泰瑞達 (TER) 2010 Q3 法說會逐字稿

Good morning, my name is Thea, and I will be your conference Operator today.

At this time I would like to welcome everyone to the quarter three 2010 earnings release 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.

At this time I would like to turn the conference over to Mr.

Andrew Blanchard.

Sir, you may begin.

Thank you, Thea.

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 details of our performance for the third quarter of 2010, as well as our outlook for the fourth quarter.

First I'd like to address several administrative issues.

The press release containing our most recent financial results was sent via business wire out last evening.

Copies are available on our Web site or by calling Teradyne's Corporate Relations office at 978-370-2221.

This call is being simultaneously webcast at Teradyne.com.

Note that during this call we're providing slides on the website that may be helpful to you in following the discussion.

To view them, simply access the investor page of the site and click on the Live Webcast icon.

In addition, replays of this call will be available via the investors page of Teradyne.com about 24 hours after the call ends.

The replays will be available along with the slides through the 14th of November.

The matters that we discuss today will include forward-looking statements that involve risk factors that could cause Teradyne's results to differ materially from management's current expectations.

We encourage you to review the Safe Harbor statement contained in the earnings release as well as our most recent SEC filings for a complete description.

Additionally those forward-looking statements are made as of today and we take no obligation to update them as a result of developments occurring after this call.

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

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

To view them go to the Investor page 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 Piper Jaffray TMP conference in New York on November 10, Sidoti and Company's Emerging Growth Forum in New York on November the 16th, Credit Suisse's annual technology conference in Phoenix on December 1st and 2nd, and Barclays technology conference on December 9th in San Francisco.

And finally Eric May luncheons in Chicago in November, and New York and Boston in December.

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

First our CEO Mike Bradley will review the state of the Company and the industry in the third quarter and will review our outlook for the fourth quarter.

Then our CFO Greg Beecher will provide more details on our quarterly financial performance along with our guidance for the fourth quarter.

We'll then answer your questions.

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

Mike?

Good morning, everyone.

Thanks for being with us again today.

Our results in the third quarter speak for themselves, so I won't go into detail there other than to say we've posted record numbers and are quite pleased with how the financial results reflect the overall strength of the Company.

We're a significantly different operation from a few years back with a richer product portfolio, stronger market share position, a very efficient cost structure and a solid balance sheet.

Add to that the upside of our growth initiatives and we believe that the picture going forward is quite promising.

And so I will let Greg go through how our business model is performing as well as our cash strategy and the cash calendar.

But I would like to focus my remarks this morning first on what is happening in the test market in the short run; second how we expect our full-year results to play out; and, third, what we expect over a longer horizon.

The most obvious short term issue is the sharp correction in demand we've seen in this past quarter in the SOC space.

Although memory orders were up slightly, our SOC test orders declined 47%, led by a OSAT pullback of $120 million.

As I've mentioned in the past, our industry's annual run rate was over $3 billion, which is above the trend line, so this correction isn't unexpected.

For 2010 the SOC market will now likely come in a $2.6 billion to to $2.7 billion or double the market size in 2009.

But will likely exit the year at an annualized ship rate of about about $2 billion.

So it's been a sharp correction down to a level below the average market size of the past few cycles.

I would note that we'll be operating in Q4 at about model profitability in this correction, roughly ten points higher than in prior cycles and so our structural work of the last couple of years should stand up well.

Equally important is our continued progress on market share.

While the overall overall SOC market will double in 2010 we'll grow by nearly 2.5 times.

This will lift our share position to somewhere between 45% and 50% for the year.

This is obviously a bigger gain than in the last few years, so it deserves some comment.

There are three things happening here.

First, we've been focused on high growth end markets like smartphones, automotive electronics and consumer white goods.

These markets are growing faster than other end market segments like personal computers, netbooks or low-end cell phones.

Second the test content in these products has a tight fit to our instrument portfolio and system architectures, most notably our power management and wireless instrumentation plus our micro controller test capability.

As an example of how that plays out, we capture about 50% of the test seconds in a typical tablet, versus only 15% of the test seconds in a netbook.

And, third, designed for test methods are implemented more heavily in digitally dominant chips like PC processors, with the rest of reducing the test buy rate in these segments versus the mixed signal technologies in the consumer, automotive and industrial spaces where the test market continues to grow.

The bottom line is that our FLEX and Eagle products have tapped into the growing demand for mobile, energy efficient ICs that are at the heart of this new wave of consumer products.

So the share gains you've seen from us in the last few years are real, they are hard won, of course, socket by socket.

And, of course, we don't win every battle but our cumulative performance has been undeniable.

Shifting now to memory, you will see on a table on our website that memory test demand is inching up but remains well below prior cycle peaks.

In that environment we had a small increase in our bookings in Q3, up to $27 million, and will continue to ship at about $30 million in the fourth quarter.

More significant is our continued progress on strategic design wins.

This past quarter we won new business in DDR-3 wafer sort testing with our Magnum II test system from Nextest.

This is a new beachhead for the Magnum and represents another avenue for growth in high volume, high parallel wafer probe applications.

