Good day, and thank you for standing by. Welcome to the Q1 2022 Teradyne, Inc. Earnings Conference Call. [Operator Instructions]. I would now like to hand the conference over to your speaker today, Mr. Andy Blanchard. Mr. Blanchard, the floor is yours..

Thank you, Chris. 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 2022's first quarter, along with our outlook for the second quarter of 2022.

The press release containing our first quarter results was issued last evening. We're providing slides on the investor page of the website that may be helpful to you in following the discussion. Replay 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 our 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 those non-GAAP financial measures, including reconciliation to the most directly comparable GAAP financial measure were available 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 Cowen, Luke Capital, Bank of America, Stifel and Bernstein. Now let's get on with the rest of the agenda.

First, Mark will comment on our recent results and the market conditions as we enter the new quarter. Sanjay will then offer more details on our quarterly results, along with our guidance for the second quarter. We'll then answer your questions, and this call is scheduled for 1 hour.

Mark?.

Hello, everyone, and thanks for joining us. Today, I'll summarize our Q1 results, review current market conditions, and provide an update on Q2 and the full year. Sanjay will then take you through the financial details, including our outlook for the second quarter. The first quarter played out as expected from a financial perspective.

We delivered results toward the high end of guidance as we cleared a few more supply chain bottlenecks than expected. As outlined in January, we expect revenue growth throughout the year as we build toward 2023 and the transition to 3-nanometer. Consequently, we expect roughly 7% to 9% sequential quarter-over-quarter growth throughout the year.

Since January, we've seen incremental strengthening of demand for Semi Test and wireless in the areas of automotive, memory, WiFi 6c and 7. On the other hand, for the first time in 2 years, supply chain challenges are materially impacting our Semi Test shipments. This is reflected in our wider-than-normal revenue guidance range in Q2.

Sanjay will describe these details shortly. From a full year market perspective, we estimate the SOC market is trending to the high end of the $4.6 billion to $5 billion range we discussed in January. Strengthening automotive test demand is one element driving the market increase as both per car content and unit complexity are growing quickly.

The accelerating move to electric vehicles is a key part of this increase with EVs growing at a 20% plus CAGR while the chip content of these vehicles is running more than 3x compared to gas-powered cars. This year, we are seeing particular strength emerging in high-end automotive ADAS processes.

Complexity of these processes is approaching the level of high-end cellphone applications processors. Additionally, high-end ADAS processors have about a 3 to 4x longer test time due to the more stringent test requirements for devices used in automotive safety applications.

Furthermore, there are usually multiple ADAS processors per vehicle, amplifying the unit demand. Combining the enhanced EV semiconductor content with these ADAS trends, we expect the automotive test market to outgrow the core test market for the receivable future. Another area of growth is in hyperscaler silicon development.

While the material test revenue impact from these complex chips is in 2023 and beyond, both the complexity and pace of development is accelerating. This has been a focused investment area for us over the last 18 months, and we are pleased with our win work -- sorry, pleased with our win rate for these new opportunities.

Shifting to the memory test market. Our market size estimate for the year remains at about $1 billion. But within that, we have seen the DRAM demand soften a bit, offset by an increase in flash demand.

In System Test, defense and aerospace and production board test groups collectively grew over 30% from Q1 '21 on strong automotive board test demand and program buying in defense and aerospace. In Storage Test, sales were down 28% as expected versus 1Q of '21.

Customer concentration here causes this lumpiness, but the long-term complexity and unit demand drivers remain in place. Our wireless test business at LitePoint remains very healthy with sales growing 26% year-over-year in Q1. Strong demand for emerging WiFi 6c and WiFi 7 standards is driving this growth and the outlook for the year.

LifePoint's strategy delivers high throughput, easy-to-deploy test solutions for the full array of wireless standards. Our chipset test library approach to programming allows customers to shorten their time to market and achieve superior test economics for these emerging standards. Moving to Industrial Automation.

Group revenues were up 29% from Q1 of last year. Demand in North America was particularly strong with 55% growth year-over-year. While we cleared some supply issues at UR rate in the quarter, IA shipments overall continue to be constrained by material shortages. Globally, the PMIs for the U.S.

and Europe remain over 50, while in China, the PMI dipped below 50 in March. We are closely watching to confirm that China data point is a short-term COVID lockdown issue and anticipate recovery in 3Q and 4Q.

