Teradyne Inc (TER) — Q4 2022 Earnings Call Transcript

Thank you, Daryl. 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 our CFO, Sanjay Mehta. Following our opening remarks, we'll provide details of our performance for 2022's fourth quarter and full year, along with our outlook for the first quarter of 2023. The press release containing our fourth 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 language 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 events 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 measures, which are 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 Citi, Susquehanna, Luke Capital, and Morgan Stanley. 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 year. Sanjay will then offer more details on our quarterly results, along with our guidance for the first quarter. We'll then answer your questions, and this call is scheduled for 1 hour. Mark?

Hello, everyone, and thanks for joining us this morning. I'm going to limit my remarks today as Greg will be taking full leadership of the company from next week. I'll leave the outlook to Greg, and Sanjay will provide the financial details, including our updated midterm earnings model. 2022 was another good year for Teradyne with our second highest sales in history. Midyear, we saw a turn in our markets with the SOC test market softening after 6 years of growth and Industrial Automation growth slowing. At the company level, our financial results were slightly under the long-term trend line after operating well above trend in 2020 and 2021. This oscillation around the trend line is a familiar pattern that we expect to continue. We manage our business investments according to this trend line and tend not to chase these excursions up or down. Sanjay will note how these trend lines roll into our updated midterm earnings model. Looking at a longer-term perspective, over the last 8 years, Teradyne's revenue has about doubled and EPS has grown about 4 times. Growth of our core test markets is part of the story, as is expansion into new markets like Industrial Automation and System Level Test. This, combined with a rich cash flow and a balanced capital allocation plan, has been the recipe for shareholder returns. As you will hear, we see all of these drivers remaining in place for the years to come. Since this is my last earnings call, I would like to thank all of you who follow, invest, and influence our journey at Teradyne. As Greg takes on the role, I'm confident we won't miss a beat, and he's been a key part of developing and implementing our strategy for many years. With that, I'll turn things over to Greg for his deeper perspective on our results and outlook. Greg?