Having said that, the memory growth story continues to be tied to fab expansion plans for next year.

But we're increasingly well positioned with the UltraFLEX and Magnum products in that space.

Turning now to systems test, we nearly doubled our bookings with nearly $91 million in orders for the quarter.

This was led by our defense business and our hard disk drive products.

You'll recall that these sectors were lagging earlier this year and so the resurgence in those groups plus some continued strength in commercial board test has improved the overall systems test outlook.

And so the overall picture is a correction in the SOC test market back below the trend line as companies digest the new capacity put in place earlier this year, but continued growth going forward in semiconductor industry units and revenue projections driven principally by next-generation smartphones, automotive electronics and mobile connectivity products.

All of this bodes well for the long-term semi-test outlook.

In summary, we'll have one of the highest revenue years in our history in 2010.

We'll have our highest profit rate ever this year due to steady cost controls and market share leverage.

And our performance will compare well to the lead companies in the overall industry, and will stand out in the test sector.

So, independent of how this correction plays out, we're positioned well for future over the cycle performance, both in our core and in new markets.

Now I'll turn this over to Greg for an in-depth review of the financials.

Thanks, Mike.

And good morning, everyone.

I'd like to touch upon some of the key highlights before I get into the details of our third quarter results and fourth quarter guidance.

I'll also update you on our model and on our cash plans.

Starting with the third quarter recap, we posted sales of $502 million, with a non-GAAP operating profit rate of 32.8%, and EPS of $0.82.

This was our highest non-GAAP operating profit rate in history, eclipsing the 32% rate set just last quarter.

For the fourth quarter, we're expecting sales to be between $300 million to $325 million, with non-GAAP EPS of $0.21 to $0.28.

This would be put us on course for full-year sales of $1.6 billion, with non-GAAP EPS of $2.05 to $2.12, which would top our prior annual EPS record.

It would also put us on course to achieve our highest full-year operating profit rate in history at approximately 27%, and will likely be our first year of operating above our model, 15% profit target for each quarter.

One shorthand way to show how we've modeled the Company for improved over the cycle performance is to combine 2009 and 2010 and compare this two-year period with similar two-year periods.

We've done that on our supporting slides on our website, and you can see that we're on course to generate just over 16% non-GAAP operating profit over the 2009-10 period.

This is at least 10 points better than the 2007-2008 combined period, or the 2005-2006 combined period.

You would also have to go back very far in the archives to find a year where the SOC test market was as low as $1.3 billion, as it was in 2009, or averaging about $2 billion over this two-year period.

So this is by no means an easy comparison.

Perhaps, though, more important than our strong over the cycle earnings performance is our free cash flow generation per share.

Our 2010 free cash flow is expected to be approximately approximately $430 million, plus or minus $15 million.

Using our non-GAAP diluted shares, this amounts to about about $2.20 per diluted share.

This would significantly exceed our past record of $1.21 per diluted share in 1999.

This would also be a new record for free cash flow yield at about 20%.

This past upturn was extraordinary.

Our revenue grew from $121 million in the first quarter of 2009 to just over $500 million this past quarter.

In the third quarter just ended Eagle and Nextest were the standouts, each topping their past high watermarks in revenue.

We grew faster than our peers as our SOC test market share expanded from about 41% in 2009 to an estimated 50% through the first nine months of 2010.

The reason for the significant share-gain is twofold.

We have high-market share in faster growing markets and we've also gained considerable share across all products on a socket by socket basis.

Moving now to the demand side, semi-test demand fell sharply in the quarter.

OSAT bookings were only $47 million, the lowest level since the first quarter of 2009.

Customers are clearly in a digestion phase, which overall is healthy.

On the other side of the bookings ledger, systems test group had record bookings.

This was primarily due to strong bookings for hard disk drive and defense test systems.

While we're expecting a significant drop in sequential sales for the total Company of about $190 million in the fourth quarter, we expect to be operating at model profitability.

We've pulled the only lever we need to in a slowdown, which is to adjust our inventory pipeline.

As sales decline, we expect our costs to come down, similar to how they rose as the vast majority of our quarterly cost growth was in variable compensation.

I should add that these variable costs are spread over the respective performance periods which range from a year to six months, and this can cause some bumpiness in quarterly costs.

We'll also have some bumpiness in engineering as we incur NREs or from time to time invest slightly more to capture additional growth.

Stepping back for a moment.

The macro economic environment and our customer sentiment is nothing like what we saw at the end of 2008.

It feels much more like what we saw in late 2004.

While we cannot call what is around the corner, whatever unfolds we're clearly in a much stronger position than at any time in our past with our much improved model and strong product lineup.

Moving next to cash.

In our last conference call I said that we intended to go a full cycle and then update you on our plans.

But given the strength of the operating model, we now plan to move this update into our next conference call, as we are currently reviewing our cash requirements and alternative uses of cash.

What I can say now is that we intend to maintain sufficient cash resources for our worldwide operations under both very harsh operating environments and periods of fast growth.

