Teradyne Inc (TER) — Q3 2023 Earnings Call Transcript

Thank you, and good morning, everyone, and welcome to our discussion of Teradyne's most recent financial results. I'm joined this morning by our CEO, Greg Smith, and our CFO, Sanjay Mehta. Following our opening remarks, we'll provide details of our performance for 2023's third quarter along with our outlook for the fourth quarter. The press release containing our third quarter results was issued last evening. We are providing slides on the Investor page of the website that may be helpful to you in following the discussion. Replays of this call will be available via the same page after the call ends. The matters that we discuss today will include forward-looking statements that involve risk factors that could cause Teradyne's results to differ materially from management's current expectations. We encourage you to review the safe harbor statement contained in the earnings release as well as our most recent SEC filings. Additionally, those forward-looking statements are made as of today, and we take no obligation to update them as a result of developments occurring after this call. During today's call, we'll make reference to non-GAAP financial measures. We've posted additional information concerning these non-GAAP financial measures, including reconciliation to the most directly-comparable GAAP financial 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 Baird, UBS, and Wolfe Research. Now, let's get on with the rest of the agenda. First, Greg will comment on our recent results and the market conditions as we enter the fourth quarter. Sanjay will then offer more details on our quarterly results, along with our guidance for the fourth quarter. We'll then answer your questions. And this call is scheduled for one hour. Greg?