Thanks, Mark, and good morning, everyone. Today, I will summarize the full year of 2022 and then comment on our early view of 2023. For the full year, we delivered sales of $3.155 billion and non-GAAP earnings of $4.25 per share. 2022 was the second-highest revenue in company history but down 15% from 2021's record level due mainly to reduced demand in SOC test, specifically in mobility and compute. This was offset somewhat by strength in the automotive end market, including substantial demand for ADAS processor test. Overall for 2022, we estimate the SOC test market was about $4.6 billion, down 6% from 2021, and the memory market was down a similar amount for the year. Industrial Automation grew about 7% in dollar terms. Foreign exchange was a major headwind in that business. Our growth was 15% in constant currency. I'll divide my comments on market conditions into an early view of 2023, followed by our outlook for the midterm. In July of last year, we noted the Semi Test equipment market was entering a downturn, with demand declining in end markets such as smartphones. This began to create chip supply/demand and inventory imbalances. We noted these types of corrections typically have a 4- to 6-quarter duration. Now we're a bit more than 2 quarters in, and as the downturn continues, our customers continue to rebalance their production and inventory with end market demand. Much of the imbalance is in test-intensive end markets like smartphones, compute, and networking, where we see lower utilization. At this point in time, with limited visibility into the second half, we estimate a market size for SOC tests to be 10% to 30% below 2022's $4.6 billion level. Major SOC producers are expected to start the transition to 3-nanometer later in 2023, and this could mitigate the headwinds a bit. Our historically largest end customer is expected to lead this transition, and revenue driven by this customer is expected to grow in 2023, moving from less than 10% of our revenue in 2022 to low double-digit percentages of revenue for this year. Demand won't be finalized until Q2 and will be weighted towards the second half of the year. In general, our models factor in 2 key demand drivers, unit volume and device complexity. We've read the same press reports that you have, that smartphone volumes are likely to be down in 2023. The complexity growth associated with the 3-nanometer transition is likely to offset the test demand impact of the unit decrease, and the net effect is the increase in revenue that I've described. Our assumption that this transition is going to be gradual is likely to mute the peaks, but it will also fill in the troughs as the full portfolio migrates to 3-nanometer. Overall, averaging across the entire life of a process node, like 5-nanometer or 3-nanometer, we expect that each new node will drive continued higher test investment in total than the prior node. On top of that, increased unit growth and the addition of new part types to the portfolio will drive further increases in test investment. In the memory test market, technology transitions continue to drive demand. Faster interface speeds in DRAM with DDR5 and in flash with UFS 4.0 cannot be tested on existing testers and are driving purchases of next-generation ATE. Offsetting this technology-driven replacement demand is a difficult end market for our memory customers, which is likely to reduce capacity buying for this year. We are seeing some impact of that in the first quarter. On balance, we expect the memory test market size to be flat to slightly down from 2022. We expect Storage Test will be weak in 2023 due to excess capacity in the HDD end market. And Wireless Test demand will be soft on lower smartphone shipments and a demand lull in advance of the transition to WiFi 7 beginning in 2024. Shifting to Industrial Automation. As we expected, the macro outlook in industrial markets is cautious, with weak industrial PMIs. We expect this will be a growth headwind in the first half of the year. Rolling up these headwinds and offsetting factors over the first half of the year, our current judgment for the total company has our second quarter about flat with Q1. However, in Industrial Automation for the full year, we have 3 notable factors that should help offset these headwinds later in the year. First, we do not expect the currency exchange impacts we experienced in 2022. Second, growth initiatives that began in 2022, including a channel transformation at Universal Robots, will gain traction. One component of the channel transformation is supplementing our traditional distributor channel with a focused OEM channel. That effort delivered 26% growth in 2022, and we expect this to continue in 2023 as our existing OEM partners continue to grow and we add additional OEMs in targeted verticals. The third factor driving IA growth is expanding the served market through new products. Most notably, in 2023, shipments of the new long-reach, heavy-payload cobot at Universal Robots, the UR20, will ramp in the second half of the year. Barring