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 Q1 2015 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you. I would now like to turn the call over to Mr. Andy Blanchard, Vice President of Investor Relations. Please go ahead.
Thank you, Ginger. Good morning, everyone, and welcome to our discussion of Teradyne's most recent financial results. I am joined this morning by our CEO, Mark Jagiela, and our Chief Financial Officer, Greg Beecher. Following our opening remarks will be 15, as well as our outlook for the second quarter. The press release containing our first quarter results was issued last evening. We are providing slides on the investor page of the website that may be helpful to you in following today's discussion. Those slides can be downloaded now, or you can follow along live. If you do not see the download icon, simply refresh the page. In addition, replays of this call will be available via the same page about 24 hours 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, including with respect to our dividend and share repurchase programs, which may be discontinued depending on general economic and market conditions and other considerations. Additionally, those forward-looking statements are made as of today. We take no obligation to update them as a result of developments occurring after this call. During today's call, we will make reference to non-GAAP financial measures. We have posted additional information concerning these non-GAAP financial measures, including reconciliation to the most directly comparable GAAP financial measure where available on the investor page of our website. Between now and our next earnings call, Teradyne will be participating in investor conferences hosted by D.A. Davidson, Cowen and Company, and Bank of America. 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 second quarter. Greg will offer more details on our quarterly financial results, along with our guidance for the second quarter. We will answer your questions. You should note that we intend to end this call after one hour. Mark?
Thanks, Andy, and good morning, everyone. In today's call, I would like to focus on three topics: our first quarter highlights, our outlook for the remainder of 2015, and our longer-term view on growth at Teradyne. We are off to an excellent start in 2015. Sales and profits were at the highest level for first quarter since 2012, and bookings were at the highest first quarter levels in five years, all driven primarily by mobile end markets. Greg will take you through the details that drove the financial performance, but I will provide a few highlights. Semiconductor Test was our outstanding performer in first quarter. On the order front, record demand for our Magnum V memory tester and our UltraFLEX high-speed memory tester drove memory bookings to an all-time high.
As I have highlighted in past calls, we continue to see the memory device mix skewing toward higher bus speeds and right into the sweet spot of our product line architecture. In SOC Test, stronger than expected demand for applications processor test, combined with the rapid adoption of our new J750-based system for image sensor test, led to a surge in orders. Analog test applications related to automotive and industrial electronics also showed strong growth, where our Eagle product bookings more than doubled compared to the first quarter of 2014. In our System Test business, storage test continues to strengthen. After two-plus years of excess test capacity limiting business in this market, the continued growth in cloud and enterprise drive storage has absorbed this idle capacity, resulting in a return to incremental capacity adds.
This return of hard disk drive buying, on top of the inroads we made last year in solid-state drive testing, sets up a strong year for storage test. At LitePoint, we had our strongest first quarter revenue in history. However, the outlook remains cloudy. Orders in the quarter were below expectation as customers remained focused on optimizing their production operations. Demand from a large customer was down, and China was particularly slow as manufacturers saw a drop in smartphone shipments in Q1. We expect orders to pick up as production plans solidify, but our visibility into the full year remains quite limited. Finally, in Q1, we began execution of our previously announced $500 million share buyback and paid our fourth consecutive quarterly dividend.
Turning to our full year outlook for 2015, our strong start to the year in Semiconductor Test raises our outlook on the SOC market size for the year from our previously forecasted $1.9 billion-$2.2 billion range to a $2.0 billion-$2.25 billion range. The market growth is driven both by incremental demand and the purchase of previously leased equipment. In SOC, we still expect the typical fall off in the second half of the year. In Memory Test, we still expect a flat market at around $500 million, but a continued increase in market share as growing high-speed memory unit volumes drive capacity onto our products. System Test should show a strong year-over-year growth, driven by the strength in storage test and steady demand in defense and production board test.
At LitePoint, we see the market in the $450 million-$600 million range, although at this point, it's trending towards the lower end of that range. Finally, I'd like to turn to the subject of growth at Teradyne. We believe that the best returns for our long-term investors come from a balanced approach to capital allocation. This consists of first investing in our core business to grow market share and incremental EPS. Second, executing attractive M&A to expand our portfolio for greater competitive advantage and earnings power. Third, a solid program of returning capital to shareholders. This balanced approach is in full motion at Teradyne. In our core business, we've been investing in new products and targeting select growth segments to gain share over time.
Some of these investments, like our 5th-generation RF test instrument in SemiTest, or our next-generation ETS-800 Eagle tester, enhance our position in markets we already serve. Other investments, like our J750 LCD driver test option or the LitePoint NFC tester, expand the TAM closer to our core. These organic investments are fully funded within our operating model, where we deliver at or above model profits. Over the past three years, we've grown 9 points of SoC Test share, 12 points of memory test, and about 14 points in wireless test share. With that has come a solid earnings model that has generated just over 20% company PBIT during the period. As I've noted in previous calls, the SoC Test market is showing signs of inflecting from what has been a sustained 3% average annual decline to about a 3% average annual growth.
