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 speakers presentation, there will be a question-and-answer session.

[Operator Instructions] I would now like to hand the conference over to your speaker today, Andrew Blanchard. Thank you. Please go ahead, sir..

Thank you, Patrice. 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 and our CFO, Sanjay Mehta. Following our opening remarks, we'll provide details of our performance for 2021's Third Quarter along with our outlooks 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 discussed then 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.

We are 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 over to the rest of the agenda.

First, Mark will comment on our recent result, current market conditions, and thoughts on the rest of 2021 and 2022. 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. Good morning, everyone and thanks for joining us.

Today I will cover 4 topics, the highlights of our third quarter and the first 9 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 tests and automation markets as we close out this year and look into 2022 and beyond.

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 under-shipped demand.

Sanjay will describe this in more detail, but we expect these constraints to persist into Q4. Despite this for the first 9 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 and our test businesses, the unit growth, and complexity drivers to power these markets continue unabated. For example, our Semiconductor test business grew 18% through Q3, with SOC leading the charge, growing 22%.

Sales continued 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 9-month period as automotive and industrial test markets have also rapidly expanded.

Eagle's unique architecture hits the sweet spot in these markets by balancing high precision, with the stress testing needed for these demanding applications. Within SOC, there has 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 is dropped from the high 50% range of the SOC test market in recent years to the high 40% range this year. Over the mid-term, 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 [Indiscernible] rapidly progressing along the complexity scale. This is true in many areas of smartphone silicate, 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, was 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 entrants into the chip design space for compute engines. The complexity of these chips, whether for laptops, servers, autonomous driving, AI, or graphics is incredible and advancing at an accelerated rate.

For example, laptop CPUs are now crossing the 3 billion transistor level, which is a hugely 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 families 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 collectively driving WFE investments higher as applications expand and competition heats up. We expect this race to lead the higher test times. And given the higher performance and faster designed to market cycle times, more share gain opportunities for Teradyne over the mid-term.

Our System Test segment last year -- sorry, our System Test segment year-to-date sales grew 11% from 2020 and storage kept continued its multi-year growth trajectory expanding sales 12% in the same period. Higher capacity HDDs and more complex SOC devices, which required system level test, are driving this demand.

Both trends are expected to continue into the foreseeable future. At LitePoint, sales were up 24% through 9 months compared with 2020 driven by WiFi 60 production, WiFi 7 R&D demand, as well as ultra-wide band.

More connected devices demanding more bandwidth while managing growing congestion, drive complexity increases in each new WiFi standard and more tests. UWB on the other hand has 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 Robots revenue grew 50% for -- through the first 9 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+ offerings, making it easier for customers to deploy our robots to do new applications. We highlighted welding in our last call, but other examples include, screw driving and palletizing.

The UR+ ecosystem is key to expanding these tasks and now totals over 360 products created by over 300 partners both riding on and broadening the co-tails of our UR platform.

This is a key advantage and the combination of our organic investments and our UR+ and OEM partners are in the dollars and creativity, that's going into expanding the UR platform and it's unmatched. At MiR, the story is about new products. The MiR250 which was introduced just as COVID hit last March of last year, is now our largest seller by far.

This year, we added the MiR Hook to the MiR250 family to expanded applications into tugging. We've introduced higher payload products such as the MiR600 and MiR1315 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 IA remains very bright. Looking at the capabilities of UR robots, today, we estimate the penetration rate is less than 2% of the serviceable 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 serviceable 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 robots and we estimate we're close to number 2 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 IA businesses, the fact that our penetration of today's serviceable market is low single-digits and that the serviceable market continues to expand each year with product enhancements, sets up a fantastic future.

Even with very high growth rates in our IA 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 mid-term 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, onshoring 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 high business and investment strategy. These systemic long-term trends paid an exciting future for Teradyne. With that, I will turn it over to Sanjay..

Thanks, Mark and hello, everyone. In my remarks, I will 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 or 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 these 3 items was 14.8% on both a GAAP and non-GAAP basis. Non-GAAP diluted share count was approximately 176 million. We had 2 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 industrial 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 a $103 million, which was down 13% year-over-year.