a significant deterioration in the macro economy and reasonably stable currencies, we expect channel expansion combined with new products to drive greater than 20% growth for IA in 2023, weighted to the second half of the year. Now shifting to the midterm outlook. The short-term changes in customer buying patterns in semi cap equipment can be abrupt. We built our flexible operating model to accommodate those cycles. Our midterm plans track the long-term historical trends and the future demand drivers in each of our businesses rather than the short-term cycles. In any given year, we will land above or below trend, but that trend line has provided a reliable baseline for planning. Sanjay will be going through a quantitative view of our 2026 earnings model. To set up that discussion, I'd like to make a few qualitative comments to provide some context. Our 2026 earnings model shows significant revenue and EPS growth, and it's reasonable to ask why we assume midterm growth when the short-term environment is so weak. There are several factors that give us confidence in our midterm outlook. End markets, like AI and cloud computing, mobile processing and automotive, including ADAS and EV, are driving increased semiconductor content and increasing chip complexity. The deployment of advanced wireless standards will support ever higher data volumes and the pervasive deployment of edge AI. This end market demand will drive the timeline for new semi fab nodes and packaging technologies, like 3-nanometer, chiplets, and gate all around. We have seen these technology transitions drive demand for test as the new nodes enable more complex chips and multichip packaging technologies like chiplets drive higher quality level requirements. Both of these factors drive longer test times and higher ATE TAMs. But the landscape is changing. These complex chips are increasingly developed by a new class of vertically integrated producers, or VIPs, including hyperscalers and automakers. We've had good design-in success to date with this emerging customer type, and these VIPs provide Teradyne with an opportunity to grow share in a space long dominated by legacy x86 architectures, where our share has historically been lower. These large, complex devices are used in uptime-critical applications and will require exceptionally low defect levels. To achieve this quality level, our customers will increasingly adopt an additional test step, system-level tests or SLT. We have a strong footprint in this growing market, and our design-in success with new customers is expected to be a growth driver over the midterm. Over the midterm, we expect to see WiFi 7 ramp and the rapid expansion of UWB-enabled devices for both precision location tracking and security. These new standards obsolete existing test instrumentation, and this replacement cycle will be a growth engine over the midterm for both SOC test and Wireless Test. Turning to IA. Global labor shortages and converging regional wages will continue to be unrelenting demand drivers. Market penetration for collaborative robots, including AMRs, is under 5%, providing enormous opportunities for long-term growth. The steady application of new technologies in our products will continue to expand our served market, and the transformation of our channel will enable us to serve a broader range of customers and drive revenue to the $1 billion level in 2026. Summing it up. Over the midterm, our strong core test businesses will support share gain and trend line growth, while IA will grow to be about 20% of company sales and become a meaningful contributor to earnings. In 2022, we have planted the seeds for future growth. We expanded our design-in footprint in the vertically integrated producer space and recognized substantial revenues from this emerging market. We expanded our customer base in SLT. We grew our IA sales in challenging business conditions and set the foundation for higher long-term growth at both Universal Robots and Newark. We're in a cyclical downturn in the semiconductor capital industry, and visibility in downturns is always a challenge. We expect sales and earnings to be below our midterm trend line in 2023. While we don't have line of sight to an inflection in demand, that's typical in these cycles. The market will recover, and we expect to return to historical growth rates driving strong earnings over our midterm planning horizon, as Sanjay will describe. Before turning it over to Sanjay, I would like to thank Mark for his more than 40 years of service to Teradyne and his 9 years as CEO. He has steered the company through an extraordinary period in the semiconductor industry and helped to assure our future growth through our investments in robotics. More personally, it's been an honor to work for Mark during that period. His candor and insight have made me and all of us at Teradyne better. Although we're facing a cyclical downturn, we're facing it as a company with tremendous financial strength, a great team, and a clear strategic vision, thanks to Mark. Now Sanjay?

