Q2 2022 Teradyne Inc Earnings Call

Yeah.

2022 conference call at this time, all participants are in a listen only mode.

After the speaker presentation, there will be a question and answer session to ask a question. During the session you will need to press star one one on your telephone I would now like to hand, the call over to Andy Blanchard. Please go ahead.

Thank you Latif and good morning, everyone and welcome to our discussion of Teradyne's. Most recent financial results I'm joined this morning by our CFO CEO Mark to Gallo President, Greg Smith, and CFO Sanjay Mehta.

Following our opening remarks, we'll provide details of our performance for 2022 second quarter, along with our outlook for the third quarter of 2002.

Press release containing our second quarter results was issued last evening, we're providing slides on the investor page of the website that maybe helpful to you in following the discussion.

Replays of this call will be available via the same page after the call ends.

The matters that we discussed 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.

<unk> 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 will make reference to non-GAAP financial measures. We've posted additional information concerning these non-GAAP financial measures, including reconciliation to the most directly comparable GAAP financial measure where available on the investor page of the website.

Looking ahead between now and our next earnings call Teradyne expects to participate in technology or industrial focused investor conferences hosted by Keybanc Davidson Jefferies Deutsche Bank City, Evercore Piper Sandler and Goldman Sachs.

Now, let's get on with the rest of the agenda first Mark and Greg will comment on our recent results and the market conditions as we enter the new quarter. Sanjay will then offer more details on our quarterly results along with our guidance for the third quarter. We will then answer your questions and this call is scheduled for one hour Mark.

Hello, everyone and thanks for joining us Greg will summarize our Q2 results and I will comment on our full year outlook and technology drivers, we expect in 2023.

Sanjay will then take you through the financial details, including our outlook for the third quarter Greg.

Thanks, Mark and good morning, everyone.

Teradyne's second quarter sales and profits were above the midpoint of our guidance and revenue and profit with sales of $841 million and $1 21, and non-GAAP earnings per share.

From a market perspective, we're seeing mixed signals.

While the pressure to improve lead times in some test markets is as strong as ever and we continue to work through supply issues. We have seen some softening in mobility demand our largest test market.

So it now looks like <unk> growth in the second half will be similar to first half growth.

In today's call, we'll try to provide some context on how we are navigating this complex environment.

Diving into the details of the second quarter semiconductor test revenues were in line with our plan as were profits the.

The automotive and industrial end markets served by our Eagle platform were notably strong in the quarter.

In memory Flash final test and DRAM wafer sort, where the strongest markets.

From a strategic perspective semi test had a strong quarter of competitive design wins for both R&D applications and for devices that we expect to ramp in volume production over the next year or so.

The design wins were in a wide range of end markets. There were ultra flex family design wins, and mobility, where the systems architecture supports higher throughput for large complex devices, especially when time to market is an important factor.

Eagle Test had a significant design win in our battery management application, where the systems highly accurate voltage measurement capability enables customers to get to market faster with better device specifications delivering higher value.

In systems test sales were on plan in the quarter with solid year on year growth for storage test and production Board test.

At light point strong wireless test demand for Wi Fi six Wi Fi seven R&D and ultra wideband test products drove double digit year on year growth.

Notably, we're seeing strong interest in Wi Fi seven development test, where we're qualified at all major chipset vendors and to date, we have 120 of 21 design in opportunities with and product design teams.

This sets us up to expand our already high share of Wi Fi production test as these products ramp.

In industrial automation revenues grew 10% from last year's Q2, and 19% for the first half.

This lower than planned growth in the first half is attributed to two primary factors and warmest warrants a few comments.

The first factor was foreign exchange.

The majority of IAA revenue is linked to the Euro for example, within Europe at <unk>, we saw a robust 34% unit growth in the first half of 2022.

But the decline of the euro with respect to the dollar has muted you our revenue growth in that region to 20%.

The dollar's appreciation was a revenue headwind in the first half and Sanjay will comment further on the full year foreign exchange outlook.

The second factor is lower regional demand that can be traced to a variety of region specific causes including Covid lockdowns in China and distribution partner staff shortages at North America, where end demand remains quite strong.

Staff shortages for integration partners is an ongoing challenge in the past we've noted that our distribution partners struggled to grow staff at the same rate as I am IAA demand growth.

Our strategy to overcome this is to use software technology and plug and play applications from Europe , plus and mirror go partners to shorten the deployment time to make these critical staff more productive.

But an equally important part of the strategy is to build a robust OEM channel.

For example, at Universal robots, our OEM channel, which includes verticals like welding powered grid maintenance in order fulfillment is doing very well growing 39% in the first half of 2022.

The OEM channel is an important complement to our distributor base channel because these OEM partners deliver are mostly complete solution to their customers that can be put in operation almost immediately.

In many cases these Oems have an existing distribution network that can reach customers beyond our traditional channel.

These partners can scale much more efficiently than distributors that add staff in proportion to revenue growth for customer support.

We are actively adding new OEM partners to serve these and new market verticals.

Now I'll hand, it back to Mark for more on the market in the second half outlook and the demand drivers for next year.

