Semiconductor testing company Teradyne (NASDAQ:TER) beat analysts' expectations in Q2 FY2023, with revenue down 18.6% year on year to $684.4 million. Guidance for next quarter's revenue was also $680 million at the midpoint, 1.27% above Consensus. Teradyne made a GAAP profit of $120.1 million, down from its profit of $197.8 million in the same quarter last year.
Teradyne (TER) Q2 FY2023 Highlights:
- Revenue: $684.4 million vs analyst estimates of $658.1 million (4% beat)
- EPS (non-GAAP): $0.79 vs analyst estimates of $0.66 (20.1% beat)
- Revenue guidance for Q3 2023 is $680 million at the midpoint, above analyst estimates of $671.5 million
- Free cash flow of $103.5 million is up from -$22.1 million in the previous quarter
- Inventory Days Outstanding: 112, down from 123 in the previous quarter
- Gross Margin (GAAP): 58.8%, down from 60.2% in the same quarter last year
With most major chip manufacturers as customers, Teradyne (NASDAQ:TER) is a US-based supplier of automated test equipment for semiconductors as well as other technology and devices.
Teradyne (NASDAQ:TER) was founded in 1960 by MIT classmates Alex d'Arbeloff and Nick DeWolf and remains headquartered in Massachusetts. The company went public on the NYSE in 1970.
Throughout the semiconductor manufacturing process, chips need to be tested to ensure they comply with accepted industry standards and are accurate and functional. Since semiconductor manufacturing is a complex and resource-intensive process, detecting flaws early in the process means saving money and time.
Historically, much of the testing was performed manually, leading to bottlenecks. Teradyne speeds testing up through automation, and their testing products range from simple, single digital measurement devices to complicated systems containing multiple instruments that automatically reveal faults on wafers or in packaged parts. This automation ensures quality control while increasing speed to market and improving production yields.
In addition to automated semiconductor testing equipment, Teradyne systems are also used to ensure the readiness of aerospace electronics systems, such as tactical aircraft and missile systems. The company also provides solutions for testing the reliability of hard drives and Wi-Fi, Bluetooth and cellular chips.
Competitors in automated testing equipment include Advantest Corporation (TSE:6857), Cohu (NASDAQ:COHU), Keysight Technologies (NYSE:KEYS), and Rohde & Schwarz.Sales Growth
Teradyne's revenue growth over the last three years has been unimpressive, averaging 3.06% annually. This quarter, its revenue declined from $840.8 million in the same quarter last year to $684.4 million. Semiconductors are a cyclical industry, and long-term investors should be prepared for periods of high growth followed by periods of revenue contractions (which can sometimes offer opportune times to buy).
Even though Teradyne surpassed analysts' revenue estimates, this was a slow quarter for the company as its revenue dropped 18.6% year on year. This could mean that the current downcycle is deepening.
Teradyne's revenue growth has slowed over the last three quarters and its management team projects growth to turn negative next quarter. As such, the company is guiding for a 17.8% year-on-year revenue decline, but Wall Street thinks there will be a recovery next year. Consensus estimates call for 7.07% growth over the next 12 months.
Product Demand & Outstanding Inventory
Days Inventory Outstanding (DIO) is an important metric for chipmakers, as it reflects a business' capital intensity and the cyclical nature of semiconductor supply and demand. In a tight supply environment, inventories tend to be stable, allowing chipmakers to exert pricing power. Steadily increasing DIO can be a warning sign that demand is weak, and if inventories continue to rise, the company may have to downsize production.
This quarter, Teradyne's DIO came in at 112, which is 41 days above its five-year average. These numbers suggest that despite the recent decrease, the company's inventory levels are higher than what we've seen in the past.
Pricing Power
In the semiconductor industry, a company's gross profit margin is a critical metric to track because it sheds light on its pricing power, complexity of products, and ability to procure raw materials, equipment, and labor. Teradyne's gross profit margin, which shows how much money the company gets to keep after paying key materials, input, and manufacturing costs, came in at 58.8% in Q2, down 1.4 percentage points year on year.
Despite declining over the last 12 months, Teradyne still retains reasonably high gross margins, averaging 58.2%. These margins point to its solid competitive offering, disciplined cost controls, and lack of significant pricing pressure.
Profitability
Teradyne reported an operating margin of 22.1% in Q2, down 8.2 percentage points year on year. Operating margins are one of the best measures of profitability because they tell us how much money a company takes home after manufacturing its products, marketing and selling them, and, importantly, keeping them relevant through research and development.
Teradyne's operating margins have been trending down over the last year, averaging 22.8%. This is a bad sign for Teradyne, whose margins are already below average for semiconductor companies. To its credit, however, the company's margins suggest modest pricing power and cost controls.
Earnings, Cash & Competitive Moat
Analysts covering Teradyne expect earnings per share to grow 23.5% over the next 12 months, although estimates will likely change after earnings.
Although earnings are important, we believe cash is king because you can't use accounting profits to pay the bills. Teradyne's free cash flow came in at $103.5 million in Q2, up 48.5% year on year.
As you can see above, Teradyne produced free cash flow of $462.9 million in the last year, a decent 15% of revenue. This FCF margin puts Teradyne in a position to reinvest, but we wouldn't mind seeing its cash flow conversion improve a little.
Teradyne's average return on invested capital (ROIC) of 50.6% over the last five years implies that it has a strong competitive position and was able to invest in profitable growth over time.
Key Takeaways from Teradyne's Q2 Results
With a market capitalization of $18.2 billion, a $708.4 million cash balance, and positive free cash flow over the last 12 months, we're confident that Teradyne has the resources needed to pursue a high-growth business strategy.
We were impressed by how significantly Teradyne blew past analysts' earnings per share (EPS) expectations this quarter, driven by a nice revenue beat and even stronger non-GAAP operating profit beat. We were also glad that its inventory levels shrunk. On the other hand, although margins beat expectations, they are deteriorating year-on-year. Also while next quarter's revenue guidance was ahead, non-GAAP EPS guidance was slightly below expectations. Overall, this quarter's results were not perfect but still seemed fairly positive . The stock is up 1.84% after reporting and currently trades at $116.75 per share.
Is Now The Time?
When considering Teradyne, investors should take into account its valuation and business qualities, as well as what happened in the latest quarter. We think Teradyne is a solid business. However, its revenue growth has been very weak, and analysts expect growth rates to deteriorate from there. But on a positive note, while its operating margins are below average vs. semiconductor peers, the good news is its high ROIC suggests it is well run and in a strong position for profit growth, and its gross margins are suggestive of good pricing power.
Teradyne's price to earnings ratio based on the next twelve months is 31.3x. There are definitely things to like about Teradyne and looking at the semiconductors landscape right now, it seems that the company trades at a pretty interesting price point.
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