We'll also maintain sufficient cash for attractive M&A that is close to our core capabilities and exceeds our cost of capital.

As you know, over the last five years we've returned just over $500 million through stock buybacks when we had excess capital and invested about $530 million in aggregate in Eagle Test and Nextest when we determined we could earn more than our cost of capital with those acquisitions.

We believe this will be other attractive acquisitions close to our core of smaller size to these two acquisitions.

Before I move onto the details of the quarter, I want to clarify our non-GAAP EPS calculation, as there has been some confusion.

You may recall that when we issued the convert we entered into a call overlay to reduce dilution.

We bought a call on 34.7 million of our shares, matching the number of shares embedded in the convert at the convert exercise price of $5.48.

We also sold a want at $7.67 for the same number of shares, 34.7 million, which helped offset the cost of the call.

These two instruments essentially moved the dilution from our convert from $5.48 a share to $7.67 a share.

In our non-GAAP EPS calculation we include our call option at $5.48.

GAAP, however, does not include our call option in the EPS calculation.

Rather, it recognizes only the dilutive components which is the embedded option in the convert at $5.48 and the warrant we sold at $7.67.

Sorry for the long-winded explanation but I thought it was important to explain why we make this adjustment.

On the balance sheet we ended the third quarter with gross and marketable securities of $899 million.

Our net cash after deducting the $190 million face amount of convertible debt due in 2014 and the $9 million loan in Japan is $700 million.

We expect to add approximately $100 million in the fourth quarter to our cash balances.

I should add that we also contributed $45 million to our frozen US pension plan to fully fund it in 2010, and we don't expect a need to make any significant future contributions.

As at the end of the third quarter, our US carry forward net operating losses total about $240 million, and we have federal tax credits of about $55 million.

The third quarter top line of $502 million was up $47 million from the second quarter.

Semi-test was $448 million, up $35 million.

And System's Test Group was $54 million, up $12 million.

Semi-test product shipments increased 10% from a quarter ago and tenfold from the trough in 2009, (inaudible) $205 million Service revenue was $66 million, up $2 million from a quarter ago.

Semi-test service revenue was $48 million.

Total Company product turns business was 18% versus 29% a quarter ago.

Semi-test turns business was 18% versus 29% a quarter ago.

Memory revenue was $29 million in the quarter, up from $21 million sequentially.

Moving on to P&L, gross margins decreased from 55.9% in the second quarter to 54.9% in the third quarter, due to lower sales of written down inventory, higher obsolescence charges, and less favorable product mix.

R&D expenses were $50.1 million, or 10% of sales, compared to $50.4 million, or 11.1% of sales in the second quarter.

SG&A expenses were at $61.1 million or 12.2% of sales, compared to $58.3 million or 12.8% of sales in the second quarter.

Operating expenses of $111.2 million were up $2.5 million from the second quarter, due to variable compensation, offset somewhat by savings elsewhere.

On a year-over-year basis, operating expenses were up $27 million, of which $22 million is variable compensation and $5 million is from the restoration of temporary pay cuts.

We've obviously kept a very firm hand on fixed costs.

Our net non-GAAP interest and other expense was $1.4 million.

Taxes were $6.7 million in the quarter and benefited from the full-year rate adjustment to 6%.

In the third quarter, Semiconductor Test sales were 89% of the total and Systems Test Group was 11%.

Our book-to-bill ratio for the second quarter (sic) was 0.7 for the overall Company, 0.58 for Semiconductor Test and 1.7 for Systems Test Group.

At the end of quarter, our backlog stood at $482 million, of which 79% is scheduled to ship and be recognized as revenue within the next six months.

Cash flow from operations totaled $237 million after capital additions.

Depreciation and amortization for the third quarter was $32 million.

Including $8 million of stock-based compensation, $7 million for acquired and tangible asset amortization and $2.7 million for (inaudible) of the GAAP imputed debt discount.

As noted in our press release, sales for the fourth quarter are expected to be between $300 million and $325 million, and a non-GAAP EPS range is $0.21 to $0.28 on 198 million diluted shares.

I should add that this guidance excludes the amortization of acquired intangibles and the noncash imputed interest on the convertible debt.

Our gap EPS range is $0.14 to $0.20.

The operating profit rate at the midpoint of our fourth quarter guidance is about 16%.

Now moving to the P&L percentages in the fourth quarter, we expect gross margins to be 49% to 50%.

R&D should be 16% to 15%.

And SG&A should be 18% to 17%.

I should quickly add that we're in model in the fourth quarter when you adjust for mix.

Non-GAAP net interest expense is expected to be about $1.7 million.

The taxable provision should be about $3 million.

In summary, our over the cycle model is clearly delivering, we're well positioned in good markets and our products are winning.

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

Thanks, Greg.

Thea, we would now like to take some questions.

(Operator Instructions).

The first question will come from Timothy Arcuri with Citigroup.

Hi, guys, a couple of things.

If you look at what is going on with back end tester orders and you look at how strong front end orders still are, there is obviously a pretty big digestion happening at the OSAT levels, but foundries continue to really order lots of equipment.

