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spk00: Ladies and gentlemen, thank you for standing by and welcome to the Teradyne Third Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone keypad. If you require any further assistance, please press star 0. I would now like to hand the conference over to your speaker today, Andrew Blanchard. Thank you. Please go ahead, sir.
spk01: Thank you, Patrice. Good morning, everyone, and welcome to our discussion of Terra9's most recent financial results. I'm joined this morning by our CEO, Mark Jagaler, and our CFO, Sanjay Mehta. Following our opening remarks, we'll provide details of our performance for 2021's third quarter, along with our outlook for the fourth quarter. 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 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. 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, where appropriate, 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 Baird, Credit Suisse, Davidson, and UBS. Now let's get on with the rest of the agenda. First, Mark will comment on our recent results, current market conditions, and thoughts on the rest of 2021 and 22. 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? Thanks, Andy.
spk07: Good morning, everyone, and thanks for joining us. Today I'll cover four topics, the highlights of our third quarter and the first nine months of the year, the changes we're observing in the SOC test market, our outlook for the industrial automation market, and how we're thinking about the test and automation markets as we close out this year and look into 2022 and beyond. Thank you. As our Q3 results demonstrate, demand remains strong across all of our businesses. At the company level, Q3 sales grew 16% from last year's record Q3, and non-GAAP EPS grew 35%. We did experience increased supply chain bottlenecks in our industrial automation business in the quarter and undershipped demand. Sanjay will describe this in more detail, but we expect these constraints to persist into Q4. Despite this, for the first nine months of 2021, Company-wide sales grew 19%, and non-GAAP EPS grew 31% from the year-ago level. In each of our businesses, we are riding long-term secular trends that we expect will drive revenue and earnings growth for years to come. In our test businesses, the unit growth and complexity drivers that power these markets continue unabated. For example, our semiconductor test business grew 18% through Q3, with SOC leading the charge, growing 22%. Sales continue to be dominated by our Ultraflex product line, which is well aligned to the performance requirements of the growing compute and mobility markets. Additionally, sales of our Eagle test systems more than doubled in the nine-month period, as automotive and industrial test markets have also rapidly expanded. Eagle's unique architecture hits the sweet spot of these markets by balancing high precision with the stress testing needed for these demanding applications. Within SOC, there's been a clear shift this year to higher demand from the compute, automotive, and industrial markets. While mobility is still the largest subsegment of SOC and growing, it has dropped from the high 50% range of the SOC test market in recent years to the high 40% range this year. Over the midterm, we expect mobility will remain the largest SOC submarket and continue to grow, but we also expect compute to grow at a faster rate, while automotive should remain at its current elevated levels. For the last decade or so, mobility has made rapid annual advances in semiconductor complexity that has enabled the advancement of smartphone sophistication. The refresh pace has been much faster than traditional PCs, graphics, automotive, and industrial end markets, leading to smartphone ICs rapidly progressing along the complexity scale. This is true in many areas of smartphone silicon, apps, processor, compute engines, graphics engines, AI engines, image sensors, power management, and more. Our leading position in testing these key technologies has driven our growth. At the same time, up until recently, the traditional compute testing market has been relatively flat with slower refresh rates and slower complexity growth. However, the groundwork laid by mobility designs, combined with advancing lithography nodes and design tools, has enabled new entrance into the chip design space for compute engines. The complexity of these chips, whether for laptop servers, autonomous driving, AI, or graphics, is incredible and advancing at an accelerated rate. For example, laptop CPUs are now crossing the 30 billion transistor level, which is a huge leap over previous legacy designs. As we've said in the past, increased transistor counts drives increased test time and increased tester demand. We've seen that this year, and there's more to come. We're targeting this expanding collection of new players and new designs, leaning heavily into our Ultraflex family's hardware performance and time-to-market advantages of our software. We've been adding new design wins every quarter, and while development pipelines can be long and these new designs can be speculative, we're confident we'll see growing production business from these wins in the future. It's also notable that the traditional chip suppliers in these markets aren't standing still. They are doubling down on their advanced designs, too, which is collectively driving WFE investments higher as applications expand and competition heats up. We expect this race to lead to higher test TAMs and, given the higher performance and faster design-to-market cycle times, more share gain opportunities for Teradyne over the midterm. Our system test segment year-to-date sales grew 11% from 2020, and storage tests continued its multi-year growth trajectory, expanding sales 12% in the same period. Higher capacity HDDs and more complex SOC devices, which require system-level tests, are driving this demand. Both trends are expected to continue into the foreseeable future. At light point, sales were up 24% through nine months compared with 2020, driven by Wi-Fi 6E production, Wi-Fi 7 R&D demand, as well as ultra-wideband. More connected devices demanding more bandwidth while managing growing congestion drive complexity increases in each new Wi-Fi standard and more tests. UWB, on the