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Cohu, Inc. (NASDAQ:COHU)

Q3 2008 Earnings Call Transcript

October 23, 2008, 05:00 pm ET

Executives

James Donahue – President and CEO

Jeff Jones – VP, Finance and CFO

Analysts

Kelly Anderson – Sidoti & Company

Brad Evans – Heartland

Operator

Greeting ladies and gentlemen and welcome to the Cohu Incorporated third quarter 2008 earnings call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. James Donahue, President and Chief Executive Officer. Thank you, Mr. Donahue. You may begin.

James Donahue

Good afternoon everyone and welcome to this conference call that covers Cohu’s results for the third quarter ended September 27, 2008. With me today is our Chief Financial Officer, Jeff Jones.

I hope you have a copy of our earnings release and have had an opportunity to review it. But if you need a copy, you can obtain one from our website, cohu.com, or by contacting Cohu Investor Relations at 858-848-8106.

I’ll provide an overview of our results and comment on the quarter. Jeff will then take us through the financial statements and I’ll conclude with our view of the business environment and guidance for the fourth quarter and we’ll then take your questions.

First though, Jeff has information concerning forward-looking statements, estimates, and other matters that we will discuss in today’s call.

Jeff Jones

Before we go on, I must remind you that the company’s discussion this afternoon will include forward-looking statements reflecting management’s current expectations concerning certain aspects of the company’s future business. These statements are based on current information that we have assessed, but which by its nature is subject to rapid and even abrupt changes.

Forward-looking statements include our comments regarding the company’s expectations regarding industry conditions and future operations and financial results and any comments we make about the company’s future in response to your questions.

Our comments speak only as of today, October 23, 2008, and the company assumes no obligation to update these comments. The company’s actual results may differ materially from those stated or implied by our forward-looking statements due to risks and uncertainties associated with the company’s business, which include but are not limited to the concentration of our revenues from a limited number of customers, our ability to convert new products under development into production on a timely basis, support product development and meet customer delivery and acceptance requirements for next generation equipment, failure to obtain customer acceptance resulting in the inability to recognize revenue and accounts receivable collection problems, inventory write-offs, intense competition in the semiconductor test handler industry, our reliance on patents and intellectual property, compliance with U.S. export regulations, the cyclical and unpredictable nature of capital expenditures by semiconductor manufacturers, difficulties in integrating acquisitions and new technologies, and other risks addressed in Cohu’s filings with the Securities and Exchange Commission, including our most recently filed Form 10-K and Form 10-Q.

We assume no obligation to update any of the information shared on this conference call. Further, our comments and responses to any questions will not make reference to any specific customers as we are precluded from disclosing such information by our non-disclosure agreements.

James Donahue

Okay thanks, Jeff. Cohu’s third quarter sales were $48 million compared to $64.5 million in last year’s third quarter and $51.8 million in the second quarter 2008. Net income was $37,000 essentially breakeven on this lower sales volume. Orders were $46 million compared to $50.1 million from the second quarter 2008. Third quarter orders from semiconductor equipment were $31 million compared to $39 million in the second quarter, and backlog at the end of the third quarter was $52 million.

Unit order breakdown from semiconductor equipment in the third quarter was high-speed handlers 41%, thermal handlers 14%, thermal sub-systems 38% and other systems 7%.

Despite challenging business conditions our operations are extremely busy and we made significant progress in the third quarter. Delta designs MATRiX handler was approved for wireless test applications at a major U.S. based IDM. Our EDGE handler was approved for testing of home entertainment devices by a major European based Semiconductor Company.

And following an extensive evaluation process, our Summit handler was qualified for testing of small form factor devices at two major U.S. based microprocessor manufactures. While we don’t expect any incremental sales of thermal handlers for these applications in the near term, we are already seeing an increase in orders for handler conversion kits.

We completed the first data system of our ETC-3000 that incorporated Delta’s latest modular thermal technology in a compact footprint for engineering and validation applications. We expect to ship the first system in the fourth quarter. The ETC-3000 uses the same thermal technology that is at the heart of our next generation thermal production handler that’s now in development.

This enables customers to accurately and consistently characterize in the engineering lab and the pre production environment, the test performance that they will achieve as they ramp production. The development of our next generation thermal handler is progressing very well and we expect to complete the initial beta unit in the fourth quarter. Customer testing will begin soon thereafter and subject to market conditions, production shipments could begin in mid 2009.

As we have discussed previously, we are manufacturing dedication kits, the package specific tooling that configures our test handlers for ICs at a production facility we established in the Philippines in 2004. This operation has been highly successful in providing cost effective solutions with shorter lead times to our customers, the majority of whom are located throughout the Southeast Asia region. We just recently completed an expansion that increased production capacity by 60% in this facility and we plan to further expand the operation in 2009.