That growth will be driven by slowing parallel test impact, increased device complexity, and steady unit volume expansion. We've discussed parallel test in the past, so I'd like to touch on the complexity component for a moment. The unrelenting drive for higher performance, whether you measure performance by processing power, battery life, transistor count, or some similar metric, drives differentiation for our customers. That drive for performance has been very evident in the mobile space, with some applications processors now moving beyond desktop MPUs and transistor counts. Power management chips have emerged as a major new class of integrated circuit and have evolved in complexity at a faster rate than even applications processors. We also see growing complexity in microcontrollers, sensors, motor controllers, and the thousands of other devices that are used to power industrial, automotive, and consumer applications.
This all translates into more complex test programs and longer test times. When combined with the diminishing impact of parallel tests, this, in turn, should drive long-term growth for test equipment. With this expected market growth and continued disciplined market share gains, we are poised to reap increased EPS benefit from the added drop-through. At LitePoint, we are launching twice the number of new products this year than last to drive future growth. Over the next few years, these new products will increase the size of our addressable market. While we expect the market conditions in wireless tests to remain challenging during this period, continued market share growth in connectivity and cellular test, combined with new products to expand our TAM beyond these traditional segments, forms the basis for our growth plan at LitePoint. Again, all these initiatives in our core are funded while making at or above model profits.
This, in turn, generates the free cash flow to pursue other initiatives in capital return and M&A. Our confidence in our core operating model has allowed us to ramp up our capital return program while still pursuing M&A. As always, we will continue to assess our cash portfolio and investment prospects to best optimize long-term returns to shareholders, which brings us to the other driver of growth, M&A. Technology businesses evolve rapidly, and that high rate of change disrupts markets and creates new opportunities. Many of these opportunities are addressed through our internal R&D investments noted above. Others require M&A to fully capitalize on a trend or exploit a new turn in the market. We envision several areas where M&A can augment our portfolio to capitalize on technology trends we see developing over the next several years.
As we've discussed before, we have a very strict set of financial hurdles to meet with any acquisition. We look at where we can deliver the highest long-term value to owners and are very disciplined in our analysis of potential additions to Teradyne. We're confident that this thorough but patient M&A strategy, combined with capital returns and sustained organic R&D, provide positive long-term results to our shareholders. Let me now turn it over to Greg.
Thanks, Mark, and good morning, everyone. I'll start with some brief comments on the start to the year, our key 2015 goals, then I'll cover the first quarter results in more detail and the second quarter outlook. On the demand front, despite our expectation for a smaller sequential SemiTest market this year, we began 2015 with a stronger start than last year. Company sales were $342 million at the high end of our guidance, and non-GAAP EPS came in at $0.17, $0.03 above our high-end guidance. SemiTest demand and favorable mix drove this strong start. Orders in the first quarter totaled $490 million, up 48% from the fourth quarter and 9% above the first quarter of 2014. Structurally, we're seeing some early benefits from the slowing of parallel tests that Mark talked about in October. Specifically, chip-to-tester interface challenges have been rising for complex SOC parts.
Interface layers may cost twice as much or more than their predecessors, which when combined with thorny signal integrity issues, can negate the payback of higher site counts. We also received orders in the first quarter to buy out about a third of the fleet of lease testers that we put in place last year. We expect more of the remaining balance to be bought this year by third-party financing companies, as they have a lower cost of capital than we do, and they can offer more attractive lease terms. In memory test, we had our highest quarterly bookings ever at $64 million. The recently introduced Magnum V, with its high frequency range and high pin count, is very well positioned for testing flash devices.
Mobile NAND is moving from 533 megabits per second today to over a gigabit per second later this year, and the Magnum architecture provides frequency and pin count advantages for these high-speed devices. Those advantages are also helping Magnum make steady inroads into some test insertions in the DRAM market. Final test for DRAM is seeing similar speed boosts as we move to LPDDR4 and DDR4, both operating above 2 gigabits per second. The UltraFLEX M offers headroom up to 8 gigabits per second, which was a key driver of our Q1 memory orders. This is another example of seeing where the hockey puck is going in our product planning process, which is a key part of our long-term sustainable advantage. This proven roadmap insight allows us, on average, to invest our R&D dollars more efficiently than our test competitors.
In storage test, we saw strong resurgence in cloud-based testing demand for both nearline and enterprise applications, fueled by strong storage capacity growth. Our new 3.5-inch tester serves high-capacity cloud applications with as many as 13,000 test slots in a single tester, further lowering the per site cost with greater density. Shifting to the 2015 vital goals. The first goal is to hold and consolidate the strong SoC Test share gains over the last several years. In memory test, the goal is to continue the share gains of a few points a year and put us above 30% for 2015. Recall that we've expanded from 16% share in 2012 to 28% share last year.
