Teradyne Inc

NASDAQ:TER

Earnings Call Transcript 2020-Q2

[Operator]

Good afternoon, ladies and gentlemen, and welcome to the Q2 2020 Teradyne Incorporated Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host Andy Blanchard, Vice President of Investor Relations. Please go ahead.

[Andy Blanchard, Vice President of Investor Relations]

Thank you, Vincent. 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 the CFO, Sanjay Mehta. Following our opening remarks, we'll provide details of our performance for 2020's second quarter along with our outlook for the third quarter of 2020. The press release containing our second 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. Replay 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 statements 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 have 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 our website. Also, please take special note of the Safe Harbor Statement in the press release and slide deck for risks related to the COVID-19 pandemic and changes to U.S. export regulations. Looking ahead between now and our next earnings call, Teradyne expects to participate in technology or industrial focused investor conferences hosted by KeyBanc, Citibank and Deutsche Bank.

Now, let's get on to the rest of the agenda. First, Mark will comment on our recent results and the market conditions including comments on the COVID-19 pandemic and expanded trade regulations. Sanjay will then offer more details on our quarterly results, along with our guidance for the third quarter. We'll then answer your questions. And this call is scheduled for one hour. Mark?

[Mark Jagiela, Chief Executive Officer]

Good morning, everyone. Today I'll summarize our results for the second quarter and the first half of 2020, comment on the impact of current environmental conditions, including new trade regulations and then describe our view of the second half of the year. Sanjay will then provide the financial details on the quarter and our guidance for Q3. Despite the pandemic trade issues and shutdown related headwinds and industrial automation, Teradyne is performing exceptionally well. In the second quarter – our second quarter results affirmed the trend of growing test intensity and the efficiency of our business model.

As you can see from our Q3 guidance, the market demand remains robust. While Q2 saw record SOC shipments, 3Q is being driven by growth in memory test and system level test. Industrial automation continues to pull out of the effects of global industrial shutdowns as we saw sequential monthly growth in sales throughout second quarter. We expect second quarter to be the bottom for IA and 3Q sales to be back close to 2019 levels. Superb execution by the global Teradyne team was on full display in second quarter as we managed to deliver new shipment records and test.

Supply line constraints were largely mitigated and remote technical collaboration with both within Teradyne and with our customers continues to show success. It takes dozens to hundreds of engineers working in concert to develop new test products. It takes similar numbers working with customers to launch test programs for new silicon. Flipping a switch to do this remotely without missing a beat is a fantastic accomplishment. And I congratulate and thank all the employees of Teradyne for this achievement. On the trade front, new regulations related to both Huawei and China military end users were announced in the second quarter. We expect the China military end-user restrictions to increase our compliance work and costs, but we currently do not expect any material impact on our sales into China.

In the case of Huawei, while the new regulations do not impose any new restrictions on our business with Huawei directly, we expect it will likely impact our business with sub-com customers who test Huawei devices using our test equipment. However, we expect the macro global test demand to be minimally impacted as alternative sources of silicon supply grow to fill in whatever gap is created by these regulations. This alternative supplies should absorb any idled test capacity as well as drive new demand in the future.

Shifting to the highlights. As we reached the midpoint of the year, our January forecast for a $3.1 billion to $3.4 billion SOC test market is playing out about as planned while our memory test market estimate has moved up to about $800 million to $850 million. In SOC, our sales grew 60% in the first half and 82% compared to 2Q of 2019 as our participation in this year's mobility tooling cycle is significantly stronger than in the last two years. As expected 5G infrastructure related capacity as remains weak after a strong 2019, while handset related silicon is driving the bulk of the demand. While 5G related silicon is beginning to add a small piece to the mobility handset market, the vast majority of the test demand is complexity growth in non-5G related handset silicon.

Weather related to high resolution still or video photography, artificial intelligence, augmented reality, gaming, location sensing, or advanced wireless connectivity, there is a rich set of features in addition to 5G that we expect will continue to drive mobility demand for the foreseeable future. Specific to 5G, we are still in the early innings of a multi-year rollout and expect it to be an incremental demand driver going forward. Additionally, our new UltraFLEXplus platform will continue ramping in 3Q providing new revenue sources in mobility and computing going forward.

Beyond mobility, the automotive and industrial segments of the SOC test market remain weak and we do not expect to see recovery until 2021. In memory, our 2Q sales were about flat with Q1, but up 45% from Q2 of 2019. Flash package tests and DRAM wafer tests combined with ramping shipments of LPDDR5 package testers drove Q2 results. DRAM test is growing faster than flash test in 2020 due to the LPDDR5 transition. And our design win in DRAM should allow us to hold our share position in the low 40s this year.

In the system test group, sales were up 43% for the first half compared to 2019 due to strong storage test demand. We expect storage test shipments to grow sequentially and substantially in Q3 driven by both HDD demand and semiconductor at system level test shipments. System level test is a great example of derivative products opening new markets for Teradyne. By combining silicon test instruments with our HDD test product, we've grown the combined sales from $60 million in 2017 to over $200 million this year.

At LitePoint, sales were up 32% for the first half and 19% compared with 2Q of 2019. Demand is being driven by WiFi 6 and growing shipments are 5G test sets. Wifi 6 has recently been allocated additional frequency spectrum in the 6 to 7 gigahertz range. Testing this expanded standard called Wifi 6E will require new testers, which we expect will be a positive force in 2021 and beyond.