Thanks, Andy, and good morning everyone. Today, I will summarize our Q3 results, describe the current business conditions, and provide some insight on how we're thinking about 2024 and beyond. Sanjay will then provide the financial details on Q3, our outlook for Q4, and offer some comments on modeling next year. Third quarter sales and earnings were at the high end of our guidance range, as Robotics sales came in above plan, and we cleared some supply constraints and tests. The second half of 2023 is playing out as we described in July. We expect to close out the year with strong Robotics shipments, amplified by new product shipments at UR and seasonally softer test shipments. In semiconductor test, the mobility correction cycle persists and shipments remain well below historic levels while our automotive test shipments remained high in Q3. Memory test shipments in Q3 were down sequentially due to the timing of shipments, but demand remained strong. LPDDR5 and HBM, both of which require higher-speed testers, drove the results. In wireless, demand remained muted in the quarter, given the weak smartphone market and lack of new wireless standards this year. In system test, defense and aerospace, and storage test groups were unplanned while production board tests softened in the quarter. Robotics demand has stabilized. In the first half of 2023, demand was quite low, down 21% versus the first half of 2022. In Q3, demand strengthened, with revenue nearly at 2022 levels and up 20% from Q2. Our shipments have stepped up, as we execute an aggressive ramp of the new UR20 product and PMI seems to have stabilized a bit. Looking at the full-year of 2023, our estimates of the SOC test market size are unchanged at $3.7 billion to $4.1 billion, down about 15% at the midpoint from last year. The weakest segment of SOC is mobility, down about 40% from 2022 on slower complexity growth in smartphone semiconductors and year-on decline in units. The compute, automotive, and industrial analog segments of the market will finish the year at similar levels to 2022. In memory test, we expect the market will be at the low end of the $900 million to $1 billion range, also unchanged from our July view. The demand for high-speed DRAM test remains high, as we close out 2023, which will help us tick up a few points of memory share for the full year. Teradyne's System Test Group will finish 2023 down more than 20% from 2022. Within this group, we expect defense and aerospace will grow by 10% year-on-year, as global defense spending ticked up. The other segments of the business were negatively impacted by oversupply in the HDD market and mobility weakness. Shifting now to Robotics. The macro environment for industry is incrementally better than last quarter, with global PMI stable or improving slightly. The highlight of the quarter was a well-executed volume ramp of our UR20 collaborative robot. We delivered more than 300 units in Q3 and we expect to deliver a multiple of that in Q4. The UR20 extends UR’s ease-of-use and quick ROI to higher payload and longer reach applications, expanding the market in many segments. The strongest segments for UR20 so far are welding and pelletizing. The distribution channel transformation that we described in past calls is also making steady progress. Complementing our existing distribution channels with direct coverage at large accounts and adding OEM partners is a long-term project and we're beginning to see positive benefits. For example, in the OEM space, we've added 48 new OEM partners so far in 2023, bringing the total to 144. And we've seen direct OEM orders grow nearly 20%, driven by the high demand from the pelletizing market. At MiR, our account strategy continues to deliver with our top 10 customers expanding their collective installed base by over 15% year-to-date, a rate that's more than 50% greater than the overall install base growth. Shifting to the future, I'd like to describe our current thinking about 2024. Please bear in mind that it is still too early and visibility is too limited to be certain about what will happen next year. However, there are some longer-term trends that we expect to play out. As we've previously discussed, we expect the SOC market and our revenue to grow from 2023 on broader 3-nanometer adoption in the mobility space, driving market growth and continued strength in the compute market. The real question is the magnitude of the mobility recovery, which depends on smartphone unit growth, complexity growth, and how quickly the industry can consume idle test capacity. For reference, we estimate subcon tester utilization is still low, up only marginally from our July estimate and well below the typical Q2 to Q3 increase. The automotive test market has been sustaining at a higher level in 2023 than we originally expected. It appears that channel inventories in automotive are stabilizing and we've seen some spot weakness in the market. We aren't expecting a significant change in the full-year market size next year, as unit forecasts and semiconductor attach rates driven by the crossover from internal combustion to EV remain bullish. The technology buys that have supported memory TAM in 2023 should continue into next year, and we expect the memory market to grow as HBM, DDR5, and LPDDR5 penetration expands to support AI and computing growth. In flash, as the protocol interface speeds continue to increase, we expect flash package test demand to grow as well. Overall, we expect the total ATE TAM to be up modestly from this year and the key factor is the strength of recovery in mobile. Growth in our wireless business, LitePoint, will be strongly linked to handset growth, a recovery in the PC market, and the start of the rollout of Wi-Fi 7. The supply-demand imbalance in HDD is likely to persist through 2024 and we expect HDD test to remain weak. System-level test will depend largely on smartphone unit growth in the near term while we expect our defense and aerospace business to grow in 2024 on increased defense investments worldwide. In Robotics, we're finishing 2023 on a positive note in a tough market, with Q4 revenues up about 10% year-on-year on the strength of the new UR20 product introduction. That performance reinforces our optimism in Robotics. We see Robotics as a marathon, not a sprint. We are serving in an emerging market of $2 billion this year that we expect to grow to tens of billions of dollars per year in the future. Our operating model for Robotics is built for that marathon, with a strategy that prioritizes product and support investments that deliver value to customers now. We are counting on building relationships with those paying customers to help guide our ongoing investments to meet their evolving needs for the future. The key to this strategy is driving towards our model of 5% to 15% profit from our Robotics portfolio. While we may fall short of this objective in 2023, it remains a key operating metric for 2024. We do this to ensure that we remain focused on our customers' most important automation priorities while we grow the business. Rolling it all up, 2024 looks to be stronger than 2023, with all of the uncertainty around chip inventories, low utilization rates, and macroeconomic worries. I call it incrementally stronger, but we'll get a better view over the next quarter or so. We're also assuming a quarterly revenue profile in 2024, similar to 2023, with Q1 as the low point and then growth from there. While early, we're modeling Q1 sales to be similar to Q1 2023. As we finish the year, I'm encouraged by indications that our largest market, semi-test, appears to have troughed in 2023 at a level that delivers an operating profit of 20% for the total company. We are confident about the long-term growth outlook of the semiconductor market, as the substantial fab equipment investments made in the recent past have not yet seen matching test investments. Also, we see consistent investment in tooling to enable continued process development, whether it is building a family of process nodes at 3 nanometer or enabling gate-all-around and two-nanometer technologies. While the timing of test investments will be driven by end-market chip demand and complexity growth, we are confident that this investment will happen. To be clear, our customers are still cautious about their near-term demand and we're reflecting that caution in our initial outlook for next year. But long-term, there is significant upside potential. In Robotics, we have a pipeline of new products, new applications, and distribution changes that are now beginning to yield. At the end of the day, the global population trends are inarguable. The long-term demand for advanced automation must grow to deal with the increasing shortage of manufacturing workers. That coupled with market conditions that favor low-cost, short-ROI automation investments and our team's growing execution skill, I expect renewed growth in Robotics in 2024 as well. With that, I'll turn things over to Sanjay for the financial details. Sanjay?