other hand, is a whole new wireless standard and application space. It's a new proximity detection wireless technology with a future of many promising security applications. We expect these trends to continue and to provide a long-term tailwind to our wireless test business. Shifting to industrial automation. Universal Robot's revenue grew 50% through the first nine months of the year, while MIR grew 40%, despite supply chain challenges. Each has a unique story. At UR, it's a combination of increasing sales for existing tasks and the expanding number of UR Plus offerings, making it easier for customers to deploy our cobots to do new applications. We highlighted welding in our last call, but other examples include screwdriving and palletizing. The UR Plus ecosystem is key to expanding these tasks and now totals over 360 products created by over 300 partners, both riding on and broadening the coattails of our UR platforms. This is a key advantage in the combination of our organic investments and our UR Plus and OEM partners' R&D dollars and creativity that's going into expanding the UR platform, and it's unmatched. At Muir, the story is about new products. The Muir 250, which was introduced just as COVID hit last March of last year, is now our largest seller by far. This year, we added the Muir Hook, to the 250 family to expand its applications into tugging. We've introduced higher payload products, such as the MIR 600 and 1350, to expand our footprint in the fast-growing logistics market. Unfortunately, with all this good news come supply chain issues that will limit IA growth in 2021 to be between 30% to 40% year-on-year, but demand is strong. The long-term outlook in IE remains very bright. Looking at the capabilities of UR Cobots today, we estimate the penetration rate is less than 2% of the servable market. UR's approximate 45% market share puts us clearly in the lead, and we continue to drive R&D and distribution investments to extend our competitive advantages, expand the servable market, and drive penetration higher. It's a similar story at MIR, where we estimate the autonomous mobile robot penetration is under 3%. The AMR market doesn't have a single dominant player like UR Cobots, and we estimate we're close to number two in the broadly defined market. And like at UR, we're making investments in both the distribution and product level to both reinforce our advantages and extend our product reach. In both IE businesses, the fact that our penetration of today's servable market is low single digits and that the servable market continues to expand each year with product enhancements sets up a fantastic future. So even with very high growth rates in our IE business, we expect the penetration rates to remain low for many years, sustaining our long-term annual growth forecast of 20 to 35%. In January, we will update you on the outlook for 2022 and our midterm earnings model. Between now and then, we'll be looking at the rate and timing of new semiconductor fab capacity coming online, especially at the more advanced lithography nodes, and we'll also be looking at the rate of adoption of DDR5 as key swing factors. In IA, we will be looking at the manufacturing output expansion, on-shoring trends, and PMIs in our principal geographies as tailwinds for continued robust growth. On the other hand, in both markets, supply chain bottlenecks could slow certain industries and become a headwind to growth demand. Short-term demand is influenced by many factors, but we manage our business aligned to the long-term trends. The trend of growing prevalence of increasingly complex semiconductors and a myriad of applications drives our semiconductor business and investments. The trend of new, increasingly smart, cost-effective automation in a world with labor scarcity, and on-shoring challenges drives our IE business and investment strategy. These systemic long-term trends pave an exciting future for Teradyne. With that, I'll turn it over to Sanjay.
spk06: Thanks, Mark, and hello, everyone. In my remarks, I'll review our Q3 financial results, discuss our supply line strategy in this challenging environment, provide Q4 guidance, and comment on our full-year financial outlook at the midpoint of our Q4 guidance. To the financial headlines for Q3. Our third quarter sales were $951 million, was near the high end of guidance driven by strength and semi-test and wireless test. Gross margin in the quarter was approximately 60%. Our non-GAAP operating expenses were $242 million for 25.5% of revenue. The favorability in OpEx drove a non-GAAP operating margin of approximately 35% and non-GAAP EPS of $1.59. A few more components of third quarter data. Our tax rate, excluding discrete items, is 14.8% on both a GAAP and non-GAAP basis. Non-GAAP diluted share count was approximately 176 million. We had two 10% customers. Looking at the results from a business unit perspective, semi-test revenue of $688 million was up 16% from Q3 20. SOC revenue was $575 million, up 28%, driven by strength in applications processors RF, industrial, and automotive applications. Automotive and industrials doubled revenue year over year. Memory revenue was the second highest in history at $113 million, but down 21% from Q3 of last year's record. Flash final test demand was the strongest segment on handset and SSD end market demand. System test group had revenue of $103 million, which was down 13% year over year. Recall storage is the largest business in this segment and has lumpy shipments. While storage tests will still grow more than 15% for the year, sales including HDD and SLT declined to $56 million on the timing of shipments in Q3. Defense and aerospace and production board tests combined grew 10% year-on-year to $47 million. At Lightpoint, revenue of $69 million was up 70% from prior year due to early success of our new Wi-Fi 7 product, continued strength in 4G cellular, and UWB. Now to industrial automation. As in July, given COVID shutdowns that impaired the UR business in 2020, I'll provide revenue metrics comparing Q321 results with both Q320 and Q319. Industrial automation revenue of $91 million was up 32% from both Q319 and Q320. North America delivered the highest revenue growth from last year, but all regions expanded year on year. As Mark noted, supply issues, primarily semiconductors, reduced