InTest Corporation (INTT) is a designer, manufacturer and marketer of mechanical, thermal and electrical products that are used by semiconductor manufacturers in conjunction with automatic test equipment, (ATE), in the testing of integrated circuits, (ICs). Beyond its blue-chip portfolio of semiconductor manufacturers, the firm has diversified into non-semi thermal testing products. This has the effect of diversifying revenue and opens the company up to new markets. In the test equipment world change is good; be it the broad switch to mobile computing, the march to finer geometries, or the growth of electronic content in automobiles more chip content means more testing for inTest.
InTest has been trading around book value recently due to the fact that investors tend to view it solely as a Semiconductor Equipment stock. While industry conditions became increasingly challenging throughout the third quarter as a result of a number of capital equipment suppliers and semiconductor companies delaying certain capital expenditures, inTest remained profitable and delivered third-quarter financial results that exceeded its guidance for both revenue and earnings per share.
Two things separate inTest from other capital equipment stocks. First it is building a presence in non-semiconductor thermal testing. The build to test model makes it unique. Second the Electrical Division has emerged as a very profitable segment with long cycles of working with the client.
Focus on Thermal
Over the last few years inTest has been transforming itself through the strategic diversification of its Thermal products segment. As a result the company now addresses growth markets in both the semiconductor and non-semiconductor areas, which include automotive, consumer electronics, defense aerospace, telecommunications and most recently the nuclear market.
This non-semiconductor revenue should be a bit more inelastic and run on a different cyclical time frame than the semiconductor business. Non-semi revenue grew from 19% of total revenue ($9 Million) in 2010 to 29% of total revenue ($13 Million) in 2011. The firm's goal is to grow Non-Semi revenue to 50% of revenue. The potential for Non-Semi is enormous because it incorporates any market that uses thermal.
InTest is benefiting from the increasing need for temperature testing of circuit boards and specialized components.
The firm competes mainly on two levels.
- Wafer Level
- Discrete product Level
Wafer level is a solid business for the firm but will never be a significant growth engine. Standards in this area are not stringent and in the past 10 years prober manufacturers have taken over. InTest serves smaller OEMs in this area with its Thermochuck product which tests semiconductor wafers at high and low (-65 to +400 C) temperatures at the wafer probing station.
The Discrete product level is where inTest will experience growth over the next several years. These products provide the ability to characterize and stress test a variety of materials over extreme and variable temperature conditions that can occur in actual use.
The focus of is on four main areas solving unique and challenging temperature problems.
- Sensor Technology
- Fiber Optics
- Defense and Aerospace
inTest solves unique and challenging temperature problems
Many of the thermal businesses the firm competes with are large companies that have standard products. The only model out there that has been in industrial thermal test to date is one where a customer must modify its test. InTest's business model is quite the opposite. The company asks the question "what do you have to do to test?" and builds the equipment to fit the product. This is a model that's not generally been used out there because most of the companies it competes with are very large. Being small and able to move quickly allows inTest to win these custom jobs.
Acquisition in Thermal
In January 2012, Temptronic Corporation, a member of inTest Corporation's Thermal Solutions Group, closed on the acquisition of Thermonics, Inc. With a purchase price for the assets of approximately $3.8 million in cash (which included net working capital of approximately $1.1 million),Thermonics is expected to further enhance inTest's presence in the ATE industry as well as provide additional leverage into growth industries outside of the semiconductor industry. The integration of the acquisition is on track and management expects a 30 percent net contribution margin on incremental revenue, which is expected to improve sequentially throughout 2012, eventually reaching as much as 35 percent to 36 percent over time.
The breakout quarter for the electrical Division was the June quarter. Electrical (the smallest division) was for the June quarter, as well as on a year-to-date basis, the most profitable segment. Electrical had a very strong Q2 with sales of $4.0 million, substantially increasing 89% over Q1 electrical sales. These sales were substantially driven by both an end-user customer and an OEM customer. (Click here for Form 8-K regarding the earnings call.) Given the weakness in semiconductor this division showed weaker sales and bookings in quarter three. However it appears sales are set to increase at one of the firm's larger existing customers as a new interface design will take the place of a competitor's product. This has the result of offsetting weakness with expanded market share.
The electrical business is a little different in that it's a long-term sale and the product is very engineering intensive, and so you work with the customer for several months before you ship the first product. Once you ship that product and if they're ramping, you get that business no matter what because it's very difficult for another supplier to break in since it wasn't part of that development cycle. There tends to be an overall disconnect between the general economy of the semiconductor world and the way those sales go.
Responding to questions regarding sustainability, Senior Vice President and General Manager of inTest's Electrical and Mechanical Products Segment Dan Graham, was positive and is currently seeing reasonably strong bookings at this point still for electrical -- and it's across several fronts. The firm is capitalizing on strength in smartphones, laptops and the automotive electronics segment.
The takeaway in electrical is if you have very long development times with customers, it is very difficult for your competitors to make any headway after these contacts are established.
Here's how I view the valuation of inTest. (Source for background info: Investment Valuation, Aswath Damodaran.)
Two-Stage Free Cash Flow to Equity Model
FCFE = Net Income - Net Capital Expenditure - Change in Net Working Capital + New Debt - Debt Repayment
- The firm is expected to grow at a higher growth rate in the first period.
- The growth rate will drop at the end of the first period to the stable growth rate.
Rationale for Using the Model
As the non-semiconductor business ramps up to 50% of total revenue, we expect the firm to grow at a higher overall rate than the industry. As these products mature and the firm faces more competition, we expect the growth rate to level off.
Weakness of the Model
As you add more layers to the model it becomes more sensitive to the assumptions you make. The growth may look more "lumpy" than we have it in the model.
We used the following inputs:
- A five-year period with an earnings growth rate of 8.0% and a discount rate of 13.77%.
- A continuing period assumed to go on forever, with earnings growing at 5% and a discount rate of 13.05%.
With these inputs we arrive at a target price of $7.23.
Our price target of $7.00 per share is the average of 11.8 times our 2013 EPS estimate and our two-stage model.