Thank you, Greg. Good morning, everyone. Today, I'll cover the financial summary of Q3, provide our Q4 outlook, and update you on our supply chain and resiliency progress. Now to Q3, third quarter sales were $704 million with non-GAAP EPS of $0.80, both at the high end of our guidance as Robotics delivered above plan and some supply constraints eased in Test. Non-GAAP gross margins were 56.6%, in line with our guidance. Non-GAAP operating expenses were $243 million, down about 3% from the second quarter on spending controls and lower variable compensation. Non-GAAP operating profit rate was 22%. We had two 10% customers in the quarter. The tax rate excluding discrete items for the quarter was 14.5% on a GAAP basis and 15.7% on a non-GAAP basis. Semi-test revenue for the quarter was $498 million, with SOC revenue contributing $404 million and memory $94 million. As noted earlier, we continue to see strength in SOC concentrated in auto end-market and image sensor parts of our business in the quarter. Memory sales continue to be weighted towards technology retooling for higher-speed protocol flash for smartphones, DDR5, and HBM DRAM for server applications. System Test Group revenue was $83 million, with $38 million in storage test, as SLT in HDD production demand remains muted. In wireless test, revenue was $37 million in Q3, with low demand from both PC and smartphone end-markets. We expect this market trend to continue over the next several quarters. Now to Robotics, revenue in Q3 was $86 million, with UR contributing $71 million and MiR $15 million, which was above plan, as Greg noted. Shifting back to the company-level financials. Our free cash flow was $140 million in the quarter, and we returned 97% to shareholders. We repurchased $119 million of shares in the quarter, paid $17 million in dividends, and settled $9 million of debt. We have the final $24 million of convertible debt, which will be repaid in the fourth quarter. We ended the quarter with $820 million in cash and marketable securities. Now, to our outlook for Q4. Q4 sales are expected to be between $640 million and $700 million, with non-GAAP EPS in a range of $0.61 to $0.81 on 162 million diluted shares. Fourth quarter guidance excludes the amortization of acquired intangibles, restructuring, and other charges. This outlook is in line with our July view at the company level for the second half. Our revenue guide for Q4 has no material supply constraints. As supply has become more in line with demand, we are now back to including normal supply issues in the revenue range. As a result of supply and demand coming into balance, our lead times continue to improve. This enables customers to place orders more in line with our incremental production requirements. In Q4, there is a component of this behavior, but we expect to see more book-ship variability in Q1, as lead times continue to be reduced. Fourth quarter gross margins are estimated at 56% to 57%. OpEx is expected to run at 35% to 38% of fourth quarter sales, in line with Q3. Non-GAAP operating profit rate at the midpoint of our fourth quarter guidance is 20%. A little more color on gross margins and OpEx profile for the second half. Recall, our long-term model has gross margins at 59% to 60%. In 2021 and 2022, we were in our model range, with margins of 59.6% and 59.2% respectively. In our July call, we noted the gross margin profile by quarter, which showed lower gross margins in Q3 and Q4 due to the timing of spending to strengthen our supply chain, but that we expected our full-year 2023 gross margins in the 57% to 58% range. That outlook is unchanged. Turning to resiliency spending, in our operations, manufacturing spend will continue in Q4, but the spend associated with enabling our new factories to be qualified and producing testers is behind us. Packing up inventory and some capital equipment from old locations is what is left to do for our manufacturing in Q4. In short, we have successfully completed our objectives of moving many product lines to new locations. I would like to thank our internal teams and our partners for their tireless effort in de-risking our supply chain. Some component qualification will continue in 2024, but the majority of the test operational resiliency spending is behind us. Regarding OpEx, as noted, our full-year spend will be flat to slightly down versus 2022 spend levels. This is due to both spending controls and lower variable compensation. Recall our operating model has a variable component for operating expenses where the model flexes compensation expense with revenue and profits. As both are lower than 2022 levels, we're spending less than 2023. As revenues are expected to grow in 2024 and in future years, that variable compensation component will also grow. For the full-year 2023, at the midpoint of our guidance, revenue will be slightly below $2.7 billion with non-GAAP EPS of $2.85 and operating profit of 20%. Gross margin for the full year should be about 57.5%. Our GAAP and non-GAAP tax rates are forecasted to be 15.75% and 16.5% respectively in 2023. Looking at 2024 business levels. Greg noted we expected revenue growth in 2024. How much growth is tough to call at this point. Starting the year with Q1 2024 revenues similar to Q1 2023 levels, Q1 is expected to have an unfavorable product mix yielding lower gross margins than Q4 2023. For the full-year 2024, we expect gross margins to be better than '23 on higher volume and lower resiliency spending. Summing up, our second half is playing out as expected with the highlight being strong execution by our UR team, as they ramp UR20 to meet high customer demand. For the full-year, while the end markets have softened in 2023, our company operating model has flexed costs down to support profitability while enabling our R&D and go-to-market investments to support our long-term growth objectives. We've transformed our supply chain to reduce geographic risk and strengthened our operations capacity. From a shareholder return perspective, year-to-date, we've returned 181% of our free cash flow to owners. Our cash position and strength in our balance sheet enables us to continue to invest in strategic organic initiatives and has the firepower to support a wide range of M&A options for inorganic growth in the future. With that, I'll turn the call back to Andy.