our IA shipments in the quarter. UR sales were $78 million in Q3, up 46% year over year and 31% over Q3-19. MIR sales were $13 million, up 27% from Q3-20 and 35% from Q3-19. IA was about break even in the quarter and full year we expect low single digit profitability. As we've noted before, we continue our strategy of investing during this high growth era while maintaining gross margins to enable mid 20s operating profit in the future. Shifting to supply. We continue to deal with numerous supply constraints across the company. While semiconductor shortages are well reported, we're also seeing delays in mechanical parts and logistics all exacerbated by rolling COVID-related shutdowns or labor shortages. We expect these issues will continue through the first half of 2022. Despite these issues, we've been able to deliver record shipments and a big part of that performance as a result of the supply line management, operations teams, and engineering teams working with our supply chain and contract manufacturing partners. We view our operational business model and execution against it as a core competence. Our gross margin performance over the last 10 years displays the financial value of this model. In our test portfolio, our execution has kept most of our tester lead times within the range that meet customers' needs to expand their production capacity in this dynamic environment. The significance of this lead time performance is that customer orders more closely reflect true test demand. While a bit counterintuitive, we feel that maintaining short lead times are a more accurate indicator of test demand, with lower risk than holding orders with lead times far beyond chip manufacturing cycle times. Of course, our supply line and operations model isn't static. We began adding resiliency through both geographic and supplier diversity prior to COVID. Those efforts have accelerated over the last 20 months. This work is paying dividends in the current environment and will continue to invest to harden our supply chain further. Our lead time performance is an example of our resilience and execution. Another example is the ability to scale to significantly increase demand. Auto and industrial sales have more than doubled year over year. While we're not perfectly aligned to all customer requested delivery dates, we are managing through delivery issues in a reasonable manner. The value of these efforts can also be seen in the operating leverage in our gross margin line. In IA, we've seen lead times extend from our normal one to two weeks to four to six weeks for some products. While this is a challenge with the business growing so quickly and ongoing industry supply issues, we've already seen the positive impact of our work in material sourcing and manufacturing cycle times. We expect to bring lead times back to model over the next two to three quarters. shifting to the balance sheet and cash flow. Our cash and marketable securities at the end of the quarter totaled $1.45 billion. We had $493 million in free cash flow in the quarter, and through nine months, we've spent $103 million on CapEx, and we expect we'll spend $148 million for the full year. We spent $210 million and $16 million on buybacks and dividends, respectively. Year-to-date, we've repurchased 3.3 million shares for $406 million at an average price of $123.53. In 2021, we expect to return over 80% of our free cash flow to shareholders, and from 2015, when we began repurchasing shares, we've returned 85% of our free cash flow to owners. Regarding our convertible debt, $302 million of principal was paid in the first nine months to the convertible bondholders ahead of maturity. By mid-December, bondholders will have converted approximately $343 million, leaving a face value of $117 million. Now to our outlook for Q4. Sales in Q4 are expected to be between $820 and $900 million with non-GAAP EPS in a range of $1.14 to $1.40 on 174 million diluted shares. Fourth quarter guidance excludes the amortization of acquired intangibles and non-cash imputed interest on the convertible debt. Our guidance assumes no significant changes, positive or negative, in the availability of materials and assumes that we won't see additional pandemic-related issues. Fourth quarter gross margins are estimated at 59 to 60 percent. OPEX is expected to run at 28 to 31 percent of fourth quarter sales. The non-GAAP operating profit at the midpoint of our third quarter guidance is 30%. Regarding OPEX for the full year, we spent a bit lower than planned Q3, and we expect the full year OPEX will be about $980 million, up 17% from 2020. At the midpoint of our guidance, 2021 will be another year of growth in both revenue and EPS, while sales growing with sales growing 18% to $3.7 billion and non-GAAP EPS growing to $5.88, up 27%. Gross margin for the full year should be approximately 59.5%, up from 57.2% in 2020, reflecting the ramp of new products, product mix, and operating leverage, offsetting component and logistics cost increases. Our 2021 non-GAAP operating profit rate is expected to be about 33%, up from last year's 30%. Our full-year tax rate is expected to be 14.8%. These results put us comfortably in the range of our 2024 earnings model this year. We'll update the model on our regular cadence in January. The breadth of our customer buying in 2021 is also broader than last year. In 2020, we had one customer that drove 25% of sales. In 2021, we do not expect to have any customer larger than 20% of our yearly revenue. This reflects the trend Mark noted about 2021's higher growth in compute, auto, and industrial demand compared with mobility demand and semi-test. IA growth of over 30% year over year continues to diversify our revenue. This growth is expected to continue over the midterm and become a larger portion of our revenue. In summary, we expect to end the year with another quarter of strong year-on-year revenue and EPS growth. On a full year basis, we'll exceed our midterm targets on stronger than expected demand on our test businesses, continued high growth in IA, and excellent execution across the company. While we don't have a clear picture of 2022 yet, we're confident that the long-term industry trends powering our test and IA businesses remain firmly in place. With that, I'll turn the call back to Andy.
