Good day and thank you for standing by. Welcome to Cohu's Second Quarter 2023 Financial Results Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded.

I would now like to hand the conference over to your speaker today, Jeff Jones, Senior Vice President and Chief Financial Officer. Please go ahead..

Morning and welcome to our conference call to discuss Cohu's second quarter 2023 results and third quarter 2023 outlook. I'm joined today by our President and CEO, Luis Muller. If you need a copy of our earnings release, you may access it from our website at cohu.com, or by contacting Cohu Investor Relations.

There is also a slide presentation in conjunction with today's call that may be accessed on Cohu's website in the Investor Relations section. Replays of this call will be available via the same page after the call concludes. Now to the safe harbor.

During today's call, we will make forward-looking statements reflecting management's current expectations concerning Cohu'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.

We encourage you to review the forward-looking statements section of the slide presentation and earnings release as well as Cohu's filings with the SEC, including the most recently filed Form 10-K and Form 10-Q.

Our comments speak only as of today, August 03, 2023, and Cohu assumes no obligation to update these statements for developments occurring after this call. Finally, during this call, we will discuss certain non-GAAP financial measures. Please refer to our earnings release and slide presentation for reconciliations to the most comparable GAAP measures.

Now I'd like to turn the call over to Luis Muller, Cohu's President and CEO.

Luis?.

Good morning and thanks for joining us. Second quarter gross margin and – profit was strong, driven by Cohu's resilient recurring business model. Q2 non-GAAP gross margin of 47.8% increased 130 basis points year-over-year and is better than our target financial model at this revenue level.

Cohu's recurring business contributed 48% of second quarter revenue at approximately 55% gross margin. Our recurring business achieved a three year compound annual growth rate of 7% to 2%, and it is the key driver of Cohu's new baseline profitability through industry cycles.

As communicated last quarter, we're expanding our infrastructure in the Philippines to support growth in our interface business. At the end of second quarter, we were approximately 60% through construction of a new 92,000 square foot facility that will become operational in the first half of 2024.

We'll also continue working in the local supply chain to increase flexibility and quickly ramp production in support of customers' needs. In the second quarter, we received a first DI-Core software order from a European IBM for monitoring performance of Cohu's third handlers.

Although in early stages, we estimate the business potential at approximately $1.3 million a year in future software subscription sales at this customer. We had several design wins of our interface products, both contactors and probe cards, mostly driven by our products RF performance and final test.

Switching over to Cohu's systems business, it contributed 52% of second quarter revenue at approximately 41% gross margin. As expected, automotive and industrial continue to be Cohu's main market segments with combined system – 31% of the Q2 total. Other markets remain below historical levels with mobility particularly weak this year.

When market conditions soften as it is currently the case, we focused on expanding our product portfolio and winning new customer applications, positioning the company to deliver revenue growth in the mid-term. Aligned to this approach, there was an important ATE win in the second quarter at a leading OSAT in Korea.

This business is for outsource testing from a European semiconductor manufacturer. This is a high value target we have been working with to expand use of Cohu's Diamondx platform in analog IC tests. Finally, we had a couple of distinct design wins for the handler group during the second quarter.

We broke in at a large Taiwanese foundry customer with a thermal handler for hyper scaling device test. And this test – for Cohu and creates an opportunity to serve a much broader customer base in high performance computing, including those developing their own processors.

Then there was a handler design win in the high power semiconductor market, adding another customer to a new expansion in this segment. All of these are great product validations and give us confidence for 2024 revenue growth.

But despite improving demand for a thermal handlers for high performance computing, power reduction in customers utilization this past June, driven by soft conditions affecting all other market segments. Estimated test cell utilization is down 4 points quarter-over-quarter, ending Q2 at approximately 73%.

Several customers paused system orders originally planned in the second half of June, delaying capacity expansion to the latter part of the year ending into 2024. Continue mobility weakness and recent order in automotive and industrial segments have extended this downturn into Q3, resulting in a lower revenue guidance.

However, current order forecast is projected to grow sequentially again in the third quarter. In the near term, we’ll continue to tightly control expenses while focusing on winning new customer applications.

We’ll continue executing a strategy to grow recurring business, broaden the use of Diamondx into automotive and industrial customers, add to our inspection and metrology portfolio, and increase subscriptions to our emerging software business.

I want to stress that we’re committed to expanding Cohu’s recurring business that is key to profitability through industry cycles. Let me now turn this presentation over to Jeff for further details on second quarter results and third quarter guidance.

Jeff?.

Thanks, Luis. Before I walk through the Q2 results and Q3 guidance, please note that my comments that follow all refer to non-GAAP figures.

Information about the non-GAAP financial measures including the GAAP to non-GAAP reconciliations and other disclosures are included in the accompanying earnings release and investor presentation, which are located on the investor page of our website. Now turning to the Q2 financial results.

Cohu delivered strong profitability on revenue of $168.9 million, which is slightly higher than the midpoint of our guidance range. During the second quarter, two customers in the automotive market each accounted for more than 10% of sales.

Q2 gross margin was strong at 47.8%, about 80 basis points higher than guidance, driven by Cohu’s resilient recurring business and differentiated products. Operating expenses for Q2 were approximately $1 million lower than guidance at $50.8 million. Second quarter non-GAAP operating income was 17.7% of revenue, and adjusted EBITDA was 19.7%.

The non-GAAP effective tax rate for Q2 was approximately 27%, higher than guidance due to the projected concentration of annual pre-tax income in higher tax rate jurisdictions. Non-GAAP EPS for the second quarter was $0.48. In summary, Q2 gross margin and adjusted EBITDA were strong exceeding the midterm financial targets at this level of revenue.

Moving to the balance sheet. Cash flow from operations in Q2 was strong at $53 million and cash and investments grew to $372 million at the end of the quarter. Debt repayment in the second quarter totaled $1.5 million, and we ended Q2 with net cash per share of approximately $7.

Cohu’s shares repurchased in Q2 totaled 2.7 million and CapEx in the quarter was $3.1 [ph] million with approximately $2 million related to construction of the new Philippines facility to support long-term growth prospects in our interface business. Total CapEx for 2023, including the new building, is expected to remain at approximately $20 million.

And overall Cohu’s balance sheet maintains a strong position to support debt reduction, the share repurchase program and investment opportunities to expand our served markets and technology portfolio in line with our growth strategy. Now moving to our Q3 outlook.

We’re guiding Q3 revenue to be approximately $150 million, reflecting the recent weakness across our end markets and lower test cell utilization at customers production facilities.

Q3 gross margin is forecasted to be approximately 46% better than the financial target model at this level of revenue due in part to Cohu’s differentiated products and our stable high margin recurring business, which adds resilience to profitability and provides consistent cash flow through industry cycles.

Operating expenses for Q3 are projected to decrease quarter-over-quarter to approximately $50 million as we continue to exercise tight control over OpEx while navigating through the trough of this cycle. We’re projecting Q3 interest expense to be approximately $1 million and offset by interest income of approximately $2 million.

We expect Q3 adjusted EBITDA to be approximately 15%, and the Q3 forecasted non-GAAP tax rate is approximately 26%.The diluted share count for Q3 is expected to be approximately 48.4 million shares.

And while we're not guiding full year, the expectation is that we're passing the trough of this industry cycle – by the current order forecast that is projected to grow sequentially in the third quarter. That concludes our prepared remarks and now we'll open the call to questions..

[Operator Instructions] Our first question comes from the line of Brian Chin with Stifel..

Hi, there.

Can you hear me?.

Yes..

Okay, great. Sorry, I got cut off there. Good morning. Thanks for letting us ask a few questions.

Maybe to start off with Luis, what – I guess, in the past 60 days or 45 days, what – can you be more descriptive on sort of what changed in terms of deliveries? It sounds like it's mainly towards sort of auto industrial and tied in maybe with the yield change, which seems to be, I guess, mainly driven by IBM give [indiscernible] already were kind of operating at lower levels.

So can you maybe be descriptive about kind of what you've seen there? And then reconcile that with sort of the – I guess the positive sequential order trend that you're seeing, because that seems to be kind of counterintuitive relative to the sequential revenue guide down.

