泰瑞達 (TER) 2008 Q2 法說會逐字稿

Good morning.

My name is Kate, and I will be your conference operator today.

At this time, I would like to welcome everyone to the quarter two 2008 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.

Tom Newman, you may begin your conference.

Thanks, Kate, and 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 second quarter of 2008, as well as our outlook for the third quarter.

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

The press release containing our most recent financial results was sent out by a business wire yesterday evening.

Copies are available on our website or by calling Teradyne's corporate relations office at 978-370-2221.

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

Note that during this call we are providing some slides on our website that will be summarized, and that reinforce some of the highlights.

They may be helpful to you in following the discussion.

To view them, simply access the investor portion of our site, and click on live webcasts, followed by click here for webcast.

In addition, replays of this call will be available starting around noon today eastern time.

The phone replay number in the US and Canada is 800-642-1687.

Outside the US and Canada the number is 706-645-9291.

The pass code for both numbers is 12340.

A web replay will also be available.

You'll find it by going to www.teradyne.com and clicking on investors.

The replay will be available along with the slides through the seventh of August.

The matters that we discuss today may include forward-looking statements about events, or the future financial performance of the company.

Such statements involve risks and uncertainties.

Actual results can differ materially from such forward-looking statements.

Some of those risks and uncertainties other detailed in our press release, and our filings with the SEC.

Additionally those forward-looking statements including guidance, are made as of today, and we do not take any obligation to update them.

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

During today's call we will make reference to non-GAAP financial measures.

We have posted additional information concerning these non-GAAP financial measures, including a reconciliation to the most directly comparable GAAP financial measure where available on our website.

To view them, go to the investor portion of our website, and click on the GAAP to non-GAAP reconciliation link.

Also you may want to note that between now and our next conference call, Teradyne will be participating in the Morgan Stanley Midwest Semi and Semi Cap Day in Chicago on August 26, and Citigroup's 15th Annual Global Tech Conference in New York, on September 2 through 4.

Now let's go down the rest of the agenda.

First our CEO and president Mike Bradley will review the state of the company and the industry, in the second quarter 2008, and we'll review our outlook for the third quarter of 2008.

Then our Vice President, Treasurer and CFO, Greg Beecher, will provide more details of our financial performance in the second quarter, and on our guidance for the third quarter 2008.

We will then answer your questions.

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

Mike.

Thanks, Tom.

Good morning, everyone.

Thank you for joining us today.

Let me give you the conclusions first, then I'd like to expand a bit on what's contained in our Q2 results, and in our projections for this next quarter.

Plus I'd like to also give you an update on our longer term strategy.

First of all, we're making steady bottom line progress as reflected on our second quarter results, and third quarter guidance.

Second, we're on plan with our new product roll-outs, in our SOC test business after a very good first half.

Third, our memory test business is making good headway with its new product roll-outs as well, but its not seeing any significant amount of capacity buy.

And finally, we're on pace to meet our end of year break even target of $250 million or less.

We're not immune to the headwinds in the general economy but our ties to many of our customers' new product programs, and continued socket wins, have driven our progress this year.

Greg will go through the financials shortly, but you can see that from the fourth quarter of last year to this coming quarter, our steady work on a cost and productivity side of the equation continues to have an impact on the bottom line.

Now let me spend a few minutes on our SOC new product progress this year, as that's the centerpiece of our 2008 plan.

If you remember, we've got five new products where we're shooting to get $150 million to $200 million in business this year.

As planned, we about doubled our new product orders in this last quarter, so we're more than halfway to that goal.

The big story in this area for us, is wireless.

We just completed the strongest six-month order period for wireless configurations in our history.

Demand for our 12 gigahertz Ultra Wave subsystem is growing rapidly, and this is buttressed by continued strong buying of our high [vot] fourth generation product.

In the RF segment where we have more than 50% market share, we have nearly doubled our bookings in the first half of this year, versus the second half of 2007.

I think we'll see continued adoption as the Ultra Wave instrument is coupled with some of the other new products and subsystems that we have launched, such as our high density version of the UltraFLEX.

I should note that although total SOC bookings were flat, system demand, that is non-service bookings, climbed 8% sequentially after 14% sequential growth last quarter.

This was driven in addition to the surge in wireless, by power management, consumer, and base band segments.

OSAT demand grew over 35% sequentially, while specifier buying dropped just under 30%, resulting in OSATs accounting for about 55% for our demand this quarter, up from 40% in Q1.

So in total the appetite for our products has continued to grow through the second quarter, despite a pretty harsh economic climate.

There are some soft spots, of course.

Some driven by weaker end markets and others by cyclical supply and demand patterns.

We have seen a sequential decline in the image sensor area and in micro controller applications.

Tied to normal lumpy demand patterns.