spk01: Thanks, Andre. Patrice, we would now like to take some questions. And as a reminder, please limit yourself to one question and a follow-up.
spk00: As a reminder, to ask a question, you will need to press star 1 on your telephone keypad. To withdraw your question, press the pound or hash key. Please stand by while we compile the Q&A roster. Your first question comes from Atif Malik with Citi.
spk03: Hi, thanks for taking my questions, and good job in the tough supply environment. Mark, if I look at some of the recent ARM-based notebook processors, the transistor count is growing two to four times versus prior generations. You commented mobility to grow and compute auto analog to grow faster than mobility in the midterm. Understand, you guys, and generally talk about next year outlook in January. How confident do you feel about your SOC growth next year?
spk07: Well, I think at this point, pretty confident. I mean, we look at the trends that you cited and I cited and see that there's very little standing in the way of sort of this increased But the caveat I would mention is there's a lot of supply chain bottlenecks in the system. So if end products get bottlenecked, that can slow down the unit volume demand for new semiconductors. And the other thing we're looking at is when do these new nodes really come online in terms of capacity? All that $90 billion of WFE that was put in place this year hasn't yet had a single impact on tests. That's all to come. But it kind of depends on when do those additional five and three nanometer fabs come online. That is kind of a big swing factor in the calendar year 2022 as to how our growth will chunk out. And that's kind of why we wait until January, because we don't get good enough visibility on that right now.
spk03: Great. And Sanjay, as a follow-up, Can you talk about concentration within mobility and compute customer and impact on long-term gross margins? There have been talks about price discounts with equipment suppliers by Tier 1 foundries.
spk06: Yeah, as I stated in my prepared remarks, we won't have any customer above 20%, so it's a broader breadth of customers. And regarding gross margins, You know, throughout the year, we've improved gross margins. And as I said in earlier calls, really driven by a couple of key test systems coming online and we're shipping in volume that have come down the cost curve. We've seen some benefits to product mix shift as well as our operating leverage offsetting the component cost and logistic cost increases. You know, from a look forward in sustainability of that gross margin, obviously we'll give an update to our earnings model in January. But, you know, I see the second half of our gross margin performance kind of going into the first half of 2022. Great. Thanks.
spk00: Your next question comes from Mehdi Hosseini with SIG.
spk12: Yes, thanks for taking my question. The first one has to do with your largest customer. Given your commentary in terms of revenue mix, it seems to me that that particular customer is going to be down like a 5% to 6%. In that context, should we assume a return to growth in 2022, and this is a trend that has happened over the past several years, and should that happen now? happen again, should that pattern happen again in 2022? And I have a follow-up.
spk07: Yeah, we, of course, Mehdi, can't talk about any individual customer and what they might do or not do in the future. So that I have to leave aside. But I just point out in your first point that, yes, our largest customer is dropping below 20% in a growing revenue year. So the amount that you might think, compute that they're falling below has to be taken against our numerator of higher revenue.
spk12: Got it. Thank you. And then I want to follow up to the question that came up three months ago when we were looking into your market share in the compute. Can you update us where you are with that market share in 2021? And as hyperscalers ramp their own ARM-based CPUs, How will your market share change over the next one or two years? Thank you.
spk07: Well, like the total SOC market, year-to-year market share is very volatile. It depends on whose customers are buying what in any given year. So what our market share might be in any given year, in a sub-market like Compute, it can swing 20 points year-to-year depending on who's buying. So for this year, It tends to be a very good compute year for us. You know, our compute market share is up in, I would say, close to what our average share is in SOC this year. But I would say that it's not steady Eddie. It's going to be pretty volatile year to year. It has been in the past. It probably will be going forward too.
spk12: I know we're supposed to ask only two questions, but just a quick follow-up. I think what I'm trying to understand is, I think on the GPU side, it's pretty clear that your competitor has dominated. And assuming that that were to remain unchanged, I think the incremental change to the compute is all driven by ARM-based. And I was just trying to better understand how you look at your competitor position as these new chips coming to the market, addressing the compute and market.
spk07: Well, we look... We're very... pleased and confident with our progress in ARM-based compute and design-ins in that realm. But I would say that it's not, you know, there's the tester market for computes also driven by more traditional x86 demand as well. You've got a couple of suppliers there that are not standing still, as I mentioned, and are upping their kind of complexity growth curve. And so there will be certainly a lot of growth there as well, I believe.
spk12: Okay, thank you. Thanks for the detail.
spk00: Your next question comes from Tashia Harry, Goldman Sachs.
spk09: Hi, good morning. Thank you for taking the question, and congrats on the strong execution. I had two questions as well. My first one is on the supply constraints, maybe for Mark, maybe for Sanjay. Just curious how significant the headwinds were for IA in Q3 and what's embedded in your Q4 guidance. If you can share that, that would be helpful. And just wanted to confirm that there was little to no impact on your semi-test business. And then on gross margins, similarly, you came in at the high end of your guided range, but was there any impact on your profitability in the quarter from supply chain shortages? Thank you.