And also what that means in terms of sort of duration that you expect this sort of pause in business to occur?.

Okay. Well, there are – several questions there, Brian. But what we did see was actually predominantly in the auto and industrial space, and, as you know, those tend to be generally the same customers for us.

They basically hit the pause button on orders in June and started pushing some things out to later in the year about restarting the ramp again, latter part of this year, beginning of next year, and this is to the tune of about $30 million that they got pushed down – down the line here by about six months.

Concurrently with that, and as I commented in the prepared remarks here, we noticed that we end up with a lot of handlers. I mean, we've got about a hundred handlers right now that are awaiting testers to be installed, most of it through the third quarter.

And with that utilization came down about four points at the end of June to 73%, that's just sort of the level we saw at the end of June. I think, as these handlers start receiving testers getting installed in the third quarter that utilization is likely to start climbing again.

So, concurrently that we're seeing also an order forecast that starts picking up in the third quarter, which leads us to believe basically that we're passing the trough of the cycle..

Okay. And maybe to hone in on that, again, the order increase you're seeing, and I don't know if it's a book-to-bill above one for the entire business or maybe a specific segment.

So maybe on a segment basis, are you seeing this trend in auto industrial, but – how about also wireless in some of these markets that have been soft?.

It's is predominantly auto and, Brian, we continue to see the same softness in the mobility space that we have been talking about. I don't necessarily see that changing course here in the third quarter. So it's more of the auto and industrial and that – that's the segment that had orders pushed out in a softness at the end of the second quarter.

And that's the same segment that seems to be turning around the corner here in the third quarter from an order perspective..

Okay. Got it. Got it. Lastly, I think, I heard in the prepared remarks maybe a comment about confidence on calendar 2024 growth.

I guess, what are some of the components of that in terms of market and recovery as well as maybe any initiatives you have line of sight to in terms of SAM expansion, market share gain, et cetera, in any of the product areas?.

Yes. So from a – starting from a market standpoint the – some of the orders that we're talking about in the third – for deliveries already planned in Q1 of next year and at least a couple of these are fairly sizable actually in given an indication that there is a turn – turn of the tides coming above.

One of them in particular is in the industrial space more specific and the other one is in the automotive. From an internal – what we can control standpoint, we have three main activities on tester design wins that we are in the final innings of the game here in the second half of this year.

We expect to convert those customers to our Diamondx tester platform and start getting orders probably late this year, early next year. I mean, it's really going to depend on the timing of the ramp of their particular devices that we're getting the system qualified for, but that's what we align aside from our equipment standpoint..

Okay. Great, thank you..

Our next question comes from the line of Craig Ellis with B. Riley..

Yes, thanks for taking the question. Luis, I'll start maybe picking up on some of Brian's questions, but ask a little bit differently. So as we look at the mix of order activity, and this is no surprise, it's been playing out, I think, year-to-date, Mobility has been very weak given all the pressure on smartphone sales. Consumer is pretty low.

Compute is slow. But there was some very positive commentary on hyper scale activity.

How would those dynamics expect to normalize if we had a more normal demand environment next year? When would the business start to see order improvement? And what would be some of the early indicators that customers are moving back to more normal utilization levels and equipment order rates for Cohu?.

Well, Craig, as I said, we do expect third quarter orders to improve relative to Q2, right? So, I mean, I'm not going to say that's necessarily at abnormal levels, but we do expect a turning of the quarter on bookings already at this quarter.

From a normalization level I think automotive is going to start picking up, automotive and industrial are going to start picking up to normal levels in Q1 of next year. Mobility, quite frankly, I don't know. We keep waiting for the signs of improvement.

I think I've seen a couple of our customers put out earnings release here in the last 24, 48 hours that are a little bit more encouraging. We haven't really seen ourselves yet that fast, that demand forecast. So I'm going to hold my forecast to that.

Computing, as you said, I mean, computing on a sequential basis, Q2 orders were already about 30% higher than first quarter. So it is – small numbers and computing is a smaller segment for us, but nevertheless, the data center hyper scaling business is starting to get some momentum.

But honestly, I think, to – a return to normality requires both – first and foremost, and not just orders, but shipments, which I think recovers in the first half – sorry, in the first quarter of next year.

And then a return of mobility, which is yet at this point something that is a little hard to pin down, we expect late this year, early next year, but at what magnitude, question mark. I don't know the answer to that question on the mobility side..

Yes. That's helpful, thank you.

And then turning to comments that you made on the Philippines manufacturing expansion and that facility's ability to go live next year, can you just provide some more color on what that means for the company's ability to meet upside demand and what that expansion will mean from a cost standpoint and therefore a gross margin standpoint from levels that are already quite strong in the business?.

Yes, I'll start on the first half of your question and let Jeff step in to talk about the gross margin impact. That new facility is going to give us an opportunity to increase output on the interface business by about 50%. So it adds about $65 million of incremental revenue opportunity out of that factory..

And with respect to gross margin, so that increase in volume help us leverage better some of the manufacturing fixed costs that we have. That business at the moment is running roughly in the 44% to 45% gross margin in the model.

We have them closer to 47%, 48% which is achievable as we put all the pieces together here and add capacity and continue to leverage those costs..

That's helpful. And then if I could just sneak in one more before going back into the queue, guys. Luis, I was hoping you and maybe Jeff since this is a longer term question dealing with just growing the business, but also focusing back on the mid-term target. Luis, you mentioned that that we've got the seeds of growth visible in order activity.

We’ve heard that the gross margin is performing at above target levels for current revenue rates. So can you guys just address your confidence in getting back to the midterm targets, $1 billion in revenues and getting gross margin up to 49%, given the dynamics that you see in the business and the order that you’re starting to see? Thank you..

Yes. The – honestly, the confidence is pretty good, Craig, I mean, this industry goes through its cycle, as you know, been in for long enough to know that we do hit some speed bumps in order and that’s where we are now. We’re sort of that trough of the cycle.

And when business recovers, it’s not unheard of it going up 15%, 20% and a subsequent followed by another year of growth that could be 10%, 15% following that. So we have a pretty solid position in the automotive and industrial market with our thermal handlers. It’s a market that for the first time in years, it’s growing at a double-digit rate.

The semiconductor industry part of it is growing at a double-digit rate. I happen to be in Asia this week, actually call from, and had an opportunity to visit five of our customers in the space, and pretty much all of them are doubling their footprint in test – assembly and test.

And I saw, got to see actually some of the factories being built that are coming up into production first and second half of next year. The opinion on the customer you think pick. So the opportunity in the automotive industrial markets is just and I think that ramp is happening next year.

And probably for the foreseeable few years as more electric and ADAS capable vehicles come to market. The computing space we see the event of AI and AI-driven data center processors. We are seeing a little bit of that ramp. They’ll be – it’s a smaller market for us.

And over the long haul that is going to drive a significant number of edge computing and communication chips that will also benefit the business, but in a different, sort of in a different dynamic than the automotive and industrial. So if you look at all of that put together our handler business is pretty solid with solid growth ahead.

The interface business similarly, particularly because of the market, the automotive and industrial market. We’re working pretty hard to broaden the penetration of our interface business to high performance digital tasks basically more computing.

At the same time, we’re working really hard to broaden the penetration of our ATE business into analog power semiconductor tasks. Again, more leverage towards automotive industrial applications. These are the – these are sort of the customers that I mentioned earlier on an earlier call.

We have some line of sight business wins for the second half of the year and then sort of enjoy the – that customer’s demand is going to be in 2024 and beyond. So I’m fairly confident on that revenue growth aspect. Obviously, we’re really confident on the gross margin aspect because we’re basically there or better than model at the moment.

So the way I see it is we’re passing through that trough of the industry cycle delivering $0.48 of EPS in the second quarter and looking ahead for growing with the market and headwinds on the tester side and the interface side, which is what we’re focusing on..

Thanks guys..

Our next question comes from the line of Krish Sankar with TD Cowen..

Yes. Hi. Thanks for getting my question. I have two of them. First one, Jeff you mentioned that the September quarter weakness is tied to auto industrial, some of your test equipment peers, I said auto is still pretty strong.

I’m just curious, is this specific to your customer exposure for your auto handlers or is there, can you give an update on what’s happening on the auto handler market share for you and then I had a follow-up?.