In addition, the LCD driver space has overcapacity, so we're not seeing volume buying there, in spite a very strong qualification activity.

But the overall new product order rate has been quite good for us in the first half.

Finally, we're closing in on the 2000 system mark on FLEX products and will likely break through that mark in the next few months.

Similar we expect to get to the 3000 mark for the J750 products by year end.

I mention this only to reinforce the ongoing strength of these products in the market.

Now, you can see from our $20 million lower guidance range for Q3, that we're pulling in our horns somewhat in the short term, in both our SOC and memory applications.

This obviously reflects the near end caution that we're hearing from customers, with a very flexible supply line, we can move this up or down of course, but the very close in indicators from customers are increasingly on the side of caution, and close monitoring of their capacity needs.

Let me give you a few words on the memory side.

There's good news on the new product front, and not so good news on overall market demand, that I know you're all aware of.

You've probably seen our recent announcement of the Magnum II product.

This product incorporates higher frequency, and enhanced redundancy analysis, there by broadening our test capabilities for advanced flash technologies, and other applications like multi-chip packages.

We have a number of installations in place now with full customer acceptance, and expect those to broaden in the months ahead.

The Magnum II development was one of the lynch pins in convincing us that Nextest could expand its share of market, and gain share long term.

The product gives us access to multi-chip package tests where NAND, DRAM, and controller functions can now be tested in a single pass.

We're very pleased with the momentum of the Magnum line, and we've made important inroads this last quarter in Taiwan and Korea.

The overall memory test market has dropped by 50% or more in recent quarters, so we'll be shipping at a slightly reduced revenue level in the third quarter, held back by this overall market decline.

Now in our system test business, it's a somewhat similar story, but with revenue projections about flat from Q2.

Our Mil/Aero results remain solid, and we've seen increased in circuit test demand from PC, server, notebook, and telecomm test applications.

Automotive test is in a lull, due to a dip in program buying.

We're likely to see softness in the automotive sector for the next six months or so, so we're counting on good performance from the MIl/Aero business.

As I'm sure you know, our customers' forecast visibility remains extremely short range.

Our revenue guidance is set by our backlog plus a very short demand horizon.

Over that horizon it's difficult to predict.

Since much of our energy focuses on our customers' new products, I'm confident that we'll continue to make headway in competitive shoot outs, and strengthen our position in the market.

Now, the longer-term picture for us remains very promising.

In addition to the TAM expansion and memory driven by Nextest, we intend to enlarge our presence in memory test next year, for high speed test applications.

In addition we're exploring a potential new adjacency in hard disk drive testing, which has the promise of technology leverage from some of our other businesses.

I can't comment further on these areas but will certainly do so when they have secured a customer beachhead, and are expected to make a meaningful bottom line contribution.

So our growth strategy continues to unfold in a consistent way.

First, to enlarge our SOC core through steady market share gains, in that $2.5 billion to $3 billion market.

Second, to enter the flash market through Nextest, then expand our served market and testing more complex memory architectures with our next generation platform from Nextest.

Third, to leverage our SOC technology into the high speed memory space.

And fourth, to venture into test segments outside our core, such as hard disk drive testing, that have market scale, and where we can bring unique solutions based upon our enabling technology.

All of this expands our serve market by over a billion dollars, by this time next year.

Now let me turn it over to Greg for some further explanations on the financials.

Greg.

Thanks, Mike.

Good morning, everyone.

I plan on covering three main subjects in our call today.

First, is an update of our progress and achieving model profitability by year-end at mid cycle revenue.

Next provide some color on our second quarter results, and lastly, I'll provide some details around our third quarter guidance.

First, how are we doing in achieving 15% model profitability by year-end at mid cycle revenue?

The short answer is that we're on plan.

We remain on track in lowering our quarterly operating break even level, as well as achieving our new product grow out goals.

As Mike has already covered the new product momentum, I'll focus my comments on the cost side of the ledger.

As you'll recall, we described that we would get our quarterly operating break even level to $250 million or lower, by the end of 2008.

This would fully offset the $20 million a quarter break even increase from the addition of Nextest, and what amount to just over three percentage points at the operating income line.

So where do we stand against this commitment?

At the halfway point in 2008 we have about two-thirds of this $20 million reduction behind us, and are on plan to get the full amount by year-end.

The final one-third improvement will show up in engineering, and in gross margins.

In engineering the savings will come from the completion of engineering projects, higher levels of modular reuse, and improved development processes.

Moving to gross margins, I'm pleased to report that the FLEX outsourcing to Suzhou, China was completed during the past quarter, ahead of schedule.

We're now unique in that our full FLEX manufacturing line from Ford assembly to final configuration and test, is all in one low cost outsource site, which has many benefits, including lower freight cost, less in transit inventory, lower oversight costs, and higher responsiveness.