spk06: Sure. So I'll take those. So from an industrial automation perspective, you know, year to date, we've grown 40% in IA. And Q4 demand is high. If we can't supply it all, that's why we've, you know, I think it's going to be growth year on year of about 30% to 40%. And so predominantly it's in semiconductors. And I expect we'll be out of the supply chain crunch given our visibility in Q2 or Q3 for IA. So that's the IA side. And then from a supply chain perspective on the test side, you know, we've seen the supply chain tightening on the test portfolio quarter over quarter where we don't think it's going to be abated until, the end of Q2 of 2022. And again, mainly semiconductor parts. And really, we see that coming back online in the second half, really tied to the wafer and the substrate capacity coming online. And then from a gross margin perspective, we've been managing through the component increases and logistics increases in cost And as I've said earlier, we've had favorable product mix. And as our volumes or our revenues are higher, we're gaining operating leverage along with coming down the cost curve of our new product that we've introduced late last year. So we're managing through it. And it's true, well-publicized component cost increases.
spk09: Got it. That's super helpful. And then as my follow-up, Mark, I wanted to ask about your Eagle Test business. In your preparator marks, you noted that the business is up more than 2x year-to-date. I guess historically, like many other parts of your business, I think Eagle Test has been quite cyclical. You would be up for a year, year and a half, four to six quarters, and then down a little bit as customers digest their test capacity. Based on what you said, it seemed like you're expecting 2022 to be another strong year. I guess the question is what's different this time? As you think about Eagle Test into 22, I realize, you know, there's complexity growth, but you could argue there's been complexity growth for a very long time. So just curious how different this cycle could be relative to past cycles. Thank you.
spk07: Right. Good question. And in addition, you know, Automobile unit volume isn't near its historical peak either, so how could this thing keep going beyond the normal six-quarters surge in automotive, which is, you're right again, that's kind of the traditional pattern. But I think what we see happening and makes us believe this will persist at least through 2022 is there's a lot of silicon refresh going on that's new in the automotive space, new kind of racing to get new more current generation lithography node silicon into automotive design because the legacy lines out there are hard to get at. Chip suppliers are trying to obsolete those fabs. And so the automotive customers don't have as much, I would say, power in this frothy demand environment on the semiconductor supply side. And so the semiconductor suppliers are kind of saying, you know, get with the program, move to more advanced nodes. And a little bit of that's happening, which is what, you know, that means complexity, yield issues, and that means a little more test than you might expect. And I think that's what's giving us a different view this time.
spk09: Thank you.
spk00: Your next question comes from John Pitzer, Credit Suisse.
spk10: Yeah, good morning, guys. Thanks for having me ask the questions. Congratulations on the solid results. Mark, I want to go back to increasing test times in the semi-test business. You've done a good job kind of helping us understand complexity and transistor count. I'm kind of curious, as we move from a world of sort of general-purpose compute to one of more optimized silicon, you're going to move from a world where you're testing huge volumes in one device to smaller volumes across multiple devices. What does that do for test efficiency at your customers and hence test times as that trend takes hold?
spk07: It is a, you know, building, let's say, 100 billion transistors on one chip versus four, to give an example, isn't equivalent test time. You know, the four-chip version is is likely to, you know, these are going to be rough rules of thumb, but let's say 25% more test intensive than the single chip design because there's a premium on sort of known good die testing when you put those together in an advanced package. And then the advanced package itself has more potential defect failure modes that need to be tested. So that's one thing around the whole chip-lit, you know, multi-chip package thing. The other thing, though, that's happening, and this is really going to become prevalent at 3 nanometer and beyond, is the move from FinFET to gate all-around transistor architectures. And if you remember, when the world moved from planar to FinFET, it was back in 2012, 13, 14 era. That drove, if you go back and look at the history of sort of the test market, that drove incremental test intensity and complexity And we're headed for another one of those with gate all around. There's going to be new defect modes, new kind of test intensity boosts coming from this new architecture on the transistor. So even at equivalent transistor counts, we're going to see a little bit more test intensity because of that. So these two trends of chiplets and gate all around and three nanometer, that's probably all the 2023 and beyond story, given where three nanometer is right now. But it's coming.
spk10: That's helpful. And that's my second question, Mark. Just going back to your largest customer, I'm kind of curious if you can help me better understand the diversity of business with that customer. I mean, clearly it's been mobility-led for the last several years. Now you've got them doing more in the compute space. You've talked about in the past the complexity around these air tags. Are you seeing a meaningful diversification of demand drivers at that customer. And can you help me, because I just don't know, how fungible is their test capacity across those different product families?