Similarly, the conflict in Ukraine slowed EU demand in March and has the potential to impact the European industrial activity throughout the year.

While we expect these constraints to continue in 2Q, we do expect IA growth rates to increase through the year as supply constraints ease, AutoGuide begins to ramp shipments and UR and MiR see increased growth on China and EU recovery. At UR, our OEM welding application continued on a tear with 1Q growth of over 100% compared to 1 year ago. The U.S.

geography was also strong with over 50% year-over-year growth. Our UR+ program of plug-and-play applications for our cobots is passing in the 400-product milestone this quarter. Each of these applications leverages an independent third-party developers knowledge of a specific market vertical to solve a specific problem.

This application is then certified by UR so our customers can deploy automation solutions quickly by spending less time on programming and integration work. The resulting network effect is a powerful differentiator for us, and we continue to invest to support this growing army of developers.

At MiR, we are seeing two positive trends emerge as we grow the business. First, we are seeing a steady movement toward higher payload, higher ASP AMRs. In 2020, about 10% of our sales were above the 500-kilogram payload range. This moved to 22% in 2021. And in Q1, we saw over 30% of our sales in this class.

This represents a broadening of AMR applications to a wider range of material handling tests and manufacturing and logistics. Second, we are seeing the trend toward both growing fleet sizes and increasing multifactory deployments at major customers.

Within these environments, our fleet management software is an increasingly important product differentiator.

These larger customers also have demand the uptime and support requirements, which also plays to our strength as MiR is leveraging Teradyne's global support and large account experience to meet these customers' needs in ways that smaller players can't. With one quarter of 2022 in the books, the year is unfolding roughly in line with our forecast.

The incrementally stronger demand in test is being balanced by supply constraints.

Longer term, I am encouraged by the continued strength in WFE investments, which fuels our growth; the progress from industry leaders on 3-nanometer technology; the growing opportunity for our human scale automation projects and the resilience of Teradyne's global team and our partners that are enabling us to muscle through some very tough supply and operational constraints.

And before closing, I want to note an important milestone at Teradyne. Mike Bradley will retire from our Board of Directors in May. Mike's Teradyne career spans over 40 years, including 10 years as CEO, helping shape Teradyne's products, business model and culture.

Mike has had an incredible impact on our company, our customers and shareholders, and I'm especially appreciative for the help he's given me along the way. Thanks, Mike. Sanjay will now take you through the financial details.

Sanjay?.

Thank you, Mark. Good morning, everyone. Today, I'll provide details on our Q1 results, offer additional color on the operating environment, including the supply line update and describe our Q2 outlook. Now to Q1. First quarter sales were $755 million, with non-GAAP EPS of $0.98.

Non-GAAP gross margins were 60.2% and our non-GAAP operating expenses were $248 million, slightly below our guidance due to slower-than-planned hiring. Non-GAAP operating profit rate was 27.4%. We had no 10% customers in the quarter. The tax rate, excluding discrete items for the quarter was 16% on both a GAAP and non-GAAP basis.

Please note, you should now use this for the full year tax rate as well. Looking at the results from a business unit perspective. Semi Test revenue of $482 million was down 9% from Q1 '21 as expected. SOC revenue was $387 million driven by strength in mobility and compute end markets.

Memory revenue was $96 million, driven by flash final test and DRAM wafer sort. System Test group had revenue of $119 million, which was down 11% year-over-year, again, as expected. Storage Test sales, including HDD and system-level test solutions were $68 million in the quarter, down from $95 million in Q1 '21.

Defense and aerospace and production board test grew year-on-year. At LitePoint, revenue of $52 million was up 26% from prior year due primarily to strong shipments of WiFi and UWB test systems. Looking at our test portfolio overall. The positive demand environment, Mark noted, reinforces the trend line growth built into our 2024 earnings model.

In Semi Test, growing device complexity supported by no transitions and unit growth will provide a long-term tailwind to that business. At LifePoint and in System Test, similar increases in complexity continue to drive growth. A couple of examples. One, LitePoint revenue in 2021 was approximately double the 2017 level. Two, our Storage Test business.

Revenue in Storage Test has more than quadrupled from 2017 to 2021. At LitePoint, we expect growth to continue to be driven by more complex wireless standards for connectivity, sophisticated location tracking and security technologies and cellular applications.