Recall storage is the largest business in this segment and has lumpy shipments. While storage test 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 test combined grew 10% year-on-year to $47 million.

At LitePoint, revenue of $69 million was up 70% from prior year due to early success of our new WiFi 7 product, continued strength and 4G cellular and UWB. Now to Industrial Automation. As in July, given COVID shutdowns that impaired the UR business in 2020, I will provide revenue metrics comparing Q3 '21 results with both Q3 '20 and Q3 '19.

Industrial Automation revenue of $91 million was up 32% from both Q3 '19 and Q3 '20. 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 breakeven in the quarter and full -- breakeven 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 Test or lead times within the range that meet customer's needs to expand their production capacity in this dynamic environment.

The significance of this lead time performance is that customer orders more closely reflect through Test demand. So 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 ship manufacturing cycle times.

Of course, our supply line and operations model isn't static. We begin in 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 we'll continue to invest to hardened our supply chain further.

Our lead time performance as an example of our resilience and execution. Another example is the ability to scale to significantly increased 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 and our gross margin line. In IA, we've seen lead times extend from our normal 1 to 2 weeks to 4 to 6 weeks for some products.

While this is challenged 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 2 to 3 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 9 months, we've spent a $103 million on capex, and we expect we'll spend a $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 9 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 a 174 million diluted shares. Fourth quarter guidance exclude 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%, OpEx is expected to run at 28% to 31% 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 in 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 mid-term 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 with the long-term industry trend powering our test and IA businesses remain firmly in place.

With that, I'll turn the call back to Andy..

Thanks, Sanjay. Patrice (ph) would now like to take some questions and as a reminder, please limit yourself to 1 question and a follow-up..

[Operator Instructions] Please stand by while we compile the Q&A roster. Your first question comes from Atif Malik with Citi..

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 processor, the transistor count is growing 2 to 4 times versus prior-generation. You commented mobility to grow and compute auto analog to grow faster than mobility in the mid-term.

Understand you guys on January talk about next year outlook in January, how confident do you feel about your SSE growth the next year?.

While I think -- at this point, pretty confident. We look at the trends that I just -- you cited and I cited and see that there's very little standing in the way of this increased growth, but the caveat, I would mention is there's a lot of supply chain bottlenecks in the system.

With end product get bottlenecked, that can slow down the unit volume demand for new semiconductors. And then 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 test. That's all to come.

But it depends on when do those.

additional 5 and 3 nanometer fabs come online. That is a kind of a big swing factor in the calendar year 2022 as to how our growth will chunk out and that's why we wait till January because we don't get a good enough visibility on that right now..

Great. And Sanjay, as a follow-up, can you talk about concentration within mobility and compute customer on impact on long-term gross margins? There have been talked about price discounts with equipment suppliers by Tier 1 foundry..

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, in -- 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.

From a look forward sustainability of that gross margin, obviously, we will give an update to our earnings model in January. But I see the second half of our gross margin performance kind of going into the first half of 2022..

Great, thanks..

Your next question comes from Mehdi Hosseini with FIG..

Yes, sir. 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 5% to 6%.

And in that context, should we assume a return to growth in '22? And this is a trend that has happened over the past several years and should that happen again -- should that have -- hadn't happened again into '22? And I have a follow-up..

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 on your first point, that yes, our largest customer's dropping below 20% in a growing revenue year.

The amount that you might think compute that they're falling has to be taken against our numerator of higher revenue..

Got it. Thank you. And then I wanted to follow-up to the question that came up 3 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 1 or 2 years? Thank you..

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. What our market share might be in any given year, it can -- in a submarket, like, compute, it can swing 20 points year-to-year depending on who's buying.

For this year, it tends to be a very good compute year for us. Our compute market shares 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 that probably we'll be going forward to..

I know we're supposed to ask only 2 questions, but just a quick follow up. I think what I'm trying to understand is 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 computers were all driven by ARM-based.

And I was just trying to understand how you look at your competitive position as these new chips come into the market addressing the computer market..

