Teradyne Q3 2022 Earnings Call Transcript

Participants

Corporate Executives

• Andrew Blanchard, Vice President, Investor Relations
• Mark E. Jagiela, Chief Executive Officer
• Greg Smith, President
• Sanjay Mehta, Chief Financial Officer

Analysts

• Krish Sankar, Cowen and Company
• C.J. Muse, Evercore ISI
• Timothy Arcuri, UBS Group AG
• Samik Chatterjee, JPMorgan Chase & Co.
• Mehdi Hosseini, Signal Hill
• Vivek Arya, Bank of America Co.
• Joe Moore, Morgan Stanley
• Toshiya Hari, The Goldman Sachs Group, Inc.
• Atif Malik, Smith Barney Citigroup

Presentation

[Operator]

Hello, and thank you for standing by. Welcome to the Teradyne Q3 2022 Earnings Conference Call.

[Operator Instructions]

It is now my pleasure to introduce Vice President of Investor Relations. Andy Blanchard.

[Andrew Blanchard, Vice President, Investor Relations at Teradyne]

Thank you, Andrew. Good morning, everyone, and welcome to our discussion of Teradyne's most recent financial results. I'm joined this morning by our CEO, Mark Jagiela; President, Greg Smith; and CFO, Sanjay Mehta.

Following our opening remarks, we'll provide details of our performance for 2022's third quarter, along with our outlook for the fourth quarter of '22.

The press release containing our third quarter results was issued last evening. We're providing slides on the Investor page of the website that may be helpful to you in following the discussion. Replays of this call will be available via the same page after the call ends.

The matters that we discuss today will include forward-looking statements that involve risk factors that could cause Teradyne's results to differ materially from management's current expectations. We encourage you to review the safe harbor statement contained in the earnings release as well as our most recent SEC filings.

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

During today's call, we'll make reference to non-GAAP financial measures. We've posted additional information concerning these non-GAAP financial measures, including reconciliation to the most directly comparable GAAP financial measure, where available on the Investor page of our website.

Looking ahead between now and our next earnings call, Teradyne expects to participate in technology or industrial-focused investor conferences hosted by Baird, Credit Suisse, and UBS.

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 fourth quarter. We'll then answer your questions, and this call is scheduled for one hour.

Mark?

[Mark E. Jagiela, Chief Executive Officer at Teradyne]

Thanks, Andy. Hello, everyone, and thanks for joining us this morning. In today's call, Gregg will review our 3Q results and 4Q outlook, I'll then describe the longer-term view and Sanjay will provide the financial details of the quarter. Greg?

[Greg Smith, President at Teradyne]

Thanks, Mark, and good, morning, everyone. Teradyne's third quarter sales and profits were above the midpoint of our guidance in revenue and profit with sales of $827 million, and $1.15 in non-GAAP earnings per share. At the company level, the quarter unfolded generally as planned, but at the operating level, we cleared some supply bottlenecks, which allowed us to ship more semiconductor test products planned in the quarter. On the other hand, Industrial Automation was weaker than we forecast in July.

Putting the third quarter into context. When we spoke in July we noted that slowing SOC and wireless tester demand in the second half were related to declines in the end-market shipments of smartphones, compute products, and associated infrastructure. With that backdrop, we reduced our estimate for the SOC market size and reduced our second half shipment plan approximately $300 million. About one-third of that amount was already confirmed in June and about, two-thirds $200 million was our judgment on how the second half would unfold.

In the subsequent three months, about $110 million of the $200 million additional decline was realized and about $90 million was not, as overall Test demand held up better than we expected in July. This incremental strength in Test has been partially offset by weaker IA demand as reflected in the Q4 guidance.

The highlight in Semi Test is the continued strength in Automotive Test demand. This year, we're seeing a step increase in our shipments for ADAS processors, silicon carbide drive and charging ICs and battery management devices. Our UltraFLEX platform is well-aligned to the unique requirements of multi-billion transistor ADAS processors and our Eagle platform is well-suited for thousands of volts and hundreds of amps often required for silicon carbide devices.

It's notable that these three device -- device types collectively will add over $100 million of incremental SOC TAM in 2022 and they were insignificant five years ago.

Shifting now to Industrial Automation. Because only about 30% of our sales are transacted in dollars, and there have been significant changes in exchange rates in 2022, we'll describe results in both constant currency and dollar terms.

In constant currency, Automation Group Q3 revenue grew 7% from last year's Q3, and is up 19% for the first nine months of the year. In dollar terms, however, revenue contracted 2% in the quarter compared with Q3 '21 and growth is 11% for the first nine months.

Looking at the full year, we expect IA growth from 2021 will be about 6% in dollar terms at the midpoint of our Q4 guidance. In constant currency terms, IA growth will come in at about 14%. Even using constant currency terms, this is below our 2022 plan to grow in the mid-30s from the 2021 level and reflects two additional factors.

First, slowing industrial activity, especially in Europe where PMIs dropped below 50 in July and have remained in that contraction zone since. Europe is our largest end-market for Automation, and this is a 10-point headwind to growth. Second, labor scarcity continues in our distribution channel, which we expect to reduce growth by about 5 points.