In Storage Test, growing chip complexity combined with higher density, hard disk drives are driving long-term growth. Now to Industrial Automation. Industrial Automation revenue of $103 million was up 29% year-over-year.

This was ahead of what we planned in our Q1 guidance as we were able to work through several supply line constraints in the quarter at UR. I'll also note that we expect IA revenue to follow the historical pattern and grow as we move through the year. UR sales were $85 million in Q1, up 30% and year-over-year with the highest growth in North America.

MiR sales were $17 million, up 22% from Q1 '21. As Mark noted, higher payload products with higher ASPs contributed to that growth, and we expect this trend to continue. Overall demand at both UR and MiR remained strong as labor availability and rising costs make the financial case for our human scale automation compelling.

But as noted, we are watching for the impacts of COVID events in China and the Russian-Ukraine war closely. From a financial perspective in IA, the group was breakeven on a non-GAAP operating basis in the first quarter.

And for the full year, we expect to operate in the 5% to 15% range we discussed in past calls, with 2022 trending towards the low end of the range. Recall in 2021, IA delivered a 4% non-GAAP operating profit for the full year.

As noted in the past, with market penetration for cobots and AMRs below 3% and high market growth, our strategy is to prioritize growth over obtaining model profits. Simply put, we are investing to capture these markets as we see significant growth beyond the midterm. Shifting to supply.

While the demand environment is strong, supply issues are getting progressively worse. We continue to manage through a very challenging supply environment as we have for the past 2 years.

Our supply management operations teams and partners have done an incredible job, including navigating through a multi-week plant shutdown at one of our major contract manufacturers in Q1. Fortunately, it was mid-quarter, and we had time to recover.

Had the shutdown happened later in the quarter, the recovery could have shifted into the following quarter. It highlights the risk which will persist during the global COVID pandemic. In Q2, there is more demand to ship if we could align supply. Issues range from chip shortages to COVID-related delivery shutdowns.

We're taking numerous actions to harden our supply chain, including expanding our production operations geographically, adding new geographically diverse suppliers, redesigning products to use available components and many other actions.

However, even with these actions, we expect supply line constraints to remain an issue through at least the first half of 2023. Shifting to the balance sheet and cash flow. Our cash and marketable securities at the end of the quarter totaled $1.2 billion. We had $37 million in negative free cash flow in the quarter.

Cash burn in the first quarter is typical for us as we pay variable compensation and profit sharing in the quarter. We spent $201 million and $18 million on buybacks and dividends, respectively, in Q1. As noted in January, we expect to purchase a minimum of $750 million -- sorry, $750 million of shares in 2022. Regarding debt.

To date, $384 million of convertible bonds have early converted in Q1. We paid $21 million to bondholders in the quarter. Now to our outlook for Q2. As you've heard this morning, customer demand is strong in all parts of the business. Our guidance range is wider than normal as number of material shortages continues to expand.

And while we've been successful to date in addressing these issues, the margin for error continues to narrow, and the guidance assumes we won't see extended shutdowns of our production facilities due to COVID.

With that said, sales in Q2 are expected to be between $780 million and $870 million, with non-GAAP EPS in a range of $1 to $1.29 on 170 million diluted shares. The second quarter guidance excludes the amortization of acquired intangibles. Second quarter gross margins are estimated at 60% to 61%.

OpEx is expected to run at 31% to 34% of second quarter sales. The non-GAAP operating profit rate at the midpoint of the second quarter guidance is 28%. Turning to the impact of inflation on our P&L. First, gross margins. We are seeing increased costs primarily in components and labor, both internally and at our partners.

We're mitigating those increases through a variety of measures, including product pricing, operational efficiencies, multi-sourcing and seeing the benefit of our prior investments to reduce our bill of materials. Our gross margin performance in Q1 and outlook for Q2 reflects our success to date with these measures.

But I remind you, this is a very dynamic environment. On the OpEx front, we have planned for increased costs tied to inflation and we still plan on growing OpEx 11% to 13% over 2021 as noted in January. Looking at our revenue profile for the year. The first half is shaping up a little bit better than expected with very tight supply.

The second half is looking to be slightly up versus last year's second half, reasonably consistent with our expectations at the beginning of the year, even though test demand is incrementally higher. Supply issues may push some of that incremental demand into 2023.