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 -- now 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 up being there kind of complexity growth curve. And so there will be certainly a lot of growth there as well, I believe..

Okay. Thank you. Thanks for the detail..

Your next question comes from Toshiya Hari, Goldman Sachs..

Hi, good morning. Thank you for taking the question and congrats on the strong execution. I had 2 questions as well. My first 1 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..

Sure. I'll take those. For an Industrial Automation perspective, year-to-date, we've grown 40% in IA and Q4 demand is high. If we can't supply at all, that's why we've -- and it's going to be growth year-on-year above 30% to 40%.

And so predominantly, it's in semiconductors and expect we'll be out of the supply chain crunch given our visibility in Q2 or Q3 for IA. That's the IA side.

And then from a supply chain perspective on the Test side, 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.

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, logistics increases in cost, and we've -- as I've said earlier, we've had favorable product mix.

And as our volumes or revenues are higher, we're gaining operating leverage along with coming down the cost curve of our new products that we've introduced late last year. We're managing through it and it's true well publicized component cost increases..

Got it. That's super helpful. And then as my follow-up, Mark, I wanted to ask about your Eagle Test business. In your prepared remarks, you noted that the business is up more than 2x year-to-date. 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, 4 to 6 quarters, and then down a little bit as customers digest their test capacity. Based on what you said, it seem like you're expecting 2022 to be another strong year.

The question is, what's different this time? As you think about the Eagle Test into 22, I realize there's complexity growth, but you could argue those been complexity growth for a very long time. So just curious on how different this cycle could be relative to past cycles. Thank you..

Right good question. And in addition, automobile unit volume isn't near its historical peak either so how could this thing keep going beyond the normal 6-quarter surge in automotive, which is you're right again, that's 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 nodes, silicon and automotive designed.

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 saying get with the program, move to more advanced nodes.

And a little bit of that's happening, which is what? 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..

Thank you..

Your next question comes from John Pitzer, Credit Suisse..

Good morning, guys. Thanks for me asking 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 helping us understand complexity and transistor count.

I'm curious as we move from a world 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 enhance test times as that trend takes hold?.

It is a -- building let's say, 100 billion transistors on 1 chip versus 4, to give an example, isn't equivalent test sign.

The 4 chip version is likely to -- these are going to be rough rules of thumb, but let's say 25% more test intensive than the single chip design, because there is a premium on known good die testing to, 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 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 the test market, that drove incremental test intensity and complexity in the market. And we're headed for another one of those with Gate-All-Around.

There's going to be this new defect modes, new kind of test intensity boosts coming from this new architecture on the transistors. So even at equivalent transistor counts, we're going to see a little bit more test intensity because of that. So these two trends have chip lifts and gate all around and three nanometer.

That's probably all of 2023 and beyond story given where three nanometer is right now. But it's coming..

That's helpful and this is 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.

Clearly, it's been mobility led for the last several years and now, you've got them doing more in the compute space you've talked about in the past, the complexity around these Airtags.

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 your -- is their test capacity across those different product families?.

I'm not going to be able to talk too much about the breadth there. I think you can imagine it. 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. Those testers tend to be a little more unique.

But we talked about in the past that I think people have looked at us and said, well, in a world where cell phones are plateauing doesn't that -- unit growth of cellphones, doesn't that pertain some kind of slowing for us? And what we've always said is that look, cellphone unit growth can slow, complexity isn't, and 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. 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 as I said in my script, we worked 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 semiconductor -- high compute engine semiconductor applications to the market. And all of those are UltraFLEX, UltraFLEXplus family devices..

That's helpful. Thank you..

Your next question comes from C.J. Muse of Evercore..

Good morning. Thank you for taking the question. I guess Mark another technology question. You taught us to think about transistor count and thinking about test times or for mobility compute.

And curious as we go to more high-performance compute where there are more thermal issues, perhaps more complex software algorithms, how should we be thinking about the test times in that transition?.

Well, I think the test times have less to do with the application. The only place where the application drives really fundamentally different test times is automotive because of the issues there. It's more of the technology.

So I'll go back to C.J., what I said before about 3 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 then any of those end market applications..