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

Thanks a lot. Greg, you had talked about there being some critical points where utilization has to get to, to then see mobility start to grow again. So how do you think about where we are sort of in aggregate? I know your large customer has their own dynamics, but how do you think about where we are right now in terms of utilization versus where you think we have to get until before the non-large customers would come back and start to buy again?

Thank you, Tim. I'm hesitant to provide exact numbers because our measurements of utilization are indirect. We tend to focus more on changes from quarter to quarter rather than absolute levels. However, utilization is significantly lower than the demand we see for purchases. There's also a notable difference between our IDM and OSAT customers. Our IDM customer utilization, according to our measurements, is in the low 80s, which typically encourages purchases. On the other hand, our OSAT customers are about 20 points lower, with minimal increase in utilization from Q2 to Q3, remaining significantly behind what we observe in IDMs. Therefore, there is a considerable challenge ahead in terms of increasing utilization before we can expect OSATs to begin purchasing to support the mobile sector.

Thank you very much. A lot seems to depend on your large customer for next year. Considering their plans, especially with new chips across the entire product lineup moving from N3D to N3E, there is an expectation of 30% more transistor density. While the die size will influence this, it appears there will be a significant increase in transistors throughout the product range next year. Without asking you to predict outcomes for that large customer, could you discuss what indicators you are monitoring to gauge whether next year might be favorable for them?

Sure. I believe we are both analyzing the same data regarding this large customer. We are uncertain about their product plans. We are closely monitoring how quickly 3-nanometer technology is integrated into their high-performance computing products; a greater adoption of this technology within their product line could indicate increased complexity and lead to better loading outcomes. Additionally, we are interested in how they utilize the next-generation 3-nanometer process—whether they aim to reduce die size and costs or prefer to maintain die size while increasing features and complexity. We are also keeping an eye on any changes in their strategy concerning the use of the N-1 processor in their lower-end phone product line. A shift in that strategy could shorten the timeframe for chip production and potentially enhance peak loading. We currently lack detailed information on these matters, so we are proceeding cautiously in our forecasts for the future. However, as you noted, several factors may contribute to potential upside.

Great, Greg. Thank you.

Hi, thanks for taking my question. My first inquiry is about next year's outlook, following up on an earlier question. Traditionally, your major customers reach out around April or May to confirm their expectations for the year. Was this year's pattern different? Do you anticipate returning to the usual schedule next year, or is it still too soon to make that commitment? I also have a follow-up.

I believe they followed a familiar pattern this year. However, in April and May, they did not meet a lot of additional capacity. We've mentioned in previous calls that we expect this major customer to contribute less than 10% in 2023. There hasn't been any significant change in timing. Previously, we noted that we did not have confirmed demand during that April and May period, but there remained some uncertainty regarding their peak loading and whether they needed extra capacity. Ultimately, the situation developed as expected, and I think they are still on basically the same schedule.