We expect third quarter revenues will grow high single digits from the Q2 level and Q4 will grow sequentially as well. Our current view is that the first half revenues will be 46% to 47% and second half revenues will be 53% to 54%.

To sum up, demand across the company remains strong and growing supply constraints are moderating our shipments more than at any other time since the pandemic began. We're expanding our playbook to address these issues, but it's a very dynamic playing field and we're calling a lot of audibles along the way.

Our global teams in go-to-market operations, engineering and support functions continue to execute and collaborate in a challenging and dynamic environment to meet customer demand and deliver shareholder value. The passion is enjoyable to observe. Well done, team. With that, I'll turn things back to Andy..

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

[Operator Instructions]. Our first question comes from C.J. Muse of Evercore..

I guess first question, regarding your largest customer heading into 2023, and obviously, that's a long time from now.

But curious, as you think about the move to 3-nanometer, how are you thinking about test demand as it relates to units versus complexity? And I guess the worry in the marketplace is that the adoption of 3 could be spread out over 2 years as opposed to 1, and that would reduce kind of the demand for testers from you guys.

So would love to hear how you're thinking about that. And obviously, the caveat is it's very early to have a great view there..

Yes, C.J., it's really early on that. But first of all, I think there's two parts of your question. I think overall, we're looking at 3-nanometer in 2023 as mostly a complexity growth equation versus a unit growth driver in the cellphone device arena. I think the other part of your question is, well, what is the adoption is partial for 3 nanometer.

Certain devices go to 3 and other ones sort of lag. I think that is something we've seen before in iPads and other kinds of products in the market where they bifurcate migration. If and when that ever occurs, there could be a 1-year depressed demand for test.

But then in subsequent years, those sort of bifurcated product lines kind of then move in lockstep again north, maybe one's waterfall back a year, but the complexity growth resumes thereafter. So it's all hypothetical, but something like that would have an impact..

Very helpful. I guess for my second question, just trying to think through your kind of stronger second half versus first half. And obviously, the robotics piece is helping on that. But this is the first time I think I've ever seen you guys have kind of a stronger outlook for Semi Test.

Into the back half, we're normally -- Q2 is seasonally is your strongest quarter.

So is that all a factor of supply constraints? Or are there other drivers to that change in trend?.

Well, there's three things going on there. The biggest thing -- Q2 is usually large because our largest customer has a big tooling peak in 2Q and 3Q. So that's absent. But the other thing is that the visibility is a bit longer now with lead times out. Customers are ordering a little bit in advance for capacity.

So we do see or of what's to come towards the back end of this year and early '23. And it sort of aligns to this complexity growth related to new nodes that we're seeing.

So I think this year is a little unique in that absent the mobility bubble we usually see in the summer and adding in the move towards this node transition next year, we get this more linear ramp through the year of demand..

Our next question comes from Mehdi Hosseini of SFG..

I want to go back to your outlook, especially looking into next year, and you made a reference to WFE, which is very positive, given all the investment this year. But it also appears that the investment for trailing edge is growing much faster and particularly a higher level of investment in China.

What I want to ask you is how are you positioned in China, especially for with OSAT houses? And is there any incremental opportunity for share gain? And I have a follow-up..

Yes. I think in China, we're positioned very well in legacy nonleading edge. The one place in China, we're not positioned well is with Huawei and the Huawei associated companies, which tends to -- are trying to skew as best they can toward more leading-edge positions.

But to the extent China will continue to grow on trailing edge -- but overall, our share of, let's say, the non-Huawei part of China is roughly the same as it is outside of China. So it's not a balloon or an anchor, so to speak. We're kind of going to float up and down there, I think, with investment and demand..

Okay. So nothing really out of ordinary. If they are indeed investing more, it should trickle down to the back end and you as 1 of the 2. Okay. And then moving on to Industrial Automation. And thanks for color on ADAS incremental opportunity.

But it also seems to me that in order for you to fully realize the synergies between your Semi Test and Industrial Automation for EV and ADAS application, you would need to have more of a software content.

And I'm just curious if I'm thinking about this the right way? And whether you would have to go to the market and acquire software IP so that you can have a more comprehensive portfolio for these growth the end markets?.

No, I don't see that, Mehdi. I think where we are positioned now, we're completely aligned to the technology trends in EV and ADAS and everything else there. So no, I don't see the need for that..