I get that there's this copper/gold issue in the bonding world but is there something different going on in the tester world this time?

Why the OSATs would be digesting so much tester capacity, and yet front end owners have not really come down that much?

I'm just wondering in your business is there something different this time that is causing them to digest orders more than they would in the front end?

Tim, I know that you've covered the correlations between front and back end.

We're a little bit more focused on back end and on units because that is what drives our business.

And, of course, there is a lead time difference between different types of equipment.

But I don't think, if you looked at the pattern here, even though it is a big drop, it's not that different from some of the past cycles, if you look back at 2006 or 2007 parts where the OSATs look to move down.

And aside from the real meltdown of '09, late '08, they dropped down into the $40-ish million level of demand.

And so for us, it is dramatic but it isn't a different pattern.

I don't know how to speculate on the front end.

I'll let the front end companies do that.

But from our perspective, it's quite a drop, but it's not an unusual one in a business like ours that has such short lead times now.

Yes, got it.

It just seems very odd.

Okay.

And then last thing for me is that you are going to have roughly $800 million, it sounds like, at the end of the year, cash.

And I'm wondering, two questions embedded in this, first of all, what is the minimum cash that you think that you need to run the business?

So what is the excess cash balance in there?

And two, am I correct in interpreting your comments that it sounds like you are going to take whatever extra cash that is and you are more looking at maybe some strategic M&A with that cash?

Thanks.

We're looking at this topic very carefully now, Tim.

There's a range that we're looking at now.

It will be higher than where we were last time, how we thought about cash, but it will likely be short of $1 billion.

But there's some set of numbers that we're going to land on before long and then make sure we get that reviewed and we stress test it a bit.

And so we're in that process.

And we think by the next conference call we can be much more crisp in terms of how we think about the use of cash.

And, we do also believe that there are some attractive, very close to our core opportunities, not in test but some other very close adjacencies that could be a good fit if the evaluation stars align.

And at a point like this where we think our valuation is low we would be more inclined to use cash.

So we are going to keep a reasonable amount of cash for some attractive acquisitions, as well.

But, again, next call we can be much more specific as to how we thought about it.

Got it, guys, appreciate it.

The next question will come from Krish Sankar from Bank of America, Merrill Lynch.

Thanks for taking my question, I had a couple of them.

Number one, Mike, if you look at your slowdown in Q4, clearly there is a huge dilution going on but in a normal cycle the OSATs do not tend to have a huge appetite in calendar Q1.

Is there any reason to think that this is going to be different this time around?

In other words would this weakness continue into Q1?

Krish, I do not think it is just OSATs.

The seasonal pattern now is the big quarters are Q2 and Q3, if you were in a normal period where you weren't correcting from a prior downturn.

The point that I would make is that this move down moves the market into about a $500 million a quarter arena, which runs at $2 billion.

And then you have to add to that, is there seasonality that tends to be a little bit softer in Q4 and Q1.

And so I do think that the betting man wouldn't say that this has a sharp move up in the winter months.

Having said that, I think we're at a level where the market is below this trend line that it's been at in terms of annual demand.

How it distributes over the quarters though, I think that I would say that your picture is probably a fair one.

Got it.

And looking into Q4, I know that you guys do not break it out, but if you had to tell directionally which side of your different businesses are going SOC, non DRAM, Eagle, SGD and your other assembly disks, could you just help us out with that?

The mix of shipments in Q4?

Yes, are they all down or is one up versus --

All right.

This is Greg.

Systems Test Group will be up quite significantly in the fourth quarter.

And that in part affects the gross margin guidance we've provided, so Systems Test Group growing.

The Nextest business about flat.

And then our SOC test businesses, including Eagle, would be down.

Got it.

And then final question, what is the mix of IDM and OSAT in the quarter?

Thank you.

Yes.

This quarter in demand, that's 80/20 in Q3.

Last quarter, I think two-thirds, one-third, maybe a little bit less than that, 64/36 I think is what we had last time.

Is that right, Andy?

Yes.

Thanks.

The next question will come from Mehdi Hosseini with Susquehanna International.

Thank you.

A couple of questions going back to your prepared remarks, should I assume that by the next quarterly conference call we would finally hear about a strategic acquisition that you have your eyes on?

This is Greg.

No, I would not assume that.

What I meant to say is that over numerous periods, it may be a three or four year period, there could be opportunistic, attractive M&A situations.

I did not want to imply at all that there is something right in front of us.

Just in our cash planning, we have to have operating cash, we have to have M&A cash, we have to have downturn cash.

And that's the breakout that we just want to be sure that we delineate next quarter at this time how we think about all of those pieces.

Sure.

And two follow-up, first on the memory side, I'm assuming most uptick in booking is in flash, correct?

We don't break it out, Mehdi, and haven't in the last quarters, just because I think it will go up and down.

But we've had a small amount of growth this quarter, bookings at $27 million and the mix between NAND and flash.

I think that there's some speculation going forward as fabs possibly shift more to flash than we would ship with that but we don't break it out.