Got it. Got it. Very helpful. And then a quick follow-up on the auto market. You said that it's been strong. We've seen some spot weakness, but still expected to grow or be strong in calendar '24. Is that purely because you think increasing semi content is going to offset unit weakness? Is there anything else you're seeing in autos? Thank you.

No. So I think that what we're seeing in automotive is most of the players in that space, they're large IDMs, and they all have significant capacity expansion projects in process. And they've needed to place orders way in advance due to the lead times that they have for front-end equipment and where our lead times were running, say, even six months ago. They needed to place orders way in advance. And as they're building out that capacity, they need to phase their deliveries so that it lines up with their commissioning. And so we've seen some rescheduling, but we haven't seen anything that we would consider to be a significant signal of demand change.

Yes, thank you. I have two follow-up. And I'm not going to ask you about how to forecast iPhone 16 builds for next year. But what I want to learn is, actually, I want to get an update on the compute end market. We all hear of more ASIC design ramping, hyperscalers ramping their own ASIC solution. By now, everyone has seen the Graviton and TPU in the headlines. And in that context, what's the update on Teradyne’s content market share? And I have a follow-up.

Okay. So right now, the computing market, if you just break it down, there are a couple of components of the compute market. There's end equipment PCs. That part is significantly weak and continues to be. Then there's cloud computing, and the thing that's driving cloud computing is really AI acceleration. The beneficiaries of that are GPUs and then hyperscalers doing their own silicon. There's definitely an increase in the amount of bespoke silicon that's going in, but it's still dwarfed by traditional GPU-driven accelerators at this point. The TAM, or the amount of testers that are being sold to support the hyperscalers, is not very consistent at this point. We had a big hit last year from a revenue perspective, it's quieter this year, but we think that this is something that's going to play out over probably the next three or four years. So we're really looking at it in terms of socket wins. And right now, I can tell you that we are on track with socket wins. We have low share in traditional compute. We were aiming to try and win half and half, like half the battles we get into on hyperscalers, and that's about what we're doing this year, that we're winning half of the sockets that we are fighting for and the other guys are winning the other half.

Okay. And my follow-up has to do with your color on Q1, and I appreciate going out of your way to help us with the modeling. The midpoint implies an 8% sequential decline. And SOCs has historically been the weakest in Q1. So should we assume that semi-test SOC will be down by more than 8%, and everything else would be down less than 8%?

Hi, Mehdi, it's Sanjay. Yeah. So the seasonality decline is really coming through, I would say, in robotics. Obviously, seasonality comes down. And then we're ramping UR20 in Q3 and really in Q4 that goes down to run rate. The other component of the decline in Q1 or the forecasted decline in Q1 is tied to storage, really the mobility of the end market and SLT. And from an SOC perspective, we're seeing that as roughly flat at this point, from Q4 to Q1. So those are really the drivers of what we see now. And as I said in my prepared remarks, I'll just remind you that we're seeing, as lead times come down, a lot more kind of book-ship and customers coming to us with incremental orders within lead time. So we're expecting to see kind of more bookings at the tail end of Q4 for Q1 shipments. So there's a little bit more volatility there.

Thank you. Very helpful.

Hi, thank you for taking my questions. I would like to follow up on the previous question regarding your indication that you're achieving 50% of wins in the accelerated compute or custom ASICs you're targeting. Could you provide more details on when we might expect these wins to translate into revenue? Specifically, how does the revenue progression look as you build your pipeline? I have a follow-up question as well.

Yeah. So right now, the noted characteristic of it is volatility year-on-year. Our model of it, though, is by the time you get out to sort of the 2026, 2027 timeframe, we expect that these vertically integrated producers are going to represent about $400 million to $500 million of the compute test TAM. And for reference, that's probably going to be on the order of 1/4 to 1/3 of the total compute TAM out in that timeframe.

Got it. And then for my follow-up, I know you're talking about 2024 being a year of incremental growth, and there are lots of puts and takes here, but you're starting Q1 in line with Q1 '23 and when I look at consensus, it has you growing 20% for the year. So obviously, as a magnitude, there’s an overall difference in sort of where you're starting Q1 versus what consensus is expecting. Any sort of thoughts around whether that's a realistic assumption? Or if that 20% growth were to be realized, what do you need to see in terms of uplift, which quarter that needs to come through for you to be able to realize that kind of strong growth through the year?