And next, we have Timothy Arcuri of UBS..

So Mark, you were saying that the SOC TAM is trending toward the high end of the $4.6 billion to $5 billion. I'm just wondering if you can give us some idea of sort of what end market's driving that the high end? I think last quarter, you gave us some breakdown. Compute, you thought would be $1.3 billion. I think you saw mobility would be $1.8 billion.

Autos would be about $500 million. So can you just give us sort of what end market is driving that toward the high end? It sounds like autos might be a little better..

Sure. It's Sanjay here. I'll take that one. So we're seeing strength in -- incremental strength in compute and in auto that's driving us to the high end..

Okay. And then I guess a question just around China. So are you seeing any impact or any pushouts or delays in shipment time lines from Chinese OSAT customers as a result of the lockdowns and maybe just as a result, also of weak demand in the consumer segment? So I mean, obviously, demand is still very strong if you look holistically.

But if you look at the consumer markets and you look specifically in China, are you seeing any examples of customers delaying shipments of testers?.

No, we're not seeing any tester real meaningful delays at all yet in China. We have seen in Industrial Automation business, the robotics business, some slowdown in China. Sanjay referred to the Q1 performance there was a bit weak, and we're watching that. So that's more immediate. And as factories shutdown and things, we feel that.

But I think on the test side, the headlights and the investments needed along the trend line are kind of obvious and compelling, and there's no yet any blips..

And next, we have Brian Chin of Stifel..

I guess the first one focused on test. Given the supply challenges that you're discussing, do you think you're baking in enough conservatism on the '22 TAM outlook? And I ask in part because I think despite strong order rates, your competitor Advantest, they widened their 2022 TAM outlook, but at the lower, not higher end of the range.

So kind of curious about that. .

And also, beyond your largest customer with telegraphed last call, have you seen any incremental signs of capacity digestion in the broader SOC -- mobile SOC market?.

So just a quick comment from me first, and I'll let Sanjay talk a little more about it. I do think that compared to Advantest, we're in a very different supply chain situation. You look at their backlog out at almost a year.

There's a very, I think, limited ability for them to see a road to incremental revenue in the year whereas we're months and less versus 1 year. And we do have capacity growth capability in the back half. So that's the difference, but I'll let Sanjay address the broader question..

Yes, I think overall, supply is getting tighter. As I've said on prior calls, I thought with substrate and fab capacity coming online in 2022, we'd be a little bit more in balance with supply and demand, but that hasn't been the case. As I said, our current view is that we see the tightening continuing into the first half of 2023. .

And from an overall market perspective, we do believe that there is a constraining element of supply to meet the overall demand. And it's in the places where you'd expect in the semiconductor parts, FPGA linear logic, memory, other ASICs..

Got it.

And then as I missed the part, I think I asked about whether you're seeing any signs of digestion in the broader SOC mobile market?.

No, not really. And I think the demand is still strong and the request for shipments are not pushing out. So I don't see any signs yet in test of sort of slacking demand..

Okay. Maybe just for my follow-up. In Industrial Automation, sorry if I missed this, but is sort of mid-30% plus still the bogey there in terms of growth rates? Obviously, talking about accelerated growth rates moving through the year.

Improvements on our lead times, but also still some constraints, I think, was the discussion and also some -- want to see sort of how the pattern unfolds in China.

So maybe can you discuss that and then also what that China exposure is? I think it's a fairly minority portion of the business, right?.

Yes. So it's Sanjay here. So 35% plus is still our objective or our plan this year. It's progressing as we'd expect. I would say that, as Mark noted, China, which has traditionally been a very high-growth environment for IA, was slightly down year-on-year. And as Mark noted, we believe it's really tied to the plant shut down.

So we're watching it very closely. . I would say on the supply front, a large -- a significant portion of that range increase is tied to supply. With UR, the range is approximately, let's say, $20 million, which is really a supply-driven range.

And then secondly, I'd say secondly, we are seeing supply from an IA perspective, lead times -- or sorry, our backlog will still be -- we expect it to be between 4 to 6 weeks as opposed to our objective of 1 to 2 weeks to keep it a fast turns business..