I was just trying to figure out, nine months ago we were expecting DDR-3 test booking would pick up by now.

It seems like it is not and has continued to push out.

So what is your latest view on that?

And the final question has to to with the hard disk drive.

Most of your customers that have recorded quarterly results have talked about continued weakness, so would you attribute this uptick in bookings to share gain or is that just your customers buying in anticipation of pickup next year?

Okay.

The picture on DDR-3, I think I'd agree with you that the amount of buying on the DDR-3 final tests end has been less.

That chart on our website that you will see today reflects the overall demand in memory.

And it's inched its way up over the course of the last four quarters, so that the run rate in memory is annualized about $700 million a year.

So a piece of that shortfall between that and the past is that the back end and the DDR-3 buying has not been very, very strong.

I think I mentioned, I want to just comment, that that's why opening up the probe side, the wafer test side, of the DDR-3 space is important to us.

It is not a lot of volume at this point but it does open up really the last segment, if you think about it, in the memory space for us.

On the HDD side, as we've mentioned in prior calls, the capacity adds this year were pushed from the first half of the year into the second half.

We're seeing that now and we've built some backlog up in that business that will ship into 2011.

So there's been a shift in capacity adds in that space and we've felt that shift.

Now, our position in hard disk drive is pretty much consistent with what we said last quarter, and that is that we expanded our product coverage from mobile drives, 2.5-inch drives, to enterprise drives.

And at the same time we're getting a beachhead at a second customer.

So as we look into next year, our objective is to be able to put all of that together, and the objective is to double our business from the $40 million to $60 million annual run rate to twice that.

So that would be share gains.

Thanks so much.

The next question will come from Gary Hsueh with Oppenheimer & Co.

Yes, great, thanks.

Just a quick question here from a macro perspective.

You brought up the analogy with 2004 but if you look at 2004, there was a similar sharp correction but it came from, A, much higher test strip buy rate levels, and, B, much higher days based inventory levels for chip units.

And yet, in this correction we're coming off of a much lower tester buy rate and lower inventory levels.

Just wondering if you could share, first of all, what you think the tester buy rate is on SOC testers in Q3 and just what the reset level is in terms of stabilization in Q4 and Q1.

It has consistently been around 1%, and I'm just wondering if you see any obvious reasons why it should be any lower than 1% in this mid-cycle correction?

Gary, we're a little more sensitive to the annual run rate, because we build the Company around this mid-cycle performance.

I don't even know if I've got the quarterly buy rates on it but the annual rate through this year, we're eyeing that to be in the 1.4% level which is about what it was in 2008.

2007 was 1.5%.

And so that number, I think, is probably going to be pretty good for 2010, incorporating this correction, Q3 correction, which we think others will feel, as well.

And so is your question what is that going to look like going forward?

Yes.

Going forward in a typical correction you bounce around and stabilize at 1%.

Is there any sort of near-term cyclical reason why it's going to go below 1%, anything from a technology or product perspective that would lead you to believe that they can drive more efficiency out of testers this time and drive that bounce below 1%?

I don't think so.

But I wouldn't be disturbed if it goes below 1% for a short period of time.

I think that our picture is that this recovers and gets back.on, what prognosticators are projecting here is a $200 billion SOC IC market.

So, taking different buy rates against that, even 1% would give you a $2 billion market.

So I think the range of steady state market, it probably falls in the $2.2 billion to $2.6 billion range.

Okay.

And just more of a near-term question, a clarification.

You said that there was a $120 million pullback in orders from OSATs.

Is that pullback a pushout or is that pullback a cancellation?

And was that cancellation booked against gross orders that you reported in Q3?

No.

It was a drop in bookings.

The cancellations in the quarter were still very, very low.

We haven't had, for some time now, including the Q3 bookings picture, a writeoff, take off the books orders.

I think we've operated at around 1% or below 1% on an ongoing basis.

And this quarter wasn't very different from that.

I think we're about 1% in cancellations.

So even though our lead times have gone out, the backlog has not been populated with double ordering, as far as we can see.

And I think, as you go into fourth quarter we would have seen that by now.

And so anything that occurred here has been in the nature of a pushout, and we did have, we have had had some of that, but it is not an overwhelming number.

But I think that if you looked at our backlog, you would see that there's some amount of shipments that are into the first quarter.

We might want to explain that a little bit more if there is a question on that front but, anyway, that is the picture.

Okay.

Let me just ask the question then, what percentage of that $482 million backlog is shippable over the next six months?

That is a good question.

Hang on, Greg's got it.

That was in my prepared remarks, I think it was 79%.

Let me comment on backlog.

In our backlog, in our Systems Test Group business there's about $100 million of backlog that will ship post the fourth quarter.

And why that is, is in our mil-aero business we do book demand if it is a funded program up to a year.

Our other product businesses we'll only book orders that are scheduled to ship within six months.

So there's the mil-aero business that extends over a year.

There was also some hard disk drive business that got booked, that has longer lead times.

Some of that will ship into Q1.

