it by two, for those of you who would want to say well last year was slightly low and this year was slightly high.

You get 6 billion, that's a $3 billion market.

We've got about a third of that.

Our model, and therefore 250 million a quarter.

Quick math.

We need about 275 million q quarter to hit, in semitest, our target model.

So we need 10% more in share than we have.

We've got about a third, we need about 3 points more.

Okay.

Thank you, that was very helpful.

Your next question comes from Gary Hsueh with CIBC World Market.

Hey, folks.

Thanks for taking my questions.

Just a quick basic question here.

You talked about a crash diet in semitest spending.

It looks like you're getting it in September with bookings down to 239, but you're guiding December 255 to 275.

Now, are you seeing an uptick in orders in December?

I know you don't talk about orders, but in this case, are you seeing an uptick in order in December supporting a higher revenue level?

Or is there something else going on here?

We're running the revenue plan against the slot plan we've got.

And the short-term demand is obviously it's very, very cloudy at this point.

Most of our customers aren't getting visibility from their customers.

So it's as cloudy as it could be.

So we take what's our backlog and in our backlog most of the business is for very, very urgent delivery.

And then we have some short-term visibility that customers are saying they are likely to need slots.

And we put that all together and that gives us our revenue plan.

Okay.

Just to help me out, what's your backlog number at the end of September?

Is it around 515?

315.

315.

315.

Okay, and my last question is about your commentary on subcon test spending being more rational.

You talked on a percentage basis where we are, on absolute level, where is semicon -- where is -- actually subcon test spending relative to the prior chop in the second half of '04?

Are we at those kind of levels or we still got a little bit to go here?

We're exactly -- exactly -- we are very, very comparable to the levels of subcon bookings at the trough of '04.

So we're running at much higher percent utilization rates, so that's pretty encouraging.

Is that the right interpretation?

I think that's what the subcons would say to you.

Okay.

Great.

Thank you.

Your next question comes from Chris Blansett with JP Morgan.

Hi guys, thanks.

I wanted to kind of get an idea what the quality of your backlog's looking like.

Wanted to see if you were getting a drop off in some of the lower gross margin, older platforms.

Two questions embedded in there.

The quality of the backlog in terms of is it secure, it's been very, very solid.

And that's all part of what I was talking about before in short lead times.

And the bias is towards early delivery versus delayed delivery.

So we're seeing very, very little of shuffling backward in the slot plan.

People want things quickly.

Now quality in term -- or mix, I should say, of backlog, I don't have how the backlog is broken down.

But I'll tell you that on a bookings basis, the -- we're above 90% now in FLEX and J750 bookings.

In the last year if you take those two combined, that's over 1,000 systems.

And so right now we've really got a -- virtually -- essentially a double barrel here with FLEX and 750.

The legacy products of Catalyst, Tiger, A5, et cetera, all of those are single digits now.

And then --

Booking percent.

So would you expect that this would be the last big wave of purchases for that -- those type equipment platforms?

Let me tell you how we're playing it.

I think that's a fair speculation.

We'll see spot buying.

You know there's so many customers and it's the capacity utilization on those products.

So there'll always be some spot buying.

We'll be at above 90% in FLEX and 750 going forward, probably above 95%.

There'll be some spot buying going forward.

Our plan is, and we're working with all of our legacy customers, is to finalize our system level shipments of the legacy products, Catalyst and Tiger, somewhere around the middle part of next year.

Past that point, we'll continue to sell options, upgrades, and so on into those systems.

So there'll be a long life of those systems in the field and we'll obviously support them out well past multiple years from now.

But in from a system level basis, if you told -- asked me today what are we expecting, we think the demand for system level -- for systems will be extinguished by time we get to the middle part of next year.

Okay, just a couple real quick.

Your pro forma tax rate, do you guys have a number?

Yes.

You could use 15%.

15%.

And then in general, how are -- how are sales looking for your IP750s right now?

I wasn't sure if there's been a drop off based on possible expectation of a inventory build in that area for devices?

Well, the image sensor segment has been very strong.