Last year we begin planning for the transition of certain of our handler manufacturing Southeast Asia. We determined that the most cost effective alternative was to utilize an experienced and qualified contract manufacturer. Delta’s EDGE handler, a mature and high volume system in our high-speed handling line was the logical first handler to transition.

Earlier this year we began that process and it’s going even better than we anticipated. Last quarter the initial systems manufactured at the Singapore based CM were shipped to our main facility here in California for testing and validation. We are very pleased with the results and expect continue the migration of manufacturing to contract manufacturers in lower cost geographies in Asia. Overtime and with sufficient volumes we believe that we will achieve gross margin improvement of up to seven to 10 percentage points.

Turning to our non-semiconductor equipment operations, as a result of the transition of handler manufacturing we have been able to free up space in our primary facility in Poway, California. Cohu’s electronics division will be relocated from leased space into this facility next month resulting in annualized savings of approximately 750,000.

Operating results at the electronics division were essentially flat sequentially. Camera products developed over the last 18 months are gaining traction and we have growing pipeline of opportunities particularly in the high-end security and surveillance area, and we expect this will lead to improve results in the fourth quarter.

Results at our microwave operation fell short of expectations primarily as a result of administrative delays and obtaining customer acceptance on several larger contracts and a shortfall in business that was expected to be booked and shipped in the third quarter. EMS orders for the third quarter reached $10.2 million, the highest since Q4 of 2005 and the second highest quarterly bookings ever for BMS. We expect BMS to report improved operating results in the fourth quarter.

Jeff will provide details on Cohu’s financial results for the third quarter.

Jeff Jones

Semiconductor equipment related revenues for the third quarter of fiscal ’08 were approximately 77% international and 23% domestic. International sales were distributed 87% Asia-Pacific 10% the Americas and 3% other. We recorded approximately $1.1 million of FASB 123 (NYSE:R) stock based compensation expense in Q3.

The comments I make regarding operating expenses include the impact of FASB 123 (R). Gross margin was 36.6% in Q3 compared to 35.6% in Q2 and it was inline with our projection. We expect the gross margin in Q4 to be approximately three points lower than Q3 due to lower volume and product mix.

R&D expense was $9.1 million in Q3, $10.4 million in Q2 and was slightly lower than our projection due to reduced product development cost at our semiconductor equipment business. We expect Q4 R&D expense to be slightly lower than Q3.

SG&A expense was $9.7 million in Q3 compared to $9 million in Q2 and slightly higher than our projection due to a formula driven increase in the accounts receivable reserve at our semiconductor equipment company. We expect the SG&A expense in Q4 to be lower than Q3 and approximately the same as Q2.

Interest and other income was $1.4 million in both Q3 and Q2. Our effective tax rate for the first nine months of 2008 was 44% compared to 43% at the end of Q2. Our Q4 rate is dependent on our pre-tax income level and will benefit from the Federal R&D credit that was extended on October 3, the credit is retroactive and therefore the benefit for all of 2008 will be recorded in Q4. Net income per share in Q3 was computed based on $23.4 million weighted average share and share equivalents from stock options and RSUs.

Moving to the balance sheet, cash and investments were $171.2 million at September decreasing approximately $4.6 million from June, due to an increase in inventory of $4.5 million related primarily to the initial production of our MATRiX handler. Net accounts receivable were $34.5 million at September compared to $36.3 million at June and represented about 65 days’ sales outstanding. The decrease in accounts receivable was due to steady cash collection and lower shipments in Q3.

Additions to property, plant and equipment for the first nine months of fiscal ’08 were approximately $2.1 million and depreciation and amortization was approximately $5.1 million. Deferred profit at September was $4.8 million compared to $6 million at June. Deferred profit relates to revenue deferrals pursuant to SAB104 primarily on Delta test handlers and thermal subsystems and BMS products. Our deferred revenue at September 27, 2008 was approximately $7.8 million.

James Donahue

Okay, thanks Jeff. Conditions in the backend semiconductor equipment industry were relatively flat for the first half of 2008, but began deteriorating mid year. Last week semi reported that preliminary orders for test and assembly equipment for September declined 47% from September 2007 and that the book-to-bill ratio drop to 0.7.

The effects of the global financial crisis are spreading rapidly through the supply chain and have accelerated the decline in business not only for semiconductor equipment manufacturers, but in semiconductor devices and technology in general. Recent earning releases from technology companies and others indicate that order rates declined sharply towards the end of the third quarter.

Business and consumer confidence have severely eroded and in this environment it’s highly unlikely that capital spending will expand. It seems clear or less that business conditions will remain difficult well into next year and accordingly we will continue to reduce expenses wherever possible. For the fourth quarter, we estimated the sales will be approximately $37 million.