Thanks, Greg.

While the long term drivers in our test and automation markets remain firmly in place. The recent deceleration we're experiencing in test will impact our full year results.

Over the past few weeks, we've seen a market slowdown and Src in wireless test demand in the second half related to declines in end market shipments of smartphones compute products and associated infrastructure.

These demand adjustments are associated these demand adjustments are happening in real time and.

And we are projecting this will continue over the next several weeks as the market continues to align their production plans and inventory levels to this new reality.

This extends across multiple customers and device types, including apps processors power management and RF.

I will note that auto MCU industrial in memory test demand remained strong entering Q3, and we've seen no deceleration of demand in these markets.

When forecasting the second half of 2022, we are expecting the test realignments, we've seen in the past few weeks are not a blip and that further adjustments are coming.

Beyond the reductions we've already seen several customers have indicated they are in a capital review phase, which were assuming will lead to some additional impact to Q4 demand.

At a macro level.

Also assume that China's smartphone volumes will not accelerate through the remainder of the year.

We also believe that short term global economic conditions will remain weak, resulting in softening consumer demand and associated electronics inventory digestion.

Nia, we forecast that our second half business will continue to grow at about a 20% year over year level consistent with our achievements in the first half, but below our 35% goal.

As Greg highlighted we believe that China demand will remain muted.

Distributor labor shortages in North America will limit the rate of installation expansion in the short term and FX headwinds will not abate.

Summing it all up we now expect our second half revenue to be slightly lower in the first half, resulting in a roughly 52%, 48% first half second half split.

Our latest forecast projects. The 2022 Soc test market will be in the range of four 2% to $4 6 billion down from our April estimate of about $5 billion. While in memory. We expect the market will remain at about $1 billion.

To reiterate.

Much of our forecasted slowdown assumes continued yet to be identified demand decline in the fourth quarter.

Looking further ahead after six consecutive years of robust Soc test market growth. We have entered a period of demand slowdown in digestion. This is not uncommon as we've seen this most recently in 2013 and 2015 and over the years, we've built our operating model to anticipate these kind of demand swings.

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Predicting the depth and duration of these corrections is challenging but in each of the last three corrections growth returned after six to 12 months, but the subsequent year showing strong growth.

The ramp of three nanometer starting in 2023, followed by gate, all around and increasing multi chip packaging remains unaltered drivers of growth ahead.

Interface transitions in both flash and DRAM are also eminent hyper.

Hyperscale is continue to expand their chip design starts and edge AI as a new class of silicon application gaining momentum.

In industrial automation the value proposition has only strengthened as the short ROI remains compelling.

Increased resiliency in a world of questionable labor supply as another motivation to automate.

So while the first half of 2022 unfolded roughly as outlined in January the second half is looking considerably softer as we than we expected just three months ago.

However, we are confident of our long term growth strategy and are focused on execution of our design ins at R&D programs. So that we are positioned to capitalize on growth of these markets that we serve.

Sanjay will now take you through the financial details Sanjay thank.

Thank you Mark good morning, everyone. Today I'll provide details on our Q2 results offer additional color on how we are addressing both the slowdown in some markets and supply shortages and others and.

And describe our Q3 outlook.

Now to Q2.

Second quarter sales were $841 million with non-GAAP EPS of $1 21.

non-GAAP gross margins were 62% at our non-GAAP operating expenses were $251 million.

$14 million below mid guidance.

The main driver.

The main driver of the lower than planned Opex was in industrial automation group or IAG due to lower variable compensation tied to lower revenue projections and slower than planned hiring.

non-GAAP operating profit rate was 33%.

210% customers in the quarter.

The tax rate, excluding discrete items for the quarter was 16, 9% on a non-GAAP basis. Please note you should now use 16, 5% for the full year non-GAAP tax rate.

Looking at the results from a business unit perspective semi test revenue was $541 million Soc revenue was $461 million driven by strength in automotive and industrial markets.

Memory revenue was $81 million led by Flash final test and DRAM wafer sort.

System Test group had revenue of $135 million, which was up 29% year over year.

Storage test sales, including both HDD and system level test solutions were $86 million in the quarter.

Up 49% from Q2, 'twenty, one defense and aerospace and production Board tests combined grew 4% year on year.

I'd like point revenue of $64 million was up 16% from prior year due primarily to strong shipments in Wi Fi and Wi Fi seven and UW B test systems.

Now to industrial automation industrial automation revenue of $101 million in Q2 was up 10% year over year.

This was lower than expected as Craig noted.

Spite the lower growth, we still expect IAA revenue to follow the historical pattern of growth as we move through the year.

<unk> sales were $883 million in Q2 up 8% year over year with the highest growth in northern Europe .

Mirror sales were $17 million up 9% from Q2 'twenty one in the quarter.

From a financial perspective Nia the group was slightly under breakeven on a non-GAAP operating basis in the second quarter and for the full year, we expect to be towards the low end of the 5% to 15% profit range, we discussed in past calls.

We view, the roughly 20% growth rate in IAA as a short term situation as Craig noted.