And it's been one of the -- if you said what are the top 5 segments, we break the SOC market down into many pieces.

It's been very strong.

But it goes up and down because it's an IDM driven business and there's big tooling moves.

If goes up and down.

But it has stayed as one of the top 4, 3 to 5 segments all through this year.

All right.

Thanks a lot guys, I appreciate it.

Yes.

Your next question comes from James Covello with Goldman Sachs.

Good morning, guys, thanks so much.

I apologize, I had to hop off for a second.

So if someone asked this just let me know, we can cover it off line.

But the updated plans in the memory space at this point?

On new products?

Yes.

Well, we're silent on any development programs there.

What we've said in the past is what still the case and that is if we enter an adjacent market to SOC, we look for two things, discontinuity that we can take advantage of, number one.

And number two, we look for leverage of our SOC platforms.

That's still where we are.

I guess if I can follow up on that.

I mean, I think it's safe to say that this upturn kind of came and went maybe without as much profitability as you had been hoping for.

Does that make you more or less inclined to seek adjacent markets?

Well, on the first question, it is actually -- of course we would like the cycle to go on longer.

But as we exit 2006, with a normal buy rate, then even though it feels like a peak period, it's really not an over buying environment.

So I'd look at it and say for a -- on the trend line of CapEx, I think the performance has been very, very good.

Well, if I -- I hate to be picky.

But you're earned $0.83 in 2006, or $0.85, let's take the mid-point of your guidance, that's lower than 3 other years that you had.

So just in terms, defining cycles is how much you earn as opposed to buy rates, which are kind of arbitrary and maybe secularly heading down.

Just defining it based on how much you earned, this is lower than 3 other years of earnings and now we're heading into a downturn, by your own words, where you're not going to earn anywhere near as much.

So again, does the fact that you didn't make as much money in 2006 as you had in 3 other previous upturn years, does that make you more or less likely to get into adjacent markets?

Actually it makes us more likely to keep driving on the expansion of share in the core market rather than thinking that that market can't yield the growth that we have as -- in our objectives.

So that would be number one.

And the adjacency move would be an offensive move, if we do it, with a leveraged engineering strategy rather than move into another segment because we don't think SOC has got the profit pull.

Okay.

Final question.

Does the lack of profitability in the upturn, relative to previous cycles, does that change your views on consolidation in the industry at all?

Thanks a lot.

This is Greg.

I'll answer that.

At some price consolidation is interesting.

But there's been no fundamental change in valuations of companies that would cause us to think differently.

And we like our organic share gain plan.

It has been yielding and we think that is the best way to hit our model and return value to shareholders.

In terms of your other comment, Jim, this is going to be a very good year for Teradyne.

If I take out TCS in the past and look back over various periods of time in terms of profit, percentages or profit dollars, it does stand up there with some of the best years.

I think it's a good year for the Company and I think the other thing to keep in mind is the free cash flow and the Company never had a model that could throw off so much cash as we are now.

So, I might be a little bit more positive on the business model.

Let me -- okay let me ask a question on it then.

Is the idea, again I don't want to get wrapped up in semantics, but isn't the idea to make more in each cycle as opposed to making less in each cycle?

I guess I would think that you would be happy if the earnings were higher in this cycle than they had been in previous cycles.

Yes, but if you're looking back to a 2000 cycle, I'm not going to compare to that cycle.

I'm not looking at the 2000 cycle, I'm going back a lot further than that and saying there were years in the past where you earned, go back to 1995 where you earned -- made $0.97.

You only need to ask one.

I'm looking at profit percentages and profit dollars.

Maybe when you come up and visit us, we should go through all this in a more organized way.

Okay.

Thanks.

Your next question comes from Timothy Arcuri with Citigroup.

Hi guys, actually this is kind of related to what Jim was talking about.

But your business is primarily a chip unit business.

And if I look at your orders and I look at ship units, your semitest orders were down 48% '04 to '00, chip units were up 20%. '06 to '04 your orders were down 20%, chip units are up 25%.