While 2022 growth is below our plan we, have a number of bright spots in IA, and I will highlight just a few. At Universal Robots, customer demand for our higher payload longer-reach UR20 has been stronger than expected since its introduction midyear, and we expect it to be a meaningful contributor to results when it begins shipping in 2023.

The UR20 expands our capability in the palletizing, welding, and machine-tending end markets. Also, we've continued to grow our OEM channel at UR, including supporting partner expansion from national to international sales coverage. The OEM channel is a powerful growth driver for us. For example, our welding channel grew over 80% in the first nine months compared with last year.

And for this year, we expect to ship well over 1,200 robots in that vertical. At MiR, our sales to large customers continue to expand with more than 30 customers having fleet sizes greater than 20 robots. The number of customers with these large fleets has increased 30% in 2022. This is significant as our fleet management software is an increasingly important differentiator as fleet sizes grow.

On a related note, at the end of Q3, we merged AutoGuide into MiR as we prepare to offer customers a broad payload range from hundreds to thousands of kilograms sold by the same team, using the same fleet management software, backed by the same global distribution -- same global network of distributors, all while increasing our engineering, marketing, and back-office leverage.

Finally, MiR service and spares revenue has more than doubled to about 5% of revenue through the first nine months compared with 2021 as we begin to expand our customer support offering.

Across Industrial Automation, the investments we're continuing to make are giving us the foundation to support high growth with differentiated products to global customers through multiple distribution channels.

While we are not satisfied with 2022's growth rate and have taken actions to improve, we remain confident of our long-term strategy in these growing markets.

With that, I'll now pass it back to Mark.

[Mark E. Jagiela, Chief Executive Officer at Teradyne]

Thanks, Greg. I'll comment on the longer-term view of our markets and the impact of changes in the regulatory environment. Although better than estimated in our July call, the demand has slowed across our Test markets as we enter Q4.

As I noted at the time, predicting the depth and duration of these corrections is challenging, but in each of the last three corrections, growth has returned after six to 12 months.

We haven't seen anything in the last three months to change that view. So while it's too early to offer estimates on 2023 full year market size, based on the historical patterns and current market conditions, we expect next year's first quarter and first half demand to remain relatively weak. That, combined with the weak macro environment in industrial markets suggests that our Q1 revenue will likely be about 10% softer than Q4.

Looking at the full year 2023, it's too early to make quantitative predictions, but I'll point out how we're thinking about the balloons and anchors for the year ahead. First, the balloons. We expect the semiconductor industry to begin to transition to 3-nanometer technology and our largest customer to grow from less than 10% of company sales in 2022 to more than 10% next year. However, we expect them to be at a lower than historical past peak level as 3-nanometer will not hit full stride until 2024.

In Industrial Automation, we also expect to grow year-over-year with the exact amount governed by macro conditions. Balancing these balloons are a few anchors. Semiconductor unit volumes and revenue are expected to decline in 2023, due to inventory digestion and macro headwinds.

In Industrial Automation, slowing industrial growth worldwide and a pronounced slowdown in European manufacturing are additional anchors. So we're keeping a balanced view of next year, and we should have a better view of the full year in January. Looking longer term, the case [Phonetic] for growth in both Test and IA remains intact and compelling.

In Semi Test, we're operating on a market growth trend line of 10% since 2017. Growth in our Test businesses is driven by unit growth and complexity. We expect those drivers to remain in place as new semiconductor technologies such as 3-nanometer, gate-all-around and chiplets ramp over the next few years. These technology building blocks enable applications to continue to grow in complexity, including emerging applications like AI, ADAS and new compute architectures.

In Industrial Automation, we remain bullish on the future. While we're not immune to macro conditions, we recognized the underlying drivers of demand are favorable for cobot and AMR automation. Labor demographics and economics and the growing range of tasks our cobots can perform, ensures an expanding market opportunity, and our strategy enables us to capitalize on that opportunity for many years to come.

Regarding the recent changes in trade regulations, indigenous Chinese memory makers have been a significant and growing part of our Memory business. And while the new regulations mainly focus on fab equipment rather than Test, tighter restrictions combined with potential reduction in their wafer volume will likely impact our business.

This situation is dynamic, but as of now, we see these regulations as about a $75 million to $100 million headwind going into 2023. On the supply side of the trade equation, we have a large manufacturing footprint in China, and our global support team has a professional services operation in place to support local and global customers.

As part of our resiliency planning, we have been enabling additional global sites for these activities. Given the current environment, we will be accelerating the capacity growth of these other sites. Sanjay will take you through more details of those plans.

Stepping back to look at the full year. Despite the drop in demand in the second half, we're on track to deliver our second-highest revenue in history. We've balanced our growth investments with financial discipline and we positioned Teradyne for high growth as our core Test and IA markets improve.

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

[Sanjay Mehta, Chief Financial Officer at Teradyne]

Thank you, Mark. Good morning, everyone. Today, I'll provide details on our Q3 results, update you on the impact of the new trade regulations and describe our Q4 outlook.