SemiTest share gains have come from our focus on and success in segments that are growing faster, such as mobility, microcontroller, and analog, and of course, from head-to-head shootouts where we differentiate with our product architecture. We do not try to gain share with aggressive price moves or at the expense of gross margins, given that capital equipment demand is highly inelastic. In System Test, we're focused on meeting the increasing customer pull for our new 3.5-inch cloud tester. This involves completing the engineering and ramping our supply chain for this new product. System Test is also driving to expand the board test customer base for the new automated in-line test station products introduced last year, and to build on the addition of AIT into the defense and aerospace group. At LitePoint, the laser focus is on expanding in Asia.
Last year, we broke into several new major Asian cellular manufacturers with initial orders. This year, we want to win a larger share of their wallet and continue to fan out in Asian accounts. As Mark noted, we're also fielding new LitePoint products for closely adjacent segments that should contribute to next year's financial results. I'll talk more about our progress against these key goals later in the year. At the corporate level. We'll continue to both return capital consistent with the buyback plans outlined last quarter, while also pursuing highly attractive and complementary M&A. We, of course, can't comment on the active M&A candidates in our pipeline. We will, however, constantly compare the small number of attractive M&A opportunities in our funnel against returning even more capital to ensure we secure the maximum shareholder returns.
On the buyback front, we've repurchased 3.9 million shares totaling $75 million at an average price of $19.15 through yesterday. These buybacks are against our $500 million authorization approved early this year, leaving a remaining balance of $425 million. As a quick reminder, we plan on buying back at least $300 million in 2015, which when combined with our quarterly dividend, will lower our U.S. cash and marketable securities to a level much closer to our minimum U.S. operating balance. We closed the first quarter with total cash and marketable securities of $1.271 billion, of which $621 million is onshore and $650 million is offshore. First quarter free cash flow was $16 million, as strong profits and better-than-expected collections helped offset the settlement of annual compensation plans and tax payments.
In April, we secured a $350 million bank revolver credit facility, which will serve as dry powder for attractive M&A or other corporate purposes. The key terms are contained in an 8-K filing this morning. Let me now quickly comment on the weakening yen and euro, which is a frequent investor question. First, we haven't seen a noticeable difference in the SemiTest pricing environment, which of course remains competitive. You can see that our company gross margins continue to hold up well. The steady introduction of new products and instruments and ongoing material cost down efforts by our supply line group offset the natural price erosion. The area where price competition has been the sharpest company-wide is in wireless tests, which is from oversupply rather than a currency issue. I should add that we have considerably less currency volatility than many industrial companies.
Our test systems are predominantly quoted and sold in U.S. dollars worldwide. On occasion, we'll quote and transact sales in local currencies, most frequently in Japan, which was 4% of company sales last year. In those situations where we do have foreign currency exposure, such as our foreign-denominated monetary assets and liabilities, we enter into foreign currency forward contracts to hedge our short-term exposure. Moving to the details of the first quarter. Our sales were $342 million, gross margin was 56%, the non-GAAP operating profit rate was 14%, and non-GAAP EPS was $0.17. We had two 10% customers in the quarter. Our non-GAAP operating expenses were up $7 million to $143 million compared to the fourth quarter due to higher variable compensation accruals. Moving to our segment-level detail. SemiTest bookings were $397 million, driven by the seasonal patterns and strong first-half pull-ins.
SoC Test orders were $333 million, and memory test orders were $64 million. SemiTest service orders were $54 million of the total. Shifting to wireless test, we booked $27 million and shipped $34 million in the first quarter. Moving to System Test , orders were $66 million in the quarter, and shipments were $37 million. Storage test orders were up 40% from the fourth quarter on strong demand for our new high-density three-and-a-half-inch test system. Shifting to our outlook for the second quarter, sales are expected to be between $470 million and $500 million, and the non-GAAP EPS range is $0.42 to $0.48 on 217 million diluted shares. Q2 guidance excludes the amortization of acquired intangibles and the related tax impact. The second quarter gross margin range is 58%-59%, and the operating profit rate at the midpoint of our second-quarter guidance is about 27%.
Our 2015 tax rate outlook is unchanged at 27%. If the R&D tax credit is reinstated for 2015, that rate will drop to 25%. The 2015 demand is starting stronger than last year. We're returning significant capital to our shareholders, and we're seeing some promising long-term trends in SemiTest, SoC Test market size. In summary, we're very excited about our future prospects, and we'll continue to sharpen our focus on how we best allocate our hard-earned capital to ensure the highest possible returns. With that, I'll turn the call back to Andy.
Thanks, Greg. Ginger would now like to take some questions, and as a reminder, please limit yourself to one question and a follow-up.
Ladies and gentlemen, at this time, if you would like to ask a question, please press star followed by the number one on your telephone keypad. Again, that is star one. You do have a question from Krish Sankar from Bank of America.
