Andrew Blanchard - Teradyne, Inc. Mark E. Jagiela - Teradyne, Inc. Gregory R. Beecher - Teradyne, Inc..

Timothy Arcuri - Cowen & Co. LLC Jagadish K. Iyer - Summit Redstone Partners LLC Farhan Ahmad - Credit Suisse Securities (USA) LLC (Broker) Krish Sankar - Bank of America Merrill Lynch Toshiya Hari - Goldman Sachs & Co. Thomas Robert Diffely - D.A. Davidson & Co. Edwin Mok - Needham & Co. LLC Mehdi Hosseini - Susquehanna International Group C.J.

Muse - Evercore Group LLC Stephen Chin - UBS Securities LLC.

Good morning. My name is Ginger, and I will be your conference operator today. At this time, I would like to welcome everyone to the Teradyne Quarter Three 2016 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. Thank you. Mr.

Andy Blanchard, Vice President of Investor Relations, you may begin your conference..

Thank you, Ginger. Good morning, everyone, and welcome to our discussion of Teradyne's most recent financial results. I'm joined this morning by our CEO, Mark Jagiela; and our Chief Financial Officer, Greg Beecher.

Following our opening remarks, we'll provide details of our performance for the third quarter of 2016 and our outlook for the fourth quarter of this year. The press release containing our third quarter results was issued last evening. We're providing slides on the Investor page of the website that may be helpful to you in following the discussion.

Those slides can be downloaded now or you can follow along live. Replays of this call will be available via the same page after the call ends. 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. 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've posted additional information concerning these non-GAAP financial measures, including reconciliation to the most directly comparable GAAP financial measure, where available, on the Investor page of the website.

Also between now and our next earnings call, Teradyne will be participating in investor conferences hosted by Baird, UBS, Credit Suisse, and Bank of America. Now, let's get on with the rest of the agenda. First, Mark will comment on our recent results and the market conditions as we enter the fourth quarter.

Greg will then offer more details on our quarterly financial results along with our guidance for the fourth quarter. We'll then answer your questions, and this call is scheduled for one hour.

Mark?.

a summary of 2016, an early look at 2017 including an update on the long-term growth drivers of our business, and a brief update on our capital allocation plans. Strong bookings in our third quarter led to shipments above guidance and an increase to our fourth quarter production plans.

At the midpoint of our Q4 guidance, we will exceed $1.7 billion in annual sales at Teradyne and grow non-GAAP earnings per share to $1.40, up from $1.27 last year. As we've moved through 2016, we've seen a continuous strengthening of our Semiconductor Test outlook.

We now see the 2016 SOC market at the high end of our $2.2 billion to $2.4 billion range. In Teradyne's case, a tick up in microcontroller and automotive analog test demand in the third quarter helped drive our Semi Test bookings up 18% over the third quarter of 2015.

This is an encouraging sign as microcontroller and automotive analog test have been weaker than normal for five quarters. While the mobile device market will continue to dominate, we expect it will be supplemented by increasing demand in transportation, automotive, in particular.

For example, over the next few years, millimeter wave radar will move from a niche option on high-end cars to widespread availability across all automotive market segments. Similarly, the connected car and autonomous driving will accelerate the use of cameras, physical sensors, data processors, wireless communication and support ICs.

Complexity growth in mobility devices continues to drive test time increases that have more than offset slowing unit growth.

The consumer benefits of lower power, higher performance and smaller form factor that come with the most advanced lithography nodes and advanced packaging, drive increased test intensity to both weed out defects and tune the performance of these devices.

This increase in test time combined with a plateau in parallelism is buoying (04:22) the test market. In memory test, flash continues to be the largest part of our business but we also saw a nice improvement in DRAM test orders in the quarter as well.

Buying patterns in memory can be lumpy but we expect the market will be about $400 million this year and our share should grow to about 33%. The move to higher speed flash is well under way and we expect the combination of SSD and mobile applications will drive the flash market for the foreseeable future.

We're well positioned in this market with our high-speed Magnum architecture, so we expect this to be a continued source of share gains for us in the future. Year to date through the third quarter, our Semi Test sales were up 10% over the same period last year, a trend we expect to continue through the fourth quarter.

Universal Robots had another strong quarter with sales up 46% from last year's third quarter. Through the first nine months of the year UR sales on a standalone basis are up 67% and we are tracking to exceed our 50% growth target for the full year. We continue to invest in this business as we see a significant potential for long-term growth.

To achieve this, we've increased our quarterly operating expense at UR over 70% in 2016 compared with 2015. We've added talent globally throughout the UR organization, as we put in place the foundation to support this growth. We've opened new regional offices in Japan, Taiwan and South Korea to support our growing base of distributors and end-users.

We continue to expand our base of active distribution partners as well as our average revenue per distributor. While many of these investments will pay dividends next year and beyond, early indicators of the effectiveness of the strategy are positive.

The combination of growing global wage rates, our cobot's ease of deployment and use, expanding applications, a short payback period, and low penetration combined to create a market that has enormous potential.

Growth is driven by expanding the awareness of UR's cobots combined with expanding the distribution capacity to execute the application specific work to deploy our cobot. While manufacturing remains the main opportunity, it's noteworthy that a range of applications with cobots continues to expand.