It just seems like arguably the growth business isn't even positive, it's actually negative.

And I'm looking at your cross cycle EPS, this cycle you earned about $0.50 over the cycle.

So when I look at the stock, up here 7% today at $14, you have $0.50 of cross cycle earnings and you have about $5 in cash.

It doesn't argue for a lot of up side for the stock from here.

So I guess I'm trying to look big picture.

It seems like you have to kind of shake things up here a little bit to really cause meaningful appreciation in the stock.

So, from a strategic perspective, do you think that that's kind of a meaningful analysis?

This is Greg, I'll take the first part of that one.

I don't share the $0.50 calculation you've arrived at.

At -- think -- I look -- think at it many different ways on how to get there.

But let me just give you one way possibly to think about it.

Is you looked at this year 2006, 2006 the EPS, I guess is somewhere in the $0.80 for this year, which I accept that.

Well, sure, I'm just looking at your peak earnings quarter was $0.39 and your trial earnings quarter was going to be break even or even negative.

So you take $0.15 to $0.20 across the cycle, it's not a whole lot better than $0.50.

I'm trying to -- so you agree that this fourth quarter period is $0.80 (spkr said 80 something cents).

And them to get about to your $0.50, I guess you'd be saying the next four quarters are about $0.20.

So 80 plus 20 is a $1 divided by two is $0.50.

And just don't think that the next four quarters, even the next five quarters, we'll say fourth quarter 0, the next 5 quarter is -- adds up to $0.20, that seems a bit conservative to me.

I might be wrong, but that's how it feels to me sitting here now.

Okay.

Well regardless of how we calculate the cross cycle number is, I think the point is that with the stock at $14,and whether you $0.50 or $0.60 or $0.70 in cross cycle earnings, it isn't $1 like I think many people thought that it was going to be.

So, when you take that -- right now you have lots of cash, cash is about 35% of the market cap, when you think strategically about the test business going forward at about how it grows and might not even grow, in fact at all, are you considering radical moves to get into some of the new technologies that might be eating away at the test business.

Because you're sitting there with all this cash and you didn't earn nearly as much as I think many bulls thought you might have.

Yes, Tim, we believe that the SOC segment in our position in it gives us the best foundation for earnings growth because of the strategic position, because of the investment rate that's required, because of the -- even because of the volatility in the market, which strains all players.

So that's the foundation element that is going to give us the earnings growth, the largest piece of the earnings growth.

Now, do we think that we can move into other markets?

And the answer to that is yes.

And that would be first of all into segments within SOC that we're not currently playing in and then potentially to leverage technology into other test segments over time.

So we're considerably more bullish on the prospects there over the next 3, 4, 5 years.

And don't have the view that the buy rate that this market as semiconductors go up that this market is going to stay flat or actually decrease.

And you know in post-2000, I think that was a reasonable rate.

But today there's been four years of CapEx rates that have been just under 2%.

Okay.

I guess just kind of a last point there.

So it sounds like from a bigger picture perspective that you're going to focus on the test business in the next couple of years.

You would do that before you would consider getting into probe cards or some technology that maybe even in fact eating away at the overall test business.

We look at it that if there is enabling technology that we can get leverage from, it certainly is a candidate to augment or product portfolio.

All right guys, thanks.

Your next question comes from Tom Diffely with Merrill Lynch.

Yes, good morning.

You talked about the utilization rates at the subcons being down 5, 6 points?

What is at IDMs and what's the relative utilization rate between the two?

Hang on a second and we'll get it.

It's trending similar to what we've said in past quarters, which is IDMs are higher than subcons.

The slope of both is comparable.

This 5% or 6%, which is an outside monitor on utilizations says that the IDMs are -- and subcons are comparably down.

What's it for us?

For us IDMs are about 7 or 8 percentage points higher than subcons at this point.

And that's about the same as it was last quarter.

Okay.

And if we do see a bounce back over the next couple of quarters, do you think it first comes from the IDMs or the subcons?

The subcons are -- turn harder, so it probably moves back up. but the leading indicator that you'd look for is that the subcons make a sharper move.