Yeah, hi. Thanks for taking my question. I have two quick questions. Hey, congratulations on the execution and the share gains. First one, on the memory test side, are you actually seeing LPDDR4 adoption driving some of the increase in your memory test revenues, or is it purely share gains?
Yeah. Certainly, LPDDR4 adoption is accelerating. Because of the interface speeds, that's driving more testing of that type of product onto our testers. It is share gains, but it's related to that interface speed.
Got it. That's very helpful. Then as a follow-up on the wireless test side, it seems like it's been structurally challenged for over a year now. The question I have is the way to grow this business really by getting into the R&D side of wireless test? You guys are right on the production side, which obviously has better margins, but looks like the bigger dollar run rates are actually in the R&D side. I'm kind of curious, would you ever consider getting into the R&D side for wireless tests? Thank you.
Krish. First, LitePoint, over the last three years, has operated above the company targets. It's done well financially, albeit the sales have declined, but it's a good profit contributor. In terms of how to grow the business going forward, there's a whole set of adjacencies around LitePoint that are more connected to some number of our production, whether it's smartphones and tablets, there's other test insertions that we can go after. We're going to target that, but that won't start showing up until next year. We do have a small footprint in pre-production tests, but it's small. There are some opportunities there, but we certainly don't cover the entire pre-production portfolio that some of the larger competitors do.
Thanks, Greg.
Next question comes from Mehdi Hosseini from SIG.
Yes, thanks for taking my question. I want to go back to these leased systems that are now purchased. Can you help us understand the order of magnitude of these systems that are still in the market and are categorized as leased and that could turn into an outright purchase? I have a follow-up.
Mehdi, last year, we talked about putting in about $75 million of leased testers, which was more of an aberration, not business as usual. In this call, we mentioned about one-third we got orders for. That means there's two-thirds left, we would not be surprised if over the next some number of quarters, a significant portion of those testers could also be purchased.
Sure. You said $35 million, correct?
I'm sorry, Mehdi?
You said $35 million, correct?
$75. Well, $75 million was the book value, Mehdi. When we put lease testers in, we do it at our cost, $75 million. We obviously sell them for a different amount than the book value. If we just took the book value for a moment, $75 million of book value put in place, orders for one-third to date with some comments that I provided that we would not be surprised if more of those testers were bought out during this year.
Got you. Just to make sure I understand, what you recognize for revenue for these lease systems, this is above and beyond the SoC TAM. You just raised the SoC TAM slightly, and this is something completely different, correct?
Well, this would be a factor as to why the SoC TAM came up among other factors. At the beginning of the year, we weren't expecting to have this volume of testers being converted from lease to purchases. That drives more revenue into this year. That's one factor, again, among several others that cause us to adjust our estimate of the market size.
Sure. I also want to get, my second question has to do with the dynamics in Asia. It still is almost three-quarter of your SemiTest. Do you see any change in more business in Korea versus Taiwan? There is a dynamic going on there which could have an impact on your SoC Test , especially where in Korea is more of an IDM that purchase, where in Taiwan, more of a subcons that purchase SoC Test ers. If you could help us understand how do you see that dynamic playing out in 2015, and is there any pluses and minuses that we could think of?
Yeah. In SoC, I would say that Taiwan continues to be by far the strongest place for demand for capacity. It can episodically move back and forth, but I would say this year, there's nothing that's going to clearly shift that Taiwan dominance of demand.
Got it. Thanks so much.
Your next question comes from C.J. Muse from Evercore ISI.
Yeah, good morning. Thank you for taking my question. I guess first question, gross margin guidance is pretty phenomenal. I was just looking back at your model, and I don't go back far enough, I guess, but I don't think you've ever hit a number like that. I guess a couple questions around that. The first one is, can you talk about whether that's 100% mix-related or there are other factors? Presumably around mix, I'm assuming that there's an uplift of Eagle test and analog in there. Curious to hear your thoughts around spend there, considering from the analog guys this last earnings cycle, we've heard about guys lowering utilization to temper their inventories, and curious how that has impacted your vision of analog spend for this year.
Okay, I'll take the first part, then Mark will take the second. The most significant impact is mix, and our mix can vary quite considerably. We're obviously doing a lot of work to continue to introduce new instruments and lowering the material costs behind the scenes. This was a very good quarter for mix in our guidance. When you look at the second quarter, we have no charges in our guidance for ops or retrofits. When you go back to some other quarters, you might find attractive gross margins that have been diluted a little bit by special charges. We're not expecting any charges next quarter. That's in part why it might look higher than other periods.
There's no doubt this is very strong gross margins, and it's consistent with what we've been trying to do, is target what we go after with differentiation, not try to get market share quickly or too aggressively. Mark, do you want to take the second part?
On the analog business, it's still very strong. It's not, in our view, being tempered by anything related to some of the recent announcements. Automotive, in particular, is an area that continues to draw heavy demand from the Eagle product line. That's a particularly strong area. I would say there's other power applications that are more industrial as well as automotive. Inverters and IGBT-type devices are also pulling demand. We see that compared to years past, analog's never quite as volatile as the digital side of test, but that is a steady, growing good business for us.
Okay. Very helpful. I guess as a follow-up, one quick one on the gross margin. How does the lease impact gross margins? As my, I guess, true follow-up, maybe that's sneaking in trade. In terms of the upside to SoC, you've got the lease conversion, but also curious where else you're seeing the strength. Is it really the image sensors plus Samsung going in-house with captive baseband and AP, and that's driving upside for you guys? Or is there another sort of high-level area of strength that we should be thinking about?
I'll do that. The lease is just normal product sales. It doesn't move the margins materially one way or the other compared to other SemiTest range of products. That's not a big factor. It's hard to pin down mix. It depends what you look at in terms of our portfolio, but this is a very good quarter for mix, the second quarter, and again, we have no inventory charges planned or retrofits in the second quarter. You're looking at the numbers against other quarters where there may have been some of these charges, and the charges are found later in the quarter. They're not found at the time you're given the guidance.
On the image sensor business, image sensor testing has been a very strong piece of our portfolio for years. It is volatile. It is more volatile than, let's say, the analog market. This year looks like we could see business levels for image sensor testing twice the size we saw last year. That's really taking off. A lot of it's mobility, but there's also cameras more and more moving into automotive applications, part of the story there. There's a higher test intensity around that kind of image sensor. There's a wider proliferation of styles of image sensors. There's infrared, for example, compared to just visible light and some other innovations going on. That looks like a solid piece of the portfolio. On the comment around Korea and such, I don't think that's abnormally distorting any part of the market size estimate that we've given.
The increase, I would say, is by and large, the lease conversions, the image sensor business, and the analog business, those three pieces being somewhat stronger than we expected.
Okay, next question, please.
Great. Thank you.
Your next question comes from Timothy Arcuri from Cowen and Company.
Thanks a lot. Guys, I had a couple of questions. I guess the first thing is just to dive a little deeper on this TAM improvement in SoC and trying to figure out how much is structural versus how much is cyclical. If I go back to this lease number, we had $75 million worth of leases, but at your cost, that was going to support roughly $150 million if they had been ordered upfront. It seems like the swing factor, the sort of TAM swing factor from the lease element is like $150 million. You raised the TAM $100 million at the low end and $50 million at the high end. It seems like the lease factor more than accounts for the raise in the TAM. I'm just trying to figure out how much is structural versus how much is cyclical.
Yeah. You've got rough math, right? Remember, we're not necessarily baking in full conversion. As we've updated our market size forecast, we haven't assumed full conversion of those leases. As Greg mentioned, we got about a third converted in the first quarter. If more convert, it's likely that would raise the estimate for the market size for the year. That's a piece of what we've looked at. Then the other two, as I mentioned, would be image sensor and analog being stronger. You might think at this point in the year, half of the increase comes from the lease conversions and half come from strength in those other two segments. As we go through the year, there's a little bit of a bias here that it could go up.
Okay. All right, thanks. Then I just had two quick follow-ups. One is, the guidance seems to sort of imply that the orders in June, I know that you guys don't guide orders and orders are sort of a tough thing to even talk about, it sort of seems to imply that the orders in June will be down a bit, that's sort of counter-seasonal, I'm wondering, maybe is my math on that wrong? Then lastly, the sort of real question is, wireless test is still obviously bad, I'm wondering just what's going to make it better? Does it actually require one or two of your competitors to actually leave the market? What is going to have to structurally happen to make that market better? Thanks.
Maybe on the last point first. The market for wireless test and Teradyne's history in it has been dominated historically looking backwards by some very large customers. The benefit of serving those large customers was evident in some of the returns we've had in LitePoint in the past. As those large customers begin to change their test strategy and come back to a much lower level of buying, that decline has not yet been offset by growth in other regions like China and Korea. We're very close to the sort of inflection point on that, is what we believe. Offsetting that large customer will be growth in other suppliers in other regions of the world. It will be a slow pullout from that. Certainly compounding the issue will be oversupply.
There are four major suppliers in a $450 million-$600 million market at this point. That will have pretty intense competition as the market turns around to some modest growth. That's why we see in that core connectivity cellular test business, modest return to growth for us and the market over the next few years, and that's also why we've launched these other products to go after other test insertions that aren't related to those two areas. We've got to expand the TAM in order to get our target growth rates back in wireless test. That's how we think about it. That's what we see going on. I think the first part of your question was the bookings trend.
I should just add that a chunk of the bookings in the first quarter were connected with our new 3-and-a-half-inch hard disk drive tester, which the lead times are quite long on that we provided customers. That's going to ship in the second half of the year, that product. Therefore, bookings come in a bit earlier than they might otherwise.
Got it. Thank you so much.
Next question please.
Next question comes from Jim Covello from Goldman Sachs.
Hi, this is Chelsea German on behalf of Jim. Congratulations on the strong results, thanks for letting me ask a question. You mentioned that you're expecting a fall off in SOC Test demand in 2H. Can you just talk about if that's based on normal seasonality or if there are other specific factors that are leading you to be more conservative?
No, we're just seeing the normal seasonality expectations for the second half. At the beginning of the year, we outlined how there is a pattern tied to the complexity of new consumer products that are introduced in any given year. If you look backwards, coincidentally, even years tend to have been larger test markets than odd years, completely tied to complexity increase in products, our customers' products. That still is a theme this year. That's what makes the overall market, in our estimation, down from last year. Albeit we're revising it up a bit, it's still down. What we see in the second half as a pattern is really not that different from what prior years have shown in the second half.
Got it. Then can you talk a little bit about your visibility into the pipeline for other segments in the second half, such as memory or wireless test or even the image sensor business?
Yes. Well, the image sensor business will, I think, be strong throughout the year. The memory test business will be similar. I don't think there's a seasonal pattern around those two necessarily. Wireless test typically has a very front-end loaded pattern as well, similar to SOC Test. There we'll probably see most of the demand be put in place through mid-third quarter.
Got it. Thank you so much.
Your next question comes from Jairam Nathan from Sidoti.
Hi. Thanks for taking my question. Just with regard to wireless test, is there a point where you think you will need more restructuring on the cost side within that segment? I know you said it is profitable and stuff, do you see a point where you kind of have to align it to lower revenue?
That's not in the plans now. I can't say that would never come to pass. Just last year, we were above the company model for operating profits, so even in a down market, and I know you hear about our competitors bemoaning the space, we still have very good gross margins and good operating profit. For us, it's less about percentages, it's more the dollars aren't as high as we need them to be or would like them to be, particularly given the prior two years when the volumes were substantially higher. There's always a chance that we'll have to fine-tune any of our businesses, and LitePoint is not an exception to that.
We have made some adjustments, and we need to see how this year plays out, and we have a number of new close adjacencies and other test insertions, so we need to see how they latch. We'll look at that through the year, and we obviously have a history of adjusting where we need to, so if that's necessary, we'll take the action.
Okay. I don't know if you probably answered this question, but on the apps processor segment itself, is the outlook similar to what we had last quarter about the declines in the apps processor?
Yes, I'd say that substantially nothing's changed. The lease conversions, which is part of the drive for a larger market, really are not new capacity going in. It's just a financial transaction. In terms of new capacity adds for apps processors for the year, it's tracking with about what we expected.
Okay. Thank you. That's all then.
Your next question comes from Farhan Ahmad from Credit Suisse.
Congratulations on the great results, and thanks for letting me ask a question. My first question is on the smartphone side. The unit growth has been decelerating, and I just want to understand how much of your SemiTest business is tied to smartphones. I believe wireless is mostly smartphones at this stage, maybe some testing on PCs as well. If you could just remind us what the exposure is, and how should we think about it as the unit growth decelerates in the smartphones going forward?
We'll probably do smartphones and tablets together, mobility.
Right.
As a market.
I would say this is a rough average, but mobility devices probably drive about half of our tester demand in general. That's a rough way of thinking about it. It's absolutely right that the rate of growth of units is declining. What's most important to us is the absolute unit growth in terms of the number of new units per year multiplied by the complexity of the devices that are in those phones, and the complexity of the devices is really what's changing. As I mentioned in my remarks, take applications processors. Applications processors are now typically more complex than the processors you find in your laptop or desktop computer. Those transistors and that complexity to get low power, high performance, move power cores up and down seamlessly without injecting any problems, talk across high-speed buses to LPDDR4 interfaces.
All of those things actually compound the complexity compared to a conventional laptop processor. The first thing that drives up is test seconds. The test seconds we see on these devices is increasing to get better fault coverage and better yields for the parts. That's actually accelerating a bit. The other theme around the die sizes are shrinking, but the transistor counts are increasing. For us, it's really a game of units. As long as units are going up, which they are, and complexity's going up, the test consequence goes up. The other part of it is that each generation of processor to enable higher bandwidth communications with memory, to enable lower power, typically have had more device pin counts. Packaging, like wafer-scale packaging and other kinds of technology, allow that increased pin count without a lot of added cost for the device.
Testing those additional pins is another multiplier effect on the test intensity. What we've seen, and I've talked about in the past, is parallel test is something that is flat-lined and, in some cases, inverting backwards. You might have seen, for example, a year or two ago, a complex application processor being tested at eight in parallel on a tester. Because of the complexity increase, some of that is inverting back to maybe six in parallel or four in parallel. That also is a good trend line for the business, and all of that is what gives us the confidence to see a market that has been declining, moving to a market that will be growing looking forward. I could go into similar issues with power management ICs, which are even, in terms of the rate of growth of complexity, are even higher.