spk07: Yeah, I'm not going to be able to talk too much about the sort of breadth there. I think you can imagine it, and you've rattled off some examples. In terms of fungibility, they're pretty fungible, the testers. across what's used for a compute engine in a phone versus a compute engine in a laptop or a desktop or anything else. The one that's a little bit unique is when you get into things like the RF type products, of course, have a bit of a different architecture. Power management type products have a bit of a different architecture. And so those testers tend to be a little more unique. But we've talked about in the past that I think people have looked at us and said, well, in a world where cell phones are kind of plateauing, doesn't that unit growth of cell phones, doesn't that pretend some kind of slowing for us? And what we've always said is that, look, cell phone unit growth can slow. Complexity isn't. And You know, some of these customers are diversifying into more silicon both in the phone and now more silicon outside the phone into compute. There are these emerging hyperscalers that are building silicon for both cloud computing and other new yet to be introduced consumer products. So the ability of a design team today to be formed and put together a 10 billion plus transistor chip for a consumer application is easier and easier and easier. And as I said in my script, we work with a lot of them. Maybe a small fraction of them will be hits in the future, but they can bring entirely new classes of high compute engine semiconductor applications to the market. And all of those are kind of Ultraflex, Ultraflex Plus family devices.
spk10: That's helpful. Thank you.
spk00: Your next question comes from CJ Muse of Epicor.
spk08: Yeah, good morning. Thank you for taking the question. I guess, Mark, another technology question. You know, you kind of taught us to think about transistor count and kind of thinking about test times for mobility compute. And curious, as we go to more high-performance compute where there are, you know, more thermal issues, perhaps more complex software algorithms. How should we be thinking about the test times in that transition?
spk07: Well, I think the test times have less to do with the application. You know, the only place where the application drives really fundamentally different test times is automotive because of the issues there. It's more the technology. So I go back to CJ, what I said before, about three nanometer is going to be more impactful to both test times in phones and in computers and in servers and in graphics and in everything else, probably than any of those end market applications.
spk08: Okay, that's helpful. And then I guess, Sanjay, question for you. Clearly, you're making investments particularly in IA. But as you look to 2022, can you speak to your outlook for operating leverage? And, you know, as part of that, how we should think about, you know, OpEx relative to top line growth? Thank you.
spk06: Sure. I'd say we're in the early innings of looking at 2022, and obviously we'll provide an update in January. But, you know, OpEx is growing in kind of a couple key areas. This year, obviously tied to higher volume, we have variable compensation, as well as engineering spends tied to our operations to qualify new suppliers, et cetera. And then we continue to invest in both go-to-market and engineering across the test portfolio. And as you noted, we're leaning in, obviously, as I noted in my prepared remarks, we're leaning into our IA investments really to help drive going forward. The other component is the G&A expenses going forward. You know, this was a big year of OPEX growth. The only thing I'd say is that next year is, you know, we're not going to be as large percentage-wise growth, but that's really all I have to say on it right now.
spk00: Thank you. Your next question comes from Timothy O'Curry, UBS. Yes.
spk05: Thanks a lot. Mark, I just wanted to see if you can update us on the SOC TAM. You had said 4.5 last call, and the segments of that was compute was about a billion, mobility was 1.8 to 1.85, autos were about 500, industrial was 5, 550. I'm just kind of wondering if you can update us on those numbers.
spk07: Yeah, good question. Fundamentally, it's in the same range. It's probably trending more up toward the higher end of that range. So I think the numbers, the sub-markets you got right on, what we talked about last time, maybe compute is driving us a little bit higher in that range at this point in time. But it's pretty close. And memory's still at about a billion-dollar TAM as well.
spk05: Okay, great. And then I guess... I guess I had a question just on, you know, profitability and IA. I know, you know, Sanjay, you just answered a question about operating leverage next year. But what's the catalyst maybe, you know, this time last year we were thinking IA would be 10% to 15% op margin, and then it got cut to 10%, and then it went to 5%, and now it's kind of low single digits. And I get that the, you know, penetration there is very low, but So what's the catalyst for you to look at? Maybe, you know, we shouldn't be investing so much money and maybe we can, you know, optimize OpEx investment. So I guess I'm just kind of wondering how you think about sort of what's going on at IA and, you know, what the long-term profitability target is. Thanks.
spk06: Yeah, so our range, as we've said prior, is 5% to 15%, and we expect to be low single digits, as I said in my prepared remarks. But really how we think about it is we manage the business on a, think about it as a rule of 40, combining the year-over-year growth with the operating profit. And fundamentally, as we see or as has been noted by Mark, where penetration is very, very low, and we look at all the jobs that can be automated and the scarcity of labor and economic growth, we really see a strong tailwind for the portfolio. And with that, we're very focused and conscious on both engineering and go-to-market investments. And so how we think about it is quite simple. And that is where we have a strong belief that we're going to grow and it's going to accelerate that revenue growth. We're going to lean into the investments. And, again, think about it in the rule of 40. And, you know, as I said in my prepared remarks, you know, our gross margins are actually improving in that portfolio. And so when we see that growth start to moderate, you know, then we'll start to moderate the op-ex to get to an operating profit of, let's say, in the mid-20s.
spk05: Okay, Sanjay, thank you.
spk00: Your next question comes from Bebek Arya, Bank of America.