Now to Q3. Third quarter sales were $827 million, with non-GAAP EPS of $1.15. Non-GAAP gross margins were 58.7% and our non-GAAP operating expenses were $247 million. About flat with second quarter opex and due to implemented spending controls.

Non-GAAP operating profit was 28.8%. We had one 10% [Phonetic] customer in the quarter. The tax rate excluding discrete items, for the quarter was 18.7% on a non-GAAP basis. Please note, you should now use 17.25% for the full year non-GAAP tax rate.

Looking at the results from a business unit perspective. Semi Test revenue was $576 million with SOC revenue contributing $451 million and Memory of $125 million. We cleared some supply constraints, which enabled the highest level of Memory shipments in the past two years.

In Memory, the transitions to new Memory standards in both flash and DRAM, along with strong demand from indigenous China customers drove the results.

In SOC, the increasing Semi content for EVs, autonomous driving and infotainment and autos, along with continued strength in analog industrial contributed to the demand.

System Test group had revenue of $116 million with Storage Test delivering $70 million and Defense & Aerospace and Production Board Test $46 million. In Wireless Test at LitePoint, revenue was $46 million in the quarter, down 33% year-over-year, primarily because of lower WiFi revenue tied to declining PC and smartphone end markets.

Now to Industrial Automation. IA revenue was $89 million with UR contributing $73 million and MiR $16 million. MiR results include AutoGuide. As Greg noted, a large portion of IA sales are outside the U.S. For the first nine months, 41% of IA sales were in Europe, 29% in the U.S., and 11% in China, and the remainder in the rest of the world. From a financial perspective in IA, the group was slightly above breakeven on a non-GAAP operating basis in the third quarter. And for the full year, we expect to be about breakeven, below the 5% to 15% profit range planned for the group. As growth has slowed this year, we've also slowed the growth in opex.

Shifting to supply. Looking at Q4, we continue to face supply issues, but the supply trend continues to improve relative to three months ago. These supply bottlenecks noted at the beginning of each quarter have moved from $50 million in Q3 to about $15 million in the fourth quarter. These amounts are outside the high end of our guidance range.

Switching to a strategic issue. We manufacture certain products and deliver certain engineering services in China for our global customers. While recent U.S. government actions have no immediate impact to these operations, due to concerns about potential future impacts, we are accelerating our strategy to expand our manufacturing and engineering service capabilities in other countries.

In manufacturing, this work has been underway for several years and we're accelerating the work to complete our expansion strategy in the next several quarters. In engineering services, the transition will likely take most of 2023 to achieve.

Shifting to the balance sheet and cash flow.

[Operator]

Ladies and gentlemen, please stand by. Your conference will resume momentarily. [Technical Issues]

[Andrew Blanchard, Vice President, Investor Relations at Teradyne]

Did John say where we lost it?

[Operator]

Ladies and gentlemen, please stand by. Your conference will resume momentarily.

[Andrew Blanchard, Vice President, Investor Relations at Teradyne]

Hey, Andrew?

[Operator]

Yes. Please go ahead.

[Andrew Blanchard, Vice President, Investor Relations at Teradyne]

All right. We're ready to go?

[Operator]

Yes. We are live with the audience. Please go ahead.

[Andrew Blanchard, Vice President, Investor Relations at Teradyne]

Back to you, Sanjay.

[Sanjay Mehta, Chief Financial Officer at Teradyne]

I'll go back to shifting to the balance sheet. Shifting to the balance sheet and cash flow. Our cash and marketable securities at the end of the quarter totaled approximately $900 million, about flat with Q2. We had $233 million in free cash flow in the quarter and our DSO came down from 74 to 58 days.

Uses of cash in the quarter included share buybacks of $217 million, dividend payments of $17 million, and debt retirement of $10 million. Due to opportunistic buying through the year, we finished our $750 million share repurchase plan for 2022 for three months ahead of the original schedule. Our Board has authorized continued opportunistic share repurchases in Q4.

Since our program began in 2015, we've repurchased 74 million shares at an average price of $45.85. Regarding debt, to date, $397 million of convertible bonds have early converted.

Now to our revolver. During Q3, we worked with our banking partners and have increased the capacity of the revolver to $750 million from $400 million. Our credit facility is in place until December 2026.

Now to our outlook for Q4. As Greg noted, our outlook is ahead of what we expected three months ago driven mainly by Semi Test. Sales in Q4 are expected to be between $670 million and $750 million with non-GAAP EPS in a range of $0.62 to $0.86 on a 164 million diluted shares. Fourth quarter guidance excludes the amortization of acquired intangibles.

Fourth quarter gross margins are estimated at 56% to 57%, down from Q3 and due to lower volume, product mix, and spending on accelerated -- accelerating our manufacturing and service delivery resiliency. Opex is expected to run at 34% to 38% of fourth quarter sales. On a non-GAAP operating profit -- the non-GAAP operating profit rate at the midpoint of our fourth quarter guidance is 21%.

Looking at the full year of 2022. At the midpoint of our guidance, 2022 revenue will be $3.1 billion with an EPS of $4.08. Gross margin for the full year should be approximately 59%. Regarding opex for the full year, we spent a bit lower than planned in Q3 in both test and IA businesses. We expect the full year opex will be about $1 billion, up about 3% from 2021 at the midpoint of our Q4 guidance.