So I do think the China piece is roughly 10% of our overall IA business. So it is flatlined in Q1 kind of on growth. But part of how we get to 35 plus through the back end of the year is assuming some of this COVID stuff goes away in China and in Q3 and -- we're presuming it persists through second quarter. But Q3 and Q4, it goes away..

Okay. That's fair..

Our next question comes from Atif Malik of Citi..

Mark, you talked about weakness in the DRAM market. If you can just provide some more color.

Is this because of DDR5 adoption pushed out because of the supply rapid delay? Or are you seeing something more?.

No, it's exactly that. DDR5 is moving slower than planned. It kind of server Sapphire Rapids delay. Nothing fundamental. The three elements of the memory market between DRAM wafer test final test and then flash wafer test final test kind of are 1/4, 1/4, 1/4 each of the total $1 billion TAM.

There is a bit more tooling this year for DRAM wafer test, but that's nothing -- I think that's noise, not signal. And as I mentioned, we're seeing some strengthening in the flash side that's sort of making up more than the difference on the DDR5 weakness.

The other thing about memory that's very encouraging for us is that we've talked about our market share being about 40%, low 40s globally there. In China, which is still investing heavily and growing quite rapidly in memory, it's moving closer to the high 50s.

So we've got some good potential here with DDR5 hopefully coming back next year with Sapphire Rapids and the continued investments going into China..

Great. And as my follow-up, I want to go back to C.J.'s question earlier about the mobile compute adoption spread maybe over -- in a couple of years.

That phone maker has publicly talked about facing physical limitations in creating a larger die to accommodate more transistors at 5-nanometer, which I don't believe was the driver in iPad-type decisions historically.

So I mean, is it fair to assume that device maker could adopt 3-nanometer more widely moving forward given the limitations on the die side?.

Yes, I think that's more likely. It was a hypothetical question, I think, that C.J. was asking. But I do think -- so just to walk it back a little bit.

This year, we've seen a slackening demand in tester demand because the complexity growth is low in phone silicon, highly correlated with the fact that we're kind of in our third year of 5-nanometer production. And yes, you just can't afford to grow the die size. It doesn't make economic sense to grow the die size.

And absent that, it's hard to get more transistors unless you do a node transition. So there's a bit of a backlog and a pent-up demand to get to this next turn of the screw, the next node of 3 nanometer. So this all depends kind of on the yields of what 3-nanometer is going to look like.

But on the other side of the argument, you could see a larger portfolio of devices driving to move to 3-nanometer next year and people will be competing for fab capacity if the yields prove to be good. And I think you want to be positioned with the customers who are in the front of the line on that fab capacity, which I hope we are. I think we are.

But I would subscribe more to the fact that people are -- there's a pent-up demand, and it could swing the other way..

And next, we have Vivek Arya of Bank of America..

I just wanted to revisit this notion of the supply situation getting tighter.

How do we reconcile that with your forecast of growing high single digit in Q2, Q3 and Q4 if the supply situation is getting tighter, how are you able to grow faster?.

Well, we've been planning for it. I think a couple of things. We've been investing in multi-sourcing of components, geographically diversing. We've been building capacity really tied to our plans that we published with our earnings model. And you can see by our balance sheet, we're building inventory.

So fundamentally, we're planning for it, and we're looking to execute..

And the other thing we've been doing is some redesigns to remove some of the bottleneck parts. And as those redesign sort of flow into the shipment stream in the second half of the year, that gives us some incremental flexibility.

So it's usually -- it's a few critical parts that bottleneck us that go through mad scrambles, negotiations, phone calls and things to try to unlock some supply from the suppliers during the course of the quarter. And we've been largely successful for the past 2 years doing that. We're still able to grow here in Q2, doing that.

It's just that the likely outcome is more and more sort of constraints on the top end of what we might otherwise be able to ship.

So for example, in the second quarter, Sanjay, roughly how much revenue and test are we thinking we've bottlenecked because of the line of sight we have on supply?.

Yes. So in test, I'd say it's in the $40 million range. And I'd say in IA, it's in the $10 million range. And that is outside of our high end of our range, which is really unprecedented for us..

Right. So that gives you some flavor of the magnitude. And that test in the past quarters might have been $10 million kind of numbers, small, but it's going from $10 million to $40 million, that's significant.

And we look out in Q3 and Q4, it's judgment still, but we still think everything that Sanjay says we've done positions us to grow with reasonable performance on clearing some of these critical parts and anticipating this constrained environment persisting and getting a little bit worse..