Okay, that's helpful. And 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 as part of that, how we should think about OpEx relative to topline growth? Thank you..

Sure. I'd say we're in the early innings of looking at 2022 and obviously, we'll provide an update in January. But OpEx is growing in a couple of key areas this year, obviously tied to higher volume. We have variable compensation as well as engineering expense tied to our operations to qualify new suppliers, etc.

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 into -- as I note on our prepared remarks, we're leaning into our IA investment really to help drive going forward. The other component is the G&A expenses going forward. This was a big year of OpEx growth.

The only thing I'd say is that next year is we're not going to be as large percentage-wise growth, but that's really all I have to say on it right now..

Thank you..

Your next question comes from Timothy Arcuri, UBS..

Thanks a lot. Mark, I just wanted to see if you could update us on the SOC TAM. You had said 4, 5 last call in the segments of that was compute was about a billion, mobility was 18 to 185, autos were about 500, industrial was 550.

I'm just wondering if you can update us on those numbers?.

Yes. Good question. Fundamentally, it's in the same range. It's probably trending more up towards 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 this -- at this point in time but it's pretty close.

The memory is still at about a $1 billion term as well..

Okay, great. And then I guess I had a question but just on profitability and IA. I know, Sanjay, you just answered a question about operating leverage next year. But what's the catalyst maybe? This time last year we were thinking I would be 10% to 15% off margin and then it got cut to 10 and then went to 5 and now it's low single-digits.

And I get that the penetration there is very low, but what's the catalyst for you to look at maybe we shouldn't be investing so much money and maybe we can optimize OpEx investments? So I guess, I'm just wondering how you think about what's going on in IA and what the long-term profitability target is? Thanks..

Yeah. So our range, as we've said prior is 5% to 15%, and we expect to be low single-digit 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, we're -- 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 are 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 investment. And again, think about it on the Rule of 40. And as I said in my prepared remarks, our gross margins are actually improving in that portfolio.

And so when we see that growth start to moderate, then we'll start to moderate the OpEx to get to an operating profit of let's say in the mid-20s..

Okay, Sanjay. Thank you.

Your next question comes from Vivek Arya, Bank of America..

Thanks for taking my questions. Mark, this move to 3 nanometer, is that a benefit for Teradyne in '22 or '23? I thought it would be '22, but I wanted to confirm.

And following on for that, what are the top 1 or 2 end markets that you are the most excited about in terms of growth for next year?.

On the 3 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 for -- by a few months so the ability to intercept them in a meaningful way in Q -- I'm sorry, in 2022, is a swing factor.

We don't see that exactly yet, but whatever happens in 2022, it might get some early ramping but the bulk of it is going to be 2023, '24, '25 and beyond. A little bit could happen in '22, how much we won't know more until January.

In terms of markets next year that are interesting and exciting, I think it goes back to these emergent 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 introduction and drive a whole new demand stream for semiconductors and the testers associated with them. That's what we're rooting for and what we're close to. And we're seeing could be breakouts for 2022..

Got it. 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 the mobility application? I understand by sizes might be different than packaging, etc., might be different.

But in conceptually, what does the mix shift from in more mobility heavy end market to something that is taking you more into the compute on hyperscaler land mean for Teradyne in terms of your growth prospects? And also, just the seasonality because mobility tend to be a lot more seasonal markets, those other markets are perhaps less seasonal.

What does that mix shift mean for Teradyne over the long term?.

Yeah, that's 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. Those aren't going to have much of an impact even if they latch, but some of them there 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 cellphone application for those technologies so it's a broad spectrum, as I guess the bottom line.

But if you play it out, I'd say the hyperscalers are going to on average bring cellphone-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 surprised everybody. It's probably not at that extreme.

It's probably more on 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..

Your next question comes from Krish Sankar with Cowen and Company..

Hi, thanks for taking my question. I have two of them. Just want to ask the 3 nanometer question in a different way. You spoke about how test investments have to catch up to front-end WFE spending. But during the 3D NAND Mcklin cycle, WFE grew in 2016 and '17, while the Memory Test spending came in 2018 in a meaningful way.

