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Cohu, Inc. (NASDAQ:COHU)

Q3 2009 Earnings Call Transcript

October 21, 2009 4:30 pm ET

Executives

James Donahue – President and CEO

Jeff Jones – VP, Finance and CFO

Analysts

Vernon Essi – Needham & Company LLC

Kelly Anderson – Sidoti and Company

Operator

Greetings, and welcome to the Cohu Incorporated third quarter 2009 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, James Donahue, President and CEO for Cohu Incorporated. Thank you. Mr. Donahue, you may begin.

James Donahue

Good afternoon, everyone, and welcome to this conference call that will cover Cohu’s results for the third quarter that ended September 26, 2009. With me today is Jeff Jones, our Chief Financial Officer. 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 may obtain one from our website, cohu.com or by contacting Cohu Investor Relations at 858-848-8106.

I will provide an overview and comments on Cohu’s results for the third quarter and discuss the current business environment. Jeff will take us through the financial statements and then we will take your questions. But before that, Jeff has information concerning forward-looking statements, estimates, and other matters that we will discuss in today’s call.

Jeff Jones

Thanks, Jim. 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 21st, 2009, and the company assumes no obligation to update these comments.

Certain matters discussed on this conference call, including statements concerning Cohu's new products and expectations of business conditions, orders, sales, and operating performance are forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from those projected or forecasted.

Such risks and uncertainties include, but are not limited to, inventories, goodwill and other intangible asset write-downs; 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; reduced demand for our products as a result of the global economic crisis; customer orders may be canceled or delayed; the concentration of our revenues from a limited number of customers; intense competition in the semiconductor test handler industry; our reliance on patents and intellectual property; compliance with US export regulations; and the cyclical and unpredictable nature of capital expenditures by semiconductor manufacturers.

These and other risks and uncertainties are discussed more fully in Cohu’s filings with the Securities and Exchange Commission, including the most recently filed Form 10-K and Form 10-Q. Cohu assumes no obligation to update the information in this release. 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. This was a strong quarter for Cohu. Sales were 44.1 million and exceeded guidance of 40 million, as a result of higher semiconductor equipment sales. We are very pleased to return to profitability on a non-GAAP basis, and each of our three business segments was profitable. Non-GAAP net income for the third quarter was 1.7 million or $0.07 a share compared to net income of 1.2 million or 0.05 per share in last year's third quarter, and a net loss of 1.4 million or $0.06 per share in 2009's second quarter.

The improved net income is the result of a 440 basis points improvement in gross margins, compared to the second quarter, arising from favorable product mix and the impact of cost reduction actions taken during the downturn. Third-quarter orders for semiconductor equipment increased 41% compared to the second quarter and unit orders were as follows. High-speed handlers 76%, thermal handlers 22%, and other products 2%.

Customer forecast strengthened as the quarter progressed and this trend has continued into the fourth quarter. Orders for handling equipment were broad based across customers and products. Unit orders for pick & place handlers were at the highest levels since the first quarter of 2008 and orders for gravity handlers were the highest since the third quarter of last year. Several of our historically largest customers who have not purchased handlers in over a year placed multi-system handlers in the third quarter and continue to have strong forecast.

A major US IDM ordered multiple full temperature range Castle handlers in response to a surge in demand for automotive ICs. A major US graphics IC company placed a multiunit ordered for our Summit handlers for use in testing next-generation GPUs. We received initial orders from a large US-based IDM for a new high parallel fast index time MATRiX that will be used by this customer for testing high performance analog ICs. And we're very excited about a major win for Rasco as a large IDM placed a multi-system order after selecting Rasco's strip handler.

This customer just placed an even larger follow-on order for more systems. We also booked additional orders for Pyramid, our next-generation handler that incorporates our proprietary thermal technology. Pyramid successfully passed a critical performance qualification milestone at the customer's validations site and we expect the production ramp to begin in the first half of next year. In the cyclical backend semiconductor equipment industry, we are familiar with sharp and sudden changes in business, as we have seen during this latest and severe industry downturn. The customer tone changed for the positive in the third quarter from a lack of visibility to tangible and increasing forecast with a need for fast deliveries.

It seems that customers have been surprised by increased demand and that demand is substantial in some cases. Having resisted adding capacity during the recession, they are now struggling to keep up, and we are under extreme pressure to pull in our deliveries. As a result, we are delaying the transfer of certain handler products to our Asia based contract manufacturers and we will continue to build them in our California factory until our CMs are fully qualified, ramped and in a position to meet customer delivery requirements.