Very helpful. And then for my follow-up, Mark, I wanted to revisit this content growth argument when you move from one node to another. So a few questions on that.

First, could you give us a range of how much your average content grew in prior cycles and mobile SOCs when your customer moved from one generation to another? Was it 10% to 15%? 15% to 20%? If you could just give us some sense of what that range has been historically.

And the other thing I'm curious about is that will this require brand-new testers? Or can part of the deployed base be upgraded? Just how much incremental is this move to 3 nanometer so we're not surprised when it happens next year?.

I'm not sure what you mean by the content growth. So just clarify that for a minute..

Sure.

So how does one quantify complexity, right, that if your average tester per unit of that smartphone is x when that SOC moves from 5 to 3, then how much extra tester revenue can you get from that for the same number of units?.

Yes. So the -- first of all, that second part of your question, which was reuse of testers. Testers are absolutely reused node to node, generation to generation. And testers we put in 10 years ago are still being used for mobile device testing. So long, long product lives. They do need to be upgraded a bit now and then.

That's part of the flow, but there's no obsolescence event coming in the short term around testers. That's not in our midterm plan and anything else and hasn't been in the past. So the node transitions typically enable transistor count bumps, and that's what drives incremental test capacity because you -- the same device requires more test time.

And so I think you could expect something in the rough jump of 30%, 40% jump in transistor counts; drive, maybe a 20% jump in tester capacity. So you've got to do the math across the whole installed base of testers and everything else.

So I haven't recently sat down and tried to pencil that out, so I can't sort of do it off the top of my head, but that's roughly the ratio is that what a node transition will give us is that big jump in transistor count.

And then you can say, okay, just to take an example, if the installed base of testers is 100, and there's no unit growth, all there is a node transition of about a 30% to 40% complexity bump, you would need 20 more testers to cover that in that year. The model is much more complex than that, of course.

You'd have to sort of do it over years and model it. But that's the tips of the waves on it..

And next, we have Krish Sankar of Cowen..

I have two of them. Mark, thanks for the color on the industry market sizes.

Given that the incremental strength in SOC is coming from auto, and memory is kind of more -- towards NAND versus DRAM, is it fair to still assume that your market share in SOC and memory is going to be about 40% this year? Or do you think SOC may be slightly higher, memory slightly lower? Then I have a follow-up..

Yes. I think for the year, memory is probably still around 40, plus or minus 1% or so, but around 40. I don't think it changes significantly with this flash shift. In the case of -- I wouldn't characterize it as much of a change. It's also probably slightly short of 40 for the year.

And it will kind of depend on what happens in the supply chain issues as we get into Q4. I anticipate we'll be -- and we anticipate in our discussion here that we're going to be bottlenecked. The 30 -- $40-ish million were bottlenecked here in Q2 will likely grow as we get toward Q4.

And if that, in fact, happens, then we'll probably be 38% to 39% share. If we can unconstrain that, we can ship more testers off, it could be in the 40% range..

Got it. Got it. And then you kind of spoke about the 3-nanometer from a large customer next year. Historically, there's been a little bit of a headwind to gross margin when they spend.

I'm just kind of curious, should that be worse or similar to historical trends, if next year auto test flows and the tailwind you have this year from the Eagle test high-margin testers moderate as your large customer becomes a bigger portion in 2023?.

Yes. It's Sanjay. So I think it's a good observation that the mobility, we'll call it the bubble. If we see that in 2023 on a margin percentage, it will have an impact. But I will say that we are having investments that continually work to both add supply assurance, but also -- and give us flexibility but also drives from a bill of materials.

And we've been fighting the cost or the component inflation. But we plan to execute in our at our earnings model level of 59% to 60% would be our expectation..

Up next, we have Toshiya Hari of Goldman Sachs..

I had two as well. Mark, you talked about the hyperscale opportunity in your prepared remarks. I think you noted that some of the customer activity seems to be accelerating and that you've been pleased with your run rate.

I was hoping you could elaborate on that a little bit and to the extent possible, kind of speak to the timing of a potential inflection in that business. I realize that's sort of a medium- to long-term opportunity for you.

But curious to hear any new developments there?.

Yes, that's -- it's tough to speculate because there's two classes of hyperscaler silicon development that are going on. There's a class of development around new consumer products.