I believe Greg outlined the potential challenges and opportunities for 2024. Currently, the first half seems to be somewhat subdued, particularly in mobility, with limited visibility. However, we anticipate positive developments in compute, mobility, and robotics for 2024, which could serve as tailwinds. The key question is the extent of these influences. We have shared what we know about Q1, and we believe it will be the lowest point, with growth expected from that stage. It is difficult to predict how the rest of the year will unfold, but we will provide an update in January with the latest information.

Thank you. Thanks for taking my questions.

Thanks for taking my question. First one on gross margins. Sanjay, could you remind us what drove second half gross margins lower than the first half? And what will drive overall '24 gross margins higher than '23?

Yeah. Good question. So it's a similar story to what I noted in July, Vivek. Fundamentally, it's product mix in the second half, and we deferred resiliency spending in operations really from the first half to the second half. And in the first half, we were focused on chasing and meeting customer demand. So some of our projects were deferred into the second half. So it's mainly mix as well as deferred resiliency spending from kind of first half to second half.

And in '24, why it would be better?

Thank you. In 2024, we believe that incremental volume will significantly influence our product mix. Additionally, there are several factors to consider. We anticipate that most of the operational resiliency costs will be behind us in 2024.

Got it. And for my follow-up, Greg, I was hoping you could help us kind of square some of the more muted commentary from customers such as Texas Instruments about industrial demand, not as much automotive but a lot more industrial demand. I think they said the industrial weakness is broadening. How correlated is that demand to what you see and what your UR business sees? Because you're noticing strength in UR, but when we look at folks such as TI or Analog Devices, they were talking about weakness on the industrial side. So how correlated have these two trends been historically? And what is the kind of the right read across?

So I think the answer to your question is not very. The business that we're in with UR and MiR tends to be a short lead time business. We tend to run with about four weeks of lead time, and customers will use our stuff for smaller projects. Much of the rest of the industrial segment that TI and Infineon and ST are serving is towards much longer lead time projects. Some of our industrial robot competitors are working off of year-long backlogs and for process control equipment, it can be even longer than that. So what we tend to see is that the cycles of investment for advanced automation lag our cycles, are actually a little bit out of phase with the cycles of investment for factory building. And right now, we're seeing that there is significant weakness in orders for our peers in industrial automation compared to where they were a year ago, and we're actually stabilizing relative to them. And that kind of makes sense. They will build a factory, they'll start running in the factory, and then they will look at different tasks in the factory that could be automated using AMRs and cobots, and then they'll make a subsequent investment to do that. So I think the answer to your question is that you can't really infer what's going to happen with our Robotics business based on the industrial semi trends.

Thank you.

Good morning. Thank you. My first question, I have two. But my first question on semi test lead times. Greg, where are they today? How much have they come in over the past couple of quarters? And over the next couple of quarters, where do you see them going? And when you talk about Q1 of '24 revenue being flat, year-over-year, I guess that's for the overall company. But within your SOC test business or semi test business, what percentage of Q1 revenue do you think will be turns business?

So I'll take the lead time, and then I'll pass it off for the percent of turns to Sanjay. The lead times, if you go back about a year, are running out past 26 weeks out to 39 weeks; we were way oversubscribed. And right now, we've managed to tighten up the supply chain and get us to the point where our lead times are running in the 16-week timeframe, and we're aiming in the short term to get those down to something that's closer to 13 weeks. That's probably where we're going to be sitting. But again, that's sort of an average lead time. We will be maintaining some ability to work within lead time for particular high-priority orders. And so going into a quarter, we will probably have a very good idea about the majority of our revenue, but we will have some ability to do book-ship. And I don't know, we're scrambling through the papers to make sure we give you a good answer for the turns question here. It's actually kind of fun to watch. So have you gotten to the right page yet?

Sure. Hi, just to provide some context, due to long lead times, we will primarily have our bookings confirmed looking into the next quarter. However, there are always instances of rescheduling and adjustments along the way. Generally, we estimate business performance at around 25% to 30%, tapering down to the semi-test level of 15% to 20%. We are beginning to observe an increase in our book-to-ship rates over time. As expected, as lead times decrease, customers will place orders when they feel they are necessary, leading to the issuance of purchase orders.