Recall our operating model flexes opex with revenue. So growth has naturally trended down through the year. A couple of points looking ahead at 2023. First, gross margins. I will note that because of the additional spending on supply resiliency, and forecasted product mix, we expect Q1 gross margin will be similar to Q4's level.

Second, tax rate, in 2023 is forecasted to be at 17%. We'll update our midterm operating model in our January call. Summing it all up, we're expecting higher revenue and profit in the second half of the year than prior update in July. Declines in our Test portfolio were less than forecasted, offset by weaker IA business driven by FX, continued economic challenges in Europe, and labor scarcity in the channel.

For 2022, opex spending will increase year-over-year approximately 3% versus the 11% to 13% anticipated at the beginning of the year as revenue forecasts have declined from our view in January. In a challenging environment, regardless if the driver is economic downturn, regulatory changes, supply shortages, labor scarcity or whatever may come our way, we're confident we have a great team, strategy, operating model, and experience to lead us through whatever lies ahead. We will continue to focus on our customers and the long-term opportunities in Test and Industrial Automation markets.

With that, I'll turn things over to Andy.

[Andrew Blanchard, Vice President, Investor Relations at Teradyne]

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

Questions and Answers

[Operator]

Certainly [Operator Instructions] Our first question comes from the line of [Technical Issues] with Krish, Cowen. Pardon me, Krish, please check your mute button.

[Krish Sankar, Analyst at Cowen and Company]

Hi. Can you hear me?

[Andrew Blanchard, Vice President, Investor Relations at Teradyne]

Yes, we can.

[Krish Sankar, Analyst at Cowen and Company]

Yeah. Hey. Thanks for that. Thanks for taking my question. First one, Mark, I'm just kind of curious. You've seen Industrial Automation flow, you've seen mobile compute flow. And then I understand the demand drivers for ADAS and Auto. Do you worry that Auto and Industrial Test is the next shoe to drop? Or do you think that it could be resilient into 2023?

[Mark E. Jagiela, Chief Executive Officer at Teradyne]

Yes. I think that Industrial is probably something we're looking to soften a little bit in 2023. And Automotive at the moment is just -- there's no sign of that. It's very strong. We're in a year where the market size for Automotive Semiconductors is all-time peak. But the ADAS and EV content is on such a dramatic rise that it could very well be that next year has a flattening. But at the moment, we don't see it softening, certainly not through Q1.

[Krish Sankar, Analyst at Cowen and Company]

Got it. Got it. That's very helpful. And then as a quick follow-up, I think you mentioned that the China impact was probably $75 million to $100 million headwind in 2023. I'm kind of curious, you mentioned a lot of the exposure was through Memory. What about the China OSAT? I thought you had pretty high exposure over there too or is that a part of this $75 million to $100 million headwind?

[Mark E. Jagiela, Chief Executive Officer at Teradyne]

Most of that headwind is Memory. There's not really a lot of incremental restrictions that we have related to China OSAT. So that's not really a headwind for us.

[Krish Sankar, Analyst at Cowen and Company]

Got it. Got it. Thank you very much.

[Mark E. Jagiela, Chief Executive Officer at Teradyne]

Yeah.

[Operator]

Thank you. And our next question comes from the line of C.J. Muse with Evercore.

[C.J. Muse, Analyst at Evercore ISI]

Yeah. Good afternoon or good morning. Sorry. Thank you for taking the question. I guess I was hoping to get a little bit more detail on gross margins. I think you talked about manufacturing, engineering, resiliency and kind of investments outside of China negatively impacting margins into Q1. And I guess, can you give a little bit more color on the plans there and how we should think about the impact to overall calendar '23?

[Sanjay Mehta, Chief Financial Officer at Teradyne]

Sure. Hi C.J. It's Sanjay. So addressing gross margin, and then I'll get to the resiliency plan. So think of Q4 as roughly a third, a third, a third volume decline, product mix and then resiliency spending of the bridge from Q3 to Q4. And a lot of that continues into Q1. Getting into the resiliency plans.

For the past couple of years, we've been working to -- on what I call a multi-country manufacturing approach. We've obviously grown over the last several years and we had to increase capacity. So we fundamentally took the approach to have redundant capacity in both different geographies and not just for manufacturing, but from a supply chain perspective. And from that, we've chosen to accelerate over the next couple of quarters.

So what you're seeing is an accelerated spend on the manufacturing. And then from an engineering services perspective, again, to create capacity in different locations, that will take a little bit longer into the second half of 2023.

[C.J. Muse, Analyst at Evercore ISI]

Very helpful. As my follow-up, you talked a bit about 2023 outlook and highlighted your top customer accelerating higher, but not getting back to prior peak. I guess any color there in terms of kind of the diversification of the business and/or when you'll have clear visibility to what kind of the magnitude of the growth might look like?

[Mark E. Jagiela, Chief Executive Officer at Teradyne]

Yeah. As usual, with our largest customer, the visibility comes pretty late April of next year. We do get signs as early as this time of the year, which is why we have the sort of commentary on it going back above 10% for them. But it's not going to go back to greater than 20%. We don't believe where we've seen prior peaks, primarily because the 3-nanometer move in 2023 will be for a fraction of the phone models that will be introduced.