Moving to Industrial Automation, the environment is mixed, but improving. At UR, the biggest unit of our IA segment, sales in Q2 contracted 32% compared with the same period last year. Manufacturing shutdowns in Europe and North America had a significant impact on UR. MiR sales on the other hand grew 7% from last year’s Q2 level as they benefited from exposure to healthcare and mobile disinfectant markets. AutoGuide, our newest IA business saw sales more than double from the same 2Q period last year. Overall, IA sales for the first half were down 15% from 2019.

We have seen positive indications of improvement as we move through second quarter. For example, all three businesses had sequential monthly sales growth across Q2, as customers began to reopen. While we expect IA demand will improve in the third quarter, we don't expect to return to year-on-year growth until Q4 or Q1. Our longer term growth outlook for IA remains unchanged at 20% to 35%. Social distancing and the need for more resilient manufacturing flow should add additional drivers for our collaborative automation products.

Our R&D and distribution investments in the IA business continue as these macro dividends slowdowns provide opportunities to widen our competitive lead. We continue to add distributors in the second quarter, expanded our UR plus stable of certified plug and play products to over 250 items. We also introduced UR plus applications moving to complete solutions for specific customer requirements like industrial bin-picking and welding. Stepping back to look at the full year at the company level, our latest estimates have revenue front half loaded at about 54% to 55%. This is similar to what we experienced in 2016 and 2017 when we saw especially strong investments for smartphone test capacity.

In summary, the first half of the year showed Teradyne’s strengths in familiar test markets and demonstrated our ability to grow in new ones with differentiated products and exemplary execution. Our business model is efficient and driving the planned drop through on incremental sales. Our investments to broaden our competitive moats in IA amidst a global industrial downturn showed the value of Teradyne’s financial strength in these nascent industrial automation markets. While our short-term visibility remains limited, we are confident that our long-term strategy will continue to deliver outstanding results for our customers, employees, and investors.

Now, I’ll turn things over to Sanjay for additional color and the financial details.

[Sanjay Mehta, Chief Financial Officer]

Thank you, Mark. Good morning, everyone. This morning, I’ll review how the pandemic is impacting us from a financial supply line management perspective. I will then summarize our Q2 financial results and Q3 outlook. Our priorities remain consistent during the coronavirus pandemic, safety of our employees, supporting our customers and crisp execution to achieve our financial objectives. In line with my Q1 earnings call remarks, I wanted to acknowledge the continued challenges, our employees, customers, suppliers, and their families going through during this pandemic.

From a financial point of view, Teradyne is stronger than ever. We generated $178 million of free cash flow in Q2 and ended the quarter with approximately $1.1 billion in cash and marketable securities and no short-term debt. During the quarter, we established a $400 million revolving line of credit for added security against future uncertainty and opportunities. The strength of our balance sheet, business model and business execution enabled us to put the revolver in place during a very uncertain time.

Our long-term debt is a $460 million face value convert, which matures in December of 2023. From an operations perspective, our team and partners have done a great job so far this year. Over many years, Teradyne has built a global supply line management team second to none and the value of that team has never been more evident. COVID-related supply line issues did not have a material impact on our revenues in Q2.

Our combined teams produce the highest number of UltraFLEX systems ever in the second quarter, ramped new products in SOC, memory and across our IA businesses all while operating in a very challenging environment. This included overcoming numerous part and labor shortages along with logistical constraints. In one case, the shortage of scheduled air cargo capacity led us to charter a dedicated 747 to deliver, quite literally, plane load of testers to a customer to ensure timely delivery. While operationally executing very well, we continue to take a critical view of how to strengthen our supply chain operations. We have identified potential weaknesses and are taking actions to strengthen our operations further.

The short-term COVID-19 related actions along with these long-term actions have a small impact on margins. While the operations team clearly shined in the quarter, they were not alone. I’d also like to extend thanks to the entire organization from HR to facilities and environmental health, to engineering, repair services, finance, legal, our global field and applications teams, which collectively allowed us to meet our delivery commitments at a revolver, introduce new products, maintain our R&D programs and run the company safely and productively with combination of at-home and on-site staffing. Well done. Very well done.

Now on to the details of the quarter. Revenue in Q2 was $839 million, up 49% from Q2 of 2019, and up 46% for the first half of the year. Q2 revenue was 5% above the high end of the range driven by accelerated shipments in SOC test. Also while IA contracted year-over-year, IA revenue was higher than expected in Q2.

Semi Test revenue was $659 million, up 76% from a year ago, driven by; one, SOC revenue was $575 million, up 82% from a year ago on broad strength and mobility. And two, memory revenue of $85 million, up 45% from a year ago, due to continued strength in flash test and ramp up of our Magnum Epic solution for DRAM.

In System Test, revenues were $72 million, which included storage test shipments of $36 million, which were down sequentially, but up 6% from Q2 of 2019. Recall our storage test business tends to have lumpy shipments. First half storage test revenue was up 106% over the first half of 2019 on strengthen in both system level test and HDD product lines. Growth in SLT was driven primarily by processor demand while HDD shipments were driven by strong exabyte growth for hard drives.

LitePoint revenue was $49 million in the quarter, up 19% from Q2 of 2019 on 5G WiFi 6 and next generation WiFi 6E demand. In industrial automation, revenue was $59 million, down 21% from Q2 of 2019 due to the coronavirus and down 3% from Q1 2020, but above our plan entering the quarter. UR contributed $43 million of revenue, near $11 million. AG and Energid made up the remainder. We believe in our IE segment revenue bottomed out in Q2, and is on the road to a sequential growth in Q3. We had one 10% customer in the quarter. As a reminder, we disclosed customers who contribute 10% or more of full year company revenue in our annual 10-K.

Non-GAAP gross margins in the quarter were 56.2%, down 130 basis points from Q2 of 2019 as forecasted. Margins reflect the impact of concentrated mobility shipments in Semi Test and the added logistics and operations costs due to the pandemic. Non-GAAP operating expenses were up $11 million to $207 million from Q1 due to company performance causing higher variable compensation. Inventory increased to $206 million to support Q3 shipments and buffer against potential COVID-related supply disruptions.

DSO in the quarter increased to 75 days due to the timing of shipments in the quarter. Non-GAAP operating margin was 31.5% and non-GAAP EPS was $1.33. Both are tracking ahead of our 2022 model. Tax rate in Q2 2020 was 13% on a GAAP basis and 14.1% on a non-GAAP basis. Our full year GAAP tax rate is expected to be 14%, down from our prior estimate of 14.5%. Our full year non-GAAP tax rate is expected to be 14.5%, down from our prior estimate of 15%. The decrease in tax rate is due to product mix.

We generated $178 million in free cash flow in Q2. We paid $17 million in dividends in the quarter. We bought back 173,000 shares for $9.4 million at an average price of $54.49 in the first few days of the quarter. As noted in April, we suspended our share repurchase program as of April 1. We look at our share repurchase and the entire capital allocation program regularly and we’ll update you next quarter.

Looking ahead at Q3, revenues will include a significant ramp in shipments of our new UltraFLEXplus SOC test system supporting recent design wins. In memory, we expect continued strong momentum for our Magnum product line for flash and DRAM applications. LPDDR5 test shipments are expected to grow significantly in Q3. In our system test group, storage test demand driven by system level tests and hard disk drive markets continue to see end market demand exceeding our expectations for the year. While this business fluctuates from quarter-to-quarter, Q3 is expected to more than double the Q2 level.

I’ll also note that while we expect multiple waves of 5G-related demand for both handsets and infrastructure in the years ahead, we are not planning on significant infrastructure test shipments in the second half, like we experienced in 2019. As a result, we expect to revert back to pre-2019 pattern of lower Q4 SOC shipments. In industrial automation, we are seeing incremental improvements in UR’s business. As the U.S. and Europe start to open up, we are seeing signs of increased momentum in quarter-over-quarter.

Recall the U.S. and Europe typically represent greater than 70% of UR’s revenue. MiR continues to execute and in the first half of the year, grew by 4% year-over-year driven by ultraviolet light disinfectant demand. In Q3, we are guiding a revenue range of $745 million to $805 million and a non-GAAP EPS of $1.01 to $1.17 on 175 million of diluted shares. The ranges reflect continued coronavirus supply risks and potential impact on end market demand. The guidance excludes the amortization of acquired intangibles and non-cash imputed interest on convertible debt.

In April, we previewed expected gross margin headwinds in the second half of 2020 due to new product ramps. While the ramps continue as planned, our latest view is the impact will be less severe than earlier expected. Q3 gross margins will be 55% to 56%. We expect to be back to historical gross margin levels in 2021. In Q3, operating expenses are expected to be 26% to 28% of sales and are on track with our revised April full-year plan to grow 7% to 8% from 2019.

The operating profit at the midpoint of our third quarter guidance is 29%. CapEx investments year-to-date are $84 million. And we expect full year investments with total approximately $175 million. We’re investing more in CapEx this year to support new product rollouts, strengthening our supply chain and new facility projects.

To summarize, we close out Q2 with outstanding financial and operational performance in a difficult working environment. We enter Q3 with a bright outlook on the strength of new product ramps and an industrial automation market that is showing signs of early improvement. While our visibility is limited and we’re not immune to macroeconomic shocks. I’m confident that we have the products, people and processes to thrive in the quarters ahead.

With that, I’ll turn things back to Andy.

[Andy Blanchard, Vice President of Investor Relations]

Thanks, Sanjay. Vincent, we’d now like to take some questions. And as a reminder, please limit yourself to one question and a follow-up.

[Operator]

[Operator Instructions] Our first question comes from the line of Mehdi Hosseini from SIG. Your line is now open. Please ask your question.

[Mehdi Hosseini, SIG]

Yes. Thank you for taking my question. Two questions. First, I want to better understand how to think about the earning power. I think it was two quarters ago that you highlighted a $3.5 to $4.25 earnings by 2022. And your recent execution suggests that you’re already at that run rate. And my question to you is given the share gains in memory and other areas, do you think there is an upside to that earning scenario that you laid out six months ago or perhaps a $4 earning is sustainable and it shouldn’t be viewed as a onetime event. And my follow up question has to do with China. How much of a revenue contribution did China provide? Thank you.

[Sanjay Mehta, Chief Financial Officer]

Hi, it’s Sanjay here. Yes, I think this year; we’ll come close or be in the range of hitting our earnings model out in 2022, and on the top line and the bottom line. And obviously there’s many puts and takes relative to what we published in the earnings model, specifically strengthened Semi Test and storage business offsetting the near term impacts of COVID and the IA portfolio. What we’ll plan on doing is in January updating that earnings model and provide guidance for the future then.

[Mark Jagiela, Chief Executive Officer]

And I think just, I’ll add Mehdi that, as you know very well, we have a very volatile market that we play in. And so to sustain linear growth throughout a decade is not the kind of business we’re in, but the trend lines we do believe support, certainly reaching and exceeding that mid-term earning model that in no way is going to be a peak for Teradyne.

[Mehdi Hosseini, SIG]

Great. Congrats. And then just quickly on China. What’s the revenue contribution of China?

[Mark Jagiela, Chief Executive Officer]

So in the quarter, China was about 12.5% of revenue.

[Mehdi Hosseini, SIG]

Okay, thank you.

[Operator]

Next question comes from the line of Vivek Arya from Bank of America. Your line is now open. Please ask your question.

[Vivek Arya, Bank of America]

Thank you for taking my question and congratulations on the strong results and the execution. Mark, you have bought up the test intensity factor a few times, but we honestly do not know how to put that in our model. When I look at your SOC test business, it’s up, I think on track for over 30% growth, but overall phone volumes are down according to TSMC in mid teens, even though the 5G part has been relatively strong. So how do you quantify this test intensity factor per unit? Is it a 5G versus 4G comparison? And importantly, how will this test intensity factor evolve as you go into 2021? Will it be 5% better or 10% better? How do we size that because without knowing that it’s very difficult to size what your SOC sales will do going forward?

[Mark Jagiela, Chief Executive Officer]

Yes, I appreciate the difficulty because if we had a formula, believe me, we would be using it and advertising it. But I do think what we’ve said is when we look at the big, big picture, we see that the growth in transistors is what drives complexity. And that over an average trend line gives us test growth, market growth in that 6% to 8% range.

Now, there’s many puts and takes to go on every year. It depends if people are making a major transition from a note like a seven to five nanometer node that enables more transistors and typically has a lower yields that come with it. So it’s very lumpy year-to-year and very hard to model year-to-year. But the net effects when you look back historically for the past five to seven years and at our projections are that sort of 6% to 8% trend line growth for test. So I don’t think anything changing in that. But it’s not going to be smooth. It’s going to be lumpy.

And the other thing is that affects this. If you look at this year, for example, the market for SOC test is really flat with last year. It’s about a three – and we said $3.1 billion to $3.4 billion market and the underlying economic effects of what’s going on in the world and cell phone unit declines and such as all and automotive being off and industrial being off is netting out to a flat market. Teradyne on the other hand is obviously picking up a lot of market share this year. That’s both good news and bad news.

I think the bad news is we’d love to see the market grow every year, but in a very difficult macro year like this, the fact that it’s holding its own, despite the weaknesses and the pockets I just mentioned is encouraging. And then we expect as we come out of this pandemic and the global economy start growing again, those markets will continue to grow along those trend lines. So I wish I had the formula, I don’t, but I think the evidence is sort of speaking for itself.

[Vivek Arya, Bank of America]

Got it. And for my follow-up, Mark, when I look at again on the business as it relates to 5G, can you give us a sense for how much of your business is infrastructure versus handsets? And as part of that, let’s say if 5G handsets triple next year right, what does that do to your SOC test business intensity being same or better? Does it mean your tester business will triple or how do we, give us some sense for how we kind of try and correlate your – the growth prospects to the number of 5G handsets and the demand for infrastructure? Thank you.

[Mark Jagiela, Chief Executive Officer]

Okay. So 5G is a piece of a phone. It’s – the silicon-related to 5G in a phone is one part of a phone. So there’s no way the tripling of 5G triples our tester business. But to give you some sense, the infrastructure piece of 5G was very robust last year, and we talked about it all year long, and you saw that our business level grew toward the back end of the year due to infrastructure investments. And then we talked about the fact that those investments would taper off in 2020, which they have, and what would come into the market would be handset related growth.

But we’re still talking about, and we’ve also said 5G in aggregate should add to our test business somewhere between $400 million to $500 million of market. And if Teradyne is at 50% of the market that should add, let’s say $250-ish million to Teradyne’s business, and when it’s peaking, but we’re not peaking. We’re not near peaking. This year, we’re – maybe a couple hundred million dollars into that $500 million envelope. So that will give you the sort of calibration on how much you might think 5G could mean to us over the next four to five years on an annual basis. When we get to that mature $500 million level, hopefully we’re running at that $250 million plus or minus additional revenue level.

[Vivek Arya, Bank of America]

Thank you.

[Operator]

Next question comes from the line of Brian Chin from Stifel. Your line is now open. Please ask your question.

[Brian Chin, Stifel]

Hi, Mark and Sanjay, great results, and thanks for letting us ask a few questions. First, as was just discussed in the last question there, but the company – and clearly company and industry-specific factors contributing to your 50%, 60% year-over-year, year-to-date growth rate in Semi Tests. However, do you think a layer of this growth could reflect your customers or customers’ customers attempt to put some inventory in place, be it wafer, chip or even end device, the safeguard against future supply chain and demand uncertainties? I would appreciate any thoughts.

[Sanjay Mehta, Chief Financial Officer]

Yes. Hi, it’s Sanjay. So, we do a lot of work and trying to triangulate our shipments and then trying to understand utilization and inventory levels of testers out there. And I think what you saw in 2019 as Mark articulated earlier was a buildup of infrastructure test tooling and which kind of built the capacity. So they could have a run rate. From an end market and inventory perspective, we’re not seeing test or inventory build. We’re always on the lookout for it and concerned about it. But from the analysis we’ve done, we actually don’t see that inventory buildup.

[Brian Chin, Stifel]

Okay, great. And you’re talking more about the equipment versus further downstream in terms of that activity.