Like the company model the IAG group.

Operating model now.

It's really flex our spending down based on profitability and we're tightening discretionary spending where appropriate but our long term IAA growth strategy and related investment plans remain unchanged.

Shifting to supply.

Our Q2 guidance excluded approximately $50 million of revenue tied to our inability to supply customer demand in Q3, we're excluding a similar $50 million of revenue from our guidance range, primarily in our test businesses.

The shortage of semiconductors, ranging from FPGA to industrial analog <unk>.

Continues to impact our production.

As I've noted in prior calls, we're taking numerous actions to harden our supply chain, but even with these actions we expect supply line constraints to remain challenging I.

I will note these actions and other factors improved our supply situation in Q2, mainly in test, which enabled higher shipments.

Shifting to the balance sheet and cash flow, our cash and marketable securities at the end of the quarter totaled approximately $900 million.

Down from $1 2 billion at the end of Q1.

We had $70 million and $70 million in free cash flow in the quarter, reflecting the timing of shipments and supplier prepayments.

Over 80% of our shipments occurred in May and June so our DSO expanded to 74 days, which we expect will decline in the second half of the year.

Other uses of cash in the quarter included share buybacks of $331 million dividend.

Dividend payments of $18 million and debt retirement of $22 million at the end of Q2 or more than two thirds of the way through our $750 million share repurchase plan for 2022.

With $217 million remaining.

In October .

In our October call.

We will note any updates to our share buyback plan.

Regarding debt to date $386 million of convertible bonds of early converted.

I'd also like to note several points regarding the strong U S dollar and its impact on our results.

And our test portfolio. The majority of revenue and expense are in dollars. So there is not a material foreign exchange impact.

In IAA businesses on the other hand.

A large amount of euro linked expenses and about 50% of their revenue is tied to the euro.

The result is.

As the strong dollar reduces revenue and gross margin in dollars in the first half the FX impact reduced our IAA growth rate approximately four points.

Assuming exchange rates remain consistent with July exchange rate, we expect six points of growth headwind for the full year compared to our January projection.

For IAA the strengthening dollar has a marginal benefit on the Opex side.

The revenue and margin degradation is offset by the opex gain yielding a neutral effect on our operating profit for that segment.

Now to our outlook for Q3 comp.

A combination of slowing demand in test extending lead times due to material shortages and reduced automation demand in Europe , and China results in a lower Q3 outlook than we expected three months ago as noted the guidance excludes approximately $50 million of shipments due to material shortages primarily in test also.

Our guidance assumes we won't see any extended shutdowns of production facilities due to COVID-19 and we won't see any new trade restrictions.

With that said sales in Q3 are expected to be between 760 $840 million with non-GAAP EPS in a range of 90.

For $1 16.

On a 166 million diluted shares.

Third quarter guidance excludes the amortization of acquired intangibles.

Third quarter gross margins are estimated at 58% to 59% down from Q2 due to product mix.

2022 investment supply chain resiliency and wage inflation.

Some of these effects are transitory and we expect our mid term earnings model gross margin range of 59% to 60% to remain intact.

Opex is expected to run at 31% to 34% of third quarter sales. The non-GAAP operating profit rate at the midpoint of our third quarter guidance is 26%.

As Mark noted, we expect second half revenue to be below the first half approximately 48% of full year sales given the reduced revenue outlook for the second half of the year. Our operating expenses are now planned to grow just 4% to 6% annually versus 11% to 13% planned in our prior guidance.

The Opex reduction from prior guidance is driven by two factors first our variable compensation model is approximately half of the decline tied to reduce revenue second we have delayed some expenditures in both test Nia, which we believe will not impact our long run competitiveness.

Spending savings of roughly evenly split between engineering and go to market.

Summing it all up we're expecting revenue and profit in Q3 in the second half of the year to be lower than we projected three months ago, but our operating model is resilient to varying revenue levels.

With the reduced revenue level, our model reduces variable compensation expense and we're taking other steps as appropriate.

A downturn is always challenging but we're confident we have the operating model strategy and experience to lead us through whatever lies ahead, while keeping our focus on the needs of our customers and the long term opportunities in the test and industrial automation markets.

With that I'll turn things over to Andy.

Thanks, Sanjay Latif would now like to take some questions and as a reminder, please limit yourself to one question and a follow up.

As a reminder to ask a question you will need to press star one on your telephone please standby, while we compile the Q&A roster.

Our first question comes from the line of Vivek Arya of Bank of America Vivek Arya. Please go ahead.

Thanks for taking my question.

Just wanted to clarify that you are guiding Q4, roughly around 670 $675 million.

Which seems to be kind of pre COVID-19 levels.

If I take your guidance into account.

Suggest that non IAA Q4 sales would be $430 million, which would be I think almost 20% below pre COVID-19 levels.

And I realize that there are headwinds, but why such a sharp decline in your Q4 outlook.

Yes.

Roughly speaking those are about right.

And I think as I mentioned in my prepared remarks.

Maybe.

We probably reduced our second half revenue targets, but somewhere between $300 million to $350 million about a third of that.