Thank you, Greg. Good morning, everyone. Today, I'll discuss the financial summary for Q4 and the full year 2022, outline our Q1 outlook, and review our updated earnings model and capital allocation plans. In Q4, sales reached $732 million, exceeding our mid guide by approximately $20 million, with a non-GAAP EPS of $0.92. Semi Test revenue was strong at $481 million, driven by Automotive, Industrial, and SOC segments. The System Test group generated $100 million, reflecting a 22% decline year-over-year due to lower sales in Storage Tests in a weakened HDD market, partially offset by increased sales in defense, aerospace, and Production Board Tests. LitePoint revenue was $40 million, down 23% year-on-year due to decreased demand in cellular and WiFi. Industrial Automation revenue was $110 million, showing a 2% dip from last year, but a 7% increase in constant currency. Our non-GAAP gross margins were 57.4%, exceeding expectations due to a favorable product mix and some deferred resiliency costs. Non-GAAP operating expenses were $252 million, remaining stable compared to the third quarter. The non-GAAP operating profit rate was 23%, with one customer representing 10% of our revenue for the quarter. Our effective tax rate, excluding discrete items, was 12.3% on a non-GAAP basis and lower than anticipated because of geographic mix. We repurchased $2 million in shares during the quarter. Looking at the full-year results, we achieved approximately $3.2 billion in revenue. QUALCOMM was our sole 10% customer for the year. The gross margin for 2022 was 59.2%, with operating expenses totaling $1 billion and an operating profit of 27.5%. Our non-GAAP EPS stood at $4.25, generating $415 million in free cash flow. We returned $822 million to shareholders through share repurchases and dividends, ending the year with $1 billion in cash and marketable securities. The full-year tax rate, excluding discrete items, was 16.3% on both GAAP and non-GAAP bases. Semi Test revenue for the year reached $2.1 billion, with SOC contributing $1.7 billion and memory at $373 million. Although SOC sales declined in 2022, Automotive shipments grew over 60% year-on-year. Memory sales slipped about 6%, evenly divided between flash and DRAM. The System Test group reported $469 million in revenue, flat compared to 2021, with strength in defense and aerospace and Production Board Tests countered by a drop in storage sales. In Wireless Test, revenue was $202 million, lower than the previous year due in part to declines in cellular and connectivity, which were somewhat offset by gains in UWB. Industrial Automation revenue was $404 million, with UR contributing $326 million and MiR $77 million. Notably, MiR saw 26% growth in constant currency and 19% in dollar terms. A significant portion of IA sales were outside the U.S., primarily in local currencies. For the year, 40% of IA sales were in Europe, 35% in the U.S., 11% in China, and the remainder spread across other regions. In terms of profitability, IA maintained a slight positive operating margin on a non-GAAP basis for the year. Looking ahead to Q1, back in October, we anticipated revenue of around $640 million, which would represent a 10% decline from our Q4 midpoint. Since then, we've encountered three revenue declines: Firstly, about $20 million was pulled into Q1 from later periods; secondly, approximately $20 million is expected to be impacted by supply constraints that weren't accounted for in our guidance; and finally, around $20 million related to memory capacity additions has been postponed until later in the year, compounded by other offsetting factors. We now expect Q1 sales to fall between $550 million and $630 million, with non-GAAP EPS ranging from $0.28 to $0.52 on a diluted share count of 165 million. First quarter guidance does not include the amortization of acquired intangibles. Gross margins for Q1 are projected to be between 55% and 56%, lower than Q4 due to reduced volume and increased spending to enhance our manufacturing and service resiliency. Operating expenses are expected to account for 39% to 44% of Q1 sales, with a non-GAAP operating profit rate projected at 14% at the midpoint of our guidance. There are a few key points to consider for modeling in 2023. We expect lower gross margins in the first half of the year, influenced by decreased volume and additional spending efforts. However, we anticipate gross margins will rebound to our target range of 59% to 60% in the second half. For operating expenses, we foresee them remaining roughly stable compared to 2022. We plan for IA profitability in the range of 5% to 15% on higher volume. Our GAAP and non-GAAP tax rate is projected at 16.75% for 2023. Regarding capital allocation, our strategy remains steady, emphasizing a balanced approach. We prioritize free cash flow to maintain essential cash levels and reserves in case of significant challenges. Excess cash flow will be allocated towards mergers and acquisitions, share buybacks, and dividends. We have replaced our previous share buyback authorization with a new $2 billion authorization, anticipating up to $500 million in repurchases in 2023. In terms of our earnings model, we expect growth in both test and IA to elevate our company revenue to roughly $5 billion by 2026, with a non-GAAP EPS target of $8.75 at the midpoint of our revised plan. Gross margin is expected to be in the range of 59% to 60%, while operating expenses as a percentage of sales are projected to decline to 26% to 28%, yielding a non-GAAP operating margin of 31% to 34%. Over the past six years, Teradyne has maintained a compounded revenue growth rate of 10% and a non-GAAP EPS growth rate of 19%. Our projections indicate that by 2026, the revenue and non-GAAP EPS CAGRs will align closely with historical performance, reflecting an increased contribution from Industrial Automation. The trends underlying our model are detailed in a backup slide included in the presentation. We previously discussed key drivers for our test portfolio, including evolving device technologies, increasing complexity, and unit growth, which we believe will enhance ATE growth over the next four years. We anticipate test revenues will grow at a CAGR of 8% to 13% from 2022 to 2026. For Industrial Automation, we believe the market remains less than 5% penetrated, and Greg has highlighted factors driving midterm growth, such as labor shortages, innovative products and applications, and channel transformations. We predict IA revenues will grow by 20% to 30% from 2022 to 2026. In summary, despite a slowdown in the SOC test market in the latter half of 2022 and necessary adjustments to our financial model, we still achieved a 27.5% non-GAAP operating profit, generated over $400 million in free cash flow, returned more than $800 million to our shareholders, reduced our share count by 4%, and concluded the year with $1 billion in cash. As we progress, our updated model relies on a solid track record of historical growth in both testing and IA while integrating new growth drivers. While uncertainty looms in the short term, we remain optimistic about the growth prospects in our markets and our team's ability to execute on our strategy. With that, I'll hand the call back to Andy.