For example, in the healthcare arena, UR cobot are currently being used for inpatient rehabilitation, assisting with repetitive function movement, as well as a variety of research applications including an innovative laparoscopic surgery project.

Our System Test business also had a strong quarter with order growth in each of the component groups Defense and Aerospace, Production Board Test and Storage Test. System Test continues to do a nice job uncovering new applications for our technology and creating attractive products to serve those needs.

The big step up in orders, our highest quarterly level in over four years, was driven by orders for a new product which we will introduce in 2017 as well as orders Defense and Aerospace customers.

As we noted in our July call the wireless production test market is in a lull as transitions to new Wi-Fi and cellular technologies are at a low point in the cycle. We expect this to persist through 2017 and have resized and refocused our Wireless group on these emerging technologies that will drive the next wave of test investment.

These include 5G cellular millimeter wave technologies as well as Wi-Fi standards like 802.11ax and ad. ax should be the first new technology to drive retooling starting in 2018, as it brings improved spectral efficiency to Wi-Fi in the existing 2.4 gigahertz and 5 gigahertz bands.

ax brings frequency division multiplexing and higher order quadrature amplitude modulation to the world of Wi-Fi driving up complexity, and, therefore, test intensity. Our LitePoint Wireless Test group returned to profitability in the third quarter and should finish the year with about $100 million in sales.

At this point, we expect 2017 to be at about a similar level. Turning to 2017 and beyond, as we outlined last fall, our $2 EPS target for 2020 is primarily based on two things. First, an ATE market growing in an average 1% rate, combined with 1% market share gains; and, second, Universal Robots continuing to hit its 50% annual growth target.

Even with a weak Wireless Test market, we are running at the EPS growth trend line in 2016. Given the even-odd year patterns in SOC tests, at this point, we see 2017 as significantly up from the comparable 2015 period. At the midpoint of our $2.1 billion to $2.5 billion SOC market size range, this would represent about an 11% market growth from 2015.

In memory, we expect the market to be back in the $450 million to $500 million range. We'll have better visibility on 2017 Semi Test market in our January call. At Universal Robots, we see 2017 as another year with 50% plus growth. We will continue to invest in building out our distribution network and in maintaining our product leadership.

On the capital allocation front, we continue to look for a balance between direct shareholder returns via dividends and share repurchases, as well as growth focused M&A. Since the start of 2015, we've paid $87 million in dividends and bought back $385 million of stock and acquired Universal Robots.

We ended the third quarter with over $1.2 billion of cash with about $800 million of that outside the U.S. We'll be working through the details of our 2017 capital allocation plans over the next couple of months, and we'll review our plans with you in our January earnings call.

Regarding M&A, while we continuously monitor the semi cap and test space, the area most interesting to us at this point is industrial automation. The convergence of enabling technologies with global demographic and economic trends makes this area very interesting and potentially rewarding from a long-term value creation perspective.

Naturally, we remain disciplined in our consideration. So to sum it up, we had a good Q3 from a sales and profit standpoint, with a shallower order trough than we have seen in recent years, which will allow a strong finish to the year.

We expect to finish the year with sales over $1.7 billion and a product lineup and operating model well-positioned for 2017. Now I'll turn it over to Greg..

Thanks Mark, and good morning everyone. I'll start with a quick summary of 2016, as you can now see our fourth quarter's guidance. I will also provide additional details on the growth drivers that Mark discussed, along with our third quarter results and fourth quarter guidance.

So starting with the 2016 summary, this year is firming up to be our seventh straight year with strong financial performance. In fact, both the top line and non-GAAP EPS are projected to be up over last year, despite the headwinds from our Wireless Test business.

Factoring (12:02) in our fourth quarter guidance at the midpoint, sales are tracking to be up 5% over last year while non-GAAP EPS is expected to be up 10%. For the full year, the projected non-GAAP EPS of $1.40 is a positive step towards our midterm $2 target outlined last quarter.

The expected 2016 earnings improvement over 2015 is attributable to Semi Test, lower taxes and a lower average share count. Not surprisingly, two of the three Semi Test and share count, along with Universal Robots, are the three key drivers to our $2 midterm non-GAAP EPS plan.

So seeing progress this year, after hovering around $1.25 a share the last few years, is encouraging. On our two key growth drivers, first in Semi Test, it's a familiar story. Tight alignment to the healthier test segments with very selective share gains, coupled with increased device complexity which is driving up test intensity.

Second at Universal Robots, it's maintaining clear market leadership in a fast-growing cobot space where various third-party research firms have this market growing from about $100 million last year to anywhere from $1 billion to $3 billion in 2020.

These very high growth cobot projections are based on the increasing costs and demographics of a shrinking labor pool and the drive for higher product quality. UR cobots today already provide a very fast payback, often in six months or less, and are very well positioned for the expected multiyear expansion.

Let me take a moment now to summarize the three key 2016 takeaways that best illustrate the Teradyne of today and tomorrow. First, we've long since proven to be very good stewards in test markets that others often struggle in. This stems from having our product roadmap headlights far out in front of current demand.