[Sanjay Mehta, Chief Financial Officer]

Yes. Mainly from the tester equipment, it’s very hard from an end market perspective, be it smartphone or industrial or automotive to think about those inventories.

[Brian Chin, Stifel]

Sure. Okay. Yes. I was kind of geared at more further downstream, but I appreciate the commentary. Maybe one last one, I know, you are not guiding fourth quarter per se here, but based on your 54% – I think the 55% first half weighted revenue comment, does that roughly suggest 4Q sales would be down something like 30%, 35% sequential. And would you expect Semi Test sales decline as similar or higher, lower rate?

[Sanjay Mehta, Chief Financial Officer]

Yes, we’re effectively guiding down 35% to 40% versus Q3 mid.

[Mark Jagiela, Chief Executive Officer]

Yes, I think what we’re – when you do the math, it is exactly what you just did. And now the decomposition of the various businesses in that, there’s a lot still in flux. So IA tends to be up in the fourth quarter and we expect that will continue. So I think last year with atypical with the strong semiconductors. So I think if you looked at prior years, you get essentially the same kind of mix.

[Brian Chin, Stifel]

Okay, great. Great. I appreciate it.

[Operator]

Next question comes from the line of John Pitzer from Credit Suisse. Your line is now open. Please ask your question.

[John Pitzer, Credit Suisse]

Yes, good morning guys. Congratulations on the solid results. Thanks for letting me ask the question. Mark, you said in your kind of prepared comments that as the next wave of Huawei bands come into effect, you don’t see much of an impact to global test capacity as other suppliers fill the void. I’m just kind of curious, and I know it’s a little bit of a guessing game, but when you look at the potential suppliers to fill that void, how does your share with those suppliers look vis-à-vis Huawei? And I guess importantly, do you think the test capacity that’s out there just gets repurposed for these different suppliers? Or do you think it might actually cause some incremental buying?

[Mark Jagiela, Chief Executive Officer]

Well, I think over the long haul, meaning let’s say a year. I don’t think there’s going to be – I think there’ll be repurposed and there could be incremental buy in early on. We’re in a period right now where the testers are still very full up being used through this September 15 date until we get past the sort of grace period and into the embargo. So post that period of time, there could be some spot buying because they’re not completely fungible. But over time, they’ll work their way into the supply and demand balance. So there’s no long-term consequence here that we see. And our share position in the alternative sources of supply, it’s some are better, some are a little lower, but I think when we’ve analyzed it overall, I think, we’re neutral. We don’t see that we’re going to be overly benefited or a detriment because of the shift in who’s going to make the silicon for those products.

[John Pitzer, Credit Suisse]

And then Mark, just going back to the implied guidance for the calendar fourth quarter, that kind of implied sequential decline is not without precedence in your business model. And if I go back to like the 2012, 2013, 2014 period, you saw that kind of fall off in Q4, but I’m just kind of curious, given how uncertain the environment is today, is that your attempt at a conservative placeholder, or do you actually have visibility out to the December quarter that informs kind of that view of 55%, 45% half-on-half split?

[Mark Jagiela, Chief Executive Officer]

Yes. What I would say is that, if even more recently you looked at 2016 and 2017. One of the differences we were seeing right now is that those were also heavy tooling years for smartphones for us. We saw pretty significant drops from Q2 to Q3 in those years, maybe on the order of 20% to 25% followed by another 5% to 7% in Q4. So this year instead of the 2Q to 3Q drop, we’re kind of seeing it all coming Q4 is our forecast. Our visibility is actually quite limited out there.

We – obviously, when you look at what we’ve been doing this year, and if you followed us a long time, there’s quite a bit of variability in the out quarter in terms of what might materialize. So we don’t have a lot of backlog that extends out that far and what will actually happen. There’s quite a wide range around it, but it’s based on the modeling we can do, the customer conversations we’re having and those kinds of things.

[John Pitzer, Credit Suisse]

Helpful guys. Thank you.

[Operator]

Next question comes from the line from Atif Malik from Citi. Your line is now open. Please ask your question.

[Atif Malik, Citi]

Yes. Thank you for taking my questions and good job in the results and guide. Mark, can you talk about the timing of the Millimeter Wave opportunity when you expect the infrastructure part of the investments to evolve and also on the mobility side?

[Mark Jagiela, Chief Executive Officer]

Millimeter Wave, frankly, I think is quite a ways off from being a big part of the infrastructure and then subsequently handset story. It’s a big test intensive event when it occurs, but it’s likely, none of the geographies are moving aggressively with Millimeter Wave. In the U.S., there’s some boutique deployments, I would say, in urban areas and some high-density areas. But it appears most of the U.S. carriers are going to do is rollout sub 6G in some flavor first and then slowly move toward Millimeter Wave.

So our view is, there certainly will be handsets at the premium tier that have that capability to run on those scarce networks and there’ll be some bump, and we’ve seen it already this year. Our Millimeter Wave shipments of test equipment at both LitePoint and Semi Test are tens and tens of millions of dollars. So it’s not insignificant even if the miniscule volumes we’re talking about. But it’s probably not until 2022, 2023 before it starts to matter would be my estimate.

[Atif Malik, Citi]

Great. And then you talked about design wins in computing, which is a relatively new area for you guys with UltraFLEXplus. We also heard that one of your customers’ customers moving to ARM-based CPUs for their notebooks. And those CPUs have much larger die size than the apps processor using smartphone. So how do you look at your computing share gain opportunity over the next 12 months to 18 months?