Thanks, Sanjay. Daryl, we would now like to take some questions.

The first one has to do with the Semi Test cycle. You mentioned in your prepared remarks that perhaps we are in the second quarter of a typical downturn that would last 4 to 6 quarters. But wouldn't that be fair to say that the situation with Teradyne Semi Test is different? If I just look at your guide for Q1, it would suggest that Semi Test is already down by more than 50% since the peak some time in early '21, and perhaps Teradyne is well into the semi cycle correction. I would appreciate if you could help me reconcile, and then I have a follow-up.

Thanks for the question, Mehdi. Our thought in terms of the Semi Test cycle is that we really don't have great visibility. We believe we are about 2 quarters in. And one thing to remember is that the peak you’re talking about was well above our trend line. So there was a fair amount of contraction to happen before we got into a region where we would have considered it to be sort of a true downturn. So we're really measuring from that sort of July of '22 timeframe. And we think we are just about 2 quarters into it. In terms of when it will inflect back up, we really don't have good visibility. There are a number of factors that make us feel a little bit better about the second half of the year than the first. But we don't see the kinds of leading indicators that the demand is returning. So I don't think we can give you a lot more color than that.

Got it. As a follow-up to your comment, would it be accurate to say that you have extended your targeted model by 2 years because we are uncertain about the rate of recovery in 2024, while you now have a new target for 2026? There is a possibility of experiencing another downturn before reaching that target. The key focus here is the rate of recovery in 2024, which remains unclear. I also want to express my gratitude to Mark for all the calls he has hosted and wish him the best in his future endeavors.

Yes. Mehdi, it's Sanjay. Yes, I think it's a reasonable comment to say that the model has shifted to the right, really tied to the economic downturn. Really, as Greg mentioned, the inventory in the channel tied to the demand in the end markets coming down and the supply in the market.

And maybe, Mehdi, thank you for those kind comments. I'll just make one quick comment on your first point, which is every downturn cycle, as we try to measure, is different. But if you classify it around when does the imbalance between semiconductor supply and demand start to inflect and cause an industry-wide downturn, from that point of view, we see it as something that started last summer. So that's how we mark it back to that date.

So the SOC TAM in 2022 was at the high end of your range. What segment contributed to that in 2022? Additionally, can you provide a breakdown for 2023 and how you anticipate the mix will look? This year, you shared some numbers for each of the markets. If you consider the midpoint and reduce it by 20%, can you discuss what the mix will be and how the various markets will evolve?

Yes. It's Sanjay. Yes, 2022, the SOC market, we estimate about $4.6 billion and continued strength in compute, a little bit down in '22 from '21 in mobility, and then strength in auto that we referenced in prior calls, and industrial continued along with service. And in '23, really across the board in SOC, we see a decline with the exception of service across the board. And most notably, of course, in compute and mobility, as those markets we've talked about, we see a supply and demand imbalance, as well as Automotive and Industrial. So really, it's across the board from a decline perspective, is our view.

Okay, got it. Greg, since you're now leading the company and have been involved with IA, I want to address the perception I have regarding IA over the past five to seven years. It seems that the growth expectations have been gradually decreasing since 2017 or 2018. I understand there have been many external challenges, but can you take a moment to evaluate the competitive landscape in the market? Do you believe competition plays a role in this? I also know you're considering potential M&A in IA. Many people are expressing concerns about whether there is as much growth potential in IA as you anticipate, given that the model continues to be pushed further out.

Yes, that's a great question. I would point out that the growth in collaborative robotics, including AMRs, has been slower than what we and other market players or analysts had anticipated. Essentially, the total addressable market has expanded at a pace that did not meet our initial expectations. While there are new competitors entering the field, we believe that this is raising the market's profile and may help speed up our overall market penetration. Particularly in collaborative robots, where we have a strong market share, we see these new entrants as both beneficial and challenging, as they provide customers with options to compare. We are confident in our product and believe we can maintain our market share despite the competition, which we think will enhance market awareness and drive overall growth. In the case of AMRs, the situation is less certain; we are among the leaders, but market share is distributed widely, and the segment is still developing as companies figure out how to monetize their offerings. We believe we have a solid strategy for the midterm, although we have less certainty regarding growth in the AMR market. Our plan takes both aspects into consideration. To summarize, while growth in the total addressable market has been slower, we do not view this as an indication of losing market share due to competition.

First off, Mark, congrats. And we'll miss seeing you on Valentine's Day, but I'm sure you'll find better dates from here. But first question, for SOC test market share in '23, I guess I would love to hear your thoughts on the moving parts. It looks like roughly 37% share in '22, which was a very off year for your Cupertino account. What kind of recovery are you assuming there? And I guess, what kind of offset on the negative side should we be thinking around Eagle from the slowdown in Auto, Industrial? Would love to hear your thoughts there.