Turning to our other businesses, Cohu's electronics division was again profitable in the third quarter and for the first nine months of 2009. Beta testing of our new high-definition PTZ camera is proceeding successfully at a municipality in Southern California. Demo units have been shipped to a Cohu's sales force and production release is scheduled for this quarter. We will then further expand our high-definition product line early next year with derivative fixed and dome HD cameras. We expect these new high-definition products to provide excellent growth opportunities in both traffic and security markets.

The strong performance in our mobile microwave communications business continued as BMS had another excellent quarter. The improvement in this business is clear in year-over-year comparisons. For the first nine months of 2009, sales increased 22%, and operating results improved from a loss of 4.1% in 2008 to operating income of 17.2% this year, an increase in dollars of 5.3 million. BMS continues to grow revenue and profit and is benefiting from a strong competitive position and products for the law enforcement, government surveillance, and tactical UAV markets. For the fourth quarter, we expect sales to be between 48 million and 53 million.

And now, Jeff will provide details on Cohu's financial results.

Jeff Jones

Semiconductor equipment related revenues for Q3 were approximately 83% international and 17% domestic. International sales were distributed 90% Asia-Pacific, 7% the Americas, and 3% other. We recorded approximately 900,000 of stock-based compensation expense and approximately 1.6 million of purchased intangible amortization expenses in Q3. The comments I make today include the impact of these items.

Gross margin was 36.8% in Q3 compared to 32.1% in Q2, and as Jim said, was higher due primarily to favorable product mix. Also, as noted in Jim's remarks, as a result of our accelerated production ramp in Q4, the manufacturing transition to Asia will be delayed and our new test handlers will be produced in our Poway plant, rather than by our contract manufacturers. This combined with typical new products start up costs will impact gross margin, and as a result, we expect gross margin in Q4 to be approximately 29%.

We expect gross margin to improve in the first half of 2010 as we transition to manufacturing subcontractors and work through the production startup. Total operating expense was 17 million in Q3 compared to 16.4 million in Q2 and in line with our projection. R&D expense was 8.3 million in Q3 compared to 7.8 million in Q2, SG&A expense was 8.7 million in both Q3 and Q2. We expect R&D and SG&A expense in Q4 to be about the same as Q3.

Interest and other income was 300,000 in Q3 and Q2 as a result of lower interest rates. We expect interest and other income in Q4 to be approximately 300,000. The Q3 tax benefit of 400,000 was primarily due to foreign losses. Since we recorded evaluation allowance on our US deferred tax assets in Q2, we had essentially no US tax provisions in Q2 [ph]. Our Q4 tax provision will be computed similarly. Absent the impact of the valuation allowance, our effective tax rate was approximately 31%. Q3 EPS on a GAAP basis was breakeven; non-GAAP EPS excluding the after-tax impact of share-based compensation and amortization of intangibles was $0.07 for the quarter.

Moving to the balance sheet, cash and investments were 87.3 million at September, decreasing 1.7 million from June, but better than our projection by 3.8 million, benefiting from strong collections. Net account receivable were 34.9 million at September, a 9.2 million increase over June from higher business volumes. Inventory was 51.2 million at September compared to 50.4 million at June. Additions to property, plant and equipment for Q3 were approximately 900,000, and depreciation was approximately 1.3 million.

Deferred profit at September was 5.1 million compared to 3.8 million in June. The related deferred revenue at the end of Q3 was 12.9 million compared to 6.7 million at June and increased place primarily from revenue deferrals on shipments of our new test handlers.

James Donahue

Okay, thanks, Jeff. Conditions have clearly improved in the semiconductor and semiconductor equipment industries. Orders for backend equipment have now increased for six consecutive months. Customer forecasts have strengthened, and there is considerable upside before we return to the order levels of recent peaks in the back end equipment industry. We are ramping production to meet increasing demand for our products. In its latest estimate, Gartner points to improved conditions in the ATE market during the second half of 2009, and estimates that 2010 ATE spending will increase 44%.

While encouraged by these positive developments in our industry and our business, the global economic environment remains uncertain, and it is unclear how this will ultimately affect the consumer electronics, semiconductor and semiconductor equipment industries. But if indeed are in the early stages of recovery in the back end semiconductor equipment industry, Cohu is very well positioned to benefit. Throughout the downturn, we continue to invest in new product development and streamlined our operations. We acquired Rasco and significantly expanded our served market. Our next-generation thermal handler, Pyramid, has been qualified and is ready to ramp. MATRiX, a new modular scalable high-speed taken pick & place handler for analog, logic and wireless IC testing is in production.