So when you add up what is going on in Systems Test Group you end up with $100 million that is going to ship outside of the fourth quarter.

The other thing is, I'm sure that you understand service, we get contracts and it is recognized quite often over a number of quarter, four quarters, and that is about $40 million to $50 million.

Those are the two big pieces in our backlog that are not due to be recognized in the fourth quarter.

Okay.

And just to wrap up my line of questioning, real quickly here on the HDD Neptune orders, in Q3, you are seeming to intimate that they are related to a new application on the enterprise HDD side.

What is the expectation for revenue recognition across those orders?

We said earlier that we thought that this year would be $40 million to $60 million for HDD, with our principle focus on one customer and having broken into a second.

We will be in that range.

Very heavily skewed towards the fourth quarter.

Some in the third.

And so that goal will be met.

And we think that next year, as Mike said, we should be able to double that revenue.

When that revenue hits, that is hard to say.

It tends to be second quarter.

It could be some in the first quarter.

But would I assume some first, some second, maybe a little in third.

But the initial installations have been accepted, which I think is the other part of your question.

Okay, great, thank you.

The next question will come from CJ Muse with Barclays.

Yes, good morning, thank you for taking my question.

First question, in terms of the lead times for your SOC business, is it correct we're now back to normalized six to eight weeks from that 10 to 12 weeks and that played a role here in the downtick on your order book?

Yes.

Okay, so from here we should track to that type of of level?

I think that's right.

You will have little variations on products when there are intra product line spikes but that is a good rule of thumb now.

Okay.

And I know you guys are hesitant to guide on orders, so say what you can say.

But the question is this.

Considering your memory outlook, considering some of the mix shift presumably helping you with HDD doubling in '11, considering the seasonal patterns for test system orders and how that is usually good for Q1, do you sit here and think that Q4 is the order trough or do you think that Q1 is a trough?

CJ,I would reiterate what I was saying before.

I think it's going to be hard to call exactly which quarter, but the rate at which orders are in, and where the revenue on the industry has downshifted pretty dramatically, I think we're pretty close to a sustainable level.

But as I think Chris asked earlier, how would you populate the quarters, a betting man would populate the shipment quarters strongest in the post Q1 period.

That's the profile I would describe.

I think the other thing I want to keep reminding here is that, with the model delivery anywhere up to 10 points of bottom line improvement, it really reinforces that as we have these kinds of adjustments we're not scrambling to disassemble the Company.

We're steady as she goes on the engineering and customer support side.

We've got a decent performance, even at this level.

Okay.

And then on your OpEx model you talked about some R&D projects that are continuing.

I'm curious now how we should think about that incremental move in revenues and the implications for incremental move in OpEx, that $2.5 million to $25 million relationship?

Has that shifted a bit here as we're entering a seasonal weak period?

Right now with R&D it is a couple million higher than where you might expect it to be otherwise.

There's some NREs and some instruments that we are working on to bring to the market, so there's a little bit of a bubble here.

We're looking at what's over the horizon.

Now, on the other side we've done a little bit better on the SG&A, and so the SG&A savings have tended to offset the engineering investments.

We're still overall within our model with a slightly higher engineering spending, but we're going to keep an eye on that and see when is the right time to moderate that a bit.

And is there something we should think about in terms of bonus accruals in Q4 versus Q1 just timing-wise?

That is more of a cash issue.

We're accruing the bonuses through each quarter.

And it can be a little bumpy, I said in my prepared remarks, because some programs are annual and you are accruing based upon a high annual profit rate but maybe the profit rate in the fourth quarter is much lower than the rate that you are accruing at.

So in the fourth quarter you'll have higher variable comp than you would otherwise.

So it is an odd way some of the comp gets spread based upon how GAAP accounting works.

But you see our guidance, it will be a little bumpy and so when you look at quarter to quarter, you just need to be mindful of how costs get allocated on variable.

It is not tied to that quarter's profitability, it is tied to the period of the program.

And one last question for me.

On the memory front, what were the memory revenues in September?

In September they were $29 million.

Perfect, thank you.

The next question will come from Jim Covello with Goldman Sachs.

Thanks so much for taking the question, I appreciate it.

First question, the $100 million that's going to shift outside of Q4, how much again of that did you say would be Q1?

And then what's the margin on that business compared to the corporate average margin?

There's (inaudible) business which is consistent with the corporate average and then there is hard disk which I think we've talked before that it is probably 20 points below.

I don't want to, Jim, break down hard disk drive because we have a thin customer base and so I want to stay away from that.

But when this ships, our cost structure should not change in any significant way.

So if the relationships are off we will be very clear to describe is it margin, were we off and why.

And obviously if a chunk of that lower margin business ships and sales are lower in Q1, we do not know that but if they are then obviously that has a bigger impact on the margin percent, but we're fortunate to have that extra business nonetheless.

Right.

And again how much of that $100 million do you think would be Q1 even if we cannot get the exact breakdown?

I would presume about $30 million.

Okay.

I heard what you said about you think that the NAND test business will be driven by NAND capacity expansion, which makes sense.