That's the general trend.
Got it. Thank you. That's very helpful. Then my second question, just a quick follow-up to some of the questions that's already been asked. In terms of the gross margin, your guidance and the reported gross margins are extremely impressive, particularly given the currency weakness. I just wanted to understand a little bit better, in terms of the lease systems that you have, I would imagine, because those were lease systems, you would be depreciating them over time, so the book value on those systems should have come down. When you're converting them to sales, the gross margins on them should be significantly higher. I just want to make sure the way I'm thinking about it is correct, and also, is the gross margin on the lease system higher or not?
You're correct that we were depreciating the systems under GAAP, and we've sold them. Now keep in mind, we got orders for one-third. Orders. We didn't ship everything. The lease systems, and you have to figure out, well, what was the original economics of the transaction, which we're not going to disclose, but they were tied to a large purchase. Certainly depreciating them and then selling them, those two factors would give you a better margin than otherwise. It's not moving the margin in a material way given the size of this business in this quarter.
Got it. Thank you. That's all I had.
Our next question is from David Duley from Steelhead Securities.
Thanks for taking my question. You've talked about how the SOC CAGR is kind of moving from a negative 3% to a positive 3%, and I think you've outlined that it's increased complexity and less parallelism as the key reason why you're seeing a change in the growth rate. Is that the accurate assumption?
Yes. It's those two factors, primarily.
Could you talk, so I guess that would imply, since 50% of your test business is mobility, that in the mobility sector, specifically in the application processor sector, you're seeing this unfold as you've described. We might expect that sector to show more consistent growth rather than this every other year kind of growth?
No, I think it's still going to show every other year kind of growth. The swing in year-over-year differences has not been that it's the rate of change of complexity. In any given year, new devices get introduced. They may have a step function increase in their complexity or a more modest increase. We still expect that cadence to continue. The test, depending on whether it's a modest or a complex increase, the test impact will still proportionally go up compared to the past, we believe. That's not just true of applications processors, that's also true of power management and RF transceivers.
Okay. As my follow-on, could you just, maybe you said it, could you remind us what memory revenue and memory orders were during the quarter? Talk about what are some of the key reasons that you think that you're picking up market share here at a pretty rapid pace. Thank you.
Okay, I'll do the numbers. The memory bookings in the first quarter were $64 million, and the memory sales in the first quarter were $44 million.
Just going back to why are we picking up share? If we look at both NAND flash and DRAM, two things have happened over the past four years that continue to happen that are very favorable for us. When we reentered the memory test market, we had to make a decision, how were we going to be different than the large incumbent? We made a bet on building testers that had a lot of high-frequency capability to test emerging bus standards. Take NAND flash for a minute. NAND flash, when it was dominated in audio applications, was a pretty low-speed device. As it moves into smartphones and as it moves into SSDs, the interface speeds on NAND flash have grown dramatically and continue to grow, and new standards are coming out faster than had been forecast even two years ago.
That means the test system has to be able to both stimulate and read data from that high-speed interface. If it can't do it's obsolete. It just can't be used. Our testers, having been architected with that headroom, sit there as the only alternative to a customer who's moving up rapidly in bus speed. That's worked in our favor both on the DRAM side, which has a similar story, and on the FLASH side. That's the real single factor.
Thank you.
Next question comes from Weston Twigg from Pacific Crest Securities.
Hi. Yeah, two questions. First, just following up on the memory commentary. I'm wondering, given that orders have typically peaked in Q2, you're seeing this sort of longer-term trend for higher speeds driving demand for test, does that maybe imply that memory demand could hold up pretty nicely through the year? Do you still think it might follow traditional seasonal patterns?
It's hard to tell, but if we just listen to what our customers are telling us, it looks like the demand will be relatively steady through the year.
Okay. That's helpful. Then just on the other side, SOC Test. I was wondering if you could help walk us through the impact on SOC Test demand from, whether it's positive or negative, just from large customers moving between foundries, particularly as they migrate down below 20 nanometer. How does that impact your business?
I think over the long haul, it doesn't have an impact. In any given period, if one customer has excess capacity that could be absorbed, it might have a period impact to us. In general, test capacity finds utilization over time, and it doesn't impact the long-term trend lines we're talking about. It could absolutely impact a couple of quarters.
Okay. That's helpful. Thank you.
Your next question is from Tom Diffely from D.A. Davidson .
Yeah, good morning. Maybe one more question on the parallelism comments that you made. Do those comments also correspond to wafer level testing and perhaps probe card limitations, or is it all just final test that you're referring to?
Yes, it refers to both, although I'd say final test is reaching the limits and inflecting earlier than probe. I think probe still has some headroom here in terms of the technology can allow parallelism to be maintained at the level it is for a while. I think on the package test side, the complexity of building these interface boards for these new devices is such that the payback is really not worth it. That's what it's really coming down to.
Okay. When you look at just wafer level testing today, what percentage of your business does that include, and where do you see that going over the next year or two?
I guess you're asking wafer test versus package test?
Correct. Yeah. The transition towards wafer.
Yeah. Well, some device classes have moved to wafer level packaging already. A lot of the RF, Wi-Fi, and combo parts are already wafer level packages, wafer scale packages. Essentially, they're only tested at wafer. For other parts, like an applications processor, as an example, or a power management IC, I see those as package devices for some time. Now, the trend that's emerging is, or that people have been trying to enable are these interposers that allow the mounting of multiple die economically on an interposer and then putting them in a single package.
The impact to Teradyne in that world is actually not bad. It's pretty good because you now have to test the wafer a little more rigorously than before to ensure that the die that you're mounting on the interposer is good. Once you have that package that now has three or four die in it has to be tested, and it's a much more complex test challenge than a singulated package would be. The complexity issues that arise from two and a half D and 3D packaging are quite good for us, we think.
Does that factor into your more bullish growth, or is it too small to be a major factor in your growth?
No, that inflection of growth, that's absolutely a factor. It's a complexity. It's part of that complexity element of the future.
All right. Thank you.
Your next question comes from Patrick Ho from Stifel Nicolaus.
Thank you very much. Mark, maybe can you comment a little bit about the new product introductions, notably on the memory side, and how some of that has impacted positively for gross margin? I think in the past you've mentioned how you've obviously tried to improve a lot of your operations internally and new product introduction gross margins. How is that positively impacting the overall business model?
Well, in memory test, on the flash or low-speed memory test side, we have a product we introduced last year called the Magnum V. The Magnum V is obviously a legacy of a long line of Magnum products that has come out of the Nextest group that we acquired several years ago. Typically what happens when you introduce a new tester, every new tester we introduce has an aggressive target around cost down. It gets introduced into the market, and as it ramps, it tends to improve the margin mix early in its life. As it ages, it somewhat diminishes in its positive mix contribution, then the next tester gets introduced. So there's a bit of a sort of sawtooth effect on margins with new products. That's not atypical.
That goes on, has gone on forever, but we're early in the life of the Magnum V at this point, and it is helping.
Great. Maybe as a follow-up to that, you mentioned the mix of both DRAM as well as flash. Do you see it, I guess, healthy for both of those markets, or is there going to be a bias towards one or the other in terms of the outlook you presented for memory as a whole?
I think that what I would say is that FLASH and DRAM probe, which are all, I would say, not low speed, but lower speed insertions, is the more interesting growth area that we see.
Great. Thank you.
Okay. Operator, we're going to just try to squeeze one more in here. Just one more question, please.
Okay, your final question comes from Atif Malik from Citigroup.
Hi. Thanks for taking my question. Mark, a question on the reuse of equipment. Your OSAT customers have talked about very high reuse rate, going from 20-nanometer to 16-nanometer, and that's reflected in their CapEx kind of coming down this year. My question is, how do you see your reuse rate on apps processor going from 16-nanometer to maybe 10-nanometer, and could the reuse rate really change that up one year, down one year scenario to more like flat to down for the next few years?
First of all, for semiconductor test equipment, and in the specific example you cite, testers rarely go obsolete. They tend to have a 10-plus year useful life. This is different than what we saw in LitePoint's business a few years back. These testers that are installed today for applications processor test will be utilized for the next generation of applications processor. There's no doubt about that. On top of that, because of the other factors that we mentioned, there will need to be incremental capacity added. Just like the surge we saw last year came on top of previously installed capacity that was also reused. There's going to always be a relatively high level of reuse of semiconductor test equipment generation to generation.
There's also upgrades that are provided, too-
Right
to keep the testers going for a longer time period, which generates good contribution.
Got it. Greg, just a follow-up. You guys are getting more and more vocal about attractive M&A, but we haven't really seen anything for quite some time, and I'm just trying to understand, is it the pricing that's the issue, or you haven't found anything, and what is the criteria for attractive M&A?
Well, it's like good wine. You can't pop the bottle before it's time. There are a couple of good candidates, but we can't rush anything, and we have to make sure that we're thoroughly comfortable, it's a good fit, we can help them grow faster. When we describe it to our investors or our board, they're very comfortable with it makes sense. It's about making sure the valuation makes sense relative to the synergies and the advantages we can give the business. We've been working on a small number for a long period of time, but it hasn't stopped us from returning capital either. I think we tried to say a couple of quarters ago, it's not an either/or, we're going to do both.
When we look at these targets, we're constantly looking at this price, with this plan, with these synergies, are we better off just buying back stock? We do that every single opportunity, and sometimes we don't do a deal because we're better off buying stock.
Thanks.
Okay, folks, thanks so much. This concludes today's call, and thank you for your interest in Teradyne, and we look forward to working with you down the road.
Ladies and gentlemen, this does conclude today's conference call. Thank you for participating. At this time, you may now disconnect.