Sure. That's a good question. We're being very careful about making predictions for 2023. While we have a reasonable understanding, there is still a lot of uncertainty regarding even the first half. In the second half, there are factors that could positively affect the market and potentially increase our share. Additionally, in 2022, there was strong buying in the compute sector from traditional customers, which has tended to decrease our share. Therefore, I can't provide a specific target number for our share in 2023, but we do believe that we will see some recovery in our share.

Very helpful. And then maybe more importantly, as you think about the underlying growth trends for SOC test, can you speak to 2024? And if you kind of had to rank order the positive drivers for your business, whether it's 3-nanometer, a recovery in auto, hyperscalers starting to really expand, could you kind of walk through the 3 most important drivers that we should be thinking about into 2024?

Yes. I believe you mentioned many of the key points. We are certainly more optimistic about 2024 compared to 2023. While it's challenging to predict the future, I think one of the key positive factors is the broader adoption of 3-nanometer technology, which allows for a significant increase in device complexity. This has historically been a strong driver for ATE market growth. Regarding hyperscalers and automakers, we see this more as an opportunity for gaining market share rather than just increasing overall market size. Essentially, the demand for semiconductors will be met by either traditional suppliers or vertically integrated producers. We believe we can perform well with this segment of customers and potentially capture some market share. Overall, I highlighted important areas such as AI, cloud computing, a recovery in mobile, and especially the rising semiconductor content in automotive. One potential factor for 2024 is the decline in smartphone units we’re seeing in 2023. Typically, if consumers take longer to upgrade their phones, the following year often shows more positive performance. This trend might also contribute to recovery.

I understand that you're noticing a decline in the test market, especially on the SOC side, particularly in the first half. You've mentioned this being the initial stage of a downturn. Based on your experience from past downturns, how do you view the recovery process across various segments? Should we anticipate memory testing to bounce back sooner? Are there specific SOC segments that you believe will recover faster than others? How should we interpret the recovery trajectory? I also have a follow-up question.

That's interesting subtlety. So I think your question is really, how should we expect the shape of the recovery? Do we expect it to come first in SOC, first in memory? The first thing that I'll say is that, right now, it appears that the SOC market is impacted more than the memory market in terms of 2023 TAM. And that's mainly because of these technology transitions in memory that are driving tester purchases, even though there isn't a need for more capacity. What that says to me is that, when there is a recovery, it's probably more likely to be SOC-led than memory-led because there's sort of a capacity overage in memory that is going to need to be absorbed as the end market for memory recovers. So that's just my opinion. I think it's pretty murky. So it could turn out a different way. But I think SOC is likely to snap back a little faster and harder than memory would.

Okay. For a follow-up, I apologize if this has already been mentioned on the call as I joined a bit late. Regarding your expectations for a potentially better second half compared to the first half, how much is that influenced by a primary customer transitioning to 3-nanometer? Also, can you share your thoughts on the revenue split between the first half and the second half?

All right. It's Sanjay here. Yes, I think from a revenue perspective, right now, our plans in the first half, as we provided, are lower, obviously, than the second half of '22. And we do expect an increase through the year really tied to IA and including in Semi Test. And we do expect that to occur in the SOC market as well.

Yes. But we're not able to sort of predict a 2023 in full, so we really can't give you an exact percentage, this percent first half, this percent second half. We're cautiously optimistic that it will be bigger.

Best of luck, Mark. Congratulations, Greg, and I look forward to collaborating with you more. To start with the first question, I want to clarify the complexity. You mentioned that you expect your largest customer to grow year-over-year and that complexity-driven revenue will mainly happen in the second half of the year. Given that the projected figures seem quite similar, is this timing later than what you expected three months ago? Also, could you explain why those shipments might be delayed to the second half instead of being concentrated in the second quarter as I might typically expect?

Yes. Thanks, Brian. Yes. I think it is a bit later than we've seen in some other years. Our customer always tends to firm up their demand during the second quarter. But oftentimes, they have sort of a directional idea of what they’ll need. I think the combination of softness in the smartphone end market and this technology transition is pushing those decisions a little bit later in the year. But that's sort of our outside observation.

Got it. This is likely still in the planning stage, which may change or be revised. Can you provide an overview of test cell utilization across our device end markets? What are your expectations for midyear and the end of the year based on your current planning?