[Sanjay Mehta, Chief Financial Officer]

Yes. Hi, it’s Sanjay here. So the compute market is roughly annually $500 million to $600 million. And our share has been roughly 30% give or take historically. Our new UltraFLEXplus product will help us grow that share. And this initial design win will help along that journey. So that’s how we’re thinking about it in the near term.

[Atif Malik, Citi]

Thank you.

[Operator]

Next question comes from the line of Toshiya Hari from Goldman Sachs. Your line is now open. Please ask your question.

[Toshiya Hari, Goldman Sachs]

Good morning. Thanks for taking the question and congrats on the strong results. Mark, I wanted to ask about your System Test business both on the HDD side as well as the SLT side. In terms of your HDD business, you’ve been speaking to this business and the strength there for a couple of quarters now, how are you thinking about sustainability of that strength into, I guess Q4, since you’re guiding up Q3? And on the SLT side, your nearest competitor here, I guess that they’ve been pretty vocal about this specific application as well over the past couple of quarters. How are you sizing the opportunity in SLT? And how should we think about your competitive position relative to not just Advantest, but also some of the other players that play here? And then I have a follow-up. Thank you.

[Mark Jagiela, Chief Executive Officer]

The whole storage test business, whether it’s HDD or SLT, has been a tremendous story, and it’s surprised us. And it seems as though the sustainability of it is pretty robust. It doesn’t mean it’s not volatile even in this year. You can see the quarter-to-quarter we can swing on shipments, 20%, 30% a quarter. So it’s quarter-to-quarter volatile, but the overall underlying demand is very strong for both HDD and SLT.

The SLT side of it, as we’ve described before, it’s still somewhat of a nascent market. This is an additional test step that some high volume – manufacturers of some high volume digital centric devices are using to further reduce defects per million. And the economics of this insertion are something that both customers and equipment suppliers like ourselves and others are working to try to make more attractive for other classes of devices, lower volume devices, more mixed signal with RF and analog content and such.

So how the rate of adoption of SLT is just a big unknown in this, but even with the limited adoption that exists today, you can see that from last year when the early adoption occurred outside of compute, which has been doing this for quite some time, it's grown to be pretty significant. It might be a $300 million tester market, something like that this year. And we're probably splitting it roughly 50:50 or so with Advantest tests and just sort of the test area. So I do think it's got legs. I do think that the underlying complexity issues, we're talking about compel these additional test steps in the very high end of complex devices. And so, it's going to be a growth industry. It's going to be volatile though. And until we get a dozen customers adopting this wildly, you're likely to see these quarter-to-quarter and year-to-year fluctuations that we've seen up till now.

[Toshiya Hari, Goldman Sachs]

Thanks for that. And then as my follow-up, I wanted to ask about the industrial automation business and how you're thinking about the long-term growth profile there. I think in your prepared remarks, you reiterated your long-term growth target, but curious just given COVID-19 and the potential impact it could have on how your customers and customer’s customers think about their factory footprint, I guess. Could this drive a significant increase in adoption rates of things like UR cobots and MiR robots? Or is it a little early to make that call? Thank you.

[Sanjay Mehta, Chief Financial Officer]

Yes. Hi, Sanjay here. So I think over since 2015, we've experienced significant growth in UR than adding MiR in 2018 and then as well as AutoGuide in 2019. And that growth we expected to continue in 2020. Obviously, COVID hit, and we're looking at potentially a contraction year depending on how the market shakes out in the second half. However, our belief is that we're going to continue over the long run to grow at the 20% to 35% as Mark stated in his prepared remarks. And really I think that you consider over the short-term, I think there's going to need to be a balance of getting people back to work versus industrial automation.

However, in the business development activities, we're seeing a lot of activity in this plant managers and decision makers looking to harden their production lines and social distance. So, we are seeing activity even in the short-term. I think in the long-term, it will provide a tailwind. However, we're still in the mid-term around the 20% to 35% growth, and we still continue to invest in product differentiation and application differentiation in those businesses.

[Toshiya Hari, Goldman Sachs]

Thank you.

[Operator]

Next question comes from the line of C.J. Muse from Evercore. Your line is now open. Please ask your question.

[C.J. Muse, Evercore]

Yes, good morning. Thank you for taking the question. I guess, first question in your prepared remarks, I just want to double check here. I think I heard you say that system test would double from $72 million in Q2 into Q3. Is that correct? And as part of that, can you give us an idea of where we should be thinking about the growth balancing storage versus a traditional system test?

[Mark Jagiela, Chief Executive Officer]

Yes, you're right. I did say that we would double and more than double in Q3, but it was off of baseline of $36 million in storage.

[Sanjay Mehta, Chief Financial Officer]

In storage.

[Mark Jagiela, Chief Executive Officer]

Yes, in storage.

[C.J. Muse, Evercore]

So that was just the storage comment, not overall system test.

[Mark Jagiela, Chief Executive Officer]

Correct.

[C.J. Muse, Evercore]

Okay. Great. And then I guess as my follow up question thinking through the SOC market, it looks like your share is probably going from 40% to low 50s year-on-year. And I guess was hoping for you to parse through the drivers there. Obviously, mix plays a role. And you do have your largest customer turning on. They're also bringing on arm-based processors, I believe, embedded AI that that really helps you guys. You have new UltraFLEXplus. And then, you talked 5G being only a minimal driver. So, amidst that backdrop, what are the key drivers of that share shift? And more importantly, how should we think about the sustainability of that share looking into 2021?