That makes sense. Thank you. And then as my follow-up, a question on China. Your peers in WFE on the front-end side of things, they're seeing 40% to 50% of their revenue come from customers in China. I think your business peaked at about 20% China a couple of years ago, and I think the most recent quarter, you were in the low teens. With new customers and existing customers expanding capacity, is China a potentially a growth area for you guys with the time lag over the next, call it, 24 months? Or is there a reason to believe that your exposure there could stay low given competition or what have you? Thank you.

Sure. Hi, it's Sanjay. I'll start by giving some context regarding our current revenue from China. Then Greg can discuss the potential growth and competition. In 2022, 15% of our revenue was generated from China. Year-to-date in 2023, this figure stands at about 12%. Of that 12%, roughly 25% comes from Robotics, production board test, and LitePoint, while the remaining 75% is from our semi-test group. Additionally, about 60% of that semi-test revenue is from local Chinese customers, and 40% comes from multinational clients. This means that the contribution from local customers accounts for approximately 5% of our overall business related to semi-test.

And so I'll talk a little bit about the growth trends. If you decompose the business that we have in China right now, probably the part of the segment that's heaviest investment for us is really in memory. And we expect that to continue to grow. There's significant capital investment, WFE investment going into memory in China, and we have very good exposure to that. And there's also a significant growth in analog and power for automotive and industrial in China, and we serve that segment very well with our Eagle Test platform. The biggest headwind that we have in China is we are unable to sell test equipment into Huawei. That's by US regulations. And frankly, that takes the biggest single chunk of the test TAM in China off of the table for us. So we're in there. We have a great team in China. We're competing for all the business that we can go after. And so we're hoping to kind of hold and potentially grow from where we are.

Hi there. Good morning. Thanks for allowing us to ask a few questions. Greg, starting with your point about the modest growth in the semiconductor test market next year in 2024. I have a couple of questions. What market share gain do you anticipate based on the expected profile of test spending for next year? Also, what semiconductor IC unit growth or demand supports your initial forecast for next year?

Right now, we believe our overall ATE share will likely remain flat or increase slightly next year, with no significant changes from the current situation. There may be a slight benefit depending on the strength of the recovery in mobility, which is the main uncertain factor affecting our share. Regarding IC unit growth, I don't have immediate figures available on our current expectations. Generally speaking, unit growth has declined this year but is showing slight recovery; however, it will still fall short of the units we saw in 2022, according to our estimates. Despite the units being at or below the peak reached in 2022, the growth in complexity since then will increase the demand for test capacity.

Got it. Got it. And is there any particular end markets where you see that sort of that unit gap filled better in terms of the complexity increase?

I'm sorry, could you repeat that?

Thinking about sort of the high watermark semiconductor shipments in calendar '22, given some markets maybe won't retest that unit level. Where is the complexity increases or quality control increases big enough to sort of fill that gap?

Yeah. So the biggest lever there is the degree to which advanced processors move to 3-nanometer technology. So it's really in the digital space. There are some tailwinds as more of the compute segment moves towards chiplet-based design. That's about a 10% to 20% tailwind on the amount of test that's required. And another area that is that complexity really helps is the more complex devices that are going into an automotive environment; they have a much higher test threshold than other markets. So high-performance processors for ADAS applications have very high test intensity for the same number of transistors as the same thing going into a phone. So that's where we're really looking for some sort of a complexity tailwind, I guess.

Okay. For my second question, this is for Sanjay. I know you typically reassess your forward financial targets in January, but given the more cautious initial outlook for calendar year 2024, what are your initial thoughts regarding the financial model for calendar year 2026?

Sure. Every year, we undergo a strategic planning process in the fourth quarter that wraps up with a review by our Board in January. We will update our earnings model after that. Right now, we are just starting this process, so the initial advice is to wait for our update in January. To provide some context, we remain confident in the key drivers and fundamentals of our model in both testing and Robotics. Although we've discussed these aspects, short-term visibility remains limited and cautious. We are currently monitoring key indicators to determine when changes might happen. Nevertheless, we believe that in the mid and long term, we will achieve our goals. We'll work through the timing of this and provide more information in January.