Is known customers weakening where the demand has been communicated to us to a source of two thirds of it is just a projection of more to come of that faith based on conversations that are just beginning with customers. So there's not a clear all of this is mostly related to test.

So there is not sort of a clear identified two thirds of that decline portion, but it's just the experience we've seen in prior.

Cycles on the test industry suggest that there's more to come if you go back to 2013 for example, when the market went through a significant 30% year over year correction. This was sort of.

At the beginning of that kind of trend now here, we're talking about a market correcting about 9% off of the peak of last year. So a much more modest correction.

But that's this is kind of how the market turns and we're using history to sort of guide us and how we're projecting these yet to be identified.

Digestion.

Phases.

Got it and then.

Mark I'm curious what is your exposure to Android.

Smartphones.

This year versus last year, and how much of a headwind.

Is that is that continues and do you think back.

We'll alleviate next year or can that can still be an offset to any three nanometer testing benefits on the iOS side.

So just the interplay between Android and iOS kind of this year.

What's your thinking about from a next year perspective. Thank you.

Yes, I think our exposure to Android.

Smartphones is a little bit higher this year than it's been in past years.

So we picked up a little bit of market share in that segment. Obviously that segment is down significantly this year in unit volume So that's having.

The part that's principally the reason for the declines were forecasting here in the second half.

Now when we look at 2023, it's hard to tell what's going to happen with Android phones part of what's happened in 2022 in terms of the declines related to China.

And part of this is predicting how China will rebound in 2023 as of the consumer demand.

Hopefully recovers, but we don't we don't have a strong <unk>.

<unk> for the Android subsegment of smartphones yet for 2023.

So I can't really give you a lot of color on that.

Thank you.

Thank you. Our next question comes from the line of to share Ari of Goldman Sachs.

Your line is open hi, good.

Good morning. Thanks, so much for taking the question I had two as well one on semi test and the other on IAA.

On the semi test side, Mark I was hoping you could speak to your expectations in terms of market share for the year.

Given given the incremental weakness you are seeing.

At the market level and given that you had sort of derisked.

Your opportunity for this year with your with your largest customer.

I feel like your market share position as of today is perhaps a little bit better than what you were thinking three months ago.

I just wanted to clarify that on the semi test side.

Yes, I think so.

So there's two pieces of semi test memory, and Soc memory, it's going to be 40 ish percent market share consistent with last year.

And so it really depends on what happens on the compute side in terms of how much.

Decline happens in the market on compute which is more of our.

Competitor strong suit.

So we've baked in a significant decline in mobility, we believe a decline in compute is eminent.

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But that's something that I think over the next few weeks as we hear from our competitor we will know more about all of that being said I think our.

Statistical share is sort of in the.

Upper mid to upper 30% range in Soc test this year, but thats based on again strong compute market week mobility market versus customers switching suppliers and that moves around quite a bit year to year.

Got it that's helpful and then as my follow up on the IAA side I guess, a two part question. The first part is I just wanted to clarify that.

Fundamentals in the business remain pretty strong and I asked the question because the reasons you noted for I guess the.

The reduced outlook for the second half seemed.

Technical transitory you talked about FX, you talked about Covid lockdowns in China and staff shortages in the U S. So fundamentally is the business still healthy and intact I guess, that's number one and then number two on the OEM channel dynamic just curious how big is that channel today as a percentage of.

And where do you see that going in a couple of years and how does that impact profitability.

As OEM grows vis vis your dusty business. Thank you.

Hi, This is Greg.

Let me try and take that so we believe that the fundamentals are still.

Very strong in the IAA market.

The effect of China, Lockdowns and staff shortages should both ease to some extent through the rest of the year. We believe that the FX headwind is going to be consistent through the rest of this year, we don't see a significant appreciation of the euro so that.

Translation into dollars is going to continue to take a couple of points off the top in terms of our growth for revenue that's denominated in euros.

To your second question, our OEM channel right now it represents about <unk> <unk>.

16% of overall.

You are revenue lower for the entirety of the industrial automation group and its growing for the first half it grew at 39% and we expect to be able to maintain that kind of a growth rate.

And in fact, our profitability so.

So our pricing in the in the OEM channel is.

A little bit favorable to pricing through our normal distribution channel. So we don't expect to see any negative impact to profitability as that channel growth.

Great. Thank you for the details.

Thank you our next question comes.

From the line of <unk>.

<unk> strategy of J P. Morgan.

Your line is open.

Taking my questions I have a couple as well I think.

Within semi test you mentioned, you're continuing to see robust demand in autos and industrial within semi test. So I was just wondering given the strength you're seeing in industrial automation.

Are you baking in any incremental weakness as you go through the remainder.

Autos and industrial as well within semi test and then I have a follow up.

No not not really most of the weakness we're baking in again in the fourth quarter that we've yet to really.

Get confirmation on is in port and mobility in compute and infrastructure, but we think.

Industrial and auto will remain strong through the end of the year.

Okay.

Just to follow up on the cost structure here would receive.

You've obviously been back some of your.