So that will expand as we go beyond 2023, and we would expect it to continue to grow, therefore, that business piece.

Outside of that, we've talked a bit in these calls about design wins in emerging vertically integrated nontraditional semiconductor companies. That should be another growth engine for us as we look into 2023. So I didn't call that out as a specific balloon, but that sits there as well on top.

[C.J. Muse, Analyst at Evercore ISI]

Thanks so much.

[Operator]

Thank you. And our next question comes from the line of Timothy Arcuri with UBS.

[Timothy Arcuri, Analyst at UBS Group]

Hi. Thanks. So I'm wondering if Mark, maybe you can help bridge the gap between Q4 is better because things aren't as bad as you thought when you guided, particularly on this Semi Test side, mostly it sounds like because of supply, but then Q1 being worse. So if -- to get Q1 down 10%, you have to assume a pretty significantly worse than normal Q1, which I assume would mostly come from Semi Test. So can you sort of help us bridge that gap? Thanks.

[Mark E. Jagiela, Chief Executive Officer at Teradyne]

Well, first of all, in Industrial Automation, our Q1 is always down from Q4. So that is a factor here. And it's reasonably significant. So that is one thing. But in the case of Semi Test, we do see some incremental weakening in Industrial, which we spoke about. The China headwinds we talked about around Memory will start to impact us in Q1 as well. So the combination of those two are kind of what leads us into that estimate for Q1.

[Timothy Arcuri, Analyst at UBS Group]

Got it. Okay. And then can you also talk about -- I know that it's a bit early to kind of talk about what the outlook is for the full year next year. But can you talk about any sense of directionality for the SOC TAM? I assume that the Memory TAM will be down. Clearly, you have front-end WFE down 40% plus next year for Memory. So I assume that the Memory Test TAM would be down. But front-end foundry and logic WFE TAM is not down that much next year. It's down probably 5%, maybe 10%. So do you have any sense in terms of where the SOC TAM could go next year, at least from a directional perspective? Thanks.

[Mark E. Jagiela, Chief Executive Officer at Teradyne]

Well, it's interesting. So first on Memory, although you're right on the WFE estimates, a lot of what's going to happen in Memory, especially DRAM next year, is the shift to DDR5 finally for server applications. That requires a brand-new Test platform. So we actually think that Memory next year for a Test will actually be pretty good. It may be, let's say, flattish with 2022 levels. It could -- because on the NAND side, it could come down a little bit, but we're pretty optimistic given what we're hearing from our customers because of the DDR5 transition.

In SOC, from a TAM point of view, I would expect the overall TAM to be a little bit weaker because the -- late in the year, declines in the PC markets, the compute markets, I think will precipitate into a lull in capacity adds early next year. And that will get offset, of course, by, let's say, some mobility growth related to 3-nanometer. But maybe the falloff on the PC side -- the impact of the falloff on the PC side might be more pronounced than the growth on the mobility side.

So -- and let's say, Automotive remains relatively strong. Industrial weakens a bit. So I could see it being marginally down next year. The first half much more so. I think that's where we're going to see the sort of digestion around capacity for PC Test and such come to fruition.

[Timothy Arcuri, Analyst at UBS Group]

Great. Awesome. Thank you so much.

[Operator]

Thank you. And our next question comes from the line of Samik Chatterjee with JPMorgan.

[Samik Chatterjee, Analyst at JPMorgan Chase & Co.]

Hi. Good morning. Thanks for taking my questions. For the first one, if I could start on gross margin, you gave us some color for 1Q. I was just thinking if you can give us a bit more color of the trajectory for the year, particularly the implications of the drivers of growth that you're outlining, which is -- it seems to have a lot of the growth will come from your primary customer next year and some from IA? But there's obviously demand slowdown across the board as well as the Memory headwinds that you outlined. So -- and there's also, I guess, supply improvement.

So as we sort of look at the puts and takes, how should we think about the trajectory of gross margin given the growth drivers? And I have a follow-up.

[Sanjay Mehta, Chief Financial Officer at Teradyne]

Sure. So first, let me ground you -- and as I've said in my prepared remarks, this year, we plan to come in approximately 59% are on model. There's no change to our operating model that we're managing the business at 59% to 60%. I think I outlined in Q1 that we expect some headwinds tied to product mix as well as spending on resiliency accelerations.

We're just going through the planning phase right now for 2023, and we'll be able to provide a little bit more color in the January call, but we fundamentally managed the business at 59% to 60% gross margins. And in any given quarter, those are going to oscillate tied to product mix and kind of what's happening in the environment.

[Samik Chatterjee, Analyst at JPMorgan Chase & Co.]

For my follow-up. I think I heard you say for the Industrial Automation slowdown that you're seeing, some level of that slowdown come through because of labor shortages. I'm not sure if I heard you correctly there. But I'm just curious if what you're hearing from your customers is more of a pullback in terms of capital investment plans that's driving the slowdown that you're seeing right now? Or is that sort of more of a next step right now, it's more about labor shortages that you sort of outlined? Thank you.