So maybe let me step in on that, Krish. It’s hard for you to pick an auto customer or industrial customer that we’re not selling handlers to. So that’s – that can’t be specific. But one interesting observation, I don’t know if you picked it up on an answer that I gave a minute ago.

We have about a 100 handlers that are waiting on tester deliveries to get installed. So I think that’s one element of the speed bump here. We got to get these testers, which are not from Cohu in this case actually it’s from some of our tester competitors to hit the production floor. So we can put these handlers into production.

Frankly, I think that has been one of the elements that caused the order pause because these customers can’t take more handlers until they can get delivery of these testers..

Got it. Got it, Luis. That’s very helpful.

So the auto handler market share is still pretty robust, right?.

Yes, it’s absolutely robust. It’s very solid..

Got it. And then just like, just another question. Is the orders are growing in September.

Is it fair to assume your December revenue should be sequentially better than September? And along the same path, if you look into next year, are the main puts and takes on gross margins still the fact that if you have more mobility test equipment that’s better for gross margins than auto handlers? Is it as simple as that or the other variance at work here?.

That does have an influence, Krish? The more ATE business we have, yes, the mix improves a bit. So definitely that is a benefit. As we’ve talked before, our handler business gross margins have expanded quite nicely over the last four to six quarters.

But yes, definitely with a growth in the tester business, yes, the overall mix improves and the margin would expand as well..

And then just a clarification on December revenues.

Is it too early to say, or was the order book growing in September gives you comfort on December revenue?.

Well, the way that we see it now, as Luis had said sequential increase in orders Q3 versus Q2, we think that translates into a sequential increase in revenue, but it is early for us to pin down a number. We think it’s an incremental increase, not a substantial increase.

But it would – we at this point think it is incremental, but again, difficult to pin down a number..

Got it. Thanks, Jeff, for your help..

[Operator Instructions] Our next question comes from Charles Shi with Needham & Company..

Hi. Thank you for letting me ask, maybe just one question.

Test utilization, what is the current visibility into the trend, let’s say into Q3 and into the – into Q4, given your visibility today?.

Charles, we don’t try to forecast cell utilization. So it’s always a rear view mirror metric. It’s what we measure. And it did, like I said, it did come down in the second quarter just down to 73%. It did come down both at the IDMs and OSATs.

But when we dug in a little bit more to understand, part of the reasons on that is we recognize we end up having there’s actually 99 handlers or close to a 100 handlers that were sitting, waiting for tester deliveries. So here becomes more of a question of if those testers really get delivered.

And we do count systems that are waiting to be installed actually as part of the utilization metric. So if we do get those testers delivered on the third quarter, and not withstanding anything else happening in the market, I would expect test utilization to climb again in third quarter.

But like I said, we don’t typically try to forecast test utilization..

Thank you. Luis, can you provide a little bit color on your design win with a hyperscaler to the foundry because I thought your testers are more geared towards analog intensive applications, but the hyperscaler, my assumptions it is probably a digital intensive application.

So almost feel like this would have been an [indiscernible] that kind of market, but you did have this design win. Can you correct any of the thoughts – any of the things I said wrong and provide a little bit more color on this one? Yes. Thank you..

Yes, Charles, everything you said is correct, except the very beginning. This was a handler design win, not a tester. But everything else you said is actually correct, including the tester that goes with our handler. And – but it’s really a thermal handler design win, not a tester from us..

Thank you..

That concludes today’s question-and-answer session. I’d like to turn the call back to Jeff Jones for closing remarks..

Thank you. And before we sign off, I’d just like to mention that we’ll be attending three investor conferences during the third quarter, and they are the Needham Virtual Conference on Tuesday, August 22, the Jefferies Conference in Chicago on Tuesday, August 29, and Citi’s Global Tech conference in New York on Friday, September 8.

So if you plan to attend one or more of these conferences, would like to meet with us. Please reach out to your respective analyst or conference contact to schedule a meeting. Thank you for joining today’s call, and we look forward to speaking with you soon. Have a nice day..

This concludes today’s conference call. Thank you for participating. You may now disconnect..