Despite the current environment, we remained highly optimistic and enthusiastic about the long-term prospects for our industry, but even more importantly we have never been more excited about our products and about our competitive opportunities. We recently introduced the MATRiX High Speed Pick-and-Place handler, targeted at a wide range of consumer device applications with industry leading high parallelism and fast index time. We are also well along with the development of our next generation thermal handler that incorporates our proprietary and enabling thermal technology

The transition of handler manufacturing to Asia-based contract manufacturers is well underway as well and we’ll improve our gross margins. So, while we plan to further reduce spending during this downturn we will continue to invest the most strategic programs and initiatives that will position us for success with our customers and lead to market share gains and improved financial performance. While the current economic headwinds are beyond our control, we have never felt better about our long-term prospects. With our strong products and profit improvement activities, we can power out of the downturn with great performance when business conditions improved.

And Scott, that concludes our prepared remarks and we’ll take questions please.

Question-and-Answer Session

Operator

Your first question comes from Kelly Anderson – Sidoti & Company. Your line is now open.

Kelly Anderson – Sidoti & Company

Hi, guys. Thanks for taking my questions. Just a quick one on the guidance for the fourth quarter; it looks like orders came in at 46 and backlog was relatively flat. Are you expecting any cancellations or delays in this $37 million guidance for the fourth quarter?

James Donahue

No cancellations Kelly, as far as delays possibly.

Kelly Anderson – Sidoti & Company

Okay and then just with respect to the new MATRiX Handler, you sort of gave a qualitative overview of what that thermal handler could ramp, it could like in 2009. It looks like you getting very good initial traction with MATRiX. Can you sort of give us some sense of, how you see that product ramping over the next six months to a year?

James Donahue

I think six months ago, I would have been in a much better position to give some fairly good insight into that. In this environment, it’s extremely difficult, the fact is that most of our customers have really pulled in the reins and borrowing some change in economic condition that I think we’ll open up the capital spending, I just can’t predict what’s going to happen, what the ramp is going to look like. As I have indicated in my remarks, we think it’s going to be a pretty difficult environment for the next few quarters and predicting specific activities like the ramp of MATRiX is just really not possible when our customers have essentially clamped down pretty tightly for the moment.

Kelly Anderson – Sidoti & Company

Fair enough. Thanks very much.

James Donahue

Thanks Kelly.

Operator

Thank you. Your next question comes from Brad Evans from Heartland. Your line is now open.

Brad Evans – Heartland

Thanks for taking my question. I guess first and foremost; Jeff, do you have a cash flow from operations number for the quarter or for your year-to-date?

Jeff Jones

Yes, cash flow from operations, I’ve got $6.8 million year-to-date.

Brad Evans – Heartland

Okay and your full-year capital budget for 2008 and just I guess preliminary thoughts on 2009, I guess in light of the environment. What your thoughts on CapEx?

James Donahue

I think that the major CapEx for 2009, Brad is, likely to be a further expansion of our manufacturing operation in Philippines and we think that’s a wise investment to make because we’re achieving cost reduction gross margin improvement by manufacturing our handler conversion kits over there. So, we’d like to build that out, we did a 60% expansion in 2008 and we might just do something slightly less than that, which fill out our facility over there in 2009. I think that’s probably around a $2 million investment.

Brad Evans – Heartland

So, there will be $2 million above your maintenance spend?

James Donahue

I’m sorry, $2 million above what?

Brad Evans – Heartland

There would be in addition to just maintenance CapEx, I’m assuming?

Jeff Jones

Yes, you’re right.

James Donahue

Yes, that would be $2 million in capacity additions in the Philippine facility.

Brad Evans – Heartland

On a base of – you are thinking, what type of number for 2009 then?

James Donahue

Total CapEx?

Brad Evans – Heartland

Yes sir.

Jeff Jones

Yes, total CapEx generally runs about $4 million and that $2 million then would be included in that $4 million total.

James Donahue

So, to say maybe $4 million to $5 million CapEx for next year, something like that we’re actually in the process of putting together our 2009 plan. Anyway, this is the timing when we do that and under current business conditions everything is being re-scrutinized anyway.

Brad Evans – Heartland

Okay, below the grow profit line your operating expenses were $18.8 million this quarter. So, if you back off the $1.1 million for stock-based comp that gives you $17.7 million of cash operating expenses? Are we to assume that for the fourth quarter that number should comedown slightly or is that to conservative?

James Donahue

You’re speaking about R&D and SG&A essentially, right?

Brad Evans – Heartland

That’s right. Yes, Jim that’s right.

James Donahue

I think its right. I think, Jeff indicated it’s going to be – we expect it to drop, right in the fourth quarter.

Jeff Jones

Right, yes. We guided down on R&D as well as SG&A, so both of those will be coming down.

Brad Evans – Heartland

Could you give us senses to magnitude? I mean, is it bigger than a breadbasket?