Expenses that were flat for the ceiling, but in relation to sort of SG&A, you're running pretty much at the theme that you will lost deal revenues will want to high yield as you start to think about sort of the strategic Capex a view by some of your customers or is it maybe some delays to the secular long term drivers that you have.

What's the sort of flexibility in terms of taking the cost structure.

Reload.

Right sizing it for maybe some will do sort of push.

In terms of revenue that you see great. If you could just sort of.

Okay.

<unk> spend as youre doing sort of announcing today. Thank you.

It's Sanjay so just a couple of comments on our business model as it relates to cost structure. So as you know the majority of our.

Test portfolio has contract manufacturing so it really provides great scalability up and down with our outsource partners kind of fixed assets.

So that helps on the margin line, but then from an operating expense perspective, we have a.

Key portion.

Of our wages in a flexible or variable compensation plan that is that as revenue and profit goes up that is passed along part of it to the employees, but as it goes down.

Which is one of its about half of the driver of the <unk>.

Growth reduction from midpoint of 12% expected this year to a midpoint of 5% as I noted in my prepared remarks.

About half of that growth reduction is driven by the variable compensation. So we believe as time moves on and let's say the market goes lower we will have the ability to reduce our operating expenses on a variable basis, while keeping our workforce intact and <unk>.

Investing for the long term.

Obviously as the market rebounds.

Our increases our revenue goes up then that will increase our operating expenses on a variable basis.

Thank you thanks for the color.

Thank you. Our next question comes from the line of C. J Muse of Evercore ISI.

Your line is that good morning. Thank you for taking the question I guess first question on gross margins.

Look at what you've kind of just.

Just in terms of mix, that's actually a positive on the FCC side yet.

Yet you are guiding gross margins I think the worst since.

Kind of mid 2020.

At a revenue run rate I think that exceeded back then so so curious what is driving the gross margin hit here is it.

Much worse mix.

Perhaps some contemplating or is it kind of the FX other.

She is around IAA.

Sure C. J. So yes, so I think when you think of the product mix. There is some mix degradation within semi test, but also.

As.

As there is less wireless test, which is higher than the corporate average.

And less than expected kind of IAA.

Higher than the corporate average so you are seeing mix, but a couple of other drivers.

But I noted in my prepared remarks, and that is we spent a lot of effort and monies on.

Making our supply chain resilience through component qualification through multi country manufacturing et cetera, a lot of those costs are going to incur.

<unk> incurred in 2022.

The second half of 2022, so we have.

Those that significantly curtail there will be some in 2023, but we will curtail.

The majority of them in 2022, so think of those as transitory and then we're also seeing a.

Little bit of wage inflation for both ourselves and our partners.

Very helpful. I guess as my follow up.

In terms of the slowdown that you're seeing in test.

Are you seeing push outs or actual cancellations and then as you think about 2023, obviously a lot of changes afoot in terms of heterogeneous compute larger die sizes smaller die sizes with shipments of advanced packaging curious, how youre thinking about that net effect into 2023 and.

Whether we could see growth or further declines and what your market share might look like thanks, so much.

Thank you.

Yes, so on the.

Heterogeneous computing and the effects in 2023, I think thats all.

Positive for US three nanometer is coming.

As planned we don't see any changes or delays and anything associated with that.

The trends toward chip, let's multi chip packages and the associated test intensity increase around known good die more pins to test.

Chip, let designed and there would be in a monolithic design all or tailwind for tests now those have been occurring in the market and we will continue to phase in over the next several years as.

That method of let's say package assembly gains more and more prevalent so that is another one of the.

Tailwind that gives us confidence in the midterms or any model that we've produced earlier in the year. So no change.

Change to our beliefs around 2023 at this point and in terms of push outs versus cancellations versus anything else, we're not seeing any cancellations, but what we have seen is that there's been a few push outs, but more significantly we do hold.

Some capacity in place for some of our key customers on a.

Basically a sort of 12 to 16 week delivery window basis that were booked and its the demand for those on quartered testers principally that.

Disappeared.

Very helpful. Thank you.

Thank you. Our next question comes from the line of Robert Graham of Loop capital.

Your line is open good morning, Thanks for taking my question and welcome aboard Greg.

Two maybe more 40000 foot theoretical if you don't mind. The first is when we started the year largest customer decides to.

Curtail.

Testers test purchases, because I think as we've determined to be correct that their complexity in this year's launch it was just not enough to warrant us Patrick.

It was that next year.

Our 23 launch would have much more complexity aided by three nanometer.

The smartphone market weaker today has anything changed that framework in your mind or perhaps even more importantly, if I may.

Your largest customers, saying to you mark.

Yes, no changes on that front, our largest customer has fared pretty well this year. Despite overall unit declines in smartphones.

And so it's a bright spot if anything else that that segment of the smartphone market is robust and we expect and there's nothing we've heard that would change our view of 2023.

Very good and then as far as this this whole six to 12 months slowdown that you've seen in the past, which is obviously documented the numbers.

Mark in your eyes does that actually start in <unk>, because the first half was kind of more teradyne specific thing with that large customer does that essentially six to 12 months timetable start now.