We're very selective in the markets we serve, which yields more efficient R&D spending on clearly differentiated products. We're able to consistently field (14:07) products in the healthier market segments with the right feature set, industry-leading software and support which drives our long-term share gains.

Second, the successful expansion of the Universal Robots top line, the strengthening of its distribution pipeline and ecosystem. For the first nine months of 2016 in the Teradyne fold, Universal Robots sales have grown 67% over the comparable standalone nine-month period last year.

We see multiple years of 50% or greater UR sales growth, ahead with our sizable product lead and a growing distribution lead. And third is our strong balance sheet coupled with our capital return programs.

These three pillars, strong and steady financial performance in our Semi Test business, high growth in the Industrial Automation cobot segment and an attractive capital return strategy, all while maintaining healthy performance in System Test and Wireless Test and a strong balance sheet are the pillars of Teradyne today and tomorrow.

Let me now go a bit deeper, first with Universal Robots. We expect over $90 million in cobot sales this year with a seasonally strong fourth quarter. Competitively, we compete mainly against manual labor and costly and inflexible automation. While there are other cobots in the marketplace, at this point the market is essentially a greenfield.

Shifting from market forces to the Universal Robot architecture, UR cobots remain unique in their ease of programming and flexibility, highly repeatable accuracy, attractive cost and redundant safety systems. They fit very well with the demands of small and medium enterprises which need easy programming, high flexibility and fast ROIs.

Recall the traditional industrial robot was designed for large scale operations such as assembling an automobile where a vehicle platform may last several years. Hence the need for easy programming flexibility are working alongside factory workers without caging wasn't necessary.

UR's human scale cobots are focused on smaller scale operations, assisting or working side-by-side with workers. Users can manually move arm or use the simple teach pendant and just click to remember the waypoint and they've programmed it.

In short, Universal Robots has encapsulated all the underlying software complexity so that the user does not need any specialized programming skills. This ease-of-use fundamentally shifts the economics of automation. Our first to market product lead is being further amplified by a growing ecosystem lead.

As the clear market leader third-party developers have a strong incentive to create new peripherals on the UR platform. To ease the integration of peripherals, we've opened up our platform for partners to embed their unique solutions into our easy programming environment via software APIs.

As a result, partners often demonstrate their solutions at trade shows using a UR cobot, which drives greater awareness and demand. For example, at the AUTOMATICA Trade Show in Munich this past June, over 15 companies used UR cobots to showcase their products.

As Mark noted we're also expanded our direct sales force to generate opportunities for our distributors and are growing our regional technical teams to assist them and their customers at the local level.

So we have a growing ecosystem of third-party developers who know they are aligned with the right partner both in terms of our product lead and our strategy to keep the cobot universal. This provides our growing global distribution network with the best cobot product in a wide range of peripherals that solve almost any customer automation challenge.

Shifting now to Semi Test, if we take a quick step back the ATE industry has long since consolidated to essentially two players; Teradyne with about 47% market share and Advantest with about 40%.

As described in the past moving share is difficult and comes in small increments as tester platform decisions are not made on a technology node (18:03) but rather by device type. And it's costly for customers to shift given the programming investments they've made.

That is why we remain keenly focused on selecting the right long-term device segments and avoiding some segments that are shrinking. For example, years ago we chose the mobile market over PCs. We also invested in software tools that accelerate our customer's time from tape-out to product launch.

Without these tools the alternative is to provide scores of free application engineers that shield the customer from complex harder to use software. The point is that we've made many trade-offs versus chasing everything and covering multiple and sometimes overlapping bets which only served to dilute performance.

Our selective investments have held both our gross margins and OpEx investment levels so that our Semi Test business has operated with gross margins in the mid 50% range and with operating profits about 5 points above the industry model of 15%.

And while we have added some OpEx back several years ago, after very sharp cuts in Semi Test, those additions were needed to ensure we stay on a share gain trajectory rather than risk sliding back. We're proud to yet again this year maintain the lowest OpEx percentages in ATE.

Going forward if we look at company OpEx more closely, you'll see our spending, excluding Universal Robots, will be down in 2016 from 2015 and we expect a flat to slightly declining test OpEx in 2017 as well. I'll provide details when I review the Q3 results.

In memory test, the trend is to higher speeds and that plays into our Magnum product strength, with our high-frequency instrumentation and very low cost architecture. We've secured over 50% of the flash final test market and expect to benefit from the anticipated NAND growth from the fab build-outs underway.

Shifting to System Test group, this year is on track to operate at model profit or better, while funding some new growth initiatives in Storage Test, more on that in subsequent calls.

As expected, LitePoint completed its second restructuring this year and is sharpening its focus in a soft wireless test production market that will likely extend into next year. We expect an improving demand environment in 2018, with two new Wi-Fi standards expected to go mainstream. Now a reminder on our capital allocation plans.

We plan to buy back a minimum of $100 million and up to $200 million of our shares this year, while returning about $50 million in dividends to shareholders. We will announce our capital return plans for 2017 in the January call, consistent with our past practice.

As Mark noted, our M&A strategy continues to be targeted at Industrial Automation, given the favorable long-term trends and our expanding distribution reach. We think of this as going down the A, or automation path, in ATE. However, I should stress that we do not need to fill any holes nor are we compelled whatsoever to do another transaction.