We've successfully integrated the Delta Design and Rasco global sales and service organizations and will increasingly leverage the resulting synergies as business improves. As demonstrated most recently by the selection of Rasco strip handler by a major Delta Design customer, we are realizing tangible benefits by offering customers the broadest range of products in the industry, supported by our strong global service and engineering support organization.

Throughout the downturn, our balance sheet has remained strong and we closed the third quarter with 87 million in cash and no bank debt. I'm pleased to report that Cohu's Board of Directors approved a dividend of $0.06 per share payable on January 4 to shareholders of record on November 27, 2009. This is the 32nd year that Cohu has paid consecutive quarterly cash dividends.

That concludes our remarks and now we will take your questions.

Question-and-Answer Session

Operator

Thank you. We will now be conducting a question-and-answer session. (Operator instructions). Our first question comes from the line of Vernon Essi with Needham & Company. Please proceed with your question.

Vernon Essi – Needham & Company

Thank you and congratulations on the business turning and a lot of good things going on here.

James Donahue

Thanks Vernon.

Vernon Essi – Needham & Company

Let's start off with I guess some more the tough question here, and that is the manufacturing transition you have and having that sort of put on ice for right now. And Jeff, walk me through the levers behind the scenes there, and how you have such a – I mean the gross margin's obviously going to be materially lower quarter on quarter, how do we get there, and what's really going on there, and how it is going to be alleviated going forward?

Jeff Jones

Well, again, that has to do with product, a combination of things, product start up costs as well as producing more units in Poway than we had anticipated recently. The products start up costs, you know it's really the learning curve that we experienced on any new product, user additional costs on the initial units, that would be driving the gross margin down. It is not that the transition is so much put on ice. There is a delay because we are accelerating to meet customer deliveries. The transition will be progressing in the background, but we will be building more units in Q4 in Poway than we had originally intended.

James Donahue

And if I can just add to that, as I commented in my remarks, Vern, customer sentiment and customer demand, it was almost like a digital switch in the third quarter. This is a – we've all seen the tremendous change in demand that can occur going up or going down in a cycle, but this is as steep and sharp as we have seen, and customers require delivery literally yesterday in most cases. So as a result, we have no other choice, but to do everything we can to accommodate their requirements. We think that is clearly in the best long-term interest of the company.

And so we are reducing the risk of missing the delivery requirements by continuing our production here. We will still accelerate the – or we will still continue with the transition of these products to the contract manufacturers, that is not slowing down at all. But we're going down to be building down them longer than we otherwise anticipated as a result of this spike in demand, and the only way to realistically meet it is to build it here where we have the expertise and the expertise is not yet developed nor the capacity at the CMs. So it is a delay not a change in strategy.

Vernon Essi – Needham & Company

Okay. So I apologize by the way for characterizing it as not – it's being put on hold for now. But to be clear here, what we're looking at is basically a combination, as you said, of start up cost. It sounds like also expedite sort of mentality going on re-pricing over time and a lot of other sort of ancillary costs around that as well. And what I'm trying to gauge is, you have obviously got some deferred revenues, some of these newer products have gone out the door, are we going to see this sort of continue into the March quarter? I mean how does this play out as you come up the curve and this sort of pressure going to be you know ongoing if you will for some time?

James Donahue

The pressure from customers for early delivery?

Vernon Essi – Needham & Company

Well that, of course, I mean we can't predict, but let's assume it is still pretty busy all the way through the fourth quarter, do you have a carryover into the first quarter where this is going to impact in the P&L as you recognize some of that revenue and what not?

James Donahue

Well, there's a couple of things going on here. There's the manufacturing transition to the contract manufacturers, and then there is the shipment of new products that are subject to customer acceptance and GAAP revenue recognition rules. So there is two issues, and our deferred revenue is increasing as Jeff indicated because of the shipments of these new products, MATRiX and Pyramid to new customers. So that was that will continue into the fourth quarter and some of it will continue into the first quarter as well.

It is somewhat difficult to predict exactly when customer acceptance is going to occur, it is not completely in our control. If you're asking do we intend to be building products, continue to build products in California until the fourth quarter, well we are always going to be building some products here, which is certain products, and then the new ones that we're transitioning over to Asia, Pyramid and MATRiX. EDGE is already transitioned. And yes, we do expect that we will continue to build both those products into early next year, precisely when the exact transition is made is not completely defined at this point.