[Mark E. Jagiela, Chief Executive Officer at Teradyne]

I pointed out there were sort of two factors involved. There is a slowdown in spend primarily in Europe due to economic conditions. And there, you do see some customers that are implementing capital freezes or limiting their investments.

In other regions, the labor scarcity in the channel is the primary factor. What we see with our partners is that they actually are maintaining very high project backlogs and they're trying to work through those projects and add to their capacity at the same time, so that they're able to support a higher level of business.

So we haven't seen a pullback in regions other than Europe, it's much more a constraint -- a capacity constraint in our traditional distributor channel.

[Samik Chatterjee, Analyst at JPMorgan Chase & Co.]

All right. Thank you for the clarifications. Thank you.

[Operator]

Thank you. And our next question comes from the line of Mehdi Hosseini with SIG.

[Mehdi Hosseini, Analyst at Signal Hill]

Yes. Thanks for taking my question. The first one for Sanjay. In a scenario -- and I'm not asking for a guide, in a scenario where your 2023 revenues would be flattish, would you expect opex flat, up or down? And I have a follow-up.

[Sanjay Mehta, Chief Financial Officer at Teradyne]

Yeah. Good question, Mehdi. We're -- as I said earlier in the Q&A, we're currently preparing our plans for 2023, and we'll provide an update. But I will say, in January, we thought opex was going to grow of this year, 11% to 13%. Our operating model, obviously, with the macro environment and our projections coming down for the back half of '22 and then for the full year.

Our operating model has our very little compensation declining opex and we also implemented spending controls. So what I can guide is that we're going to have a plan that's integrated and ties to a revenue and a market view. And then if the environmental conditions change, we'll course correct as you've seen us do this year.

[Mehdi Hosseini, Analyst at Signal Hill]

Okay. Let me come back to the question in a different way. You guys have been very proactive in helping us better help investors -- you were the first one, nine, 12 months ago to talk about 3-nanometer pushed out and this morning, again, your reset in expectation with 3-nanometer, nine months ago, you were referring to a significant front-end capacity being added for MCUs analog. And now I'm looking forward and some of those front-end equipment being added are may not be fully utilized. So why not take opportunity and be more conservative?

Now I understand you're helping us by giving an overview of Q1, but why not just be more aggressive in being conservative?

[Mark E. Jagiela, Chief Executive Officer at Teradyne]

Well, I don't think we're being conservative or optimistic in terms of beyond Q1. We just don't have visibility. And so we could be speculative maybe. But it's just being a little bit prudent of what we know versus what we speculate. And I think the days of inventory in the semiconductor supply chain suggest there's just digestion needed. And that should be something that's already starting and perhaps works its way through by next summer in many of these markets.

But the bottom line is we don't know. And so we don't want to go out too far on our speculation.

[Mehdi Hosseini, Analyst at Signal Hill]

Okay. I'm not asking for speculating, but if I go back to nine months ago, [Technical Issues] we are thinking of yes, considerable amount of front-end investments being added. But now we're finally looking at the inventory situation that is problematic. 25 [Phonetic] you're high and your customers have to cut back on production. So even if they have added investment for front-end, those equipment are not going to be fully utilized. So wouldn't none compute SOC be weak into midyear as your customers become more aggressive in working down inventories?

[Mark E. Jagiela, Chief Executive Officer at Teradyne]

Sure. It's very -- it's likely that's the case. But on the other hand, there's offsets to that, that I mentioned. Our largest customer probably is going to be stronger. And so there's offsets to what is, let's say, likely to be digestion in some of those markets. But in our neck of the woods around mobility, 2022 was unprecedentedly weak because of the factors around product migration and complexity growth that worked against our neck of the woods. That's going to work in our favor a little bit next year to offset some of what you're referring to.

[Mehdi Hosseini, Analyst at Signal Hill]

Okay. Thank you.

[Operator]

Thank you. And our next question comes from the line of Vivek Arya with Bank of America.

[Vivek Arya, Analyst at Bank of America]

Thank you for taking my question. First one on smartphone test. I'm curious how much of the existing capacity that's for 5-nanometer can be repurposed for 3-nanometer tested? Is there a large reuse element that we should be aware of? And kind of related to that, I thought that one of the incremental growth areas for next year was the possibility that if your large customer would in-source their 5G modems, that would provide you incremental opportunity, but that seems to be pushed out as well.

So just wanted to get your insights on the reuse aspect and the large customer retaining the 5G modem, what impact does that have on how you're thinking about next year?

[Mark E. Jagiela, Chief Executive Officer at Teradyne]

Yeah. So first of all, testers reuse, yes, 100%. There's no obsolescence in the short term on the SOC AP Test side. This has been true for 10-plus years. The testers do not often obsolete themselves. We will come to that point at some point in the next four or five years, where that will begin to happen, but not in the short term.