We are, however, compelled to carefully look and give shareholders the best risk-adjusted return. Moving to the details of the third quarter, our sales were $410 million, non-GAAP gross margins were 56%, operating profit rate 19%, and non-GAAP EPS was $0.33. We had one 10% customer in the quarter.

Our non-GAAP operating expenses were $150 million, down $8 million from the second quarter due to lower variable compensation accruals on decreased profit level and lower Wireless Test spending.

Total company OpEx in the third quarter this year at $150 million is down $2 million from the year ago third quarter, as higher spending at UR was offset by reductions in our test businesses.

We expect our full-year 2016 OpEx, excluding Universal Robots, to be down, while UR's full year OpEx will grow year-on-year to the $40 million to $42 million range. At the company level, as noted earlier, our initial progress on our midterm plan to reach $2.00 in non-GAAP earnings is very promising.

On capital returns, we paid $12 million in dividends and used $28 million to buy back 1.4 million shares at an average price of $20.66 in the third quarter. This leaves us with $115 million remaining under our $500 million stock repurchase authorization.

Our cash and marketable securities totaled $1.254 billion up $148 million from the end of the second quarter. We have $428 million in the U.S. and the balance is offshore. But 85% of our annual cash generation this year will be offshore.

Looking ahead, we plan to keep aggregate spending flat to slightly down in our test businesses which include funding annual salary wage increases with productivity gains and to increase Universal Robot spending particularly in distribution to stay in the 50% or greater growth trajectory.

The top and bottom lines of our model for 2017 remain unchanged at about $390 million quarterly revenue to hit the 15% industry operating profit rate. Further investments to accelerate UR growth are being balanced in part by spending reductions in our test businesses and continued strong gross margins.

At model revenue we now expect gross margins at 54% and OpEx at 39%. I should add that this model solves for (23:22) the sales level to hit 15% operating profit rather than using higher past average sales.

For example, we've operated at about a 20% operating profit rate over the last five years, and our long-term plan has us reaching a 22% operating profit rate.

Moving now to the segment level details, Semi Test bookings were $250 million with demand principally driven by mobility, SOC test orders were $221 million and memory test orders were $29 million. Memory test orders were flash driven. Semi Test service orders were $39 million of the total.

Semi Test sales were $322 million in the quarter with SOC making up $290 million and memory test the balance. Semi Test service revenue totaled $58 million in the quarter. Moving to System Test, orders were $76 million in the quarter and sales were at $37 million.

A portion of these orders carry longer than normal lead times and therefore won't all translate to shipments in the fourth quarter. Shifting to Wireless Test we booked $29 million and sales were at $28 million in the third quarter. At Universal Robots orders in the third quarter were $24 million and sales were $24 million.

Sales for the fourth quarter are expected to be between $330 million and $360 million with a non-GAAP EPS range is $0.18 to $0.25 on 203 million diluted shares. Q4 guidance excludes the amortization (24:48) of acquired intangibles.

The fourth quarter gross margin should run about 56% roughly flat with the third quarter and total OpEx should run from 40% to 44%. The operating profit rate at the midpoint of our fourth quarter guidance is about 14%.

Shifting to taxes, our full-year tax rate is expected to be about 14% lower than recent prior years due to higher offshore profits where we have favorable tax rates. Please note that we expect our tax rate to step up to 18% for 2017. Our free cash flow this year to date totals $342 million.

After a very strong Q3 driven by strong AR collections, we expect negative free cash flow of $45 million in the fourth quarter, as our DSO returns to a more normalized level. And similar to the prior fourth quarter, we will be pipelining some inventory to maintain attractive lead times entering 2017.

Over the last three years, our average free cash flow has averaged $270 million. In summary, we had a very strong quarter from bookings, revenue and profit perspective and expect to deliver both revenue and non-GAAP earnings growth for the full year 2016.

We're executing well on our $2 midterm EPS plan and Semi Test and Universal Robots growth driving the top line and bottom line expansion along with steady financial discipline and managing the share count. With that, I'll turn the call back to Andy..

Thanks, Greg. Ginger, we'd now like to take questions. And as a reminder, please limit yourself to one question and a follow-up..

Your first question comes from Timothy Arcuri from Cowen & Company..

Thanks a lot, I guess, I had two. So I just wanted to confirm some of the numbers. So you had talked about the memory TAM being up next year. It sounds like it's going to go from $400 million to – $450 million to, say, $500 million.

But can you confirm what you think that the SOC TAM does next year?.

Yeah. Look, what I said is that we've got a pretty wide range right now $2.1 billion to $2.5 billion, so at the midpoint $2.3 billion. We've certainly seen stronger performance in the market in the recent few months than we had expected even three months ago. So we're perhaps a little optimistic, but that's the range..

Okay. And then, I guess just more of a bigger picture question on Wireless Test. And I guess the question is, certainly it sounds like it did eke out a profit in the third quarter.

But can you just go through the rationale in terms of why you even want to stay in that business, if we have to wait another year, or maybe five or six more quarters until things really start to pick back up again? Why not basically restructure the business and sell it and then take that money and reallocate that into Industrial Automation as a huge aspect (27:49)?.