So if I rephrase how should we think about the timelines effect of test to front-end foundry logic WFE this time around?.

Yeah, good questions. All of the WFE investment gets recognized before -- of single testers associated with that investment. The way to think about test is whenever you see some silicon coming off a new node, assume that the testers were installed maybe 3 months or so prior to that.

Once a 3 nanometer fab comes online and you start to see product coming off a bit in reasonable volume more than pilot line volume, assume that the tester installations occurred about 3 months prior. That's 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 on SOC. Memory tends to be a bit more efficient for reasons I won't get into here.

So you can double transistors and memory, and you're not going to probably move test time more than 20%, 30% or so, let's say, whereas in SOC it's not quite linear, but it's closer..

Got it. That's very helpful, Mark. We had a follow-up for Sanjay on gross margins. Despite the constrained environment, gross margins have stepped up about 200+ basis points over the last 4 quarters or so to a 59% - 60% range. Is this kind of the new baseline we should assume at these revenue run rates? Thank you..

I think I've talked about that earlier. We're going through our strategic planning process in Q4 and it's really the basis of our earnings model update in January.

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 from -- 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. 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..

Your next question comes from Brian Chin, Stifel..

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?.

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..

Okay. Great. And then interesting discussion here on 3 nanometer and a fulcrum event in terms of test intensity again at 3 nanometer or Gate-All-Around. Maybe a couple of 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 what the yield modeling suggests for lower yield rates there, compounded by die sizes, compared by transistors, or advanced packaging.

Or is it also combination of the types of devices that you think that enables in terms of the intersection point of various customers, And they're chip road maps? Just want to get at that, and then like in bigger picture.

It's the high-performance compute test cam is a little bit more secular, a little bit more growthy, if you've benchmark test growth, that sort of 4% to 8%.

How much of a premium do you think we're looking at over the next several years in terms HPC TAM?.

Okay. There's a lot in there, Brian, so let me first of all take on 3 nanometer. The issues about 3 nanometer certainly enables more dense, 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 mid-term.

There's the chip lit thing that we talked about where you have mixed nodes going into chips and then you need known good die testing and then the multi packaging needs and 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 3 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 FinFET s 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. And so, let's say, the average test time per transistor contend 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. So -- and the world doesn't shift to 3 nanometer in mass day one either. 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 20 -- 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. Sorry, the HPC and --.

Tested HPC higher or lower?.

Yeah. The high -- the growth rate in compute is certainly going to be at the higher end of our mix of submarkets we think over the mid-term. If you think the average market growth rate, 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..

Okay. Great. That's helpful. Thanks for all the color on that..

And Operator, we have time for one more question, please..

Thank you. Your final question comes from Sidney Ho Deutsche Bank..

Thanks for taking my question. I have two quick ones. The first one is, you talked about supply constraining -- constraint impact in your IA business. I'm just curious, the gross margin has been pretty good overall. You talked about offering a leverage [Indiscernible].

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?.

At this point, we've been managing through it so materially, no..

Okay. Maybe my follow-up question is lot of discussion on 3 nanometers today. But it's really an opportunity in 2023 and beyond. If you have look at next year, I know you're going to update us in January.

How does it impact your tester business if a customer chooses to move from -- instead of going to 3 nanometer they go to a different generation of 5 nanometers, what is the tester reuse rate when you compare to two nodes between the 3 nanometers and the alternative?.

Yeah. The tester reuse, people will reuse 5-nanometer generation testers in the 3-nanometer era so a new tester is not required. And 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.

There's nothing in terms of a new tester here that comes with 3-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, since 3-nanometer in 2022 is likely not going to be a huge event because of -- it's likely to be later in the year..

People will still move down the complexity curve at 5 and 5+ nanometer nodes and increase transistor counts in such along that path. Even absent 3 nanometer, we have an optimistic view of what 2022 looks like.

We'll probably start out the year similar to how we started out years in the past and at the beginning of the year with some modest growth in the first quarter and then it 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+ 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..

Great. Thank you very much..

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..

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect..