James Donahue - Chairman and Chief Executive Officer Jeff Jones - Vice President, Finance Chief Financial Officer Luis Müller - President, Semiconductor Equipment Group.

Dick Ryan - Dougherty & Company Brett Piira - B. Riley & Co. David Duley - Steelhead Securities.

Greetings and welcome to the Cohu, Inc. Third Quarter 2014 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded. I would now like to turn the call over to your host, Mr. James A.

Donahue, Chairman and Chief Executive Officer for Cohu, Inc. Thank you, Mr. Donahue, you may begin..

Good afternoon, everyone, and welcome to this conference call. We'll be covering our third quarter results.

With me today are our Chief Financial Officer, Jeff Jones; and also the President of our Semiconductor Equipment Group or as we call it SEG, Luis Müller, who as we previously announced will be succeeding me as President and CEO of Cohu upon my retirement from that position at the end of this year.

If you need a copy of our press release, 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 Cohu's results for the third quarter and comment on our BMS business, while Luis will discuss orders and key activities at our SEG business.

Jeff will then take us through the financial statements and conclude with our fourth quarter guidance. And finally, we'll take your questions. But before we get started, Jeff will provide comments on our discussion today..

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 are subject to rapid and even abrupt changes.

Forward-looking statements include our comments regarding the company's expectations regarding industry conditions, future operations, 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 30, 2014, and the company assumes no obligation to update these comments.

Certain matters discussed on this conference call, including statements regarding the transition of manufacturing to Asia, expectations of business and market conditions, orders, sales, revenues and operating results 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, risks associated with acquisitions, inventory, 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; our reliance on third-party contract manufacturers; failure to obtain customer acceptance, resulting in the inability to recognize revenue and accounts receivable collection problems; 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..

Hey, thanks, Jeff. This was an outstanding quarter for Cohu with the highest sales and non-GAAP earnings per share since the fourth quarter of 2010 and continued strong orders in our semiconductor equipment business.

These results reflect excellent execution of our strategy to achieve significant sales synergies through the integration of our three handler companies and also the transition of manufacturing to Asia. Third quarter sales were $94.4 million compared to our guidance of $84 million to $91 million.

Non-GAAP net income was $0.42 per share compared to $0.19 per share in the second quarter. Orders were $86.7 million. Our semiconductor equipment business had a stronger-than-expected quarter, while mobile microwave data link business continued to be impacted by customer order delays.

We expect that BMS' business in the government surveillance and law enforcement markets will improve in the fourth quarter.

Semiconductor equipment sales were a record $91.6 million and above plan due in part to customer acceptances of new products that were received earlier than expected, particularly for our new NY20 turret handler that has been the fastest new product ramp in our history.

We also secured earlier than anticipated acceptance of the Saturn gravity handler at a new customer, and this marks another win against an incumbent competitor. Semi equipment borders were $82.6 million and strong across our product portfolio, up 70% from the same quarter last year and down 13% from our all-time high in Q2.

System motors were 55% and recurring was 45% of the total. We continued to see strengthening in our recurring business, which was up 8% sequentially. Handler utilization remained at 85% through September.

Now Luis will highlight the key drivers of our semiconductor equipment business in the third quarter, comment on current business conditions and provide an update on progress against our strategy..

Thanks, Jim, and good afternoon, everyone. Let's start with the automotive and industrial IC market that continued to drive the majority of our system demand, including repeat volume production orders for industry-leading MATRiX pick-and-place handler from several customers.

Many of these systems ship from our Asia manufacturing operation, establishing new capability in line with the strategy that we presented last year to lower cost and increase engineering resources close to our customers. We also received multi-unit orders for our gravity systems and a new design win for the Saturn handler at our key European IDM.

As previously stated, we plan to transfer production of these systems to our Asia manufacturing operations starting in 2015. Our Rasco business has captured significant market share in gravity in recent years, a trend that we expect will continue.

We received an initial multimillion dollar order for Jaguar strip handlers following a successful qualification for testing high-volume automotive ICs at a large IDM. We have operations in Asia. The customer selected the tri-temperature Jaguar because of its demonstrative productivity advantages displacing an incumbent competitor.

As is usually the case at this time of the year, the automotive and industrial IC markets are likely to slow down during the winter months.

The fundamentals in these markets remain strong, particularly in automotive with the adoption of new technologies in vehicles related to safety, infotainment and fast-growing driver-assist technologies that require a myriad of semiconductors.

We have tremendous experience in this space and see opportunities to combine technologies from our handler companies, including our Active Thermal Control, to solve new test challenges.

In the computing market, we saw an improvement during the quarter with a multi-system order for Pyramid pick-and-place handlers for testing PC and high-power data centers processors.

Our proprietary Active Thermal Control technology is the best solution for optimizing test hued of dissipative ICs, including high-end processors using a range of applications from smartphones to tablets and PCs to multi-core processors used in cloud servers.

Our strategy is to continue developing solutions for the evolving complex applications in this market that are usable across our handlers platforms as well as suitable for sub-system applications in custom high-parallel test solutions. We also received a follow-on multi-unit order for Pyramid for using testing high-performance memory devices.

As we noted last quarter, a large IDM selected Pyramid for its fast thermal response capability that enables precise temperature control of devices under test. This represents an extension of Pyramid beyond computing and we're continuing to evaluate new applications to solve test challenges in advanced memory.

Additionally, we obtained acceptance of our first Jaguar in-process test for 3D-specced ICs. This Jaguar is being used in the IC assembly process to verify quality at each step in the build-up of memory layers on a multi-stacked device.

Jaguar was selected, because this advanced packaging process requires delicate handling and contacting to avoid damage to exposed copper fillers and silicon structures. In the consumer and mobility markets, we made volume shipments of our Fusion HD product for system-level test of next-generation mobile processors.

This is the same thermal technology that is utilized in our pick-and-place handlers for final tests. As previously mentioned, our new NY20 turret platform has gained widespread acceptance during its rollout year and is benefiting from the growth in test Near Field Communication devices that are becoming a standard in smartphones.

In addition to successfully transition current customers, in the third quarter, we captured another cross-selling opportunity with a design win for this turret system at one of our long-time gravity handler customers. The breadth of our product portfolio and global customer support capability provides unique cross-selling opportunities.

In the solid-state lighting market, we received follow-on orders from a large European customer for testing LED and phosphor-converted products. We also made initial handler deliveries of orders placed in the second quarter by a newly acquired top-tier Korean LED manufacturer.

We continue to see gradual capacity additions for testing LEDs, going into premium lighting, particularly automotive and flash, and we're positioning ourselves to be a key player for the broader adoption of LEDs into general lighting. Switching now to our Asia manufacturing position, significant progress was made during a record shipping quarter.

As previously stated, our strategy is to perform final assembly and faster volume handlers at our plant in Malaysia. Turret platforms are already produced in this facility and by the end of this year, we'll complete the transition of our MATRiX pick-and-place handler.

We delivered some pick-and-place systems in the third quarter as well as executed on the extraordinary ramp of the new NY20 turrets. Next year, we'll begin the transfer of volume gravity and other new products we have in the pipeline for 2015.

The Philippines plant was qualified to produce pick-and-place handlers and is now working to qualify production of gravity handler modules in support of our next-year production plans.

Now looking at the current business environment, industry-wide orders for back-end semiconductor equipment have tightened in the recent months, a result at least in part of a seasonal pattern in the automotive and industrial markets and also an understandable need for customers to absorb the significant capacity added this year.

While recent economic news at the macro level appears to be driving a more cautionary tone on near-term CapEx spending at some customers, we believe market fundamentals remain strong. The IC industry has multiple major end markets that make you less susceptible to the extremely cyclicality of the past.

At Cohu, we'll continue to benefit from our breadth of products, right customer base and the diverse end markets that we serve. Going forward, our strategy remains intact, maximize sales synergy with the Ismeca acquisition. This year so far we secured over $9 million of incremental product orders from existing customers.

Expand share and mobility in LED markets, we delivered that with our Fusion HD and major new LED customer in the second quarter, with additional gains possible in coming quarters. Lower manufacturing cost structure with the transition of production to Asia, and this is being execution per plan.

And implement strict financial discipline that in combination with the manufacturing transition to Asia will enable us to deliver 15% non-GAAP operating income at $90 million a quarter in sales. This quarter's results demonstrate the progress we're making in achieving this model performance.

Now Jeff will provide details on Cohu's financial results and outlook for the fourth quarter..

Thanks, Luis. As highlighted during Jim's remarks, Q3 represented another solid quarter of execution at Cohu. Revenue grew sequentially and year-over-year and we continue to gain market share with our new products and sales synergies from the Ismeca acquisition. Our gross margin was strong in the quarter.

And with the completion of key development programs and disciplined cost controls, we've reduced our OpEx spending nearly 6% through nine months in 2014 versus the same period last year despite a 39% increase in sales year-over-year, demonstrating the leverage in our operating model.

Non-GAAP operating income in Q3 was 14.6% and within striking distance of our 15% target. Now looking at the results in more detail. In Q3, we recorded approximately $1.6 million of stock-based compensation expense, $2 million of purchased intangible amortization expense and $700,000 of restructuring cost.

The downsizing of BMS associated with consolidation of the German operation accounted for $500,000 of the Q3 restructuring, with the balance related to the pick-and-place handler manufacturing transition to Asia.

The following comments are based on our non-GAAP results, which exclude the impact of these items and a reconciliation of non-GAAP measures to equivalent GAAP measures can be found in our earnings release located on the Investors section of the Cohu's website.

In Q2 of this year, we announced the completion of the sale of substantially all the assets of our video camera segment, Cohu Electronics. And as a result, the operating results of Cohu Electronics have been presented as discontinued operations and all prior period amounts have been reclassified accordingly.

Unless otherwise noted, all amounts discussed on this call are coming from continuing operations. In Q3, we had two customers representing 10% or more of sales of compared to three customers in Q2. The Q3 customers are in the computing and mobility markets.

Gross margin was 37.1% and better than our projection due to higher sales volume and a favorable product mix, including higher revenue from recurring business and the deferral of revenue from the initial shipments of our new pick-and-place handler that has an initial higher cost due to production startup.

First-hand shipments of new handlers are subject to customer acceptance prior to recognizing revenue, and customer acceptance is not 100% in our control. However we are expecting to recognize a significant amount of revenue from the initial shipments of our new pick-and-place handler in Q4 and to a lesser degree in Q1 of next year.

As a result of the higher cost of the new handler due to production startup and lower overall sales volume, we expect our Q4 gross margin to be approximately 34%.

The transition of our volume pick-and-place handler manufacturing is tracking the plan and next year we will begin the transfer of volume manufacturing for gravity and other new products scheduled for release in 2015, leading to model profitability in the first half of next year on sales of $90 million per quarter.

Operating expense was $21.3 million in Q3 and lower than our forecast due primarily to $1 million foreign exchange gain as the US dollar strengthened significantly against the euro and the Swiss franc during the quarter. We also had a lower product development cost as the timing of expenditures on certain projects moved from Q3 to Q4.

Operating expense in Q4 is expected to be approximately $23 million, up sequentially mainly due to the foreign currency gain in Q3 and higher product development cost. We expect to incur approximately $400,000 of restructuring cost in Q4.

These are primarily due to the restructuring associated with the downsizing of our BMS operation in Germany, which will essentially be complete by the end of this year. The effective tax rate on income from continuing operations for Q3 was 26.5% and higher than projected because of higher-than-expected profits in Germany.

We're modeling at 23% tax rate in Q4 and 20% for 2015. Q3 non-GAAP EPS, which excludes the after-tax impact of share-based compensation, amortization of intangibles, manufacturing transition and employee severance costs was $0.42.

Moving to the balance sheet, cash and investments were $61.7 million at September, increasing $3.5 million from June, driven primarily by cash provided from operations totaling $6 million in Q3.

Net accounts receivable increased by approximately $16.9 million to $86.5 million at September as a result of higher sequential shipments from our Semiconductor Equipment Group. DSO at September was 78, up slightly from 75 in June. Inventory was $60.1 million at September, decreasing $1.4 million from June as a result of Q3 shipments.

Inventory days at September is 96. That's down from 113 at June. Additions to property plant and equipment in Q3 were approximately $100,000, and depreciation for the third quarter was approximately $1.4 million. Deferred profit at September was $11.2 million, increasing $2.3 million sequentially.

The related deferred revenue at the end of Q3 was $22 million compared to $15.3 million at June and consists primarily of revenue deferrals on shipments of test handlers. Cohu's directors approved a quarterly cash dividend of $0.06 per share payable on January 2, 2015, to shareholders of record on November 21, 2014.

For Q4, we expect sales of $80 million to $85 million. And at the midpoint of this guidance, we'll end 2014 with 29% year-over-year increase in sales. Now that concludes our prepared remarks and we'll now take questions..

(Operator Instructions) Our first question comes from the line of Dick Ryan from Dougherty & Company..

Jeff, just a couple of modeling questions. I think you briefly touched on R&D, it's been in a fairly steady decline this year and from 2013.

So it looks like that's going to come back up in Q4 or how should we be modeling that?.

That'll be up just maybe $300,000 to $400,000 in Q4 and looking at OpEx in total at about $23 million..

Looking at the target model and obviously that's a little bit further down the road. The gross margin, I think the target was 40%. You're at 37%. So obviously some of that is the continuing transition to Asia.

But what else was in there? Did you say there were some higher costs with first-time shipments? Did I catch that right?.