Yes.

I would suggest it starts in third quarter, because youre right the first half.

Market declines were pretty isolated to one customer having that big of an impact on the overall view of the market. What we're into now is something more classical I think it's certainly and part of this again I'll caution as a projection on our part we've seen it now in the smartphone side, but we believe.

And sense that it's coming in a broader set of markets like compute and infrastructure and theres inventory overhangs as well out there that typically in phases. Like this go through a digestion phase and working down inventory levels take that sort of six to 12 month period, and we think that as we head into sort of lower economic growth.

<unk> periods end.

And a little bit more inventory in the channel than historically has been.

There that people are going to tightened down a bit and it's going to slow demand for sort of repeat orders for devices in those categories. So yes starts in Q3 six months to 12 months I think is.

Safe bet.

And we'll see how it plays out.

Mark if I could just sneak this one in by extension to that thank you for that by the way by extension to that does the.

Does the 'twenty 'twenty four framework now is that the lower end of that maybe more likely or is the lower end in jeopardy. I was just wondering because you didn't put that framework into the deck.

No I think.

Look I think if you look at the history of the market.

That 2024 framework, our earnings model and projection is intact and in play and I wouldn't characterize it as low end either when you look at how much the markets move up and down.

Year to year, historically, we could easily see a snapback of 20, 30% growth in a subsequent year.

So I wouldn't call our 2024 in any way based on what we're seeing right now.

Thank you very helpful.

Okay.

Thank you. Our next question comes from the line, Brian Chin of Stifel.

Your line is open.

And thanks for letting us ask a few questions.

Maybe you could just backtrack to the $600 million reduction in the SFC and can you maybe just.

Delineate again.

Mobility versus compute within that reduction.

So just sort of.

Zooming in on the compute Pam are you seeing or anticipating any weakness outside of processors for client Pcs, meaning sort of.

Hyperscale or server.

High performance compute chips as well.

So I'll take the Tam side of it.

So where we're seeing in our estimates really tied to our 4.4 million sorry, $4 $4 billion mid point.

We're seeing about $300 million, our estimate is a 300 million decline in compute.

$400 million decline in mobility.

And an increase in auto.

About $100 million.

So that's that's really Brian where we're seeing it.

And then on the question of.

We're in the compute market.

Are we anticipating.

Or getting some early signals of weakness certainly.

Now the immediate corrections are occurring related to consumer laptops, a little bit of enterprise PC area, we're not seeing at the moment the correction in cloud infrastructure.

Of course service however.

There are.

I would say discussions going on in those areas that suggests that that's probably coming.

Yes.

And so part of what we've assumed in our both market projections in Q4 revenue projections are some declines starting in Q4 in those segments modest relative to mobility. However.

Okay.

Interesting.

Maybe just switching gears then.

Back to automation, we also heard that supply supply issues.

Even you are mirror, but for other complementary products like <unk> cameras are convinced.

And also been delaying automation projects.

Im curious if thats something Youre also seeing and then kind of second part of that is and is not totally fair to ask but.

How are you thinking about.

Growth rates for next <unk> like three D cameras are convinced.

We had also been delaying automation projects.

Im curious if thats something Youre also seeing and then kind of second part of that is and is that totally fair to ask but.

How are you thinking about.

Growth rates for next year, given the existing and anticipated headwinds, including including demand not only supply.

So.

Hi, This is Greg.

In terms of supply issues, we are definitely hearing from our partners that they are having trouble procuring some elements of the solutions that they are building and I think thats part of the headwind that we're seeing in North America that there is staff constraints and there is also a large number of partially complete.

Projects that they need to get off of their books. So.

We expect as those supply constraints start to ease that that will come off as a constraint and we think that that will probably happen towards the latter part of this year.

In terms of growth projections for 'twenty three it's very early but we don't see any reason to really deviate from the 30% to 45% range that we've been talking about in terms of IAA growth.

The long term because the end market fundamentals are very very strong.

We have a very low market penetration and labor scarcity is still a big factor in all of the markets, where we play.

Okay. Thanks.

Thanks, Greg I appreciate the color.

Thank you.

Question comes from the line of Sidney Ho of Deutsche Bank.

Yes.

Alright, great. Thanks.

I wanted to double click on the mobility market I think most of us understand the order pattern the largest customer, but excluding that customer issue revenue growth more closely tied to select film scales, we need to add more reflective of current demand.

The reason I ask is that if we start hearing smartphone inventory getting closer to normal levels by the end of this year does that mean, you will start seeing more test revenue growth in Q1 or do we have to wait.

Little longer because your customers may not meet the extra testing capacity until later.

Yes, so good question.

I would roughly say that in the smartphone world.

Mr capacity precede unit production by about three months.

So what we're seeing in the decline in our third quarter for test or capacity demand reflects a.

Unit production.

Reduction of smartphones in the fourth quarter, primarily primarily so if we're thinking about next year then.

We would we should start to see tester demand pick back up three.

Three months prior to major phone launches or a return to growth in the China market for example.