Tim, this is Greg. The first thing you do when a business gets in trouble, which we've had experience with, whether it was Storage Test some number of years ago or Semi Test back in 2009 is, you have to remodel it to get it healthy again so that you can grow from health. And until you do that, you really don't have any good options.

So that's the key thing we're focused on at this point, getting it healthy and it turned a profit this quarter and there are some encouraging design win momentum we have. But the meaningful business is two years out.

So we're happy that we've repositioned the company on better footing after a very strong history, but obviously the market has gone soft on us. But we think the next couple of years, or two years out, we can have better performance. And to your point about automation, we have dry powder, we have the capacity.

So LitePoint isn't stopping us from making another move. It's more, what are the opportunities? What's the risk-adjusted return? And all those discussions and analysis take time. We don't move fast. When we see something, we need to really make sure we understand the space, the fit, the culture, and that's our thought (29:03) process..

Got it. Thank you, Greg..

Your next question is from Jagadish Iyer from Summit Redstone..

Yeah, thanks for taking my question.

It's a big picture question on this Universal Robots, so given that your investment is ongoing, how should we think about it at least for the next two or three years in terms of the profitability for this UR business? Even though there is going to be sizable unit growth, how should we think about profitability, and then I have a follow-up?.

Okay. So we've tried to outline this in the past, but what we did this year is, we essentially, intentionally, are taking down their run rate profit of 15% from last year to something 10% range, or 10% or a little bit better. We are putting in much more distribution muscle power working with an ecosystem.

The reason we're doing all that is, we know there's other cobot makers coming to the plays. We're far ahead on the product. We want to get far ahead on the distribution and third party ecosystem providers, so that when someone else comes along, we are clearly the proven low-risk solution.

So, what does that mean for next year? Well, as we continue to grow significantly, we're going to grow the spending to make sure we don't curtail the possible sales growth, market share, because once you get into these accounts, they often deploy another stage in manufacturing.

So you really want to get in and then you can grow much greater once you are in an account. With that said, we would expect the profit rate next year to move from around a 10% range towards a 15% range..

Fair enough. Just on another question on memory, given that the NAND is moving more towards 3D and you also have testing of the SSD, why isn't that memory market not growing substantially than the $400 million to $450 million that you guys have outlined? Thank you..

Yeah. Well, we said $450 million to $500 million for next year, so coming off of this year at $400 million, that will be a significant step up, but kind of flat with where it's been looking backwards for several years.

And the thing that is driving the test demand is more on the order of the high speed interfaces going into NAND chips, more so than the vertical structures of NAND devices. So that technological shift in NAND really doesn't have a large impact on test but moving to UFS, PCIe, those kind of high speed interfaces, does.

So that's what'll drive the increases next year, we think. Now, the bit growth in NAND has kind of been consistent year-over-year, so it's really this technological shift to higher speed interfaces..

Thank you..

Your next question is from Farhan Ahmad from Credit Suisse..

Hi. Thanks for taking my question. I had a question on your Systems Test. You had a very strong quarter in terms of bookings, and you referenced that there are some products that should be driving your (32:20) next year.

The question I had was, can you talk about what this new product is, or is this something that is incremental to your market, or is it something that is replacing an older product?.

Yes. Okay. We're not really in a position to announce the product. But it is incremental. It's a new application for our Storage Test automation product. But we've started out here, in conjunction with a couple of key accounts, working on a new application.

And like you mentioned, the revenue and shipments of that will be early next year, probably a little bit in Q1 and more in Q2. And somewhere around that point, we will introduce the product..

If I could just quickly add, the Storage Test platform is very versatile, as you probably can see by now. It has significant automation and it's asynchronous to slots, so it is a vessel that can be used for multiple applications. So I think there is a ongoing story as to that product and that technology moving to some other markets over time..

Got it.

And could you just remind me what your expectation of the System Test market is for next year, just given that you'll have this new product as well?.

We tend to just say System Test will probably be at model profits, which is about $65 million revenue..

Storage Test..

Storage, also in the Storage Test. Was that System Test? I'm sorry, Storage Test (33:50). So Storage Test is going to be at model $65 million, and then this year about $189 million, so we're probably going to be similar to that level. We expect to be at model profit in those businesses so, I think even by (34:10) 15% then..

Got it. So you won't have growth next year just because, I mean, I would've thought like you have some new products that should have helped you grow the revenue from this year to next.

Can you just explain, like, what's moving and what's stopping your revenues from growing in the System Test next year?.

Well we got the Storage Test but (34:29) I think you're asking about Storage Test?.

No, I'm asking about System Test. I mean, Storage Test you clearly have like this product confusing (34:40). But what are the other moving pieces in the System Test that are stopping your revenue in System Test from growing substantially just given the growth in the Storage Test..

Okay. There's a slowdown in 3.5 inch test volume, that's in Storage Test. So this new application can offset some slowdown. But then when you go to mil-aero, mil-aero should be growing. The budget sequestration stopped. There's much more flight testing programs, so we see growth in mil-aero. Production Board Test we see some slight growth there as well.