That's what I look for.

All right.

And then finally, have you seen any changes in the competitive market with the IPO of Verigy?

Not really.

The pricing is pretty much as expected?

The competition, the account work that we do, the head to head battles, nothing has really changed in that respect.

Okay.

All right.

Thank you.

Your next question comes from Gavin Duffy with A.G. Edwards.

Yes, thanks, can you guys hear me okay?

Yes.

Just a couple questions.

One, with the pull backs being so quickly -- happening so quickly, are you worried about any excess test capacity?

I know at the end of last quarter, that wasn't really an issue, but what about with the pull back now?

Well, that's why we watch this utilization rate.

If that starts moving down dramatically, then obviously that's where you worry about test capacity.

But the amount of buying on the up stroke here was less and so there's less worry in the market.

Obviously, if chip production goes down then conservatism moves in and there's a -- that's when things tighten down for a while.

So you're saying, there's probably -- there might be some excess capacity but it's not as bad it was say in the '04 cycle?

If you look at utilization trends, that's what you'd deduce at this point.

Okay.

And just a second question.

You're talking about inventory turns being at record levels, but you're also talking about customers wanting things immediately, how do you guys remain flexible in keeping your own inventory levels kind of appropriate with what you think customers are going to order?

This is Greg.

I'll take that one.

We with our FLEX and J750 products redesigned the entire manufacturing inventory model.

We have everything outside of our subcontractors and we've actually worked with them to reduce their lead times, how long it takes them to bring a part or a board to a state where they can ship it to us.

So we get basically a completed unit from them.

And we do final configuration tests at our site and there's boards that we have there that we will put in into the system depending on what the customer requires.

So it's an operation that takes less than 60 hours and you compare that to multiple weeks in the past.

So it's a very lean manufacturing process and we have glass pipelines back to our suppliers, weekly, daily feeds in terms of our requirements.

So it's a fairly tight system.

And it's an area that we think frankly is in very good shape.

All right.

I appreciate it, thank you.

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

Thanks.

On the getting to the lower break even in 2007, can you tell us what you have to do to get there and any sort of time frame?

Sure, Mark.

This is Greg again.

Some of it will come from -- we're doing a more full outsourcing of our IT.

We have outsourced part of IT, but now we're putting all of it out, essentially, or 80% of it out.

So, as that gets completed and the transition costs come down, we'll see those savings.

So some of that could show up in Q1, some Q2.

There's also facilities as you may have heard, we consolidated.

Now there's also a list of 10 other items.

So, I think what you'd find is in SG&A over a three quarter period, you'd be seeing us come down and hitting those targets.

Okay.

And then just a question here on the opportunities outside of your core base here, you said that you'd look for discontinuities.

When you look in the memory market at this point, DRAM and plash testers, see any of those discontinuities coming up that you could exploit?

There are some potential ones in the architecture of next generation memories that we're looking at.

And is there technology internally in terms of the platform you have at this point that would fit there?

Yes, the FLEX, high-end FLEX performance has some attributes that may be relevant in the future memory architectures, that's what we're looking at.

Okay.

Thank you.

Your next question comes from Dave Egan with Lehman Brothers.

Hey, guys.

I have a -- not to beat a dead horse here, but on the questions of profitability, I have kind of a different take on this from some of the other guys, but I am highly focused on profitability.

What seems to us here is that to increase the profitability, you do definitely need to go deeper and get higher penetration within the segments that you're in otherwise your cost structure is too high and I was wondering if you could talk a little bit about that.

Because in the break even, you're talking about lowering the break even, it's very much infrastructure related but not necessarily looking at the SG&A or R&D levels that you're spending right now.

Well the higher penetration that's required, that was the quick math I went through before is -- represents about a 10% growth in our quarterly revenue, or a 10% growth in our market share, and that's at the -- in the 30% plus range.

So it's about 3 points of market share, $25 million a quarter, 25 systems a quarter.

So, if we look at the trade off between going after that and the cost-cutting to get the same result in the bottom line and combine that with where we are with the product momentum, we're heavily on the side to drive against the increase in share.

We also don't view that this is a market that is going to contract from a buy rate standpoint, such that we're chasing something that's moving away from us.

I concur with you, actually, that the market is growing, the buy rates seem to be fairly stable.

I disagree with some of the other guys on that statement that if you look at it over a long-term.

But, on the other hand, the -- it is much easier to control your cost structure rather than grow into your cost structure and when you look at your profitability per employee, you're at the lower end of the range and it seems like there perhaps are areas where you perhaps are marginally profitable where you could lower the cost and increase the overall profitability of the company, something similar to what KLA-Tencor's doing currently.

I think some of the numbers you might be looking at.

If we have about 1,100 people in service, so I don't know if you're picking up on that high head count in service, which is in fact quite a profitable business.

But I think the real issue is to do what you say would be a significant change to engineering programs that are each very promising and have customers waiting for these instruments to be completed.

So we see that it is a line of sight that we see that this is achievable and to disrupt the engineering organization with a significant cut, because to get there by cutting, it can be done, but you would dramatically change the PLA.

Dave, I think your other question may be getting at would we be better off if we lopped off and just focused on niches where the profitability was the highest and lopped off business segments that might be lagging in profitability because of the competitive nature of the market?

I don't actually want to get you to, I know I've had a conversation with Tom about niches versus a broad tester and you guys are definitely a broad tester, but there probably are market segments where they're less profitable, and if the end of this conversation right today is you're going to tell us that okay by this time period we're going to know that we were successful in entering these markets and we're going to get that share or not.

And if not, we're going to take action to fix the situation, I can live with that.

But that's kind of what we need to hear.

Well, that's -- that's our growth plan over the next couple of years is to be able to get a point or two each year.

And we're on track this year to gain some -- couple of points of share.

And we think that we're on the right trajectory.

Okay.

Thank you.

Your next question comes from Mona Eraiba with TCW.

Yes, could you discuss the market share gain and if you are able to penetrate somewhat the hand sets related markets with all the volume coming at the low end? the integrated DSC chip sets for hand sets?

Well, the market share gains in SOC tests come through a socket by socket progress.

And we participate in hand set SOC devices.

Those devices are moving to higher levels of integration.

So in fact, they're moving towards us in the complexity of the devices that the market is developing.

Obviously there are segments that are very, very cost sensitive, whether they're in hand sets or in microcontrollers, variety of segments consumer-driven segments are cost sensitive.

And that's the -- that's at the heart of the product line now.

There's a very, very high emphasis on both configurability of product to get high utilization and the second attribute is high parallel test and both the FLEX and the 750 have parallel tests as a main architectural element of the system.

But no specifics when -- that you would share with us.

I heard some stories that your development partner with PI with their [INAUDIBLE - heavy accent] integrated chip sets?

I can't comment on individual customers in any of the development work we're doing with them.

Okay, thanks.

Yes.

Your next question comes from Patrick Ho with Stifel Nicolaus.

Thanks a lot.

Just a quick modeling question first, maybe for Greg.

With the convertible debt going away, should we also assume that the interest income line will go up over the next few quarters?

It's probably a very marginal impact because we lose the interest income on the cash we had that we used to pay off the debt.

So I'd assume that the net interest is about the same.

Okay.

And what would share count be for next quarter?

Share count into next quarter in terms of EPS or in terms of end of the balance sheet period?

More for the EPS.

Okay.

It would be 190 -- 191 million.

191.

Right.

And one question for Mike.

In terms of your customers, what have they been telling you?

Have you seen, any, I guess changes over the last few weeks or over the last month or so between the subcons or the IDMs?

Have you noticed any trends from either customer base that gives you a confidence one way or the other?

Well, actually it's been for a few months now that the pull back has occurred.

We talked in our last conference call at the end of the second quarter, we had seen considerable softening and that's across subcons and IDMs.

The caution is high, their visibility is low.

And there's nothing that we've seen in the last few weeks.

Obviously there are anecdotes up and down in this whole picture, but from a trend standpoint, there's nothing in the last few weeks that's changed, Patrick.

Thank you.

Your next question comes from Mehdi Hosseini of Friedman, Billings, Ramsley

Thank you for taking my question.

One rather clarification, especially with the previous caller's comment.

Greg, isn't it fair that 2006 earning is lower than the prior three years because you divested the TCS business?

When we look at our earnings, we look at it two ways.

We look at it on a GAAP basis, which takes TCS out of the picture.

And we look at our PBIT without the interest that we got from TCS.

And when we look at our PBIT without the interest from TCS, okay, and without TCS in the P&L.

So that's how we've been looking at it in that respect.

Sure.

But in terms of comparison, it may be -- it may not be right to just look at the P&L and compare this year's earning to previous year's earning.

If you did it with TCS in it, you would still find that our profit percent at Teradyne this year is going to be one of our higher years.

Look past to the 10 years, Mehdi, and look where our profit percent will be.

It will be one of the highest in the past 10 years and profit dollars.

Got it.

And then a question for Mike.

I'm sorry.

Go ahead.

Question for Mike.

Do you see any technology related operating the SOC market in the next year or two?

Or is spending patterns are primarily driven by capacity buys?

Well, in every market, actually, there are technology changes occuring.

If you said in image sensors, higher -- higher speed is an access which is cutting across many of the technology segments.

Higher parallelism in RF applications is another area.

So if you looked inside our R&D portfolio, you would see the next generation of instruments all targeting on a variety of axes of performance improvements.

It's not just working on the throughput of the parallelism to get an economic advantage.

There's a series of performance attributes in every instrument area.

Got it.

And then one more question.

Given what's left in the buy back program, can you share with me -- can you share with me what's your strategy is and would it be assumed that you're going to be incremented and more aggressive?

I think the strategy will be consistent with what you saw in the prior quarter.

But with only 250 million left, should we assume that you're going to revisit the total budget and increase it?

It's 290 left, Mehdi.

Yes, 290.

So, if depending where the price is, we will buy more if it's lower, less if it starts moving up.

So we have a grid.

So if the price moves like it did last quarter, we'll probably buy the exact same dollar amount.

Will you -- I'm sorry -- were you buying earlier today?

Yes.

We're buying the black out period.

We put together a plan which we could do that.

Sure.

Thank you.

Okay.

Luanne, we'll take one more question.

Okay, sir, your final question comes from Steven Pelayo with HFCC.

Yeah, if I could just follow on Mehdi's question there.

I think he was getting at what after this authorization.

I think if you spend the whole 290 plus you pay off your debt you're still going to have, oh about 650 million in cash.

If I look at Teradyne in the past, you guys had more product lines, you lost money during downturns, you're doing half the inventory turns and yet you guys can run with 300 million in cash.

So, do we really need that much?

And what are you thinking beyond this 290 that you have authorized?

I think that's a fair question.

As we work our way through the 400, we will certainly reconsider what else may make sense at that time.

All right and the last question.

I don't know if I heard the head count numbers, did you guys say those?

Yes. 3,885.

3,885.

Excellent.

Thanks, guys.

Thank you.

That will be all, I think, Luanne.

Mike, you want to close or not?

Sure, I think the -- obviously the correction is a real one.

It is a steep correction as has been noted in this conversation.

While we observe that it is not as steep as the '04 cycle, that actually to us is not the most defining characteristic.

The issue for us is over the cycle profitability and performance.

So we're not focusing on what exactly the trough is.

We're more focused on the break even structure of the Company, the market share momentum, and the gaining of share in the SOC space as the foundation for the future.

We have very good progress on our market share trajectory this year based on our design ends.

And we're holding the line on costs and as Greg said we're going to make more improvements in that in '07.

So, obviously everyone in the market's going to be fighting through this correction period.

We think we're stronger today than we've ever been to do that.

Thanks, everybody for your calling in today.

We'll talk to you next quarter.

This concludes today's Teradyne third quarter earnings conference call.

You may now disconnect.