Okay. Thank you.

Great. Thank you. You talked about a memory business that's being driven by speeds and kind of new standards, but we are seeing some volume pickup there. So I'm wondering, are you seeing test utilizations in memory that could drive business there at some point? And then some of your memory customers have underutilized their fabs. Any indication that that supply comes back online?

Hi, this is Greg. Hey, Joe. How are you? We are definitely seeing that the market this year is being driven by technological advancements such as HBM, DDR5, LPDDR5, and next-generation protocols. The fundamentals in the memory market are improving, with inventory levels decreasing and production rates increasing. Currently, we haven't seen enough demand to trigger significant capacity purchases. However, we anticipate this will be a supportive factor in 2024. We don't expect a dramatic increase, and it may be more prominent in the later part of the year, as there is still a considerable amount of capacity that needs to be utilized before triggering more purchases. Nevertheless, it is indeed a supportive element.

Great. And do you think that you can continue to gain share within memory given the transitions that are happening?

Well, we would love to. The thing that I can tell you is that our share in memory is highest in final test, and we also tend to be a first mover, so we have the capability to test next-generation standards and protocols, and that allows us to sort of capture more share in that part of the market. In the wafer sort part of the market, that's driven really by capacity needs; there's less differentiation, less profit, and more competitors. So what we tend to see is when we're in a technology-driven retooling cycle, our share tends to be high. And when we're in a much broader capacity add that our share would tend to go down a little bit. But we're always fighting, and we do have share in the wafer sort space; it's just not as high as our share in the final test space.

Hey, thanks. Good morning. Just going back to the robotics demand stabilizing, we are seeing some plateauing in some industrial markets but the long-term model appears unchanged for robotics. So as you target bigger customers, do they have more durable robots plans relative to smaller customers? Or what gives you confidence that you can get back on track to that mid-20% CAGR by 2026?

Hi, Steve. Thanks for your question. Large customers have a different sales and application process compared to small customers in robotics. For small customers, the sales cycle tends to be short, but they usually make fewer repeat purchases. As we improve our coverage of large accounts in robotics, we're noticing they operate on annual planning cycles and tend to create multi-project plans. Since we began assigning more salespeople to this area in 2023, we now have a robust opportunity funnel, although it takes longer to navigate compared to smaller customers. We anticipate a much greater impact from large customers in 2024 than in 2023. At the same time, there is also a delay in establishing our OEM channel. When I refer to OEM, I mean selling a robot to a company that has developed a repeatable solution, such as for adhesive application, welding, or palletizing. These companies integrate our robots into their products and handle their own sales, marketing, and customer service. In 2023, we brought on 48 new partners, but they need to complete their development and build their distribution. Not every OEM succeeds; a certain percentage do, and they typically see growth about 18 to 24 months after signing up. We have sign-ups from 2021 and 2022 that are starting to show growth, while the new sign-ups from 2023 will begin to contribute towards the end of 2024 and into 2025.

So if I can summarize that, that longer selling cycle could help mitigate the cyclicality of the underlying markets just because of that length? Is that fair?

It's fair. There's still cyclicality because big companies have lean times and investment times as well. So they sort of follow these PMI cycles a bit, but they work on longer lead times. The thing that I think we're looking at long term as a key way to reduce revenue volatility is to try to increase the amount of software and service revenue as part of our robotics business. So we're working to try and make sure that we can develop some recurring revenue streams in that space. And we think that that will have a good effect, not immediately, but by the end of the '26, '27 timeframe. We consistently consider mergers and acquisitions. To reiterate, our capital allocation strategy prioritizes accretive M&A as the top use of our capital. When suitable M&A targets are unavailable, we distribute that cash flow back to our investors, mainly through buybacks, in addition to maintaining our dividend. We always have a pipeline of opportunities, and while we assess various options, we do not disclose details about our pipeline.

All right, operator, we're about out of time. So I'd like to just thank everybody for joining. And if you have questions, please reach out directly to me, Andy Blanchard. Take care and look forward to talking to you over the weeks ahead. Bye-bye.