Vernon Essi – Needham & Company

Okay. And let me -- let us switch gears here, but looking at your order book, obviously very robust. What sort of window are we looking at in terms of, is this a six months order outlook or how does that shape out, you have to remind me how that shapes out for your orders?

James Donahue

Customer visibility hasn't improved very much. They are still only looking out only about one quarter. There are several customers which forecast slightly beyond that but in general that hasn't changed. It is just that what they are seeing in their sites right now are much bigger numbers than they saw just a month or two ago. But you know my concern and the comment I made was I don't know whether the global economy is in sync with what seems to be going on in the backend semiconductor industry and specifically at our business, both of which are pretty robust right now.

Vernon Essi – Needham & Company

Okay. I was just trying to reconcile the robust book to bill versus the guidance and obviously a piece of that order book is going to be deferred going out further.

James Donahue

That's exactly right by the way. I mean that is, the shipment level, that is to say the products we are shipping out the door versus the sales that is the shipments that we are recognizing, there is a gap because we are shipping new products.

Vernon Essi – Needham & Company

Okay. And then finally, always a favorite topic of ours, the strip handler is suddenly showing signs of life, can you just walk through the evolution of that and sort of what changed per prior cycles when this concept has imploded and why is it suddenly being adopted?

James Donahue

Well, I would point out that it is the adoption by what I talked about in my remarks and the orders that I talked about, the orders from the single customer happens to be a very large customer, historically large Delta Design pick & place handler customer. And following the acquisition of Rasco last December as we made our rounds to our customers for our periodic updates and of course addressed the acquisition, including our now broadened product line which include Rasco's highly regarded strip handler, it piqued this customer's interest.

This customer had already done some work to investigate the potential benefits of transitioning the strip, just for certain its products, its packages, and made that decision relatively quickly and evaluated our machine over the summer, liked it, it did very will, and placed an order in the third quarter, and then placed a follow-on order, an even larger follow-on order this month. So we're very pleased with it but it is one customer. I don't want to signal that this is any broad-based adoption by the industry of test on strip, I don't think it is. It's very dependent on the variables customer by customer.

Vernon Essi – Needham & Company

I mean I appreciate that, and I – what I guess I'm trying too though is it is finally within – behind the scenes at this customer, and they're running the numbers. I mean it clearly is getting a green light from an economic perspective. That is what I'm trying to understand is there is still sort of an kind of in R&D Skunk Works kind of feel, or is this like a trend that you think is developing within this customer?

James Donahue

Well, I wouldn't call it an industry trend. I frankly don't know. As you know, test – the adoption of test on strip has been very slow. I still think it's going to be a portion of the total requirement. I don't think it is going to be the -- I don't at all think it is going to be as widespread as pick & place or gravity, but for some customers, in some applications, it makes sense, and it has always made sense. It is just that that there are substantial barriers that a customer has to be willing to overcome to implement test on strip. It essentially requires changing the way you assemble your product, and change the way you process them through the backend.

Most customers when they look at it, say, yes, there are some benefits, but I'm not going to actually obsolete my current production processes, so I'm going to stay with what I'm doing. This customer has, if you have, over the years made the decision. We think it makes sense, it is cost-effective, and we're going to do it. And it is high volume production, it is not R&D.

Vernon Essi – Needham & Company

Right, okay. All right, thank you.

James Donahue

You're welcome.

Operator

Thank you. Our next question comes from the line of Kelly Anderson with Sidoti and Company. Please proceed with your question.

Kelly Anderson – Sidoti and Company

Hi, guys. Thanks for taking my question, and congratulations on the strong results across all three segments no less. Just wondering if you could sort of remind me of what the timeline looks like for the new gravity feed handler launch?

James Donahue

Sure, Kip. That looks like the second half of 2010.

Kelly Anderson – Sidoti and Company

Okay, great. And just in terms of the pull-ins that you're seeing, do you currently have the capacity at your California facility to meet these new delivery days?

James Donahue

Well, we have the physical capacity, we don't have all the resources in place right now because as you can imagine, during the downturn, we have contracted our work force and our capacity in some cases significantly. So we are ramping back. But the levels, the shipment levels that we are talking about in the fourth quarter and into the first quarter are still below, well below our peak output in prior up cycles. But it is a challenge because we have to come up to speed and add significant capacity very quickly, can't do it quickly enough to satisfy the customers.