There is a whole set of applications that are high panel count that we have two test heads, the very efficient architecture that we can do the throughput much better, so we see growth in both Production Board Tests, low growth, and in mil-aero..

Can I just add to that. It's been difficult to predict the Storage Test demand over the years if you've followed that. So right now it looks as though the hard disk drive market will – for test capacity will be a bit weak. And therefore we're being conservative. But it turns on a dime, that market, so it's hard to tell.

Same thing with SSD, SSD is another thing that's hard still to calibrate in terms of size. But we're being pretty conservative at this point..

Got it. Thank you. That's all I have..

Your next question is from Krish Sankar from Bank of America..

Yeah. Hi. Thanks for taking my question. I have two of them. First one, the strength you saw in bookings in Q3, was that more related to pull-in from Q4 or in other words historically your Q4 bookings have grown sequentially. Should that be relatively more muted this time around and then I had a follow-up..

No. That wasn't related to pull-ins. That was a new application where there's some engineering that needs to get completed for the application. So.....

Well, Krish was that (36:33) – Greg, you're referring to in System Test..

That's what I thought..

But Krish are you referring to the total company?.

Yes, overall. Yeah..

Yeah, I think no. There's no pull-in from Q4. Semiconductor Test as an example, it's really the strengthening of microcontroller test and analog automotive test that has driven that. And none of that we saw as an acceleration.

So the one thing about the fourth quarter bookings, if you look at it historically, fourth quarter tends to have been a low point. However, last year we had quite a large surge as a couple of large customers shifted orders a little bit earlier out of Q1 into Q4.

And so comparing this year's Q4 bookings with last year we have that phenomena that take into account. That may happen again, it may not happen again. It's really just a matter of a few weeks worth of timing that can shift the bookings in the fourth quarter around that sort of year-end mark..

Got it, got it. And then thanks for the color on 2017 SOC. Looks like at the midpoint, the SOC market might be down 4%. I think you guys are not giving guidance for Teradyne for 2017 but historically your SOC revenues have dragged (37:56) the industry directionally.

So is it fair to assume 2015 SOC revenues for Teradyne would also be down year-over-year given the industry is down although a modest 4%..

Well, remember that part of our story here both historically and looking forward is to pick up market share. So one point of share gain is probably reasonable to think about next year for us in SOC. And we also see that the memory market will rebound a bit next year. So I think you've got to factor those into the math as well..

Got it. Thanks folks..

Your next question is from Toshiya Hari from Goldman Sachs..

Great. Good morning guys. My first question is regarding your long-term model in Semi Test. You seem to be assuming an average market growth rate of 1% and to your point earlier about 1 percentage point of annual share gains.

On your market growth rate of roughly 1%, just given what we've seen so far in 2016 and what you're guiding SOC to in 2017, do you think that 1% number could potentially be a little bit more on the conservative side? And on your annual share gain of 1% point, obviously you've done a great job in the past picking up share at the expense of your nearest competitor.

But going forward where do you see the incremental opportunity from an end-market perspective?.

Well so both of those. So yes we have the recent couple of years have been pretty strong indicators of a return to a bit of market growth. But I think we're still sticking to that 1% number for a while here because after a decade plus of a negative CAGR, we don't want to get too exuberant until we have a few more data points in.

It's certainly encouraging what's happened this year and the strengthening prognosis for next year, so those are all positive signs. But overall I think we stay with our model at this point of about 1% average CAGR and there'll be a lot of noise around that.

As you see this sort of 11% growth, 2017 compared to 2015 that's certainly well above that line. But I think it's too early to say we're going to move that up. On the share gains, the share gains come about in two ways.

One way is that we are positioned in segments with customers that tend to grow faster than the market because they're in, as Greg was talking about in his script, the sort of sweet spot of growth around mobility automotive and such. So part of our share gain story just comes from riding the rising tide of being in the more attractive markets.

Same thing on NAND in the memory space, where we tend to be a little more concentrated in NAND flash, that's growing more than DRAM and we tend to benefit from that, even without accounts, let say, trading hands (41:04).

And then on top of that there are some competitive shootouts that occur every year where we selectively go after places we think we have clear differentiation. And that without any sort of pricing, more on functionality, we can make a difference and swing a little bit more our way.

That's what we've been doing and when we look forward it looks like that's still very attractive and optimistic around how we can continue to gain share..

Great. And as my follow up, I had a question on Universal Robots as well. It seems like you're tracking to beat your 50% growth rate this year with year-to-date growth around 70% if I recall correctly.

What's been the upside surprise here and what are your preliminary thoughts going into 2017? And kind of related to that, when you talk about M&A in automation, is the focus on hardware or software or I suppose distribution capability? Thank you..

I'll start with this and maybe Mark can go in as well. First, yeah there really isn't a surprise in our 67% growth. We did say 50% or greater and we have third-party research firms that have this market in the billion dollar range in 2020. So we see explosive growth for years to come.

We're much more focused on trying to figure out by region what is it that needs to be done for particular regions to get more of a velocity through that region. Sometimes it's more technical people, sometimes it's distributor's velocity, sometimes it's leads.