We've talked before on these calls about the DDR-3 tests, is that going to be more driven by speed increases or capacity increases or some combination of both?

Where do you think you stand on that?

It is a shading.

I remember your questions from last quarter.

So not to disappoint you with saying the same thing.

It feels to us like it's a bit more connected to capacity than it is to speed.

They are both contributors.

But since there hasn't been that much additional buying in the space, that's indicative that as the speed grades -- as the production of higher speeds goes up, the stretching of the existing install base continues.

So I think that the bigger bump as a betting man will come from capacity adds in the future but it will still be from both sides but slight flavoring in the direction of capacity.

Okay.

And then final question for me on the cash, when you think about the cash that you need to run the business, are you thinking more of gross cash or net cash there?

In other words, are you comfortable carrying some debt sustainably?

Or when you really think about the excess cash in your business, is that really just the net cash?

We look at it both ways, Jim.

We look at it because the convert matures in 2014 and last time we got a convert, the market was shut down six months before.

And so we look at it both ways.

Thanks very much.

The next question will come from David Duley with Steelhead.

Yes.

I noticed you have a long-term deferred revenue and customer advance line item that is fairly substantial now at $81 million, and I also noticed the cash flow entry of $138 million.

Could you just talk about what that is about?

We have more than one customer who has planned buying out in the future.

And as part of a larger contract negotiation we received cash up front.

We've done this in the past, by the way.

If you look back to our balance sheet at the beginning of the year, you will see some large balances there, bigger than prior balance sheets.

And so, customers are earning so little on their cash, they are more willing to part with their cash earlier.

And obviously it gives us a little more flexibility and so it is all part of a multi-period, strategic deal.

And so these will happen now and then.

The cash really is one small element to a bigger deal.

I don't recall you having a longer term one which would imply that customers have given you money beyond a year period of time.

--

It's when does the customer expect to take shipments.

For some of these cash payments, we have not put all of the orders in backlog because we estimate what will they take in the next six months.

And so our backlog is filled with what will ship in six months.

The cash can be greater than that.

And then based upon their plans, we estimate what will be within a a year and post a year.

I think we've had long-term in the past, I'll go back and check but I think we've had a similar circumstance.

Yes.

I just don't recall an $80 million balance there.

And so what that means is that customers have given you advance payments for equipment and they are going to take some of the equipment in the near-term and that is classified as a short term liability, and the stuff beyond six months is classified as a long-term liability?

Yes.

Yes.

It really secures their position in our slot plan.

And how did you book the orders?

For bookings purposes, we only put into our backlog orders that we expected to ship within the next six months, which is much smaller than the total amount of advanced payments we received.

Yes.

So the $81 million long term obviously has not been booked as an order because --

Correct.

You are correct.

Okay.

I just wanted to understand that.

And one other thing.

Historically for Teradyne, isn't it pretty typical for the OSATs business to turn off pretty dramatically if they're facing more than one quarter of sequential decline in revenue or flat revenue?

Yes, they have a faster trigger finger and, as a result, they move down very rapidly.

I didn't go all the way back to 2004 but you would see that in 2006, would you see that in 2007.

It is typically -- and I'm taking "typically" to mean other than end of 2008 -- it is typically done in one or two quarters where that move takes place.

And the baseline number back in 2006 got into the the $40 million range, a little bit higher than that in 2007, and this time it has moved down into the $40 million range.

So while the drop was bigger this time, the hope hope would be that that is the floor.

But, having said that, the kinds of variation that you get in one quarter could be different from that but I think that that is a reasonable pattern.

Okay.

One final thing for me.

Inside your SOC business, as far as the incoming order rates and future revenue projections, were all of the segments weak as the forecast projects or were, let's say, micro controllers strong, or high performance analog?

Any sectors that did hold up in the down draft?

The simplest way to think of it is everything moved down a step so that the strength we've had in the past in the power management, in the RF applications, micro controllers (inaudible).

There's been ups and downs in other places but I think the pattern of that kind of movement would be the way to think about it.

Obviously memory was countered to that, as memory has moved up ever so slightly, but it did it against the headwinds of SOC.

So it has been somewhat positive but the weight class is not high enough at this point.

Okay.

Thanks.

The next question will come from Patrick Ho from Stifel Nicolaus.

Thanks a lot.

I lost a little bit of your commentary right there about the 3Q '10 market trends.

From what I heard it sounded like everything moved down.

Was there anything incremental of a surprise end more than any other?

No.

It was pretty proportional.

I'm looking at it.

The one that was really, very, very strong in the first half of the year, of those three -- power management, wireless and micro controller -- micro controller, even though it wasn't the largest, had the biggest step up.

And that is what drove so many J750 products into the market, over 500 of those over the last few quarters.

So it came down, probably came down a bit more than the others.

But those three segments lead the way.

If you put those altogether, each one of those segments for us is a $200 million plus piece of business.

That's why I was saying at the beginning that, in terms of the market segments that we are riding, we feel very good about the market segment movement and the growth in those segments and our relative position in them.

But they all did move down.