spk02: Thanks for taking my questions. Mark, this move to three nanometer, is that a benefit for Teradyne in 22 or 23? I thought it would be 23, but I wanted to confirm. And kind of following on for that, what are the top, you know, one or two end markets that you are the most excited about in terms of growth for next year?
spk07: So on the three nanometer question, that was one of the things I mentioned that we'll be looking at carefully between now and January when we update you on the 2022 view. And we've seen some push outs on some of those nodes by a few months. So the ability to intercept them in a meaningful way in 2022 is a swing factor. We don't see that exactly yet. But whatever happens in 2022, you know, it might get some early ramping, but the bulk of it is going to be 2023, 24, 25, kind of, and beyond. So a little bit could happen in 22. How much, we won't know more until January. In terms of, you know, markets next year that are interesting and exciting, I think it goes back to these emergent markets hyperscalers that are developing some new applications and very complex silicon for those new applications. Some of those could latch in the market with new product introductions and drive a whole new sort of demand stream for semiconductors and the testers associated with them. So that's kind of what we're rooting for and what we're close to and we're seeing could be breakouts for 2022.
spk02: Very helpful. And maybe just following up on that, is there a way, Mark, to contrast the additional complexity in a product that's going into a hyperscaler application versus a mobility application? I understand die sizes might be different and packaging, et cetera, might be different. But conceptually, what does the mix shift from a more mobility-heavy end market to something that is taking you more into the compute and hyperscaler land mean for Teradyne in terms of your growth prospects? And also just the seasonality, because mobility tends to be a lot more seasonal markets. Those other markets are perhaps less seasonal. So what does that mix shift mean for Teradyne over the long term?
spk07: Yeah, that's a good question. And the range of devices being developed at hyperscalers is quite large. Some of them are simpler than a classic cell phone device, apps processor in a cell phone. So those aren't going to have much of an impact, even if they latch. But some of them that are more, I would say, leverage AI, machine learning, and high-res displays are equal to or greater complexity than what you might find in a typical cell phone device. application for those technologies. So it's a broad spectrum, as I guess the bottom line. But if you sort of play it out, I'd say the hyperscalers are going to, on average, bring cell phone-like complexity applications to the market. It's probably not going to be something that's a lot. Take the 50 billion transistor device that kind of surprised everybody. It's probably not at that extreme. It's probably more in the 10 billion transistor range on average, and then moving up year over year over year after that as they iterate on the design. Thank you.
spk00: Your next question comes from Krish Sankar with Cohen & Company.
spk13: Hi, thanks for taking my question. I just want to ask the three nanometer question in a different way. You spoke about how test investments have to catch up to front-end WFC spending. But during the 3D NAND investment cycle, WFC grew in 2016 and 17, while the memory test spending kind of came in 2018 in a meaningful way. So I'm kind of curious, how should we think about the time lag effect of test to front-end foundry logic WFC this time around?
spk07: Yep, good questions. So all of the WFE investment gets recognized before a single tester's associated with that investment. So the way to think about test is whenever you see some silicon coming off a new node, assume that the testers were installed maybe three months or so prior to that. So once a three nanometer fab comes online and you start to see product coming off of it in reasonable volume, more than sort of pilot line volume. Assume that the tester installations occurred about three months prior. That's kind of the best guidance I can give you there. And then the only other thing I would caution about memory versus SOC is that the curve of test time to bit, to transistor count, is not the same in memory as it is in SOC. Memory tends to be a bit more efficient for reasons I won't get into here. So, you know, you can double transistors and memory, and you're not going to probably move test time, you know, more than 20, 30% or so, let's say. Whereas in SOC, it's not quite linear, but it's closer.
spk13: Got it, got it. That's very helpful, Mark. We're going to follow up for Sanjay on gross margins. Now, despite the constrained environment, gross margins have stepped up about 200-plus basis points over the last four quarters or so to a 59% to 60% range. Is this kind of the new baseline we should assume at these revenue run rates? Thank you.
spk06: Yeah, I think I talked about that earlier. So we're going through our strategic planning process in Q4, and it's really the basis of our earnings model update in January 2021. You know, as I've said, just having some visibility into the first half of next year, I think you should expect to see that gross margin be similar in the first half of next year as we have in the second half of 2021. And so there's many different variables in there. I noted that we've been managing through the component and logistics cost increase. We've had good mix and come down the cost curve of our new products and gaining operating leverage. So there's many variables in there that we're going to look at closely. And as our revenue gets more and more diversified, there's a lot of puts and takes. But we'll provide more guidance on that in the January call. Got it. Thanks, Sanjay.
spk00: Your next question comes from Brian Chen, Stiefel.
spk04: Excuse me. Hi there. Good morning. Nice results, and thanks for letting us ask a few questions. Sorry, first to clarify something, going back on the commentary, if you had more chips, you would be able to ship to an appreciably higher level of revenue in both the semi-test and industrial automation businesses in Q4. Did I hear that correctly? Okay.
spk06: In industrial automation, percentage-wise, we'd be able to ship more. In the test portfolio, we think we're going to manage through the majority of the supply issues at this point.
spk03: Okay.