Measuring utilization is challenging, and the absolute numbers may not always be reliable. We aim to use a consistent method to analyze it each quarter, allowing us to trust the trends. A decline in utilization is concerning, while an increase is a positive sign. In the fourth quarter of 2022, we observed a decrease in utilization, particularly in OSATs, although it has remained somewhat stable in IDMs. We anticipate it will reach a low point around current levels and possibly increase during the latter half of this year. However, there has certainly been a decline in the second half of 2022.

Got it. I appreciate the comment. Maybe if I could just sneak one thing on Automation. Greg, you provide a growth rate for the OEM business through UR, 26% last year. Can you give us a sense of how large that is, the significance relative to UR sales? And also, is that margin profile similar or different relative to traditional channels?

Let me take that in backwards order. So the margin in the OEM channel right now is the same or better than our traditional channels. So that is a potential operating margin improvement for that business. In terms of the portion of sales, if I’m recalling correctly, I think it was 16% of UR sales in 2022, but we probably should double check that number.

The weakness in SOC test this year, Greg, you mentioned it was pretty broad-based. I guess I'm a little surprised that Eagle Test, Auto and Industrial could be weak as well, just given how your customers sound as of today. Are you seeing weakness kick in, in the near term? Or are you embedding some sort of conservatism as you progress into the second half?

Yes. I think it's safe to say that we are incorporating some caution into the 2023 plan for Automotive and Industrial. It has been an exceptionally strong year in 2022, and that performance continued well throughout the year and into the first quarter. However, we have certainly accounted for declines in that market as well.

Got it. And then as my follow-up, a high-level question for you, Greg. I know you've been with the company for a long time, you've partnered with Mark for a long time. From a top-down kind of strategy standpoint, how you manage the portfolio? How you think about capital allocation? Buybacks versus M&A? What do you intend to inherit? And what are some of the changes you might introduce going forward?

Yes. So it's an interesting question because I helped to bake this cake. The strategy that we have in terms of a capital allocation strategy that prioritizes M&A, share buybacks, dividends, nothing is going to change in terms of that strategy. The thing that's happened is we've been on the sidelines since 2019 in terms of M&A, mainly because when we did our analysis of the valuations, it didn't seem like we would be able to do something that was beneficial to our shareholders by using our capital in that way. It's a different market now. And we assume that valuations are going to become more reasonable. And so you may see different outcomes across the next few years than you've seen in the past few years. That's not a reflection of a change in strategy; it's more of a change in the business conditions.

Congratulations and best wishes to both Mark and Greg. For my first one, from what you have described about the different segments, it seems like full-year sales are in the ballpark of being down 10% to 15% year-on-year. I just wanted to make sure I'm in the ballpark. And if yes, I wanted to check how you expect your mobility sales to do this year versus last year.

It's Sanjay. Thanks for the question. Yes, we do expect full-year sales to decline. As you can see from our first quarter guidance and our comments throughout the call, visibility for the second half is quite unclear. We've learned from past downturns that the depth and duration of this downturn are uncertain, making it challenging to provide a full-year outlook. However, we do agree that we expect sales to be down.

Got it. And for my follow-up, I'm curious, for the 3-nanometer transition, do I absolutely need new testers? Or is it possible to just reuse existing tester capacity?

Yes. Vivek, that's an excellent question. Unlike the memory market or the Wireless Test market, which require new equipment for new standards and drive replacements, in node transitions like 3-nanometer, the existing capacity is generally capable of testing the new parts. Tester demand is primarily influenced by increased complexity. If testing a part takes longer, additional test capacity will be needed to test the part with both the existing equipment and any new testers purchased. We pay close attention to how much of the industry is on a specific node, as this determines the number of transistors that need to be tested. There is a significant amount of reuse in the SOC market as nodes transition.

Got it. So there is a scenario where, if 3-nanometer volumes are low enough, that they don't really need to buy new testers in the back half, right?

Yes. That's certainly one scenario. It's not our current best view, but things could certainly play out that way because of this balance of units versus complexity.