Jeff Jones

Well, SG&A, it will be very similar to what the Q2 number, which was $9 million in Q2. So, we think it will be similar to Q2 for SG&A.

James Donahue

A little lower. We’re expecting it to a little lower than Q3, but about the same as Q2.

Brad Evans – Heartland

And you see R&D down directionally, as well?

Jeff Jones

We do.

Brad Evans – Heartland

Okay.

James Donahue

A lot of that has to do Brad, with just the timing of material purchases for our development project particularly thermal handler project, which is most of the material purchases behind us.

Brad Evans – Heartland

Okay, so when you are talking about the seven to 10 percentage point improvement in gross margins as you continue to outsource to the contract manufacturers, should we think about that is off of kind of the 36% level that you are currently at assuming that overtime, you get back to something north of $50 million on the quarterly base? Is that correct?

James Donahue

Yes.

Brad Evans – Heartland

And would that be sometime in 2009 or beyond 2009 that you would hope to be able to show that improvement?

James Donahue

At this point, I don’t know when we are going get a numbers like $50 million, that’s the whole rub right now; we are entering in a very difficult period. So, I give you some maybe some color on that. Let’s say we’ll get to the $50 million in mid-next year.

Brad Evans – Heartland

Yes.

James Donahue

We wouldn’t achieve the full 7% to 10%. I would say, it’s going to be a process of getting there and with decent business condition, decent shipment levels. I think we’ve get fully there in 2010, that’s what our plan looks like now.

Brad Evans – Heartland

That’s very helpful and just my last question just pertains to – I tip my hat to you guys, I mean clearly you managed in the business conservatively in the touch environment and obviously cash balance provides a lot of safety in a difficult environment. You just recognizing the stock is trading, I guess right around tangible book value or stated book value? Is there any thought as to the merits of a share buyback even a modest one?

James Donahue

Sure and we’ve talked about that before and we had questions on that before and I think Cohu, like just about every other company these days is very depressed evaluation. So, yes we are talking with the board about share buyback. We have not approved one, if and when we do, we would announce that. I still believe that the best long-term returns for our shareholders is going to be through a strategic acquisition that expand our long-term growth prospects, our serve market, but if there is no such acquisition on the horizon then at these levels certainly, I think responsible board has to look at the merits of the share buyback.

Brad Evans – Heartland

All right, thanks for taking questions.

James Donahue

Thank you, Brad.

Jeff Jones

Thanks Brad.

Operator

Your next question comes again from Brad Evans – Heartland. You may ask your question.

Brad Evans – Heartland

I guess just dovetail on your comment about the M&A environment or that the opportunity there, can you just give us a 35,000 foot view of what the M&A landscape looks like without getting in this specifics? Is it a good environment right now?

James Donahue

I don’t know that the environment for M&A today is any different then it normally as I guess expect maybe distressed companies that might be facing financial difficulties in view of the expected prolonged downturn, but our criteria for acquisitions has always been looking at the long-term fixture, looking at companies that are going to expand our serve market, provide complementary products and where their opportunities for synergies. I mean those tend not to be distressed companies.

Brad Evans – Heartland

Okay and I’m just curious in term so of recognizing that Jim, I understand your point about the environment. It’s obviously very difficult and visibility is not good. Could you just give us, your thought as to the level of capacity utilization that you are seeing in the backend in terms your tools and whatever information you have there would be helpful to help us understand kind of, if indeed we go through a period of maybe lackluster demand for a quarter or two? Does that setup, obviously as demand or the semiconductor industry show some improvement that would I guess some – we want to think that there could be a fairly strong recovery, especial when you consider the new products cycle you have coming with the MATRiX and the Pyramid?

James Donahue

Yes, I think this is not industry wide data, but just recently I had some feedback from Asia that quoted utilization rate at a major IDM in the 80% to 85% range and at sub-cons in the 70% range. I do agree with your conclusion that or your prediction that when business recovers it’s likely to recover shortly. I mean that’s the way it’s always been in this industry and I think the current difficult economic conditions are just exacerbating that.

So, I think customers are going to wait, if they waited until the 11 hour historically, they’re going to wait for five minutes to midnight before they pull the trigger on CapEx these day for over the next few quarters. So, I think we have to be prepared for a very sudden increase in demand. Fortunately, we reduced lead times over the last couple of year. We deal with that and I think we’ll be in a good position in respond.

Brad Evans – Heartland

Okay, thanks for the follow-up. I appreciate it.

James Donahue

Thank you, Brad.

Jeff Jones

Thank you, Brad.

Operator

Ladies and gentlemen, at this time there are no questions in queue. (Operator instructions) Mr. Donahue, there are no further questions at this time. Now, I would like to turn the floor back over to you for closing comments.

James Donahue

Thank you for attending today’s call and we look forward to speaking to you when we report Cohu’s fourth quarter earnings results. Thank you and good day.

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