On the drivers of Test demand at our largest customer subject for a little bit. I'm going to answer it a little bit broader than just the modem because I don't want to speculate or get into our customers' introduction plans on any specific device. But in general, when we look at 2022, now that we understand and it's public that, A, the new processor for phones that was introduced in 2022 only went to the high-end phone models and that new processor being the last processor built on 5-ish nanometer was only a 6% growth in transistor count. So very modest complexity growth, really muted the demand from that our largest customer this year, drove them below 10%, and that's all kind of clear.

Now if we look forward, the combination of what you described, the introduction of a new line of silicon, when that happens, will be a bump. And I'm not going to say if it's when, but that's obviously in the pipe. Another bump is 3-nanometer for the apps processor for 2023 phones. If, in fact, that occurs, it's likely that it will be a pretty significant complexity bump, not 6%, but probably back in the 20% to 30% complexity growth that we've seen historically with a new node.

That gets muted a little bit though because it's likely it will still only go into the top-end phone models, while this year's 6% incremental complex part waterfalls down to the other models. So the other models in 2023 aren't going to see much of a bump, but the high-end phone will. That's what kind of gives us this view that they could go back to being greater than 10%, but less than historical peaks.

Then let's look forward to 2024. We'd see another significant bump in complexity at the high end that phone app processor that was introduced in 2023 would likely waterfall down to the other models. And then the full product line in 2024 is likely to see a significant jump in complexity.

So this is sort of how the movie plays out. And then on top of that, there's new silicon. There's also high-performance computing. All of that, that moving to 3-nanometer. But it's just going to be partially I think, in '23 and probably more fully in '24. I'm sorry if that's too long an answer.

[Vivek Arya, Analyst at Bank of America]

No, no, very helpful. Thanks, Mark for that. My follow-up question is, it's interesting that you are keeping your calendar '24 earnings model of $8, which is roughly a doubling from the '22 level even though '23 seems to be facing some of these macro headwinds. Mark, what's your gut on -- what is kind of the bottom of the cycle for you, right? Is it Q1, Q2 next year? Like when do you start making the recovery to your '24 plan? Or is the '24 plan looking ambitious at this point?

[Mark E. Jagiela, Chief Executive Officer at Teradyne]

Well, we'll update you on the '24 plan in January. But what I just described gives you some understanding of why we think '24 is probably a pretty strong year. In '23, as usual, our quarters are lumpy. So our largest customer tends to tool in Q3 and Q4. So we would expect a bit of a bump there. But one thing we can't predict very well is the macroeconomic conditions that are going to occur.

The digestion of inventory in the channel and those things, we have some ability to think about a model. But if the world is going to be in a recessionary environment or -- and the effect of that on both semiconductors and IA is a little bit harder for us at this juncture to suss out. What I did say though is that 12 months is kind of a normal cycle here to go through. So that would suggest come third quarter next year, we should start to see a broader recovery, if it's like anything in the past.

[Vivek Arya, Analyst at Bank of America]

Thank you.

[Operator]

Thank you. And our next question comes from the line of Joe Moore with Morgan Stanley.

[Joe Moore, Analyst at Morgan Stanley]

Great. Thank you. Why don't you talk about Memory Test from the perspective of the DRAM and NAND vendors are building a lot of inventory right now? Is that untested and is that -- like as their volume picks up, do you see a recovery in Test volume that maybe helps you next year? And then on the flip side of that, I think you talked a little bit about what the deceleration in WFE might mean, but do you have any kind of sense of what Memory supply does next year above and beyond the DDR5? Thank you.

[Mark E. Jagiela, Chief Executive Officer at Teradyne]

Yes. I think DDR5 is the only bright spot next year. The rest is kind of very tenuous. And I would expect the first half of next year, we're going to see other than DDR5 pretty weak demand as people are trying to balance fab capacity, inventory with end-market demand. So I don't -- earlier, I said maybe Memory might -- there's an argument that Memory will hold up next year as a market for Test because of the DDR5 transition, I think that's possible. I think it's more likely though we see that happen, but NAND fall off a bit stronger. And so a little bit more of a anchor on the market next year for Memory than a balloon because of DDR5.

And then we know we have the specific issue around China, where we've been -- our overall market share in Memory Test is somewhere around 40%. But in China, it's been north of 50%. And this issue with one of our customers in China, which we may be prohibited from selling to is kind of going to be for Teradyne probably a net negative for Memory Test revenue in 2023.

[Joe Moore, Analyst at Morgan Stanley]

Okay. But on those large inventory builds on the producer balance sheets, is that Die Bank that has yet to be tested? Or is there already some test that you think has occurred on that inventory?

[Mark E. Jagiela, Chief Executive Officer at Teradyne]

There is some test that's occurred, but a lot of it is in that sort of Die Bank area, keeping the fabs running is kind of something that makes economic sense. But finishing the product doesn't make sense until the demand materializes.

[Joe Moore, Analyst at Morgan Stanley]

Thank you very much.

[Operator]

Thank you. Our next question comes from the line of Toshiya Hari [Phonetic] from Goldman Sachs.

[Toshiya Hari, Analyst at The Goldman Sachs Group]

Can you hear me okay?

[Andrew Blanchard, Vice President, Investor Relations at Teradyne]

Yes, we can.