[Mark Jagiela, Chief Executive Officer]

So you're right. We think probably our share in SOC moves up around 50% this year and much of it – the majority of it is due to the shift of who's buying. So in the last couple of years, our share kind of came down. It wasn't customers defecting. It was who was buying. And this year, the biggest piece of the 10 point or so share gain in SOC will be opposite effect of our customers are buying more. However, there's also this component.

We've talked about the UltraFLEXplus and the designs wins we've had in mobility and compute. Those are going to in the back half of the year add additional new revenue streams for us. And so, we are picking up real customers to on this. So that's not insignificant and that won't completely mature in 2020. It's going to be more of the beginning.

And so that will grow throughout 2021 and 2022. So we do have a lot of headroom to continue to move our share north of 50% based on those design wins other ones in the pipeline. But as you know the underlying sort of core buying will fluctuate year-to-year. So if you go back to 2016 and 2017, we had some very big years of tooling for our customers around smartphone silicon. 2018 and 2019 was a bit down. We picked up new business in infrastructure to sort of offset part of that.

Now, we come back, it's gangbusters. And that could persist for a while, but it's going to still be volatile, I'm sure. But riding on top of that is this little new wedge of new revenue streams in SOC based on real design wins. That gives us that ability to keep on average moving our share north. And we've talked about long-term getting to 60% share of this market is reasonable. Once you're past 60%, there'll be a little bit more difficult perhaps, but 60% is certainly within a line of sight.

[C.J. Muse, Evercore]

Great, thank you.

[Operator]

Next question comes from the line of Timothy Arcuri from UBS. Your line is now open. Please ask your question.

[Timothy Arcuri, UBS]

Hi, thanks. First of all, I wanted to get what the 5G portion of the SOC TAM of this year. Let's say you're saying $3.1 million to $3.4 million, I'm just wondering how much of that's 5G and then I had another one. Thanks.

[Mark Jagiela, Chief Executive Officer]

Yes. We struggled to estimate that one precisely, but again, what I – I'll just give you the context and give you my best guess of the numbers. So we said that at peak, 5G should represent about $400 million adder to SOC tests and about $100 million adder to LitePoint test. So of that SOC $400 million max envelope, this year 5G is probably somewhere in the $200-ish million range for TAM.

[Timothy Arcuri, UBS]

Got it. And for wireless, Mark, there's – I mean, how much of the wireless piece is coming in the current year?

[Mark Jagiela, Chief Executive Officer]

Yes, in wireless, the 100 – and we've actually seen that wireless may grow to be a bit bigger than $100 million adder. It could be a $150 million adder or so. But this year, the wireless is probably in that –this is production test, not R&D test, but it's probably in that $70 million – $60 million to $70 million range for the market.

[Timothy Arcuri, UBS]

Got it. Okay, awesome. And then I just wanted to follow up on the last question. So I mean, there's a lot of stuff going on beyond your big customer. And certainly, you have the UltraFLEXplus ramping. But usually, I mean, a significant portion will say of your share gain this year, you're going to gain 13, 14 points a share is because your big customers having an on year. And usually, they don't have 2 straight on years. So I'm just sort of wondering if you strip away all the other stuff going on and you look at how sustainable that low 50 shares into next year, why would it be different this time where they would have 2 straight big on years versus history where they've had one on year and then they've had an off year? Thanks.

[Mark Jagiela, Chief Executive Officer]

Well, I think history is interesting in this. If you look at 2016 and 2017, actually our smartphone related business was pretty flat and consistent and hot. Those were peak years in the past, and it was 2 successive year. So I think the on/off, on/off pattern goes back to the earlier part of the decade, but I think 2016 and 2017 are equally valid thoughts and models around that. So that's one thought. It doesn't necessarily mean up and down, but at some point it's not going to be what's norm in baseline I think is a judgment, but I'd go back to that sort of trend line of the market. We expect to grow 6% to 7%. So if the SOC market this year is again, let's say, $3.3 billion, nominally, we're talking about a market that should be $3.4 billion, $3.5 billion, everything else being equal next year.

So I do think we can have two sequential strong years because we've had them in the past, and there's nothing wrong with that. Plus we have these new design wins coming online that haven't matured yet. And then the thing we haven't talked about that's out there is memory. Memory is having a pretty strong year this year. And if you look into 2021, the 2021 era is going to see this large shift from DDR4 to DDR5. This year, we're at the very early innings of the LPDDR5 shift for more mobile devices, but the DDR5 shift is coming. And as we said, that obsoletes the installed base of DRAM test equipment for final test. So there's a big retooling coming there as well.

[Timothy Arcuri, UBS]

Okay, thanks.

[Operator]

Next question comes from the line of Krish Sankar from Cowen and Company. Your line is now open. Please ask your question.

[Krish Sankar, Cowen and Company]

Hi. Thanks for taking my question. I had two of them. First one, Mark, to just follow up on your comments from the previous question. You said a couple of sequential growth years. It looks like you had like from a SOC test market standpoint, you had like five years of continuous growth. So I'm kind of curious, understand the test intensity is going up and 5G seems to be a longer and a stronger cycle. So if going forward, should a $3 plus billion be a decent bogey to use for the SOC market size? And I have a follow up.

[Mark Jagiela, Chief Executive Officer]

Go a bogey, I think is – so let me just add a few more comments about where we are. So you're right. We've seen the market show sequential annual growth for quite some length of time here. This year, it's maybe going to be about flat, but it may show a 4%, 5% growth as well by the time the year is over. And that's absent any real interesting participation of automotive and industrial buying. This is heavy, heavy mobility. And it's also in the midst of a pandemic. And it's also in the midst of all the regulations coming in around China. So I'll go back and say, I would model in a 6% to 8% TAM growth rate for SOC over the mid-term, four to five years. That is what we should be tracking at.