Okay, great.

And just a little bit of color on those trends, did a lot of these downticks happen late in the quarter or was there just a steady progression as the September quarter progressed?

Actually, the first signs of this downtick were August-based, mid-August, because as we were in this call one quarter ago, I commented that the vast majority of the customer interactions were still pulling in.

And as we got into the August time frame, where some regions of the world do go quiet, but the other ones did start to signal this move and they did it through both starting to relax on the slot management holding that they were doing, and then that translated into the bookings going down, and to some amount of pushouts.

The pushouts wasn't nearly as big as the bookings decline.

But it was a mid-August phenomenon.

Okay, great.

Just going to the business model, and I think that there is a lot of resiliency in it now.

How flexible and how fast can you ramp up and down your supply chain to keep the margin profile at these relatively healthy levels?

What are the key levers involved there?

You can look in the rear-view mirror and see what we've been able to do.

We've been able to do from this last quarter was 502, two quarters before that, it was 330.

And the gross margins were very healthy, as high as they've ever been.

So we feel really good about the model and our outsourced manufacturing with our extended partners that are out there working very closely with us.

The issue that you have in all of these ramps which we battled through was material part shortages.

It is never our ability to configure the system and get it to the customer.

It is there are part shortages, and that was in part because 2008 and 2009 was such a nuclear winter, a lot of companies really shut down their operations or moved operations and things had to be requalified.

To give you some magnitude on it, we all remember Q1 of 2009, that was double digits, 40s kind of systems shift.

But in the middle of this ramp from Q1 to Q3 we went from over 350 system units in semiconductor tests shipped to over 650 shipped.

So even with all of these parts and supply line issues we had, with the foot on the gas pedal we were able to really deliver quite a steep ramp.

So we think that we're capable of doing that, we would welcome the opportunity to do it again, obviously.

We were able to do it pretty sharply.

Final question on my end, on the HDD tests, the bookings that you got this quarter, could you just give a little color if that was a single customer or multiple customers?

Can't do it with a breakdown.

The thing I would say, and I think I have probably said this at the last call, I cannot recall, as we move into '11, it will tend to be a multiple customer environment.

While it is already multiple customers it is imbalanced at this point, but in '11 it will be multiple applications and customers.

Thanks a lot.

And, Thea, we have time for just one more call, please.

Yes, the final question will come from Atif Malik from Morgan Stanley.

Hi, thanks for squeezing me in, as always.

If I look at the semiconductor commentary this quarter, smartphones, tablets really strong.

Texas Instruments recently talked about analog and micro controller weakness.

So were there any share loss issues, or your smartphones is weaker and that's making the revenue decline or the bookings decline a lot sharper than most expected?

Atif, I will say something that is probably politically incorrect and that is that there are always wins and losses and that is why we look at the net gain position.

But in all of the skirmishes, there's always some that we're able to prevail on and there's always some that leak away from us.

The monitor on this thing is the market share shift.

Now I think this year, what is important about this year, because it is a dramatically different share growth picture, there are two or three components.

There is the design-in net win situation.

If you said that we went from the low 40s to the high 40s, about a third of that is just straight net gains from the wins and loss side of it.

The second piece is sometimes customers buy more than other customers do, and so there is maybe a temporary phenomenon.

And then the third one is that if you are riding the hot segments, then those segments grow more and then that becomes real share gain over time.

That's why even though the numbers suggest we're at 50%, we take that second piece, the one of asynchronous buying, and put that aside and say that might not go on forever.

But from a real socket win standpoint and form a real sub share in the mobile communications, micro controllers, power management, automotive, in those areas, those share shifts by our customers I think are real and we're on the strong horses there.

And so net-net we are gaining, we have been over the last few years.

The numbers are clear on that front.

And we think this is a unique year because some of the phenomenon in markets that we've been riding are amplifying the socket wins that we've had.

Thanks.

And another one, do you see the analog and micro controller market as $200 million plus next year, or do you think this year was a catch-up year?

This year, as it comes to $2.6 billion or $2.7 billion I think if the market goes back down to $2.2 billion or $2.4 billion then there will be an adjustment down in many segments.

Our view of the long-term growth, if you thought about it in terms of what share of testers would these market segments command, we think that the gaining segments, mobile and RF, we think goes from where it is in the teens now, high teens to the low 20s.

We think that micro controller and automotive go from high single digits, maybe 9%, up almost to the mid-teens, 14%.

Those two together we think take about 8 points of the market that they didn't have before.

At the same time, micro processors and graphics and chipsets, we think those, because of the high digital content are more susceptible to structural tests, DFT techniques.

And so that compression, we think that pushes that segment from what already is today high teens, 18-ish percent, down into the low teens.

So I don't know what to say exactly next year but I think the way our strategy's lined up, it was to play the trends that I just described.

Okay, thanks.

Okay, folks, we're out of time.

Thank you so much for joining us.

We look forward to talking to you in the coming weeks and we'll see you next time on this call.

Thank you.

Ladies and gentlemen, thank you for participating in today's conference call.

You may now disconnect.