Kelly Anderson – Sidoti and Company

Right. So I guess what I am wondering here, I don't know if I missed this, Jeff, but maybe did you give any directional guidance for R&D and SG&A. I imagine that with the pull ins, we are probably going to have to see at least a short-term spike in a SG&A and given the visibility, is it possible that that would not reverse?

Jeff Jones

Actually our guidance is that operating expense, both of those items, R&D and SG&A would be the same as they were in Q3. So we are holding those steady.

Kelly Anderson – Sidoti and Company

So is the motivation behind a flat SG&A number just sort of cost cuts offset by you know the addition of headcount to meet these new orders?

James Donahue

Well, we are really not adding any headcount in SG&A and R&D. This is really manufacturing.

Kelly Anderson – Sidoti and Company

Okay. And then just wondering you know I think we said previously that the EDGE handler transition for example was complete, if there are products that have already been transitioned to the contract manufacturer, would they be, would you build them out of the contract manufacturer or are you pulling those in-house too, just sort of catch up?

James Donahue

No. The first product, the EDGE is transferred, and successfully so, and the contract manufacturer is ready to fill demand for that product and is. It is the two, the MATRiX and the Pyramid that we're talking about.

Kelly Anderson – Sidoti and Company

Okay. I was under the impression that the MATRiX and the Pyramid weren't sort of going to be transitioned near-term anyway because you had to work out some of the kinks with the new product?

James Donahue

Well, the MATRiX, the MATRiX was going to be completed sooner than the Pyramid, and it's really the MATRiX that we are focused on with this immediate demand.

Kelly Anderson – Sidoti and Company

Okay. And just on a curiosity, Jim, I think you said in your prepared remarks that you had some orders there from a graphics chip manufacturer for the Summit, you know I guess I'm wondering is it that the Summit has more attractive price point these days, is it that they weren't willing to wait for the Pyramid launch, or is there anything specific why they would choose that product when you have got a better one now on the market?

James Donahue

Well, this customer already has a installed base of Summit handlers. They have been buying the Summit for a number of years and the Summit is still a very strong product with excellent thermal control capabilities. And they're simply ordering more of their existing installed base, it makes sense for them. We don't think transitioning to Pyramid, while it is not feasible for them at the present time anyway, the Pyramid isn't ready for them. And the Summit provides all the capability they need and we think they will continue to buy additional Summits for some time.

Kelly Anderson – Sidoti and Company

Okay, great. And then just one last one for me, wondering if you could sort of breakdown the broader back end picture. I mean no surprise here there is a lot of companies that have pre-announced, sort of have been saying the backend is particularly strongly these days. I'm just wondering if you're seeing the most momentum for you specifically in maybe OSATs versus IDMs and is it fair to assume that right now most of the strength is coming from high-speed handlers over maybe even gravity feed at this point?

James Donahue

Well, when we provide our breakdown, we are combining gravity into our high-speed segment. So our high-speed segment includes both gravity, pick & place, high-speed pick & place, and test on strip. And the thermal includes just that, the thermal, namely Pyramid, Submit, those handlers that incorporate our proprietary technology. So the demand has been broad based across all of our products, but there are more high speed products than thermal products. So yes, the demand is primarily in the high-speed area, and it is both pick & place, gravity, and because of the sizable, these two sizable orders from a single large IDM, strip as well.

Kelly Anderson – Sidoti and Company

Sorry. I think when I said high speed, I am too used to referring to the legacy Delta products.

James Donahue

Oh.

Kelly Anderson -- Sidoti and Company

I meant Delta versus Rasco but…

James Donahue

Well, so your question is, what we're seeing, we are seeing, we're seeing strong demand for gravity and pick & place. It is broad-based. And I think as we mentioned before, Delta's customers have tended to be concentrated on the larger IDMs and Rasco's customers have been – it's been a sort of larger customer base with no single customer accounting for the kind of volumes that Delta's largest customers do. So it is -- it is a large number of customers participating and product and demand for products across the board.

Kelly Anderson – Sidoti and Company

Well, that is great news. Keep up the good work.

James Donahue

It is good news. You're right.

Kelly Anderson – Sidoti and Company

Thanks guys.

James Donahue

You bet.

Operator

Mr. Donahue, there are no further questions at this time. I would like to turn the floor back over to you for closing comments.

James Donahue

Well, thank you everyone for joining us today, and we look forward to speaking to you next time when we report Cohu's results for the fourth quarter and full-year 2009. Thank you and good day.

Operator

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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