That's sort of the model.

Okay. That's helpful.

My follow up question is on the memory test you called out strength in memory test in second quarter, and you still expect it tends to be about $1 billion. This year, but many many memory suppliers are likely going to cut capex quite a bit of slow down production. When do you think you will feel the these adjustments annual revenue is increasing complexity and market share gain.

To offset these headwinds.

Yes, I think in memory, it's a little different.

And we don't expect to see much of a correction because theres some tester obsolescence occurring.

And the new DDR, five and LP DDR five interfaces that are growing in share in the DRAM world require brand new testers and all the fab capacity that's been put in place in 2020.

Two to produce that class of device that should start growing in the server world and in the phone world in 2023, we will need to be facilitated with testers in the second half of this year going into next year.

So I think there's a bit of a lag between.

The Capex investment on the front end and the tester investment on the backend and we think at least through the early part of 2023 despite.

What we are hearing in memory.

From the suppliers in terms of bit growth and everything else that these obsolescence technological obsolescence events will have to be.

Solved with additional customer capacity because of the old test you just can't be reused.

Okay. Thank you.

Thank you. Our next question come from the line of Joseph Moore of Morgan Stanley .

Great. Thank you.

Past you guys have sort of talked about the relationship between.

The wafer fab equipment market, particularly the logic portion and your Soc test business.

Obviously kind of diverging now and.

Not asking you to make a call on W. P, which I think most of US do you expect will probably contract, but can you just talk a little bit about that relationship.

This contraction that youre seeing it seems a little bit at odds with how much logic capacity is coming online in which how much that would presumably need to be tested just give us some context on that relationship.

You are right it is at odds.

It doesn't correlate well hit suggest that there would be some underutilized either underutilized fab capacity for a period of time or there will be wafer.

Wafer die banking going on in other words, the Fabs will keep running but the devices themselves may sit on tested on diced on package for some period of time.

I think.

That.

Is.

Likely to be the case for a little bit of a period of time coming in the next six to nine months.

But usually or historically that washes itself out at the back end of the six to 12 month correction, but thats kind of what I would expect.

Okay. Thank you and then for my follow up on the last question, you kind of referenced technology transitions and memory.

You talked about DDR five.

I didn't hear it but can you talk a little bit about is DDR five.

Kind of getting pushed back is that a factor in Q1 being a little lower this year and what does that tell you about kind of your memory business prospects for next year, yes.

Yes. It absolutely does this year, we expected if you go back to the fourth quarter of last year that DDR five.

Would be a bigger part of the market and our business in 2022 with the delay of Sapphire Rapids, and such into 2023, a lot of that tooling pushed out.

However, the market kind of held up because what what filled in behind that was pretty robust investments some for some new.

Suppliers in China.

All year long they have been very aggressively ramping capacity and so it turns out despite the delay in DDR five.

2020, twos, a pretty good year for memory.

So when we look into 2023, there could be a little bit more of an incremental delay I think everybody is hearing about maybe sapphire rapids is going to get let out another few months or so.

But.

It's coming we're getting close to escape velocity I think so.

And we're seeing the orders we're seeing the orders for capacity for that coming in now so that's what gives us some pretty.

A little bit more confidence on the memory side than we're seeing on the SSD side.

Okay. Thank you very much.

Okay.

Thank you. Our next question comes from the line.

Chris <unk> of Cowen.

Your line is open.

Question I have two of them close to a <unk> molecule Greg to.

To the extent you can answer the question on next year.

And then mobile demand starts getting better next year.

Auto industrial segment could rollover and wouldn't that be more detrimental to your margin how to think about that.

Transition if you can answer it and then I had a follow up.

Yes, I don't think the margin between auto and mobile is that significant for us frankly, I wouldn't say that there's a mix shift going on there that it's going to be a headwind or tailwind there pretty blended close to each other.

As to when we would expect mobile to return.

We know at least from the pattern from our largest customer that that's a two Q3 Q phenomenon and we see no change to that sort of timing just based on their product introduction cycles and so forth.

Teradyne's point of view.

We would expect.

Changes to occur in those two periods.

There should be a little bit of pickup in Q1.

Modest pickup I would say related to some other manufacturers phone introductions, but.

<unk> is the big quarter.

Got it got it that's very helpful and then.

A follow up you touched upon that a little bit of a decoupling between front nwfp Intest investment.

Wanted to go into one subset of that which is China.

It seems like some of the Chinese all fast or slow down spending.

But the front end spending is still continuing I am just kind of curious your view on how China.

Evolve for the test spending and looked at it on.

Yes, China is.

And it's not just China, but I would say that the fab investments.

Generally speaking are continuing unabated going back to that utilization question.

You could make the argument that the three nanometer investments that have been made going back now over a year are hugely underutilized because no revenues yet to be produced off by that so the tooling and the advanced time to tool and tune the recipe for three nanometer has become an unprecedented Italy long cycle.

And so all of that.

Fab capacity is quote unquote underutilized until next year revenue starts flowing.

Pacifically back to China.

There is a disconnect between test.