That one is incredibly difficult for us to forecast because it's unprecedented-type product introductions to see if the market will develop or will they even be introduced. So to me, those -- they're active, we're highly engaged, they're wildcards. Then there's another class that I would say is more compute, cloud infrastructure.

Chips going into the cloud for specialized. Could be AI applications going into the edge. Those are a little more, I would say, have precedented applications, and we have long-term sort of plans. And those, I expect are going to start ramping next year. I think some of these are going to ramp.

Now how material will they be? I think we're still talking from a tester point of view, tens of millions versus hundreds of millions of dollars of incremental revenue. So we're still going to be early innings, but that gives you some sense..

Got it. That's helpful. And then as a quick follow-up, maybe one for Sanjay. You guys seem to be executing really well from a gross margin perspective despite everything that's going on. I think you beat the midpoint of your guidance in Q1 by more than 100 basis points.

You're guiding to another higher than 60% quarter for Q2 despite everything that's going on. So I guess the question is, is this primarily a function of your largest customer being absent or at least being a small percentage of your revenue than typical in that driving a better mix? Or are there -- I know you guys are working on a bunch of things.

Is there anything sustainable that could drive margins above your long-term model?.

Yes. So in Q1, it was really a function of product mix and really operational efficiencies and execution that drove us beyond what we guided in Q2 and beyond. Fundamentally, we were growing IA; LitePoint is growing, as examples. And in 2022, we see those businesses having higher than corporate average margins.

I do believe that as we continue to work -- we have plans and we're working towards margin plans that are accretive. But let me remind you that there's been significant inflation and component costs and labor are increasing. So we feel like we manage the business to a 59% to 60% gross margin over the midterm.

We have internal plans that are challenging those to make them higher, but we're also realistic about some of the headwinds in play in the environment..

And we have Joe Moore of Morgan Stanley..

In terms of the supply constraints that you have, can you kind of frame that competitively? I feel like last year, you had sort of a better supply situation than Advantest did? Is that still the case? And any ramifications for market share in the more transactional parts of the business?.

Well, we're not inside Advantest to know a lot. But what we do know from the outside is their backlog's close to a year. Their customers are forced to order in advance around a year. And so yes, apparently, whatever is going on in terms of supply chain strategy, it's been slightly more favorable on our side.

But we've worked this since 2019, 2018, sort of -- as a sort of a business continuity planning exercise around a whole series of things that could have gone wrong in the world, we never anticipated COVID but generally built up inventory resilience and backups that have fared well for us for 2 years.

So it kind of -- we've been hoping we would get through all of this without any significant bottlenecks. And we're seeing our first sort of headwind here in test at about a $40 million bottleneck in Q2. So 5% of our revenue roughly. We might have been able to increase revenue 5%.

And maybe that's going to be about the percentage through the year that we're going to be bottlenecked. We hope that we can keep it at that, keep lead times in sort of a 6-month range in test. And incrementally, get some of Advantest customers to consider us as a more responsive supplier. We'll see..

And next, we have Sidney Ho of Deutsche Bank..

Just one question for me. Related to your largest customer, are you still expecting them to be a 10% revenue this year? And given normally, you have some good visibility into them in about this time April, June -- April, May time frame.

Is there much variability for the rest of this year?.

Yes. Sidney, it's Sanjay. Thanks for that question. So right now, our expectation is that we will not have that large customer be over 10%, consistent with what we thought in January..

And I think on the, is there anything for the rest of the year? I think for 2Q and 3Q, no, it's pretty locked in. 4Q, frankly, is a wildcard because that in past years has been a surprise for us. It depends on sort of the ramp in 2022, the early silicon prove-outs and all kinds of factors and other products that might be launching.

So fourth quarter is kind of still opaque to us. So I would say that if there's a potential for something in fourth quarter that we might not see yet, yes. But we'll be somewhat constrained there too, based on the earlier supply discussions..

And I see no further questions in the queue. I will turn the conference back over to Mr. Blanchard. Sir, you may continue..

Well, for the first time in over 40 quarters, we're finished in early. Thanks, everybody, for joining us. Look forward to talking to you in the days and weeks ahead. Bye, bye. ..

This concludes today's conference call. Thank you all for participating. You may now disconnect, and have a pleasant day..