There are some other smaller contributors across the company to lowering break even, which range from low cost offshoring of some transactional work, to further reducing our real estate footprint.

For modeling purposes what does all this mean using mid cycle revenue against our operating break even levels in the second, third and fourth quarter of this year?

Well, we would be at 13% operating profit in the second quarter, 14% in the third and, of course we'd get to 15% in the fourth quarter.

So we're making good steady progress, while also spending at a much higher level, than in recent years, and developing products for new adjacencies.

These new adjacencies revenue streams are not in our model revenue.

But the costs are in our current engineering spending.

More will be said on this front, when we have customer acceptance of these new products.

Now to the second quarter financial highlights.

Sales were $317.7 million, up 7% from the first quarter, while earnings per share totaled $0.16 on a non-GAAP basis, and $0.06 on a GAAP basis.

Note that our second quarter P&L included a full quarter of Nextest fixed costs, which pulled down the EPS drop-through on the higher second quarter sales.

Gross margins were 48.4% of sales, up from non-GAAP gross margins of 47.7% of sales in the first quarter, due primarily to higher volume.

R&D expenses were $56.2 million or 17.7% of sales, compared to $55.1 million or 18.5% of sales in the first quarter.

The dollar increase resulted from including a full quarter of Nextest engineering spending, versus two months in the first quarter.

Increase in SG&A for a full quarter of Nextest were offset by synergies and other reductions, leaving SG&A essentially flat at $65.5 million or 20.6% of sales, from $65.2 million or 21.9% of sales in the first quarter.

Our net interest and other income was $2.5 million down from $5.1 in the first quarter, due primarily to lower cash balances.

We had $5.9 million of income tax expense for a tax rate of 17% on a non-GAAP basis in the quarter, and our quarter ending head count was approximately 3600 employees.

In the second quarter semiconductor test sales were 83% of the total, and assistant test group was 17%.

On a geographic basis, our second quarter sales broke down as follows: Asia 57%; US 19%; Japan 11%; Europe 10%; and the rest of the world 3%.

Our book-to-bill ratios for the second quarter was 0.97 for the overall company, 0.99 for semiconductor test, and 0.87 for the system test group.

At the end of the quarter, our backlog stood at $364 million, of which 87% is scheduled to ship within the next six months.

On a geographic basis our bookings for the quarter were distributed as follows: Asia 60%; US 22%; Europe 7%; Japan 10%; and rest of the world 1%.

Now moving to the balance sheet.

We ended the second quarter with cash and marketability securities of $414 million, cash flow from operations after deducting capital additions of $14 million, totaled approximately $19 million.

Since last quarter we used $58 million of cash to repurchase approximately $4.7 million of our shares, at an average price of $12.46.

As we speak our remaining share buy back authorization totals $297 million.

Depreciation and amortization for the second quarter was $31 million, including $5.7 million of stock based compensation, $4.5 million of accelerated depreciation for real estate to be sold, and $4.8 million for intangible amortization.

Accounts receivables stood at $212.5 million or 61 day sales outstanding, an improvement of one day over the prior quarter.

We ended the quarter with product inventory of $118.4 million, an increase of $14 million over the prior quarter, primarily associated with new products.

Sales for the third quarter are expected to be between $290 million and $310 million.

Non-GAAP earnings per share for the third quarter are expected to be between $0.10 and $0.15, excluding amortization for acquired intangibles and special items.

Now turning to the P&L details, we expect gross margins to be between 48% and 49%, R&D should run between 18% and 19%, and SG&A should run between 21% and 22%.

The non-GAAP tax rate for the third quarter, and for the year should be around 20%.

Our longer-term tax rate remains at 28% to 30%.

We expect to end the quarter with diluted share count of 172 million shares.

Stepping back, in summary, we're making steady progress on our financial model, we're lower our operating break even, grinding out more market share gains in our core SOC test market, and we're investing in adjacencies that expand our serve markets at a rate much higher than our recent past.

Our work force is dominated by design and customer support personnel, our supply line is highly optimized, and we're on the offense.

So despite the near term difficult macro economic environment we're facing, we're pleased with our progress, and our longer-term prospects.

Now I'll turn the call back over to Tom.

Thank you, Greg.

Kate, we'd now like to take questions.

(OPERATOR INSTRUCTIONS).

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

And your first question is from Satya Kumar, from Credit Suisse.

Yes, thank you for taking my question.

I was wondering if you could give us the assumptions once again, remind us on the level of product mix for mix cycle revenues?

The product mix would generally be 80% SemiTests and 20% STG.

And what sort of levels are you able to get this 15% operating margins, what is the cycle?

I didn't quite get that full question.

Cycle, dollar level.

Revenue?

It's 340, 345.

340, 345.

As you sort of ramp these new products in SOC, how will that impact the gross margins in the back half of the year?

Part of our path to get to model includes improving gross margins, and the improvement in gross margins comes from both the new products.

They will improve our gross margins, as well as the continuation of the outsourcing which has been completed, and the benefits of the outsourcing now will start to be realized in full force, in the second half of the year.

So the new products are basically not sort of in line with the gross margins, are better, right, current gross margins?

They're generally better.

Okay.

And final question for me is I'm curious about this hard drive opportunity that you're talking about.

How-- can you contrast market (inaudible) opportunity for this, versus the LCD test initiatives, and who are your competitors in the hard drive test market right now, and where do you see you can add value in light of the competition?

You said in comparison to?

To the LCD market, LCD transmarket.

The LCD drivers market?

Yes, the LCD driver market.

Yes.

Well, let's see.

I think there's some significant similarities in the cost drive in both markets, and the need for very high parallelism.

that's an obvious similarity between the two.

At the moment the LCD driver test driver market has overcapacity, so it is not driving any capacity buying, and is only driving qualification work.

The hard disk drive market, which I'll just touch on very briefly, because we don't want to get into what we're doing there with regard to product, but the growth in that market, for this next generation of smaller hard disk drives is significant over the next few years, on the order of 40% compound annual growth.

And we think that drives a market of a few hundred million dollars a year, in total available market, and the capability that we are going to develop, will call upon some of the capabilities and enabling technology that we have in other businesses.

Major competitor in that market, commercial supplier, is [Zyratex].

Thanks.

Your next question is from the line of Timothy Arcuri from Citi.

Hello, guys.

A couple of things.

How much of the $150 million to $200 million that you're saying for new product revenues this year, how much of that cannibalizes current revenue?

Let's see, Tim.

Let me see if I can get it.

There's obviously a chunk of that, that's a conversion.

What we're shooting for is to get about one third of that in for new customers, so that would be share gains of $50 million to, let's say $65 million, is the target.

The rest of it compliments our overall product portfolio.

Put the math all together, the hope is when we do all of that, that we would get a point to two points of share in the SOC core this year.

And Tim, this is Greg.

On the two thirds, we would expect to get more attractive gross margins because we're putting in new technology in place of some technology that is less competitive.

Okay.

So the way to think about that is really, that you're only adding about $50 million to maybe a little more, in flat out new revenue this year?

That's the way to think about it on the new product side.

At the same time, the existing products also have a role, and have a job to do of expanding socket by socket.

So we expect a bit more from that.

The shorthand on this is, if you're trying to gain net gain one point of share, we think you have to get a gross gain of a point and a half, 1/2 because we don't win every contest.

We don't go undefeated, so we've got to win more than the net share that we gain each year.

Okay.

I guess I had a couple more.

So what do you think that that number-- let's say it 50 this year.

What do you think that number is just sheer new revenue next year?

Is it double that, maybe 100?

Haven't done that yet.

Don't know.

Okay.

Next thing, can you give me some sort of breakout in terms of the OpEx, by Semi versus non-Semi me?

Because I guess I've looked at the Semi OpEx and I've talked to Tom about this before, but if you look at the Semi OpEx, it just looks like on the Semi business you're spending a lot more money than peers are, so I'm wondering if you could break that out for me.

This is Greg.

In the second quarter in SemiTests we spent $47 million, this is with Nextest too, this is all SemiTest, $47 million in R&D and $55 million SG&A.

Okay.

That helps.

Great.

And then maybe just two more quick things.

Can you break out the $264 million in SemiTest revenue, can you break out how much of that was memory?

Yes.

The memory in the second quarter was $14 million.

And you think-- and what do you think that will be in-- like what's embedded in your September guidance, from memory?

Likely flat to down a little

Okay, and then last thing.

Isn't there a lawsuit right now, that's pending, relative to your HDTV, your entry into the HDTV market?

Tim, I can't comment on any legal activities around it.

What is out there you can get access to, but I can't make any other comments.

You can comment factually, there is in fact-- you are named in a lawsuit relative to that new product, correct?

On that front, yes.

That is true, and we are going forward with the product.

Okay, thank you.

Your next question is from the line C.J.

Muse, from Lehman Brothers.

Yes, good morning.

Thank you for taking my question.

If I could piggy back on that last question, could you tell us what your core SOC revenues were, as well as what your LCD driver revenues were in the quarter.

We can give you the SOC revenues, in total.

As we said last quarter, we are not breaking out the five product revenue pieces at this point, but do report to you on how we're doing in the overall package of those products.

And on that front, I don't know if I said it, we're about halfway to the objective that we've got this year on the $150 million to $200 million.

So we feel pretty good about the momentum on that front so far.

Okay.

And I guess on the LCD driver part of things, you talked about, you know, excess capacity there.

Have you revenued tools yet?

There is no revenue yet on that product.

Okay.

And then I guess thinking about overall guide for September at the midpoint, running my numbers, I think that suggests roughly SOC down $20 million if you assume that your service holds relatively flat.

Where are you seeing the softness there?

Softness going forward?

Yes, exactly.

One of the-- well, it's a number of places, so it's not one place.

The-- we expect that things will trend down.

We've had a record demand in wireless.

We think that comes down a little bit in the third quarter, base band was very strong.

So those would be two places where we are seeing signals from customers, that they're in a digestion mode.

Memory is down a little bit because the capacity buying is really off.

I think you know the overall memory market quarterly run rate now is 50% or less than its normal rate.

But there's a pretty broad set of places where the demand-- short-term demand I'm talking about, in other words, the visibility we have over the next month or so, appears to us to be off.

So we've-- as I said, we pulled our horns in on ship level across the board in those products.

At the same time we've got some-- remind you the new products are all ramping through this period.

Got it.

And then in terms of your incremental revenues from new products, on the last quarter call you talked about $50 million to $70 million, this call $50 million to $65 million.

Are you changing your thoughts there or is that just, $5 million is not a big deal there?

No, no changing in the thoughts.

Okay.

And then I guess last question here, can you give us an update on the move to wafer tests with your Magnum tool set?

Sure.

As you know, we introduced the Magnum II, higher frequency, more capability for the next generation of NAND parts, and the multi-chip packages.

On the wafer front, as we talked last quarter, we have a very small position on wafer tests with Magnum I and with Magnum II, and that's under 10% of our total business.

So as we look forward, we're expecting that we'll-- that's an available market to us, that hasn't really been developed yet.

This quarter we expanded our customer base with two new customers in Taiwan for wafer probe, so we're expecting that, that rate of penetration into the probe market will expand for us.

We're hoping to get that to about double that level in 2009, north of 20%.

Great.

Thank you.

Your next question is from the line of Mehdi Hosseini from FBR.

Are you there?

Mr.

Hosseini your line is open.

I'll move onto the next question.

Your next question is from Brett Hodess, from Merrill Lynch.

Hello, good morning.

You talked about the resurgence in the OSAT group in the second quarter, the high sequential growth rate, so when we look into the second half and the caution and some of the weakness that you've talked about, does that flow back from the OSAT group or is it mainly in the IDMs, and depending on the mix of those two, how much impact does that have on your margins?

Yes, Bret, definitely the OSAT numbers here have grown dramatically, right.

We're at a high-- eight quarter high in our OSAT demand, so they're into a very, very high digestion phase right now, so we think that has to come down a little bit.

We don't have it broken out in terms of what the expectation around this quarter's demand will be, but a 55%, 45% split with OSAT at 55 is high, so we think that's part of the-- that's definitely a piece of the pull back.

Okay.

And does that help or hurt margins as that piece pulls back?

I think it's neutral to the margins.

I think the margins would not be expected to vary in any significant way based on the customer.

It's more dependent upon the application, versus the end customer.

Okay.

Great.

Thank you.

Your next question is from Bill Ong from American Technology.

Yes, we've been seeing increase on pricing in raw materials and component cost.

Has that impacted your cost of goods, and if so have you been able to pass the cost along to your customer?

The impact to us to date, has been small.

We have ongoing discussions with our suppliers, where we're obviously trying to get them to lower their cost.

They're trying to pass on items you mentioned, as well as currency.

They're supplying from overseas, but net, net, we expect to hit our material cost down target goals this year, so the impact of what you've heard about, has not been significant to Teradyne as of yet.

And, Bill, we typically don't have a cost pass-through.

We just work against value of the product, and try to drive the pricing off that.

That's helpful.

Thanks.

Your next question is from Jim Covello, from Goldman Sachs.

Guys thanks so much for taking the question.

Couple quick things.

As it relates to the memory business, I think SanDisk was about 40% of Nextest's business, and obviously they reported some weak results, and talked about cutting back on their capacity growth.

Should we think about-- kind of use them as a leading indicator for what we could expect for that business, kind of when they start to see better trends that ought to map pretty closely, given that they're already cutting back?

I think that would be fair.

The-- the capacity buying as I said is off.

That's a piece of it.

So that wouldn't be a bad element.

That's why-- our overall memory business hasn't gone down, the level that the overall market has.

So that means that it's new product driven, new applications driven for us.

Having said that, we don't have a large market share in that segment, so we're able to buck the tide a little bit there.

That's helpful.

Then moving over to the SOC, and kind of the competitive environment there, how are you feeling about share and in particular, one of your big competitors is highlighting two pretty significant, orders -- order wins and shipments.

Were those situations that you guys were involved in bidding on, or is that not something that you were interested in?

Let me talk in general about the competitive landscape, versus specific sales situations.

The-- so far through this year, we think we're continuing on a trajectory here of share gains, and we get those-- you know they're not-- they're not all marquee kind of one shot deals, where you get one thing, and say that's accounting for the lions share of the share movement.

We have so many markets that we're in, we get them in smaller pieces.

We have had some important platform wins in the first half, one of those in the automotive space, which I think you're aware of, another one in the ASIC space.

Neither of those has yielded significant revenue to date, so they're really in our future.

But as you look through the first half of the year, we think the market is about a $1.3 billion so far through the first half, and we think we've gained some position on that.

Having said that, market share numbers don't solidify until you get a little bit past the end of the year, but as we count noses, the net effect of our design-ins, wins and losses, puts us slightly ahead of the game for this year.

And our target as I said before is to gain one to two points net, which is what we've done the last three years.

Great, thank you very much.

Your next question is from Gary Hsueh from Oppenheimer.

Hello, thanks for taking my question.

Some things don't quite square with me.

Mike, you basically talked about, LCD driver IC test and the flat panel display business being in oversupply, and it sounded like you were hinting that that could potentially dampen your view on volume buys for your LCD driver IC test product.

If that product is part of the $150 million to $200 million kind of new product revenue stream that you still expect this year, shouldn't that number be-- kind of cut down maybe by $20 million or $30 million so really it's $120 million to $170 million now?

Gary, great question.

The answer is that of the five new products, some are ahead of pace and some are behind pace.

In particular, the wireless new product is ahead of that pace.

We were hoping that that would give us 20% or 25% of that growth.

It's closer to 35% to 40%.

So, some of the new products are lagging because of market conditions.

Others have accelerated dramatically.

Just to give you one-- a bit of a feel for that, we'll ship about 50 Ultra Wave products this quarter.

On top of that, we'll ship one third additional units for internal use.

So the Ultra Wave is well ahead of plan, and that has more than made up for the softness in the LCD space.

That's actually a great explanation.

My second point is just on the inorganic part of that $150 million to $200 million.

You know, with the LCD driver IC kind of diminishing in terms of prospects for volume buys, is most of that $150 million to $200 million now, most of it it seems to me is organic kind of contributions either a replacement cycle, or a share gain.

So is that a right characterization?

Yes, all of that set of products that we're talking about is inside SOC.

And you're right, you could carve out LCD as a place we haven't played in the past.

So all of the other portfolio of products, for example, the new image sensor product, micro-controller product, or the high density version of the UltraFLEX, all of those build on, and fan out from an existing position that we have.

Okay.

Fantastic.

And if I look over the last five years, just doing kind of silly math and averaging the sequential growth rate in Q4 over the last five years, I get something like 12% decline, quarter over quarter in Q4, at the top line.

Anything different this year or this cycle that would make that kind of seasonal down 10% to 15% for Q4, out of the norm this year?

I don't think-- if you were looking out and modeling that way, and I would see why you would do it, I would think that we would have no argument with the fact that the seasonality in this.

I do think that this is a very, very intense utilization push on by our customers, and if you look at our utilization numbers we're actually up in utilization over the last two quarters.

And as I said before, we have been pretty steady, but the curve goes up in the March quarter and the June quarter for us, and to us that's reflective as we look at softening in the third quarter demand, we see unrelenting pressure on the utilization side of it.

So I think that might have some impact on how, the trending has-- will go in 2008.

Having said that, I'm really not speculating about Q4 at this point, because the visibility is so short given lead times.

Okay.

Just wondering if anything stood out like a sore thumb this year, versus any other year.

And last question here for Greg, not sure I caught it, but according to my math, at least on a GAAP basis gross margin came in, 40 basis points above the top end of the range, revenue obviously not at the top end of the range.

You know, what drove sort of a better margin there?

Is it mix or-- ?

The gross margin improvement was largely better mix.

Okay.

And, you know, was-- so mix was a bigger driver for gross margin than cost reduction?

There was cost reduction, but mix was the bigger driver, and what was behind mix was some of the new products.

Okay.

So some of the new products are kicking in, replacing products that have lower, lower margins.

Okay.

Perfect.

Thank you.

Your next question is from Michael [Chou], from JPMorgan.

Thanks for the question.

Could you provide an update on your DDR3 activity, and also maybe help us get a size for the part of the market that you're addressing in particular.

Well, I'm maybe a little bit redundant from what we said in the past, and that is, that all we're going to describe at this point is, that we do have ongoing R&D efforts in the high speed memory space, the DDR3 and beyond space, and we would build on technology that we have in our instrumentation portfolio, in our SOC market, as well as the history of knowledge in the memory business, plus the Nextest input.

So that's the nature of what we would have.

I don't want to get into how we're targeting that market, and what the product attributes are at this point.

But we do intend to build product for the 2009 time frame, in that market segment.

Would you provide us a sense of maybe the size of that market that you're specifically addressing, the high speed portion of the DDR3?

Yes, we think that if you have-- let's take the last few years of market breakdown of let's say close to a $1.5 billion in the memory, overall memory space.

That includes everything, flash, et cetera.

We think this is about one third of that overall market or would be one third of that market when we intersect it.

Okay.

Thank you.

Your next question is from Patrick Ho, from Stifel Nicolaus.

Thanks a lot.

Just following up on that question about the high speed memory market.

In terms of the revenue growth opportunities, I can see where-- the rationale for the entry into that market.

Can you just give your take on what the profitability levels will be like, given how competitive that marketplace is about to become?

I think that's very, very hard to call.

Greg, do you want to talk about how we might model that?

Well, we have-- when you go into a new adjacency, you do need to go in with a product that has differentiation, if we go in with the me too product, it would be brutal.

We believe our product has very distinctive advantages that we are getting validated with key customers.

So if you accept that our product is not a me too, we would expect this to look like SOC test.

In the past the memory market has been highly profitable for largely one dominant supplier, the buy rate has actually been higher there too.

I think what could happen over time is with more competition, the buy rate could come down a little bit, but I would expect the margins would look like they are in SOC test.

Okay.

Great.

As we get closer to that, we'll try to give you better guidance.

I know you have to try to build a model here on this.

That's the best we can say at this point.

No.

That's fair enough.

You know, the gross margins for the overall company obviously held off-- held up pretty well.

Can you just comment on the type of platform leveraging you're getting with the new products, how much commonality, how much of the supply sourcing are you getting, and is that a big contributor to the overall margin profile going forward?

Yes.

On the-- let me just comment on the engineering side of it.

One of the ways that we're reducing our engineering have been, and continue to do, is through a much heavier reuse model than we've had in the past.

We're now at the point where we've got a FLEX product line and a 750 product line, at very, very high volumes in both spaces.

And as you look at our product line architecture road map, a big piece of our productivity improvements there come from the reuse of technology components generation to generation.

Great.

Thanks a lot.

Your next question is from Chris [Sanchar] from Banc of America Securities.

Thanks for taking my question.

I had a question on your mid cycle assumption.

You said 80% of that was coming from Semi.

What is your assumption for the memory dollar contribution.

I remember Nextest used to be in the high teens mid cycle revenue.

Are you guys doing the same thing, or is it different this time around?

For the flash memory as we said in our last call, we are-- our game plan was to get that to $100 million or $25 million a quarter run rate.

Okay.

And in terms of R&D, are there any duplications going on in terms of R&D, i.e., like you have an excess product and you're trying to working on a Teradyne based memory product too, or have you just focused on just one product at this point?

No.

There's very little duplication.

When we combined with Nextest, the obvious thing in this space is, if you have a lot of overlap, you both have to squeeze the overlap out from a cost standpoint, and then rationalize the products for customers.

So Nextest had very little overlap, since they were predominantly driving into the memory space.

Now, going forward, we're clear about where we're headed with the memory product line, and that is that Nextest is expanding in what I'll call the flash or low speed applications, and on the high speed end, that would be a product for next year, and that's built off the FLEX product line.

But there's no contention there, there's no debate.

Okay.

And then if I look at this September guidance, and look at your long-term operating model, which is $345 million and 15% operating margin, it seems like, at that target model they need to probably have like a $120 million in OpEx, and it seems like you're already there, so is it fair enough to assume everything that's going forward to reach the target model, is more top line driven new products and the gross margin upside?

I'm going to say yes, with one exception.

On the OpEx, if we were at model, we would pay out more in profit sharing in variable compensation, so we need to take some more costs out of OpEx, so that when we're at model, our OpEx numbers add up to about $118 million.

So we will do that.

Okay.

But all your other assumptions are accurate.

And then just last question.

Can you-- do you have a number for the market size for HDTV testing?

For that-- for that subset segment?

Yes.

Or is it lumped into a bigger bucket?

It's really into the consumer space.

We don't have it -- we think about what instrumentation we have for that space but, no, we don't have the size for it.

Thank you.

Your next question is from Steven Pelayo from HSBC.

MIke, I'm sorry could you just quantify-- you said Nextest your goal was to get to $100 million-- $14 million this quarter, flattish to down, so is this year kind of looking at more half that rate for 2008?

Is that the right way to look at that?

At the moment if you looked at the prior quarter, they were up higher than the $14 million, but they are 18 last quarter on a full quarter basis, so there's no doubt that significant growth is needed in flash to get them up to that $100 million run rate, but there's a baked ham, and there's plenty of opportunities for them to expand into probe.

But Greg and Steve, I think one of the things that is mixing and matching here is, we're talking in this sentence about memory, and Nextest combined has some SOC business, so Steve, I don't know whether we're confusing you on that.

Okay.

Fair enough.

And then Greg just a quick question for you.

I notice in your 10-Q last quarter you guys are doing 37% gross margins in service, again that's a level we haven't seen in quite a long time.

Is that the new run rate we should be looking at?

We're going to do better than that.

We're going to be in the 40s.

By what time frame?

How about second quarter?

Oh, the current quarter.

Okay.

Great, thank you.

Okay.

Your next question is from Gus Richard from Piper Jaffray.

Thanks for taking my question.

I was hoping you could talk a little bit about, capacity utilization in SOC, and on the flash side.

Is it just-- where do you see that currently, and where do you see it trending over the next couple of quarters?

Don't know over the next couple of quarters, but the trending has been up a few points.

We have said in the past we're operating 80% to 90%, and we've been in that tunnel here for many, many quarters.

That's notched up a couple of points, two to three points over the last two quarters.

And the science of this isn't perfect.

There's not a meter on every system, but the indicators we get, are consistent with the discussions with customers, and they are doing everything possible to squeeze out the capacity, because of the uncertainty in the markets that they are serving.

I don't actually have capacity number-- capacity utilization numbers on the flash side.

We're going to try to get those over the next next couple of quarters, but right now we don't have the same picture on that front.

I do know it's high, by the way, that capacity utilization in our equipment remains quite high.

Okay.

And then just back on the DRR3 market.

It looks like [Halem] the new architecture out of Intel has been full forward in terms of release.

Will that accelerate the transition to DDR, or do you still have to wait for the (inaudible) platform in Q1 of next year?

Gus, it's Tom.

I think we're really going to-- we're gated by the next tier in that food chain, so we've got a list of customers we're working with, and we're going to do our best to try to meet their ramp plans for DDR3, and-- but that's what we're focused on, as opposed to the more macro issue of Intel.

Then let me try it this way.

Your expectation is for DDR3 to start to move into production in a meaningful way in Q1 still?

For the market, yes.

For the market, correct.

Yes, for the market.

Yes.

Okay.

There's been no probation in that in the over last couple of months or weeks?

Not on our end, nope.

All right.

Thank you.

Thanks so much.

Your final question is a follow-up question from Timothy Arcuri from Citi.

A couple of things.

I'm sitting here looking at your model, and I'm looking at you spending roughly 40% of your revenue on OpEx, and I was looking at [Varigy] spends about the same amount, we have the two biggest SOC companies spending 40% of their revenue on OpEx, and their Semi test business.

I guess as you look sustainbly at the business, that doesn't seem like a sustainable number in terms of OpEx.

Do you think that there's still another round of kind of realization that all the companies in the industry have to go through, that maybe the market opportunity is not as big as what the industry thinks, and that it's not sustainable to run at 40% of your revenues for OpEx.

And it's not like we're in a huge downturn right now.

Yes, it's a downturn, but your business has been reasonably okay, and yet you're still spending 40% of your revenue on OpEx?

Let me take the first crack at that.

This is Greg.

A large percentage of our engineering spending, very significant piece, is to get into new markets.

It's not trying to grind out more share in SOC tests.

So that's a very significant portion of our operating expenses in R&D, but stepping back further from your point, I do think, depending upon what the market size ultimately ends up to be down the road, it is certainly possible that there is too much spending.

I wouldn't say that today, but that is a concern, I think, all companies have, and it really ties back to what is the market size.

I think the consolidation moves that are underway are reflective of that, that the high-- that the spend rate to cover the amount of the market, that can give you a decent bottom line return, drives a very significant variety of R&D projects in this space.

And the companies in the market are moving, and have been been moving over the last few years towards being either general purpose suppliers, where that R&D is high, or into niche suppliers where they try to contain it, and narrow it, and just go after a subset of the market.

But I think as you see these consolidation moves, that's an obvious signal that the table stakes are very, very high in this market.

Sure.

I guess, Mike, I'm just thinking about most other sizable markets, and it just seems to have the two biggest players in SOC spending that much of their revenue on OpEx suggests that, yes, there have been some small M&A deals, but it suggests that there has to be even more going forward, because it doesn't seem to me, to be a sustainable model where folks can make money, when there's two big companies spending that much on OpEx, so I guess that was my point.

Yes.

That's a good point.

And then just last thing for me.

Greg, when do you think that you'll switch to your long-term tax rate?

Do you think taxes are going to jump up to the 28% to 30% next year?

I think Q1 2009 we'd likely be using the long-term tax rate.

Okay.

Great.

Thank you.

There are no further questions at this time.

Will there be any closing remarks?

No, Kathy.

I think that-- or Kate, I think that we're fine, and thank everybody for participating.

We'll see you next quarter.

Thanks, everybody.

This concludes today's conference call.

You may now disconnect.