Lead times, and thinking and fab lead times Fabs tend to get put in.

As a.

A whole slug of capacity with all of the front end equipment installed.

Quarters before production starts cast tends to be add added has a spot market had so once the fab starts running the initial capacity gets facilitated in test in a quarter.

Devices.

<unk> up an output of the fab ramps up in subsequent quarters and incrementally test ramps up as well. So test is a much smoother deployment in a fab.

And then the last thing of course going on in China. I think is just the national priority around independence.

And access to technology has focused mainly on fab.

Technology and therefore.

It's the most I would say viewed as sort of threatening and enabling at the same time and therefore theres been a more I'd say resilient.

Maybe counter economical push to invest in fab capacity there our business in China is very strong we have one major headwind, which is the largest single consumer of test equipment in China. Huawei is somebody we cannot serve but outside of that we have a very strong business.

And a very.

Decent growth that we're seeing there.

Thank you very much.

Thank you.

Final question comes from Mehdi Hosseini of ESI.

Your line is open.

Yes. Thanks for taking my question wanted to go back to the Soc test market.

When I look at the trends since 2015.

So C tests.

<unk> grew on a year over year basis and perhaps.

Two factors there kind of a test going away towards the end of the last decade and also the slides GE.

It started to be implemented in late 2019.

And now Youre guiding to 444 billion, which is still above the <unk> 20 level. So does the context, what gives you the confidence that we should see a quick snapback.

So C tests in 'twenty, three, especially since your largest customer is expected to continue with black location, not moving everything to the Knicks, leading edge nodes and I have a follow up.

Okay. Good good.

Youre right monotonic growth since 2015 has been true and even with.

The $4 $4 billion current mid point of view of the market in 2022, the trend line growth off of 2015 is still kind of a 10% CAGR and we've said all along we run the business and expect volatility and sort of manage the business. So the trend line in the 10% CAGR, it's kind of in line with our midterm, earning model too.

So.

It's hard after so many years of monotonic sequential growth may be too.

To absorb that but I think most of all of us have been around long enough to know that's part of history and not strange so the snap back or not in 2023.

One thing I might want to just rewind a bit in <unk>.

<unk> that my remarks on its debt.

Our tester market in our tester business demand is very sensitive to the growth rate of our customers.

So for example, if a customer of ours is growing units at 4%.

And a year and creates a certain tester demand for us if their.

Growth rate nominally increases from 4% to 5% small small impact on their business.

For teradyne that can be a 2025% acceleration of demand for us because we are demand is driven off the first derivative, let's say of customer growth.

And so obviously, we're very sensitive to what the macroeconomic conditions are going to be in 2023 around the growth rate of our customers. The technological issue around our largest customer in the smartphone market and the move to three nanometer I think thats kind of baked in and is going to happen macro economically.

What's going to be going on in the world and the inventory digestion or not that may be lagging from Q4 into early Q1, it's hard to tell right now we're kind of reading tea leaves based on what we've seen happen, which I said is maybe about.

$100 million of demand drop out to what we are anticipating will happen. So I really wouldn't want to get too far out and eliminate.

Forecasting 2023, but.

Those are the factors at play.

Thank you thanks for the detail and one quick follow up for Sanjay.

Given all of that.

Color on.

It seems like this year revenues could be down mid teens.

Mine is then.

And your Opex Opex growth on these four two.

6%.

Looking to next year.

If we could snap back.

You do benefit from the easy compare from 22 to 23.

Should I assume that your opex growth would.

Accelerated again or or.

Or should I assume that opex growth will be minimal to like let's say mid <unk>.

Digit percent 5%.

Yes. So many this year, we had anticipated plan and obviously as Mark said, we manage the business on a on a trend line and we believe the fundamentals that we laid out in our January call and the earnings model are still intact.

Test and IAA with that backdrop, we did have a plan to increase opex, 11% to 13%.

And as I noted, we curtail that.

We believe in delaying some expenditures that arent going to impact our long term competitiveness.

We haven't gone through the detailed planning in 2023 of course, we will provide that update in January but my expectation is that we're going to keep the focus on what's going to help us be successful, but long term and we're going to for example, we're going to keep on investing in industrial automation to.

Secure.

The market going forward, we believe that that market is still sub 5% penetrated.

Very good positions in our portfolio of companies that go to market in that fashion. So my expectation is we're going to still operate at the kind of a 5% to 15% there and still keep our foot on the gas to growth to help drive that top line and capture more business and in the test.

Portfolio, we're going to continue to ensure we have a very strong roadmap and a good go to market.

The exact numbers I don't have right now, but the fundamentals of our of our business.

Are the same we're going through.

<unk> to go through a little bit of a weaker second half than we anticipated, but at some point this will snap back which quarter that occurs but we're going to keep our investment thesis and tap.

And I think variable cost with revenue as we as we talked earlier right.

Okay folks we are out of time very thank you for the question and thanks, everybody for their questions and attention. If you have follow ups. Please reach out and we look forward to talking to you in the days and weeks ahead bye bye.

This concludes today's conference call. Thank you for participating you may now disconnect.

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