There's a whole set of factors that we are working in some regions that are growing higher than 67%. So there's a lot of hands-on to try to figure out how to get it growing as fast as it possibly can because we have a huge lead and it's a very fast payback and it's very easy to deploy. So it's a very unique opportunity that we have..

And then on the question around M&A, the things you said are yes, yes, yes. So software, some additional hardware capability and distribution, those are all three areas that we're actively looking at as a way to accelerate – not just accelerate UR but catch another wave of inflection in the market around what's going in around Industrial Automation.

This trend for cobots will pull – coattails (43:47) will pull other kinds of technologies into factories as well and those will, we think, have similar growth rates. And so yes, we're looking around all of those areas..

Thank you so much..

Your next question is from Tim Diffely (sic) [Tom Diffely] (44:05) from D.A. Davidson..

Yeah, good morning. So I guess getting back to the Wireless business, I think you mentioned that it became profitable during the quarter.

At $100 million next year do you expect that profitability for the full year?.

Tim (sic) [Tom] (44:21), if it's about $100 million it'll be close to breakeven. Maybe it's a very small profit but at $100 million I'd say it's breakeven to 2%, 3% profit growth, very low..

Okay.

And at this point, do you think the risk is to the upside or downside for that revenue number?.

I actually feel pretty good about that revenue number. I think it's cautious. So I suppose in theory there could be a little bit of upside, but we didn't see much of that this year. So I'll stick with the number that yeah $97 million and $100 million is a very good number for next year..

Okay, and then following up on the Semi bookings, in general, have you seen a shift, I know you mentioned that a lot of bookings happened very late in the year, early in the following year. But have you seen a shift over the last several years of pulling the bookings in, in general, and then peaking revenues a quarter (45:14)..

Yes, I don't think, I mean, there's no general case here. It's kind of very specific around mobility and phones. And last year was a little bit of an anomaly after four years of a pattern where orders started to accelerate in Q1 and shipments peaked either in late Q2 or early Q3.

Last year the orders came in, in late Q4 and began to come in and the shipments started to ramp a bit earlier too in late Q1. So that was very specific to last year, very specific to phones. And this year, if we look forward that possibly could occur again.

In total, there's not a big issue here, whether the orders come in the last couple weeks of this year or first couple weeks of next year. We see that there's some variability there, but nothing significant to what's going on.

The other segments that are growing, and in our case microcontrollers, we saw orders in the third quarter higher than we've seen from microcontrollers since early 2014, same thing with automotive.

So those, I think, are more indication of – that's not a cyclical business typically, and it's driven by new model years coming along that are going to take a step function in automotive safety, is one thing driving it, where the millimeter radar and other things like that will start ramping next year and become a driver for test.

So that's going to be a long, long multi-year tubing (47:02) exercise in automotive. You won't see the same peaking and sort of quarter-to-quarter fluctuations, I don't think..

Okay. Great. Thank you..

Your next question is from Edwin Mok from Needham & Company..

Hi. Thanks for taking my questions. So, first on UR, just to reiterate (47:23) your revenue actually declined sequentially in the third quarter. I was just wondering if we should read anything into that.

And in terms of kind of (47:31) growth, it sounds like you might be – while you're talking 50% plus growth, you might be a little limited by ability to kind of reach out to greater distribution network and supply that (47:46).

Will you quantify your business like that, and do you think that's where you mostly put your assets in right now, in partnership and distribution networks?.

I'll start with that one. Yes, a lot of our effort is going into the distribution network. And that includes making sure we have the best distributors, they have the right technical resources, sales persons (48:07) to follow up and close deals (48:09). It's also opening up new regions, salespeople to help get lease to the distributors.

So a lot of actions are underway. To take it back to where you started, any quarter-to-quarter change in sales, I would just caution not to read too much into it. There's a whole set of confusing factors that can move sales higher or lower. Some are as mundane as, European vacations are pretty heavy in the third quarter.

So that makes the comparison to the second quarter a bit tough. And then we have the timing of different products, when they enter the market. There's a whole set of things that make comparisons difficult.

With that said, we feel comfortable with 50% or greater for this year and next year, with some oddball changes quarter-to-quarter where it's going to be below 50% or above 50%..

Okay. That's helpful. And then go back to ATE space, I think you highlighted both the SOC market and as well as the kind of auto related market that drove the strong booking this quarter.

I was wondering, did that kind of strength in booking, was that surprising for you guys in terms of how fast it happened? And then, kind of tying that to your outlook in 2017, is that what kind of (49:36) give you the confidence of this pretty strong outlook for 2017, kind of actually flattish or maybe just down modestly from this year on the down year?.

Yeah. So the strength of microcontroller in automotive orders in the third quarter were more than we expected. And we have seen five quarters of below trend line buying in that segment. So we knew it had to return. It just so happened that it came back in third quarter and it was a bit of a surprise.

So that's a factor in our optimism around next year's market. But that's not it alone. We've also seen strong indications around mobility as well, for next year, which is our biggest segment. So in general, I would say that, as we went through third quarter, the optimism and the orders both moved higher than we had originally expected..

Great. Thanks. That's all I have..

Your next question is from Mehdi Hosseini from SIG..