[Krish Sankar, Cowen and Company]

Got it, got it. That's helpful. And then as a follow-up, Mark, can you just tell us how much of your revenue was from LPDDR5? And when I look at your memory market size, you’re talking about $800 million to $850 million, six months ago it is more like $650 million to $750 million. Clearly, the upside is coming from DRAM. And so, I'm just trying to figure out on the market size how much of the upside is coming from the LPDDR5? And within that, how much of your revenue is coming from LPDDR5?

[Mark Jagiela, Chief Executive Officer]

Yes, I'm not going to break out our LPDDR5 revenue, but I will say that the increase in the market size is both flash and DRAM. It's about two thirds DRAM and one third flash compared to our estimate in January. So we are seeing upside on flash too. And much of the upside in DRAM is related to LPDDR5. So you would expect – and because our share is kind of going to be flat, you can derive a close estimate of maybe how much revenue is coming out of that for us this year.

And we're working on design wins to hopefully capture more of the DRAM market. We just introduced that product in Q4 of last year and we're ramping it this year. So that's what gives us upside going into next year, we think around DDR5, and we talked in earlier calls about our sort of 40% to 45% market share that we have should – with the products we have today and the competitive position we have today, we should be able to move that into the 50% – low 50% range here in the next couple of years, if we really execute well. So that's what we're focused on in planning.

[Krish Sankar, Cowen and Company]

Thanks for that, Mark. Very helpful.

[Operator]

Next question comes from the line of Richard Eastman from Baird. Your line is now open. Please ask your question.

[Richard Eastman, Baird]

Oh, yes. Good morning. Good morning Mark and Sanjay. Very nice, very nice quarter to be sure. Just a couple of questions. I'm just going to kind of focus for a second or two on the IA business. Could you talk about how the business progressed? You talked perhaps a little bit about some upside in the quarter here relative to your expectations, but could you talk maybe geographically what you're seeing in IA around universal robots and maybe just discuss any successes you might have. You talked about some self-help initiatives around distribution and around some new product applications coming to market. So maybe just provide a little bit of color on there because it seems like that business has at least stabilized, if not maybe getting back towards growth mode.

[Sanjay Mehta, Chief Financial Officer]

Hi. It's Sanjay here. So I'll talk a little bit about kind of the GO and kind of monthly profile. So for UR, when I take a look at China, first to go into COVID and first to kind of come out, and when we take a look at kind of the monthly profile, we saw improvement in March and then sequentially we saw improvement throughout the quarter and really kind of coming back strong. And when we take a look at not back to last year's levels, but improving Q2 over Q1 and based on the forecast we see that improvement continuing. But when we take that recipe of opening up and we look at the data and look at the U.S. and Europe, which is over 70% of the historical UR business, we're very encouraged.

And so, we are seeing business development activities. We are seeing growth coming, but really the baseline is China and the business activity in the U.S. as well as Europe. And from a product perspective from the applications, we're continuing to invest. We've recently have launched in April our ActiNav for bin picking. And we continue to drive for ease of implementation activities and really growing the ecosystem.

[Richard Eastman, Baird]

And at that – just as a follow-up, at that $59 million revenue for IA in the quarter, how did you manage – again, if I do the math quickly and your gross margin is still hanging out in the high 50s, maybe to 60%, how did you manage the OpEX in the quarter for IA? And was that – how far from profitability were we in the quarter…

[Sanjay Mehta, Chief Financial Officer]

Yes, so I think I mentioned earlier in 2019, we were profitable and our full year plan in 2020 pre-COVID was a heavy investment year in IA, both on the engineering side as well as the go-to market side. And we still plan in IA to be profitable at similar levels in 2020. COVID hits and then you – we’re faced with a situation of not having the revenue growth. So we meet or down a lot of the go-to-market spends and that was a significant reduction. However, we continued forward with the engineering and application spend significantly.

So, what you're seeing in the immediate short-term aside from kind of the re-vectoring that we did in metering down kind of the selling and marketing or go-to market spending is you're seeing more and more online marketing, more and more virtual trade shows, et cetera, and kind of restricted travel, obviously. So, you're seeing a short-term reduction in selling and marketing spend. However, you are seeing a little bit of travel and those types of costs within the engineering ranks, but we're continuing to significantly invest on that front.

[Richard Eastman, Baird]

As far as that’s close to profitability…

[Sanjay Mehta, Chief Financial Officer]

We are – I don't believe in 2020, we will – it's very uncertain depending on the revenue levels in the back half of the year.

[Mark Jagiela, Chief Executive Officer]

Okay.

[Sanjay Mehta, Chief Financial Officer]

But we're teetering on. It just really depends on the top line, but we are – I want to reiterate that we are encouraged by the activity of Q3 and – as well as the ramp up in China for UR in Q2 and we expect that to continue.

[Richard Eastman, Baird]

Thank you.

[Mark Jagiela, Chief Executive Officer]

Okay. And operator, we are out of time. So those in the queue, I will get back to you at the conclusion of this call and thanks everyone for joining us today. And we look forward to talking to you in the days and weeks ahead. Bye-bye.

[Operator]

Ladies and gentlemen, this concludes today's conference. Thank you for your participation and have a wonderful day. You may all disconnect.