Mark, thanks for all your help, and welcome, Greg. Two quick questions. First one, Sanjay, you mentioned about gross margins in the back half of the year kind of going back up. Kind of curious, what gives you that comfort, especially given the fact that if auto does roll over, those are high-margin Eagle testers that get out of your profitability equation? So I'm just kind of curious on the second half gross margin. And then I have a follow-up.

Sure. Thanks for the question. I believe there are a couple of components in our plan. First, we expect to achieve some operational efficiencies, particularly related to our IA portfolio. Additionally, we have some price increases that will take effect in the second half, along with anticipated volume growth during that period.

Got it. Very helpful. As a follow-up, maybe for Greg, I'm curious. In the past, you have mentioned that you're not impacted by some of these China export controls because it's more of a front end. However, the Chinese OSATs have been a significant part of your China sales, and they might also experience a slowdown if some of your front-end counterparts face weakness. I'm interested in how to think about China going forward, especially considering that through 2021 and the first half of 2022, Chinese OSATs appeared to have ordered a lot of equipment.

Yes, that’s a good question because most of the business involving Chinese OSATs comes from two sources. There are local Chinese fabless companies driving volume through the value chain, as well as companies from other regions utilizing those facilities. We expect that if there are production issues in China due to restrictions, non-Chinese companies will relocate their supply chains. They still need to manufacture their chips and will find other locations and facilities to do so. Sales from indigenous Chinese companies may be influenced by new trade regulations, but it’s important to note that this constitutes a small part of our revenue in China and the overall market size there. Our exposure is likely limited to less than 5% of our total revenues.

I wanted to explore the compute SOC aspect a bit more. You mentioned there is significant adjustment occurring in the traditional x86 markets, where you hold a lower share. Does this position you more favorably? Are there differences between the hyperscalers and the traditional x86 architectures?

That's a great question because 2022 was an excellent year for traditional compute suppliers, leading to many tester purchases. We are noticing a decline in the latter half of the year, and we anticipate that this softness will continue into 2023. The new vertically integrated producers, such as hyperscalers, are operating differently. They are designing and releasing new components that typically require different tester configurations, driving capacity in areas distinct from those needed by traditional compute suppliers. Therefore, we believe that this segment will contribute more robustly to the compute market in 2023 compared to the traditional segment, which will see continued softness.

That's great. And then for my follow-up. On the automotive side, there's, I think, a portion of your revenues are tied to legacy parts and some would be more on the ADAS side of things. Could you help me understand like what that split is, essentially? Is it a 50-50 split, or is it more levered to traditional and less towards ADAS or the other way around?

Yes, the market is definitely in transition. Historically, the majority of it comprised legacy automotive parts such as airbag controllers, engine controllers, and MCUs, with a market size in the $600 million to $800 million range last year. There are now two types of new parts emerging: ADAS, which are complex digital devices, and power devices used for battery management and high-power management in electric motors for EVs and hybrid vehicles. In 2022, these new parts were likely about two-thirds the size of the traditional automotive market. The figure I provided for the automotive market size includes these new classes, which composed a little more than half of the market in 2022, while the legacy parts accounted for slightly less than half. Moving forward, we anticipate that the legacy components will follow vehicle sales trends. As vehicle sales rise, that segment will grow at a relatively slow pace. In contrast, the adoption of ADAS and the shift from internal combustion engines to electric vehicles will drive much higher growth rates in ADAS and power components.

And operator, can we sneak in just one last question, please?

I just have one question. So you talked about your largest customer going from less than 10% of sales to, I think, in '22. So call it $300 million, going to low double digits in '23. So maybe $100 million increase. But that's still quite a bit lower than in 2021. First, are those numbers right? And second, do you think that this, call it, $400 million range is the correct run rate going forward, but maybe with less volatility than in the past?

I don't want to comment on the specific numbers. However, I believe your assessment is not incorrect. I agree with your observation about smoothing out the troughs. As for what the steady state average will be, we'll have to wait and see. We are optimistic that this average will be robust due to new parts being added to the portfolio and the phased transition of all processors to 3-nanometer technology. Overall, we expect the peaks to decrease while overall performance strengthens.

All right, folks. And we've overstayed our welcome. So thank you so much for joining us today, and we look forward to talking with you in the weeks ahead. And those remaining in the queue, I'll get back to you later this morning. Thanks so much.