Yeah. It's actually Mehdi Hosseini. Thanks for taking my question. I have couple of follow-ups, and first one is for Mark. We saw earlier this morning another consolidation among the larger customer base.

And I want to see how you have factored in the continuing consolidation among your customers into the incremental $0.35 of earning that you expect Semi Test to bring in from 2015 to 2020. And I have a follow-up..

Yeah, it's a good question. First of all, we expect consolidation in our customer base will continue. Now you might think well, if that's happening, there must be some manufacturing efficiencies that can be gained that might depress the test market.

But in fact, much of the test industry has already been efficiently consolidated through the outsourcing trends of the past decade. Many of these customers utilize subcontract manufacturers in Asia, in facilities that are already – where multiple customers have consolidated test capacity.

So, we don't – have not historically, and don't expect there to be, much of a impact to the test market as a result of the consolidations..

Great. And then a follow-up, along the lines of efficiency in the system, I've seen three consecutive quarters of decline in your backlog, but you're executing really well, and maybe this decline in backlog has more to do with the industrial shorter lead times.

In that context, and maybe this is more for Greg, how are you planning to manage your working capital, since the lead time or the backlog is no longer going to be indicative of what the business trend is going to be two, three quarters out?.

We've actually been managing in that scenario for quite some time. In Semi Test, our largest business, we often get the official purchase order four to six weeks before the tests are shipped. Now we're working with customers collaboratively prior, so we're building inventory based upon the signals they're giving us. So we've been at that for a while.

If I go to Universal Robots, which is a very quick fulfillment, super quick, there there's only three products. There isn't a whole lot of different configurations or instruments where you can get stuck. So that is a very low obsolescence risk and those products last for a very long time. So we're comfortable in this environment.

And over the years periodically we've improved our supply line responsiveness. We've taken days and weeks out and work with our supply chain to do that. We think we're responsive and we don't see any inventory risk. And our charge as compared to others sort of fit with other equipment companies. We're not high. We're probably on the low side.

So I think, all told, we're doing okay against the new environment..

Great.

And just a quick follow-up, should I assume or is it conservative enough to assume the free cash flow margins are going to average like 15% given how efficient you are with working capital?.

I suppose. I mean our history has been a bit above that, but you could use 15%. That would be a slight decline..

Okay. Well the minimum is 15% and any more efficiency coming in is all upside..

Yes..

Okay. Thank you..

Okay. Very good..

Your next question is from C.J. Muse from Evercore..

Yeah. Good morning, thank you for taking my question. I guess first question, I think auto SOC test peaked around $400 million back in 2014. It sounds like we're in the low $300 million I think this year.

A, is that correct and B, how do you think about growth in that segment into 2017?.

Yeah. So C.J. this is Mark. This year we think automotive is probably just south of $400 million where the year is done. And if last year as an example 2015 it might have been closer to $300 million and then the year before that $400 million.

So as we look forward we expected it's going to probably follow that trend line we're talking about off of that $400 million base going forward. It'll be $400 million growing at a couple of percent a year..

Okay, very helpful. And then second question on gross margin.

As you look at the guide for Q4, is that uplift principally Eagle Test mix? And then looking to 2017 and the new target model can you walk through what's driving that uplift?.

It's simply better mix principally in Semi Test..

Okay and then for 2017 same thing?.

Yes..

Okay..

Our margins, I think you know, C.J. move around based upon mix, whether our large customers buying in volume or depending upon the various segment our margins can move around. But we tend to have this pattern that's continuing that in even years we're at about 54%, and the odd years we do a bit better..

So I guess the interpretation is the change to your target model is an improving mix for you led by auto and the catalog parts over time..

Yes. And we've been beating the model for so long, we just thought we should move the gross margins up, so it's more consistent with where we've been. And we also are likely to put out a bit more OpEx or considerable OpEx behind Universal Robots. So that's the way to fund it with better gross margins that we know we can get..

Makes sense. Thank you..

Okay. And operator, we have time for just one more question, please..

Okay, your final question is from Stephen Chin from UBS..

Hi, guys. Good morning. Thanks for taking my question. I just wanted to follow-up on beating your UR growth target spend (57:21). Maybe give us more color on pipeline or quoting activity that you see that give you confidence growth rate..

Yeah. It's a turns business. So the process typically is lead generation, qualification, close and then some application work to deploy the robot into the factory. All of that can occur within a handful of week period in the quarter.

So we track weekly, we're looking at metrics around all of those items to see if we're tracking toward our target and the close rate, the qualification rate and sort of those kind of things.

So as we go into fourth quarter if you look at the history, fourth quarter is always a big quarter for UR and all the indications we have right now is that will be true again this year. And that's how we're running it..

And I'll just add that, we don't have any significant distributors whatsoever. I think our largest distributor is just under 5%, so there's so many different buying locations in different countries and different applications, so it's very disperse.

But each regional person has a pipeline to their distributors that they put a probability on and all that math ends up being the forecast..

Got it. Thank you..

Okay, folks, thanks so much for joining us. And for those who are remaining in the queue, I'll reach out to you here after this call. Thanks so much..

Thank you..

Thanks..

Ladies and gentlemen, this does conclude today's conference call. Thank you for participating. At this time you may now disconnect..