There is. We did recognize a number of the NY20 units that were first-time shipments, a new product, a new turret handler in Q3. Also in Q4, we're expecting to recognize revenue from a new pick-and-place handler. The model itself is achieving that 40% gross margin, $90 million in revenue. And so those were the comments for this quarter, Dick.

Yes, we had new handler revenue in Q3 and we will have new pick-and-place handler revenue in Q4 as well..

One last one from me on the order side. Very strong orders last quarter, 98, but I think if I recall right there was a large customer in last customer.

Was there any concentration in this quarter regarding the customer book? Was it concentrated or is it fairly broad?.

Dick, there were no large customers in last quarter's orders and the same is true for Q3. It's a very broad-based demand..

Our next question comes from the line of Brett Piira from B. Riley & Co..

May just to start out, could you just recap and give us an update on where you are with these Asia transitions and when we should see the orders picking up? And then I guess kind of a follow-up on being held back by the initial shipments, do we really see the benefits for a couple of quarters after the transitions actually completed and shipments going from there?.

The transition is progressing as planned. We do expect to have this pick-and-place transition on the MATRiX unit complete at the end of the year. As I mentioned in my comments, we're going to have some deferred revenue with some higher costs that largely will be recognized in Q4, but some of it's going to spill over into Q1 as well.

So your comment about working through the first two quarters of 2015 is accurate. We're going to have to work through the deferred revenue, so that we get to the point where we're in a position to achieve the model on the quarterly revenue..

Can you help us with geographic mix in the market where you're seeing strength from? Can you break that up for us?.

Brett, most of our equipment ends up in Southeast Asia, probably 80%, 85%, just the nature of the semiconductor test process. So the orders may originate from IDMs located in the US or Europe, but inevitably the equipment ends up in Southeast Asia..

You mentioned quite a few share gains, it seems like you've capitalized on.

Where do you think the opportunity is for share gains into 2015? Is that on the gravity side?.

I think the opportunity for share gains into the going forward is on the gravity side as well as the turret handlers. But nevertheless, we do look for opportunities all around our products. Where one product is strong at a particular customer, we'll bring in other systems to it..

Our next question comes from the line of David Duley from Steelhead Securities..

I was wondering if you could just take a shot at suggesting what you think the size of the handler market will be in 2015.

I realize it's early, but maybe just help us flat or up or down, what would be your best handicap at this point?.

That's a tough to answer, taking a shot one year out for the size of the market. I would venture here, just a wild guess that this is going to be at approximately $800 million to $850 million size for our served available market in test handlers..

And how does that compare to 2014?.

We need to see the data come out to compare that. I don't have it at this point..

So would your guess be that it's a flat market? I don't know how to reference that number, so I'm just looking for some guidance here, whether qualitatively you think it's going to be an up or a down handler market next year..

I would just echo Luis, very hard to predict. But I think there is growth next year. It's going to be single-digit growth. I wouldn't expect double-digit growth..

In the handler revenue that you recognized during the quarter, could you help us understand how it breaks out amongst the three categories of pick-and-place and gravity and turret? I don't need an exact number, just kind of rough figures..

We don't break it out for competitive reasons..

As you finish 2014, now that you've guided to the quarter, that is the last quarter of the year, what do you think your market share will be in both gravity and pick-and-place?.

I have a hard time estimating what the market share is going to be. I can tell you that we're number one in pick-and-place. We're number one in turret. We could be number one in gravity. We're within a couple of points at the last milepost we looked at several months, having more than doubled our share in gravity handlers since the acquisition of Rasco.

So in a worst case, I would say, we're first, first and second. And in the best case, we have the number one market share in all three segments. And on a combined basis, we will be number one overall..

Could you just remind what your typical seasonality is for the fourth quarter? I realize that almost all back-end equipment businesses are down.

But for the handler business, what has the average been down for the last four, five years, or how would you like to characterize it and how would you characterize the typical seasonality against the guidance you just gave us?.

Seasonality is more of a market-by-market assessment. And you can see typically the automotive market will have a slowdown in the fourth quarter. Mobility, industrial, LED, they all have their own patterns. So it would depend on the strength and our position in each market to be able to give you an answer.

I mean it's really difficult when you look across the board, because there is no one answer for all markets..

I would say that just like the fourth quarter pattern is not at all atypical from what we've seen..

Our next question comes from the line of Dick Ryan from Dougherty & Company. Jeff, just a clarification.

The 34% gross margin you said in Q4, was that GAAP or non-GAAP? What was your reference there?.

That's non-GAAP..

There are no further questions in the queue. I'd like to hand the call back to management for closing comments..

I'd like to thank everyone for joining our call today, and we look forward to speaking with you next time when we report our fourth quarter and full year 2014 results. Thanks again and good day..