[Toshiya Hari, Analyst at The Goldman Sachs Group]

Okay. Great. So I had one clarification and one question. In terms of my clarification, just on the China export control. You talked about the headwind in 2023 being $75 million to $100 million. Just curious how significant China Memory Test was in Q3? And I assume that number should be zero in Q4. Am I thinking about that correctly? And can you speak to the profitability of some of these China Memory customers?

[Mark E. Jagiela, Chief Executive Officer at Teradyne]

Yeah. Well, it's not zero in Q4 or next year. So that's maybe one comment. The profitability is not distinctively different than any -- than our global margin. So there's no difference there. But there's a portion of the market in China will continue to serve. China overall, I think Sanjay mentioned is roughly 16% -- 15%, 16% of the company's revenue. Half of that is multinationals that really are not subject to any restrictions around this set of regulations. So about 8% of our annual sales, let's say, are two indigenous Chinese companies. And then roughly half of that might be Memory. And then a fraction of that is this headwind of this one customer.

[Toshiya Hari, Analyst at The Goldman Sachs Group]

Okay. Mark, just a quick follow-up. So I meant local China Memory. That should be near zero or zero going forward, correct? The multinationals you'll serve.

[Mark E. Jagiela, Chief Executive Officer at Teradyne]

We'll serve the multinationals, but there's a portion of the indigenous China Memory market that we still can serve under the current regulation regime.

[Toshiya Hari, Analyst at The Goldman Sachs Group]

Okay. Got it. And then my question is on the IA side, maybe one for Greg. I realize it's hard to predict what 2023 could look like. But hoping to get your preliminary views there. You talked about labor scarcity outside of Europe being a 5 percentage point headwind. You talked a little bit about some of the idiosyncratic stuff that you're working on in terms of the new product, the higher payload, longer-reach product, you talked about the OEM channel. Could those be sort of impactful enough for your growth to accelerate in '23? Or is it a little premature to talk about those things? Thank you.

[Greg Smith, President at Teradyne]

So it is a little premature. We haven't fully worked out our complete plans, but I think you have hit some of the major factors that are going to go into that equation. So one thing is that the reason that we are talking about our results in constant currency is that we do expect a more stable FX environment in 2023. And that alone would add significantly to the growth that we saw in 2022 because that was like a 10-point headwind to where we are.

Beyond that, we do expect significant impact from new products, both from UR and from MiR in 2023. And we also are going to continue to grow our complementary channels like OEM at similar rates to what we saw in 2022, but off of a larger base. So overall, they're going to have a greater impact on growth in 2023 than they had in 2022. So in other words, we are expecting these new things to help out with growth. We believe that our distribution partners are going to work on labor scarcity, but we are not counting on them to completely solve it in 2023.

[Toshiya Hari, Analyst at The Goldman Sachs Group]

Thank you.

[Operator]

Thank you. And our next question comes from the line of Atif Malik with Citi.

[Atif Malik, Analyst at Smith Barney Citigroup]

Hi. Thank you for taking my questions. Mark, your comments on next year's end markets, they all make sense, Memory stable on DDR5, Industrial coming down, Mobile improving on the large customer. The only one that I struggled is on the Auto side, the Auto TAM is around $700 million this year from historically $350 million. Now $100 million of that, like you said, is coming from new opportunities in ADAS, silicon carbide, power management. But what about the opportunities outside those areas like won't that see a correction next year if there's a recession?

[Mark E. Jagiela, Chief Executive Officer at Teradyne]

Yeah. I think that's likely. You're right. I think some of the things that have contributed to getting the Auto market up to the $700 million TAM level are a lot of these new technologies. But underneath that, there's a kind of core piece of legacy technologies that I would expect would soften as we get out of this sort of frenzy of trying to replenish the supply chain on those parts.

So what I was saying is we don't see that coming in Q1. It's kind of not something we baked into Q1. But for 2023, that underlying, let's say, legacy piece of Automotive technology is likely to come down.

[Atif Malik, Analyst at Smith Barney Citigroup]

Got it. And then, Sanjay, can you talk about what are the other geographies you're looking at in improving your supply chain resiliency moving out of China?

[Sanjay Mehta, Chief Financial Officer at Teradyne]

Sure. From a manufacturing standpoint, you should think about it from both manufacturing and supply chain, but think about other countries in Southeast Asia, Malaysia, Thailand, and then from an engineering services resiliency, think about Southeast Asia, but also think about other parts of the globe like in Europe.

[Atif Malik, Analyst at Smith Barney Citigroup]

Thank you.

[Andrew Blanchard, Vice President, Investor Relations at Teradyne]

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

[Operator]

Certainly. Our next question comes from the line of Steve Barger with KeyBanc.

Pardon me, Steve, please check your mute button. Pardon me, Steve, please check your mute button.

Okay. I will now turn the call back over to Vice President of Investor Relations, Andy Blanchard for any closing remarks.

[Andrew Blanchard, Vice President, Investor Relations at Teradyne]

All right. Well, thank you, everyone, for joining us today, and apologies for the technical pause along the way there. We look forward to talking to you in the days and weeks ahead. And certainly, if you have follow-up questions, reach out to me directly. Thanks so much.

[Operator]

[Operator Closing Remarks]