spk04: Okay, great. And then, you know, interesting discussion here on three nanometer and sort of like a fulcrum event in terms of test intensity again. at 3 nanometer or gate all around. Maybe a couple questions as my follow up. What is it about that? I know it probably is a longer form discussion, but in short form, what is it about 3 nanometer or 3 nanometer gate all around? Is it sort of what the yield modeling suggests for kind of lower yield rates there compounded by die sizes, compounded by transistors or advanced packaging? Is it also sort of combination of the types of devices that you think that enables in terms of the intersection point of various customers and their kind of CHIP roadmaps? Just kind of want to get at that. And then like even kind of bigger picture, if the high-performance compute test TAM is a little bit more secular, a little bit more growthy, if you've kind of benchmarked test growth at sort of 4% to 8%, how much of a premium do you think we're looking at over the next several years in terms of HPC TAM?
spk07: Okay. There's a lot in there, Brian. So let me, first of all, take on three nanometer. So, you know, the issues about three nanometer certainly enables more transistors per die. That's not what I'm talking about. That's a big driver of test in the future. That would absolutely be something that would give us a positive outlook for the next midterm. There's the chiplet thing that we talked about where you have mixed nodes going into chips and then you need known good dye testing and then the multi-packaging needs increasingly test intensity. That's not what I'm talking about, but that's real and that's there too. The thing that I'm talking about with three nanometer that's unique, let's say, is the change in the transistor architecture from FinFET to GATE all around. That happens once per decade. Again, it happened with FinFETs earlier in the last decade. It's happening with GATE all around here in the next few years. Those transitions, everything else being equal, introduce additional, typically, failure modes that need more test methodologies to make sure the device is functioning correctly. let's say the average test time per transistor can tend to be higher because of the additional verification needed related to that new architecture. Now, early in the architecture's life, that tends to be higher. As the architecture matures over time, that premium, let's say, comes down. And the world doesn't shift to three nanometer in mass day one either. So there's this bleeding up of certain devices using 3 nanometer that are highly test-intensive, and more and more come online year after year, and then the learning curve comes on. But net-net, again, if you look at the test market from 2000 to 2012, it had been a declining market. In 2012 to now, it's been growing quite well, in excess of 10%. Part of that is the parallel testing ameliorating that we've talked about. Part of it's the FinFET story that we've talked about and the growing transistor count. So we're at another one of those junctures with gate all around. And then, sorry, the HPC and... Test of HPC higher or lower? Oh, okay. Yeah. So the growth rate in compute is certainly going to be at the higher end of our mix of submarkets, we think, over the midterm. So if you think the average market growth rate, you know, we're going to update this in January, but pick a number, is 8%, we think compute's probably leading that by at least a couple of points.
spk04: Okay, great. That's helpful. Thanks for all the color on that.
spk01: And operator, we have time for one more question, please.
spk00: Thank you. Your final question comes from Sidney Ho, Deutsche Bank.
spk11: Thanks for taking my question. So I have two quick ones. The first one is, You talk about supply constraints impacting your IA business. I'm just curious, the gross margin has been pretty good overall. You talk about offering leverage is one of the reasons. To the extent that your input cost of logistics and freight costs increase, both in your test and IA business, are you able to pass along some of those costs to your customers?
spk06: So at this point, we've been managing through it. So materially, no.
spk11: Okay. Maybe my follow-up question is a lot of discussion on three nanometers today, but it's really an opportunity in 2023 and beyond. But if you can look at next year, I know you're going to update us in January, how does it impact your test of business if a customer chooses to move from, instead of going to three nanometers, they go to a different generation of five nanometers? What is the tester reuse rate when you compare the two nodes between the three nanometers and the alternative?
spk07: Yeah, the tester reuse, people will reuse five nanometer generation testers in the three nanometer era, so a new tester is not required. And, you know, testers tend to have a useful life of a decade or more at a customer, and they can span usability across many, many nodes and many, many generations of devices. So there's nothing in terms of a new tester here that comes with three nanometer. And yes, by and large, it's a 2023 and beyond type story. But absent that story, what we've been seeing for the past 10 years in test, you know, since three nanometer in 2022 is likely not going to be a huge event because it's likely to be later in the year. people will still move down the complexity curve at five and five plus nanometer nodes and increase transistor counts and such along that path. So even absent three nanometer, you know, we have an optimistic view of what 2022 looks like. We'll probably, you know, start out the year similar to how we started out years in the past. And at the beginning of the year with, you know, some modest growth in the first quarter, and then it kind of swings on what's going to happen over the summer, which is our peak quarters. around the refreshes. Will those refreshes of silicon be in 3 nanometer? Will they be in 5 plus with the traditional normal transistor count growth that we've seen for the past 10 years? Those are things that we have to get closer to next year to really understand.
spk11: Great. Thank you very much.
spk01: Okay, everybody, we are out of time. Thanks so much for joining us today. And those in the queue, I'll get back to you later today. And, again, thanks, everyone, for joining. Bye-bye.
spk00: Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.
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